Private Equity in Africa: A Private Passion
As African nations march towards more formal, regulated economies, private equity is determined to play more than just a walk-on part. But there is still much to learn about doing business in this diverse region.
The days when Africa was seen as primarily a resource base are long gone, as a huge, sprawling continent of 54 countries and over a billion people now offers a vibrant range of markets. Annual GDP in the sub-Saharan region has increased by more than 5 percent since 2002, and six of the world’s top 10 fastest-growing economies are in Africa, a result of greater political and regulatory stability, easing of trade barriers, young populations, and an expanding middle class.
This fact has not gone unnoticed among the private equity (PE) community, with major players such as KKR, Carlyle and Blackstone opening offices in Africa and setting up dedicated funds. Banking and financial services are the most popular sectors for investment, followed by agribusiness, industry and manufacturing.
Most African countries have poor or non-existent sovereign credit ratings, limiting their access to international loan markets. Savings are generally meagre, domestic capital markets are narrow, and financial instruments such as project bonds are generally unavailable. Together, these factors present a huge opportunity for investors from more established markets seeking a big return.
Compared to other emerging regions, PE activity in Africa is considerably lower in terms of funding levels (typically below US$25 million), deal sizes and exits. By 2012, only around 5 percent of all PE emerging market investment went to sub-Saharan Africa — although this is over twice the level in 2010. But with valuations at relatively affordable levels, PE interest continues to rise, encouraged by deal multiples of around eight times the initial investment — roughly the same as in India and Brazil.
A modest but important share of the African PE market comes in the form of ‘impact’ investments that aim to generate measurable social and environmental impact as well as a financial return. A 2013 survey by JP Morgan and the Global Impact Investing Network identified over US$500 million in such funds in sub-Saharan Africa, mainly directed towards microfinance, housing, food and agriculture, and clean energy and technologies.
With its favourable business climate, well-developed capital markets and strong legal and regulatory environment, South Africa leads the way with around 50 percent of the continent’s entire funds under management. Nevertheless, this proportion is falling quickly as other economies become more established, with the Democratic Republic of the Congo and Nigeria the next most popular destinations for finance. With its strong ties to Mediterranean trade, North Africa is almost viewed as a region apart, and much of the excitement is centred on sub-Saharan Africa.
Establishing the ground rules
PE deals in North America and Europe typically involve loading substantial debt onto (often-mature) businesses, to magnify owners’ returns. In Africa, on the other hand, revenue growth and efficiency gains are fuelling the gains of investors.
Less than half of the continent’s countries have stock markets, and only a few of these are liquid (such as Egypt, Morocco and South Africa), which is a big restraint on development. Consequently the majority of exits in recent years have involved direct sales to other strategic investors. Secondary exits remain rare due to a scarcity of mature assets, with many PE firms choosing to stick with their investment throughout the life cycle.
Nevertheless, initial public offerings (IPOs) are becoming a more common way to realise investments. In 2012, for example, Actis, a British PE fund, reduced its stake in Umeme, an electricity-generation company bought from the Ugandan government in 2005, through the first ever dual listing in Uganda and Kenya.
With relatively few large companies to go for, a common strategy is to buy modest-sized national enterprises and then transform these into regional outfits. In a matter of years, PE houses AfriCap and Helios International helped turn Equity Bank of Kenya from a small microfinance lender into a major commercial bank.
When considering a potential target, the degree of due diligence is likely to be higher than the norm for more mature markets, due to a dearth of credible data. Investors should also be aware of the shallow pools of local talent, and be prepared to parachute in their own resources, possibly for significant lengths of time.
Local relationships with regulators and government are vital, to manage bureaucracy and also avoid surprises. It is helpful to know, for instance, that in many Western and Central African countries, minority shareholders will find it difficult to recover decision rights if the Chief Executive Officer (CEO) performs badly.
As PPPs proliferate, governments are setting up regulatory agencies to govern procurement, contracting and ongoing management. These processes are largely untested, so on-the-ground knowledge and contacts are important for ensuring contracts are honoured and appropriate arbitration exists for any disputes.
In a diverse continent with 54 countries, tax systems inevitably vary considerably, but one constant theme is the emergence of heavy taxes on exit profits. Where no taxation treaty exists between investor and investee countries, there is a genuine risk of double and/or excessive taxation.
Much has been written about corruption in Africa, yet this threat is arguably over-hyped and obscures the true opportunities for PE. The risks may be higher in sectors with greater state involvement – such as infrastructure and natural resources – but this leaves a host of private markets where established multinationals have been active for decades. The presence of the likes of Shell, Exxon Mobil, Unilever, Nestlé, Cadbury and Diageo should be enough to persuade any doubters that this is a continent in which it is possible to do business.
Africa is not a single country, and each of its nations is in different stages of maturity, with its own distinctive culture and legal and regulatory environment. Any market entry strategy must reflect this diversity, and investors need to do their homework on local issues such as infrastructure, market size, growth rates, legal system, investment incentives, foreign exchange, and dividend and profit repatriation policies.
Infrastructure, in particular, should be regarded as a business cost, although some smart operators have turned poor transport and power capacity into a form of competitive advantage, by setting up their own dedicated supply and value chains that new entrants find hard to replicate.
Further growth of Africa’s PE market requires suitable economies of scale, with a gradual move away from small deals and funds. Governments can hasten such a transition by providing development finance and enabling regulation.
Above all, success depends upon a sustainable, long-term view that takes the interests of national and local economies and communities seriously, in order to make a genuine contribution to a country’s development. By taking such an active role, PE investors can become an integral part of the growing African success story.