Can a company based in Pakistan be responsible for the fall of one of the world’s largest private equity firms?
As the Dubai-based Abraaj Capital, which is the Middle East’s top private equity firm, continues to make headlines, one of its investments in the spotlight is K-Electric, the utility powering Pakistan’s largest city, Karachi.
Abraaj has filed for provisional liquidation after reports emerged that its management diverted investor funds to pay its own expenses. A lot of the blame for this has come down to K-Electric, which Abraaj took over as a majority shareholder in 2008.
How K-Electric met Abraaj Capital
K-Electric (then known as the Karachi Electric Supply Corporation) is an organisation that has been marred by incompetence, underinvestment and political interference since the 1990s up until it was taken over by Abraaj in 2008.
The port city of Karahchi, which hosts more than 16 million people, boasts the highest number of factories in the country and electricity breakdowns resulted in loss of production hours, straining an already frail economy. There used to be near-daily street protests by angry locals.
Successive governments didn’t bother to invest in generators, copper wire and electricity theft was rife, causing massive financial losses to the company.
It was such a free-for-all that people would even stick toothpicks in consumption-reading meters to slow them down or just steal electricity directly from overhead power lines.
In 2005, K-Electric was privatised and sold to a group of Middle Eastern investors in a bid to rejuvenate the company.
The problems afflicting Karachi's power supply didn’t go away. K-Electric continued to pile up losses, and the government kept handing out subsidies to keep it afloat.
A succession of CEOs followed with little success. And then Abraaj swooped in.
Abraaj came with an investment of more than $300 million, promising to add power generating capacity and fix the rickety distribution system.
But first it needed to deal with a bloated workforce. The company didn’t need one-third of its 18,000 employees, and it fired thousands of them.
What followed was a revolt.
Hundreds of angry workers, backed by politically connected unions began a strike and stormed the company's head office, pelting it with stones and burning official cars.
Tabish Gauhar, a Karachiite then in his late 30s, was brought in as the CEO to oversee the transition.
Depending on locals to maneuver around bureaucracy and politics had become a hallmark of Abraaj’s operations in developing countries.
Using a carefully crafted PR strategy and lobbying in Islamabad, it was able to withstand the pressure of protesting employees.
By 2012, after years of remaining in the red and relying on government bailouts, K-Electric was posting profits – even though it continued to struggle to meet a growing power demand.
All about returns
K-Electric was Abraaj’s largest investment among the more than 200 companies in various emerging markets that were in its portfolio since it started in 2002.
Arif Naqvi, Abraaj’s founder, is also from Karachi.
The life of the fund that was used to invest in the company ran out in 2016. This coincided with the time when Abraaj was hoping to sell its stake to another investor at a profit. This never happened.
Like many other countries, the money investors can make in the electricity generation and supply business is regulated by the government.
Regulation was all the more important for utilities like K-Electric, which is the sole supplier for the entire city and faces no competition.
The regulator determines K-Electric’s profit on the basis of how efficiently the company is run. That means if the managers recover more bills and increase electricity generation than the net profit goes up.
In October 2016, Abraaj announced that China’s state-run Shanghai Electric Company had agreed to buy its 66 percent stake in K-Electric for $1.77 billion.
But that deal hit regulatory snags as K-Electric is embroiled in what in Pakistan is known as circular debt – where one energy firm owes money to another along the supply chain.
“That was one of the reasons government officials were reluctant to give their consent. They wanted K-Electric to settle its dues before the deal goes through,” said a former K-Electric executive.
“The Chinese were also asking for more even though they were offered a return of 18 percent to 19 percent on their investment. It’s just sad that it didn’t work out.”
Now it is slowly becoming apparent that Abraaj's inability to sell its stake at the right time might have contributed to the cash flow issues, which resulted in its liquidation.