Key findings from the 2014 Africa CFO Survey

Why Africa is the new hotbed for private equity

Private equity investment into Africa, and fund managers’ ability to raise capital for funds dedicated to the continent, are both trending strongly upward. In 2011 private equity (PE) investors closed $3bn worth of deals in Africa, up from $890m in 2010. The Emerging Markets Private Equity Association (EMPEA) estimates that a total of $605m was invested into sub-Saharan Africa over H1 2012. Bureau Van Dijk’s Zephyr database gives an even bigger total: over a billion dollars invested in 24 deals in the first six months of the year. Long-established giants of the PE world are closing dedicated Africa funds, hiring teams and opening offices across the continent, while home-grown funds and managers are growing bigger, bolder and better.

Despite all these increases, it is important to note that PE flows remain at very low levels, relatively speaking: PE investment equals 0.1% of gross domestic product (GDP) in sub-Saharan Africa compared with 0.3% of GDP in India, 0.2% of GDP in China and Brazil, and over 2% of GDP for world leader Israel. We expect sustained growth as Africa’s economic and financial profile matures. We note that Africa saw an increase in deal flows over H1 2012, while the two big emerging markets that investors were most excited about over the past few years, China and India, saw deal volumes decline.

Characteristics that attract PE investors

The cyclical sectors are attractive mainly because of the current demographic profile of Africa, which is set to translate into massive consumer demand over the next decade or two. Africa’s population is growing fast, urbanising, and moving into formal employment. At the same time, the dependency ratio is decreasing. The result is a growing class of urban professionals with disposable income, and earnings growth in all the economic sectors that sell to that class.

Then, there is the sheer size of Africa: it comprises 30.2 million square kilometres of land, a fifth of the world’s dry land. With 733 million arable hectares, it comprises more than a quarter of the world’s arable land. This potential to serve as the world’s breadbasket as we approach peak population in the current century fuels investment in farming land and agricultural companies, as well as in water infrastructure and phosphate. Mining has been important in Africa’s economy since prehistoric times and remains relevant to the investment community, while near-weekly energy discoveries power business in that sector.

There are also political reasons why investor interest in Africa is trending upwards: advances in governance have steadily improved the business environment in Africa over the past few decades. These advances can be uneven, however, with North Africa a case in point. This does not however change the fact that the long-term trend is clear and positive, and the perceived risk that drove investors away from Africa, towards other ‘frontier’ markets that they saw as safer, is declining. The partial risk guarantees that the World Bank provides to companies that supply services or goods to governments against payment default have further reduced the perceived risk of doing business in Africa.

Aspects of the PE investment universe are tied to the listed equity investment environment in Africa. With the exception of the Johannesburg Stock Exchange, African stock exchanges remain small and illiquid compared to their global peers. Stock exchanges are often so illiquid that one of the main arguments elsewhere for preferring public equity – ease of exit – does not apply in Africa, as it can be just as difficult to exit a listed position. There is one major downside to underdeveloped equity markets: that it is often impossible for a PE investor to exit through IPO at an attractive profit.

In order to hedge their bets, PE investors tend to consider investments that they can sell on directly to another PE fund or to a trade buyer. Among the most important drivers of PE investment in Africa has nothing to do with Africa, and is a consequence of the global financial crisis. Banks are less willing than before to lend, out of caution and in order to comply with stringent new capital adequacy rules, with the result that expanding firms struggle to raise debt. PE managers are stepping into this breach with enthusiasm.

Investors

Avanz Capital estimates that 115 general partners manage 158 private equity funds dedicated to the continent, with a total of $33bn closed since 2002 or being raised. More than half the funds are smaller than $200m. The African Development Bank (AfDB) puts the figure higher: it estimates that there are 200 equity investors actively involved in the African PE market. the bulk of the equity funds attracted to Africa are ‘specialised funds’ with focus on natural resources, infrastructure and renewable energy sectors, but the picture is changing as established global players raise dedicated pan-African funds that invest across sectors, and smaller boutique outfits chase deals that the bigger traditional investors do not look at.

Among the most important PE players are public companies, which often base their investment decisions on considerations other than pure profit. The most notable of these are the international financial agencies. While the AfDB mostly finances projects through loans, it has very substantial PE commitments – $82m in 2011 – and acts as an anchor investor in a number of funds. The AfDB explicitly favours investments that will develop Africa’s agricultural and infrastructure. The World Bank’s International Finance Corporation (IFC) has investment commitments of more than $3bn in North and sub-Saharan Africa. While, like the AfDB, it seeks to develop economies, it has stakes in many small and medium enterprises.

Britain’s CDC Group (only the initials are now used; it was previously called the Colonial Development Corporation) served a similar function in the British Commonwealth. In 2004, the CDC spun off its PE business as Actis and now does all its direct investments through Actis. The latter has a total of $5bn in assets under management (AUM), of which 38%, just under $2bn, is invested in Africa. CDC remains Actis’s anchor investor and represents 40% of funding.

France’s counterpart to Britain’s CDC, PROPARCO, is majority-owned by the Agence Française de Développement, with private investors holding the remainder of share capital. It is particularly present in the French-speaking countries (especially in Morocco, where it has invested $3.5bn in the 20 years of its presence in the country). The China-Africa Development Fund (CAD Fund) had $800m invested in Africa in 2010, much of that in mining operations seen as strategic.

South Africa’s Public Investment Corporation (PIC) may yet turn out to be the biggest public fund to invest in African PE. The public pensions’ giant has R1trn ($115bn) in AUM, and in 2012, after it obtained the necessary authorisation from the government, it announced its intention to begin investing in the rest of Africa. It has set aside R5bn ($570m) to invest in all asset classes in Africa by the end of March 2013. In South Africa the PIC favours listed equities, but chief executive Elias Masilela has said that the thinness of Africa stock markets will drive the PIC to look for PE and property opportunities.

All the fund managers listed above serve as anchor investors: if they put funds into a project it is usually easy for management to raise any other capital that may be required. So the IFC’s $2bn invested in sub-Saharan Africa made it possible to mobilise a further $590m from other investors.

The managers tend to prioritise investments of a kind to unlock more economic value, especially in infrastructure.

In this way they play a hugely important role in economic development even if in the case of PROPARCO and the CAD Fund they do so to advance the business interests of national companies.

As mentioned earlier, some global PE heavyweights have started turning their sights on Africa in recent years. The Carlyle Group, a giant with $165bn in AUM, launched a $500m dedicated Sub-Saharan Africa Fund with the AfDB as an anchor investor in 2011 and opened offices in Johannesburg and Lagos. It began investing on Middle East and North Africa (MENA) markets in 2006. Other behemoths have started their African portfolios with stakes in more developed markets, like Kohlberg Kravis Roberts with its controlling stake in Egypt’s Hedef Alliance, or Blackrock with a position in South Africa’s Umcebo Mining. We expect these portfolios to include more African positions over time. Blackstone, which has a number of energy positions in its global portfolio, has invested in an offshore exploration deal with Kosmos in Cameroon. Dubai’s Abraaj collected quite a few  sub-Saharan investments with its buyout of Aureos Capital in February 2012, while Saudi Arabia’s Kingdom Zephyr manages a dedicated $600m pan-African fund and has other North African positions in its global funds. Britain’s Standard Chartered Bank has invested more than a billion dollars in private equity worldwide, much of that in Africa.

The biggest dedicated Africa PE manager is Washington-based Emerging Capital Partners (ECP), with $1.85bn in AUM in seven dedicated funds. The United Kingdom (UK)’s Helios Investment Partners is of a similar size: this Africa specialist has $1.7bn under management. London-based Africa specialist Development Partners International (DPI) manages the €270m African Development Partners fund, invested across all sectors and countries on the continent, but with a specific focus on consumer evolution stories. One of its key investors is the CDC. South Africa’s Investec Asset Management manages Africa Frontier Private Equity Fund which closed at $135m in 2008.

Because large funds face deal size constraints that force them to pass on some potentially profitable deals – Actis has a minimum investment of $50m – smaller players have recently started emerging. In this category we can list Jacana Partners with $35m in AUM and which looks at deals of between $1m and $5m, TLG Capital, where the biggest deal is $13m, or Miro Asset Management, a Dubai-based boutique investment firm that specialises in sustainable agriculture and forestry and clean energy.

Sectors and Countries

According to Bureau Van Dijk’s Zephyr database, South Africa was the most active market for PE investment on the continent in H1 2012, with South African targets attracting $547m over the period. In second place on the continent was Morocco with deals to the tune of $243m, followed by Mauritius with $106m, Ethiopia with $90m and Kenya with $57m. Nigeria, which was a very active PE market in 2010, was considerably less animated in H1 2012, attracting one deal with a value of $5m. This geographical spread of PE activity affects the sector distribution, too: as the more sophisticated markets attracted the most investment, sectors that are important in those markets, especially services, are heavily represented in overall transactions. We consider that many of these investments in South and North Africa or Mauritius do not constitute typically African deals, and think that the most exciting opportunities are in the primary sectors and in consumer goods.

African agriculture attracted $102m worth of private equity investment in the first six months of 2012, compared with $54m in the whole of 2011. Almost all of these flows were investments by Standard Chartered Bank, which spent $74m on a minority stake in grain and fertiliser trader Export Trading Group in Tanzania and another $20m for an indirect stake in Zimbabwe’s horticultural firm Ariston. Ethiopia’s attractiveness to PE investors has much to do with its strategy of welcoming foreign investors to develop its agricultural sector. While a 2011 Prequin survey found that only 23% of Africa specialist PE fund managers preferred the food and agricultural sector, we think that the long-term trends will make this sector stand out in future.

Some big and interesting infrastructure deals from 2011 include the $110m investment in Rift Vallet Railways by Citadel and the IFC, and the $48m Capital International/Standard Chartered investment in Seven Energy Nigeria. PROPARCO, the AfDB and the IMF have collaborated on the Lomé Container Terminal in Togo, a transhipment terminal to encourage the development of smaller harbours in the sub-region, at a cost of €30m.

More cyclical plays have become profitable thanks to the growth in consumer demand in Africa, a trend that is set to continue over the next few decades. So there is substantial interest in fast-moving consumer goods (especially breweries), formal retail and mobile telephony. While most investment in these sectors is by multinational corporations, PE managers have sometimes been first to sign, or have entered companies in these sectors as minority partners.

Investors and managers it consumer spending companies in Africa say that they find they consistently underestimate the size of the market, and that they find themselves surprised by levels of demand when the begin operations. Some of the explanation lies in the underutilisation of formal banking networks, so analysis that uses deposit and loan book figures to estimate demand will end up being too pessimistic.

The demographic and macroeconomic trend fuelling the consumption boom is also driving the attractiveness of real estate plays (although property investments are often considered separately from PE). Shopping malls are currently fashionable investments, although more classic residential or commercial plays remain popular. Recent news in this area has been Actis’s closing of a $280m real estate fund in October, its second of this kind. Property plays provide many of the opportunities for smaller PE funds to start investing. Healthcare benefits from the same economic dynamic. Companies in this sector have proven massively profitable in South Africa over the past decade especially, and other African countries will see similar returns on investment in the sector as the demographic dividend pays off. Aureos already figures prominently in this sector thanks to its $105m Africa Health Fund, a semi-philanthropic vehicle funded by the IFC, AfDB and the Bill & Melinda Gates Foundation.

Africa’s financial services sector is benefiting from broadly the same macroeconomic drivers as the consumer goods sectors. PE investments in financial services have historically tended to focus on sophisticated financial companies in more developed markets like South Africa or North Africa, with investment in the sector on the rest of the continent usually driven by acquisition activity as European or South African banks expand their businesses.

David Okwara

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