February 23, 2011

Opportunities to Capitalize on Egypt’s Emerging Middle Class

In the wake of recent political unrest in Egypt, there has been concern that the country will no longer be a safe or strong opportunity for investment. Although we agree that there will be short term challenges, we continue to believe that the long term opportunity for the Egyptian market remains strong.

Going forward, the biggest risk for the Egyptian economy in the short term will be increased volatility, and therefore a higher risk premium. We have recently seen short term interest rates in Egypt increase by over 200 basis points, and the government has indicated that it will increase public sector wages by 15% in the near term. In addition, the high cost of food was a firebrand for protesters, with inflationary pressure posing a significant long term risk. Insecurity over the nation’s new political and economic climate - as well as the rising cost of food - is likely to be a key driver of investors’ perception of Egypt as a destination for capital.

However, it is important to note that prior to the recent turmoil in Egypt, the country’s economy had been growing at a steady 5-6% per year for the past few years. This growth was spurred by a growing middle class, as well as economic liberalization. While regime change and political unrest may likely lead to a contraction in the short term, we believe that the fundamentals behind Egypt’s economy remain strong. There are 80 million people in Egypt, which makes it the largest economy in the Middle East by far. Growth in the country has also been driven by macroeconomic changes over the past few years, most notably liberalization of the country’s economy. It is likely that a democratic transition would accelerate this process, and foster a more participatory and lasting change.

When Egyptian markets reopen, we believe there is likely to be broad pressure to sell equities, as investors indiscriminately try to pare risk. We expect to see capital outflows in the short term from investors who are looking to reduce their exposure. This could in turn lead to domestic selling for high margin investors who face margin calls. Overall, this indicates that a near term drop in the Egyptian market is likely, but not necessarily an indication of long term fundamentals. As long term investors, we believe that favorable opportunities might develop as investors sell out of the market without regard for the underlying fundamentals. Of note, we would like to highlight a couple of sectors that we believe are well positioned for growth in the Egyptian economy going forward, and which we believe are compelling investment opportunities.

First, we believe there are good opportunities in the banking sector. Egypt, as with many countries in the Middle East and Africa, has an extremely low rate of penetration in banking, which means there is a significant potential for expansion into new and growing spaces. This growth is being targeted by a number of large financial firms, who are working to expand their small and medium enterprise and retail banking segments. With such low penetration, may financial firms have found it possible to grow these segments by double digit rates annually while maintaining strong fundamentals.

In addition, we consider the affordable housing sector to be an excellent opportunity for growth in the Egyptian market. First of all, Egyptian housing is by its nature a long term story. Over 60% of Egypt’s population is currently under the age of 30, which makes affordable housing a significant concern. At this point, demand for affordable construction far outstrips supply, and is likely to continue to maintain strong growth in coming years.

In addition, changes to the mortgage finance industry have the potential to notably spur demand. Traditionally, Egypt has not had a mortgage finance industry: rather, homebuyers would make purchases on a cash basis. This meant Egyptians who hoped to purchase a home were forced to wait until they had saved the full cost prior to making a purchase. However, ongoing changes in Egyptian regulations have begun the development of mortgage finance products. If demand for these products continues to grow (as we believe it will), an increasing number of individuals will be able to afford their own homes. Firms which construct affordable housing are well positioned to capitalize on this opportunity.

Overall, we agree that there will be weakness in the Egyptian economy, especially in the short term. However, there is a strong growth story in the Egyptian economy –driven by the expansion of the middle class - which we believe continues to make a number of Egyptian firms attractive buying opportunities.

For more information about investing in Africa, please contact Nile Capital Management at (646)367-2820 or info@nilecapital.com

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