Iran: Investment opportunities and risks

Posted on Posted in Business Guidelines
May 2014

Henry Smith, Senior Consultant for the Middle East and North Africa was recently in Tehran for a research trip, assessing the prospects for international business should the P5+1 negotiations lead to a lifting of international sanctions against Iran. Here he reports on the mood in the city and what he sees as the opportunities and challenges.

When talk turns to the motives and the speed behind Iran’s re-engagement with what is loosely called ‘The West’, suspicion, surprise and debate swirl through the streets of Tehran. That cacophony, however, comes to a cautious consensus when Tehranis discuss the potential benefits of this rapprochement. Our network of business people, professionals and officials in the capital displayed near unanimity that the rapprochement is good for Iran, good for the Middle East, and good for business. People were less committal about whether it was good for Israel and Saudi Arabia, but these are questions for a separate discussion.

In central Tehran, you have to look hard to find Iranians who think that deeper engagement, and the easing of sanctions, is not going to happen. Most, in fact, think it will happen this year. The more cautious – call them the realists – see 2015 as a more probable timeframe. Beyond that, a fringe believes a deal has already been done; they argue that the ongoing diplomacy is window-dressing for hardline audiences in Iran and the US.

Sanctions still mean that companies considering opportunities in Iran must follow specific legal and due diligence procedures. These procedures are fairly clear and, for some companies, well-rehearsed. Organisations failing to follow the rules of engagement with Iran risk significant legal, financial and reputational consequences, which remain elevated until a comprehensive agreement is reached.

Even so, three days in Tehran recently confirmed for us that companies should prepare for the commercial opportunities Iran presents, should sanctions ease.

Iran’s upstream oil and gas sector is understandably a focal point: the country has the third- and second-largest global reserves of each. These massive reserves are strategic in their importance – Iran’s production and export levels will have a significant bearing on energy security and risk premiums in global prices.  Until now, existing upstream contracts have been regulated by unfavourable “buy back” terms, and while momentum exists in Tehran to improve the terms, changes appear likely to be at the margins. As a result, upstream opportunities will take time to turn into deals for new entrants.

Iran’s downstream sector is fairly sophisticated. Still, keeping pollution down, improving efficiencies and ensuring a steady flow of exports will require international expertise and technology. While the current administration has taken steps to limit pollution, it is an obvious problem in Tehran. Beyond hydrocarbons, Iran’s mineral wealth is well known, but is under-developed relative to the extent of its reserves.

Leaving minerals aside, Iranians themselves are probably the greatest immediate prospect for foreign companies. A population of around 80m with mid-level per capita incomes, and a diversified industrial and manufacturing base – surprisingly so, given the dominant role of the hydrocarbons sector – are positive indicators. The opportunity is particularly pronounced given that Iran has been off limits for many companies for an extended period of time.

Iran is already an attractive proposition to companies providing fast moving consumer goods. The popularity of international food and beverage brands, currently limited in supply, and cosmetics was clear. The  performance of private sector retailers confirms this. It is also tempting to draw conclusions from observing 12 people in three days bearing the obvious hallmarks of recent plastic surgery, though any of Iran’s better market research companies would argue for a larger sample size.

Leisure and hospitality are clear opportunities. The low standard of Tehran’s hotels is striking, given its population of 15m and its role as the commercial and political capital of an oil-rich nation. Despite having the history, geography and climate to offer a breadth of experiences, Iran lacks international hotel chains and a developed tourism industry. Internal tourism is a significant market, driven by a combination of interest in religion and cultural heritage, health (attempts to escape pollution and congestion in the main cities), and sport (such as skiing on snow, sand and sea in one day).

If Iran presents a tempting opportunity, it also presents challenges both familiar and unique. As with any new market, venture or partner, the obstacles and risks will in part be determined by the investor’s specific profile. Among them are its nationality, sector, investment structure, and risk appetite. Beyond that, three other important factors struck us when we were in Iran.

Iran’s extensive, slow, and sometimes painfully complex bureaucratic and administrative procedures have created fertile ground for corruption in its various forms. While Iran is certainly not alone in this feature, Iran’s red-tape and business practices are idiosyncratic, varying by sector and location.

New entrants to the market should ask whether their risk governance policies are suited to the specific challenges this poses. Coming to Iran as a new entrant affords companies the opportunity to enforce, from the outset, a zero tolerance stance toward bribery and full compliance with international anti-corruption legislation. This is essential: external regulators and prosecutors will be closely watching the behaviour of companies choosing to operate in Iran.

Partner risk is more pronounced in Iran than in many other markets. Two key issues demonstrate the absolute centrality of understanding the associations and relationships of your partner. These are 1) the commercial and political role of the security forces, which have a particularly divisive reputation amongst US lobby groups and Western governments, and 2) an opaque privatisation process that transferred assets to shell companies for political and security figures. A number of our discussions in Iran also indicated that Iranian companies paint very good initial impressions, and use that talent to hide deeper shortcomings. Carefully targeted due diligence among reliable local sources can help penetrate these façades.

Iran has an engaging, educated population, but one that has suffered from professional isolation and brain drain to countries offering greater opportunities. Securing the correct local hires was routinely identified in our conversations as a key issue for companies entering or expanding in Iran. Success stories we heard from local business people focused on companies that implemented exhaustive training schemes for their Iranian employees. Successful companies also bring their strongest expatriate teams to Iran; Iranians themselves will tell you that the complexities and particulars of Iran mean foreign companies must bring their best.

The combination of these complex issues, and the controversy that accompanies commercial decisions about Iran, provides little margin for error in the market-entry decision. If the rollback of sanctions is not as swift as some Iranians hope (we regard 2015 as a more probable scenario than 2014), companies now have time to plan, stress-test and refine their commercial priorities and risk management strategies, without losing first-mover advantage. The opportunities and challenges in Iran mean it would be remiss not to.

 

FAR law firm

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