Local knowledge and value-chain approach essential to Africa private equity success
Africa’s enormous growth potential is now an open secret with the International Monetary Fund (IMF) predicting that by 2015 seven out of the top 10 fastest growing economies will be in the region.
Reassured by government commitment to economic reform and business-friendly policies, including privatising state assets and generous tax breaks, private equity investors from around the world are chomping at the bit for a piece of the action. This year, the growth trajectory will continue because quite simply Africa is a beacon of light for investors looking for alpha returns in a world that otherwise has little to offer and in spite of the challenges of infrastructure, weak institutions and perceived red tape in government
Even mainstream emerging markets have not looked quite so rosy over the past year with muted economic growth in comparison to previous years, rising inflation and the decision by the US Federal Reserve to begin withdrawing monetary stimulus unsettling stock markets. According to 2013 EMPEA’s survey, Sub-Saharan Africa (SSA) was ranked the most attractive among emerging markets (the first time in nine years) and nearly 54% of all LPs surveyed plan to begin or expand investment in SSA.
Africa is truly the last frontier: resource rich, a market of more than a billion people, a youthful demographic, growing wealth and massive expansion potential. So it’s not surprising that a wall of private equity money is knocking down doors from Nigeria to Kenya and Mozambique in search of deals. This is a welcome volte face from attitudes just 10 years ago when it was near impossible to tempt foreign capital to the region, but means PE houses and fund managers have to work harder to nail the right deal.
Given the early stage of development of the private equity landscape in Africa, convincing family-run firms – the biggest investor target after privatisations – to open up to a stranger is still quite a challenge and it will depend very much on the value add they can offer to help them grow in country and cross border. Access to capital is relatively easier than before for these firms, but what they need is operational expertise, access to industry networks and managerial talent- still lacking on the ground in any meaningful way.
Demonstrating innovation is critical, whether that be strengthening governance and processes or going so far as to set up dedicated value and supply chains to overcome poor power and route-to-market infrastructure for PE to make an impact and become a part of the African growth success story.
Africa is not one country and every one of its 54 nations is in different stages of maturity with different legal frameworks, tax systems, labour laws, market sizes, and foreign investment policies. That means without deep local knowledge and experience of the specific market’s complexities, an investment is unlikely to work out as hoped.
Teaming up with development finance institutions such as IFC and CDC could be one answer for PE houses looking for business success in Africa. These organisations, which have years of on-the-ground operating experience, are increasingly making direct investments from their own capital pool or looking to co-invest with their general partners (GPs), recognising the huge profit-making potential of supporting private sector growth on the continent.
The local knowledge and access to capital such a partnership can bring would allow PE houses to structure big transactions previously inaccessible.
In terms of sectors, I believe we will see interest in financial services continue to grow as mobile phone technology advancement in payments, transaction processing and service delivery channels continues to extend banking services to previously underserved customers. Increased regulatory oversight by central banks will support that growth. Agribusiness and consumer sectors are also ones to watch. Certain African countries, like Nigeria, are trying to fix the broken value chain in their agri-markets and create jobs by providing investment incentives for local processing of agricultural products.
Meanwhile you can expect to see a mushrooming of public private partnerships as governments commit to build roads, railways, water irrigation systems and ports but have no resource to do so. As PE grows and local pension funds allocate capital to the sector, so innovation in investment structures will become more important in achieving success and accommodating a raft of new PE customers with different risk and reward characteristics.
In the past, private equity investments have largely been in plain vanilla equities partly because investee companies were unfamiliar with other forms of investment. However, diversification into more dynamic and flexible structures is now needed to accommodate the needs of a wider pool of investors. Different types of debt and quasi-equity instruments, mezzanine finance and management incentive schemes are all options that should be considered. Already, some development finance organisations have introduced local currency bond instruments to broaden the base of financing instruments.
These and other new structures will help private equity firms and portfolio companies achieve increased tax efficiency, alignment of interest and maximise return on investment.