Evolution of Saudi Capital Markets by Blominvest

Interview with Abdullah Saud Al-Rashoud, CEO of Blominvest

Can you give us a bit of the history and evolution of Saudi Arabia’s capital market? What have been the evolution and the ups and downs of the capital market? How have the ups and downs affected investors’ behavior and adversity to risk and how did these developments affect investors to create the situation as it is now?

I think the capital markets started very early in Saudi, maybe in the 60’s or even earlier than that. It was very simple, very preliminary, there were no complications at all, and there were no rules or regulations. Brokerage services started around the 80’s when small offices, most of them real estate offices, started to trade in the securities or shares of companies which were available at that time such as SABIC, Savola or the auto company Al Sayarat. They started to trade these shares which were certificates of shares. If you owned a certificate and you wanted to sell it, you could contact these small offices and they would find a buyer for you. They took the certificate and bought and sold it. That was the first type of brokerage service.

In the 90’s, the banks started to take part in trading these shares through a Saudi company for share registration Saudi Share Registration Company (SSRC). That was under SAMA regulation. It was the old way of doing things – you go to the company premises and sign a paper saying you want to sell the shares. Another buyer comes and they make the trade. Then they tried to improve the brokerage through banks and they started the Tadawul service. This also started in a very old-fashioned and simple way but progressed to the current day where it is very improved and efficient and they have T Plus Zero for trading shares. That is for the brokerage service.

For asset management, for example, it did exist in the 60’s but it was very unregulated and not organized at all. Anybody could raise funds from people to manage these funds and buy a piece of land for example, develop the land and sell the land to another investor. Then the profit could be distributed to the people who invested with the initial purchaser. That is asset management but it was very rudimentary and there were no regulations at all.

This also improved gradually through banks until they established the Capital Market Authority in 2003, at which times the regulations were finalized. Year after year they also improve the regulations and provide more supervision to companies working under their umbrella.

The 2006 crash prompted a negative sentiment from some retail investors. How have these developments influenced investor’s behavior?

I think what happened in 2006 was a disaster for many people in Saudi. Many Saudis lost their savings that they had accumulated over many, many years. I would say that there was no regulation at that time. The CMA had just started in 2003 and before that the banks were controlling all the activities of investment banking. SAMA, in fact, can be blamed partially for that because they did not prepare people for investing. They did not focus on investment banks; they were focusing on commercial banks. For example, when they started to allow companies to open businesses for investment banking, there was no expertise in the area at all so it was very difficult to find experts or people who had a sophisticated understanding of this business. I think that was one of the problems.

So in 2004 and 2005 when the stock market was rallying and everyone was attracted to this easy money, the fund managers, for example, were not sophisticated enough to understand that this was a bubble. Everyone was just rushing to invest in the stock market. So many fund managers were not able in fact to understand the market or to manage people’s money in a professional way. I think that is what happened.

With all their sophistication in the United States, the Fed failed to see the bubble as well.

Yes, I totally agree with you but look at the market. It went down from 21,000 to 4,500. I think that was not expected in only two or three years. They lost 80% of their savings.

And are the consequences of this crash still being felt when you talk to the investors and try to persuade them? Is there still a negative lingering sentiment – the feeling of being burned?

Yes, absolutely. Now, for example, a lot of people who got burned by the 2006 crash are not ready to come back to the market. Some of them are very hesitant to come back to the market because they don’t think the market is efficient enough or the market can’t protect their money. Others won’t come to the market because they cannot; they lost their savings and they are under a lot of debt which they are still paying off. Definitely the wound is very deep.

Is this what is causing the market to stagnate? Are foreigner investors allowed to partake in the stock market?

They can only partake if they are in the GCC and residents of Saudi can participate even if they are not Saudis. But I don’t think that’s the reason why the market is going up now. I think there is another reason. If you look at the liquidity (petrodollars) which is coming into the country, it’s huge. This liquidity must find some channels to go into. Real estate went up in a very substantial way. Some properties increased by five or six times in the last four or five years so that’s huge. Some went even much higher than that.

In Mecca for example, with all the demolition of the buildings around the Holy Mosque, this liquidity is being reinvested in Mecca so some of the land went up by about twenty or thirty times.

The real estate went up multiple times and the stock market now is the other channel. There is spillover into the stock market. People are now going to the stock market, in particular to some of the real estate companies that are trading on the stock market. The valuations of these assets is two to three times higher than the market value of these listed companies. It is possible to buy the whole company and take over the assets and make a hefty profit doubling your initial investment. Therefore it has to go to another channel. I think that’s what happened. But still, many people are very hesitant to invest in the stock market.

One of the paradoxes of the real estate market in Saudi is that it is despite the country’s huge territory there is a shortage of land. This is what I see as a very paradoxical situation. Saudi Arabia has so much land and yet it is so expensive. How do you reconcile that?

The problem is on the supply side – there is a monopoly in real estate. Another thing is that if you look at the real estate in the world, usually it’s either for usage – such as you have a house or apartment you want to live in, so you want to buy one and use it – or it’s for an investment. If you have extra money, you can just buy another apartment and rent it out to other people. But there are some companies and very wealthy individuals that have huge amounts of money so that it’s not even for investment. It’s for another thing and that’s for the storage of value. Some companies reinvest their profits to real estate.

After what happened on 9/11 and the crisis of 2008, some of them are not ready to invest in Europe or America or other places, so they just buy huge amounts of land and store their value in this land because they cannot just put it in the bank as cash.

I think this is the level that they reached and this is the reason that people are not finding places to live. By the way, the government is trying to distribute these petrodollars to different levels of the people in the country but it’s not easy. In my opinion, that’s the reason why some people are owning huge lots of land where others are not able to find places to build their houses or live in.

We touched on real estate and the stock market. What about bonds – corporate bonds, investment grade quality bonds, etc.

Bonds are not really popular in Saudi. Usually people who hold bonds are the treasurers, banks, corporations and some of the wealthy individuals. If you look at the bond market, it’s not very liquid in the kingdom. If you try to buy or sell some bonds, it is not liquid as the stock market. I believe the CMA is trying hard to create the secondary market because sophisticated fixed income markets can help the society to develop and allocate the risk for megaprojects. It has to be very deep and liquid and they need time. Maybe for religious reasons, people may be thinking that they cannot or are not allowed to invest in bonds, or for other reasons. Because it’s not liquid yet, I would rather go find some shares in the market; CME bonds. If you look at some companies such as the STC, they distribute almost 6 to 7% every year and that’s not really guaranteed but the government has given up all its dividends for the investors. Investors are looking at these companies as a type of bond.

So you have a situation where you see a lot of inflation in the system because there is of course a lot of liquidity coming from the petrodollars. These petrodollars need to be reinvested and they fall into property, stock market and a little bit in bonds. Also consumer prices are not growing that much, with inflation around 4% which is much less than we see in the asset market.

There is definitely inflation. At the level of real estate, there are some areas that went up four or five times. If you were smart enough and could invest your money five years ago at 20% and now you come to buy land, you would see that you didn’t do anything. In fact you just lost the opportunity by buying the land. The house that used to cost $500,000 or $600,000 not will cost you more than $1,500,000 or even more. Definitely inflation is there and people are talking about it. They are not really happy about the standard of living because things are getting more expensive for them.

Let’s talk about your investment strategy. What asset classes are overvalued and undervalued? How do you allocate your assets? Where do you play the market? Where do you see over-valuations and under-valuations and what should smart investors do?

When I came and joined the company two years ago, we decided not to offer any services to individuals. We are not a service company; we are an investment company. For example, we closed the brokerage because it’s a service for people. Also, we closed the advisory business because it is just providing services. There were some of the products of investment banking and finance, like evaluating companies or taking them to the public that were not investment. They were services being provided to the clients.

We are focusing on investments. We are starting by investing our money and then we are going to invest other people’s money. We focus on three pillars: real estate, in which we are able to increase the asset management from 200 million to 5 billion in two years. We also have private equity in which we invest in companies and resell them later on.

We now have a fund of 500 million dollars. We are also in the security market; we now have two funds and a third fund will soon be approved by the CMA. We are focusing on investment generally.

I think it’s difficult to choose whether you are taking a contrarian strategy or you are following the trends. It is difficult to just choose one way. It’s very important to differentiate yourself. So in the real estate for example, you have to try to have a vision of where people are going. We started investing in compounds, for example, five years ago which I think is good now. Now everyone is doing compounds. Now it’s not a good idea to do as the other people do, so it’s important to differentiate yourself and find some niches in the market and focus on them.

What will they be in the future?

That’s the one million dollar question.

It might not be in Saudi. Would you be eyeing some investments abroad?

We are meeting a lot of people and discussing a lot of opportunities, whether it’s in the Arab market or in the international market. We are not planning to go to invest abroad maybe in 2014, but in 2015 it’s possible because we don’t want to go to any other market without having strong partners who are trustworthy. We cannot understand every single market in the world; we will not be able to do that. It’s very important to find some partners and then you can go with them and they will help you with the local markets there. That’s the strategy I think we are following.

Many people see Iraq as a future destination for FDI and for market growth. Many people are investing there. Is that something you will be looking at?

I think there is definitely good potential in Iraq. As you know, the political stability is very important for any investment and it’s difficult in fact for me to decide whether it’s good to start now or just to wait some time for that. I think risks come with return so unless it’s a huge return that will compensate for this risk, it might not be a good interest for us.

In your recent research note, you are predicting a strong bull market for Saudi which should be a mirror image of what happened ten years ago. Can you talk more about this?

The research was just analyzing the market today and the market in 2004. We explained that there is this kind of similarity between these two years. That doesn’t mean that it will be the same and definitely even if it is the same, we are not meaning that it will be with the same momentum that happened in 2004, for many, many reasons. We have more sophisticated investors now; they will not be another mania with PEs reaching 35 or 40 times.

I don’t think that’s what will happen. We are just discussing the similarity between two time periods and the behavior of the market.

Do you think that real estate still has some room to grow further or do you think the growth is over for real estate?

I believe that in some areas there is a potential for growth – Mecca, for example, or Medina, because the government is trying to make huge expansions for both Holy Mosques. The thing is that for those people who invest in Mecca, they cannot just go to invest in other places. They have to go and reinvest in Mecca and they cannot find good property to buy. There is a huge amount of liquidity that competes for a low number of properties. I expect to have more growth. I think the growth will continue but with less sharpness. It will not be like what happened in the previous years especially in the main cities like Riyadh or Jeddah.

Usually there is a rule. If the interest rate is very low and there is liquidity coming in, then definitely the assets will go up, the commodities will go up, real estate included. That’s the rule of thumb. There are a lot of efforts being made by the government to decrease the real estate prices because a lot of citizens are not happy with the situation. I am not sure if the government will be able to do this or not. They announced 500,000 units with a cost of 250 billion – that was five years. The achievement rate is very low. In fact, when they announced the 500,000, all the private sector developers thought wow, the government is coming to the market so we have to stop or at least slow down our development. The government did not enter the market, the private sector did not build more units, and what happened was very few units have been built and there is more competition so prices went up.

You are one of a number of companies. You have competition of course. What makes you the market leader and do the numbers support your market leadership position?

I think we are a market leader in real estate funds and we have a very good opportunity to grow and get a bigger market share. Two years ago, we only had about 280 million invested in real estate, in April 2012. Now in April 2014 we have 5 billion.

Generally, the main players in investment banking are the investment banks. If you look at commercial banks, all of them have a unit for investment banking. These banks have a long history of investment banking, such as 30 or 40 years or even more, and they have full support from the bank itself which is huge, they are definitely the main players in other services like, for example, the brokerage or asset management in securities. Definitely they are ahead of investment banks which are independent such as ourselves and some of our competitors.

Are you looking for investors at the present moment or are your funds full?

We are definitely creating funds from time to time and we will go on the road and speak to investors all the time. This is what we do.

But the funds you have now are closed?

We have two funds with total asset management of almost 2.5 billion. One of them has been closed and maybe today or tomorrow we will announce that. The other one is still open for investment.

So you are looking for some money to flow in so you will have better returns.

Yes, absolutely.

I would like to know how foreign investors can take part in the investment opportunities in Saudi. What is the easiest way? Is it to invest with you? Or the stock market?

It’s open for foreign investors to invest either through funds or through SWAP agreements with banks. We used to do SWAP agreements with Lebanon. Any investor could go to them and say I want to invest in the Saudi market and we opened this window for investments.

What is your relationship with BLOM Bank in Lebanon?

They own 60% and the other 40% is owned by some family business, namely Al-Fozan.

What do you see for the future?

Yes, in fact in 2011 the company was losing almost 10 million a year. In 2012 we made around 4 million in profits and in 2013 we made almost 30 million in profits. Hopefully in 2014 we will reach from 35 to 40 million in profits.

I think it is very promising. There is a lot of potential but we just need to be ahead of other competitors in terms of finding opportunities and finding niches. The market itself is great. We are in a golden age now as everybody knows. You just need to be aggressive in investment and just go and grab the opportunities.

Do you think that the recession year can repeat itself?

Absolutely. There is no one way for the economy. The economy is debating itself and as one of the famous economists says, the economy is balanced at the wrong tail so you cannot just expect one way. You should be very careful in terms of the fact that anything might happen. However, it’s very difficult to be too careful because what would happen if the market went up and you lost the opportunity. Everyone would blame you. But if something like a recession happened and you went down, then nobody would blame you because everyone went down.

From another point of view, we are part of BLOM Lebanon and also our other investors are very diversified. It’s very important to know that they want to get some opportunity from the market now. If you lose it, then it’s their loss. However, if the market went down and they had some losses in the Saudi market, they wouldn’t be angry because they have investments everywhere, including America, Europe and Asia. You have to think about what your investors want from you.

Is Saudi really ready for such an event as the collapse of oil prices?

No we are definitely not but I think there is good reserve with the government.

For three years?

Yes, but definitely they will stop investing in many projects. Now, if you look at the metro for example, it is 80 billion. It’s huge. That’s only in Jeddah. It’s almost the same amount. This money is only from the reserve and it’s not from the coming year’s income.