Capital shortage, underdeveloped and under representative capital markets, and ongoing generational changes in consumer and resource demand – together these can create a perfect storm for the private equity opportunity in frontier markets. Africa epitomises this paradigm and today’s capital deployed by private equity players is only just beginning to tap the continent’s opportunity set. The implications of increased private market activity for Africa’s capital markets and the quality of the continent’s continued growth are potentially very significant. In this section, Nick Tims, Managing Director of Investec Asset Management’s UK Institutional Client Group, highlights the challenges and promise of private equity investing in Africa.
The African growth story – Africa Rising, Lions on the Move, African (re)naissance, – has become clichéd since at least that Economist cover of May 2000, one of the better contra-indicators of recent times with its Hopeless Continent title. Today, Africa’s growth is now recognised widely. But how to navigate this new phase of African growth as it moves from commodities to consumer, from manufacturing to services, is a complicated matter, in a massively diverse and fast-changing continent. The last decade has seen tremendous economic developments and increased financial sophistication, but also, in places, a stubborn lack of change, economic and geopolitical setbacks, and mismatches of capital supply and demand. It is, after all, a highly complex set of countries.
Africa is far from perfect. The Westgate shopping centre attack, Boko Haram, bloody conflict in the Central Africa Republic, brutal civil war in South Sudan, and jihad in the Sahel have all tainted the African growth story.
Elections are usually anticipated with varying degrees of trepidation – and there are some 10 to look forward to in the next year, in some of the most influential African countries, such as Nigeria, Egypt, Mozambique and Ethiopia. With institutionalised corruption at the highest levels of government, as has been recently alleged in Nigeria, the failed promise of the Arab Spring, and countries like Zimbabwe still suffering under their “liberation” governments, Africa attracts its fair share of headlines. But, while the list of problems are still significant, it is much shorter than it was, and the flashpoints increasingly, but not always, deemed isolated or containable. But even in such environments, opportunities abound, and private equity has the power to influence growth and effect proper change.
Furthermore, investors are increasingly looking past these types of events and differentiating between and within the 54 states. This growing investor sophistication is an important feature in a region where investors need far more precision than, for example, exchange-traded fund type exposure.
Private equity in Africa:
current state of affairs
A substantial amount of capital is being raised, right now, for private investments in Africa, both by established African firms and by new entrants, small and large. The new phenomenon is the appearance of global private equity players – global behemoths looking to allocate to Africa – alongside larger fund raises by traditional players and South African players extending their mandates north of the border. Many private equity fund buyers have increased their own direct investment programmes, especially the development finance institutions (DFIs) and also the dedicated African fund of funds. In many cases they are all looking at the same small number of available deals.
While there is no doubt that the larger end of the African private equity market is currently over-crowded – as the small number of deals, combined with extra interest by international (especially, but not only, South African) corporate buyers, causes a squeeze in valuations – the overall picture is still one of an undeveloped asset class in a huge opportunity set. This is particularly noticeable when one moves down the deal size spectrum and into the smaller markets. In many ways, this is the “sweet spot” for private equity opportunity on the continent, something recently highlighted by the International Finance Corporation (IFC), which also warned against “the risks of markets being flooded, driving up entry pricing”.1
The macroeconomic story is still intact and it is worth repeating some of the metrics. Ernst & Young recently described Africa as “experiencing the longest period of sustained and robust economic growth since the 1960s”, with economic output having risen fourfold since 2000 and Africa having had the highest number of economies growing above 7% per annum of any continent in the world.2 The IMF predicts that by 2017, 11 out of the 20 fastest growing economies in the world will be in Afritca.3 We may have to refine that number as it included Libya and South Sudan, while also including minnows such as Sao Tome, but the case is valid, with countries such as Mozambique, Zambia, Cote d’Ivoire, Ghana and Rwanda belonging to that group. And the mere 7% growers do not get into the top 20. Half of the 54 states have reached the World Bank’s definition of “middle income”, admittedly still very highly polarised, and with significant inequalities in many cases, but still numbering some 300 million people, while three-quarters of the continent’s countries are expected to achieve that income level by 2025. Africa’s population
“The International Finance Corporation also warned against ‘the risks of markets being flooded, driving up entry pricing’.”
of 1 billion could double by 2050 according to the UN4, with Africa having the world’s fastest-growing population and fastest urbanisation rates. It’s formal labour force is predicted to be a massive 1.4 billion by then. Since 2000, African trade has quadrupled – with African-BRICS-type trade growing tenfold. The commodity boom was initially responsible, but this phenomenon has expanded way beyond resource demand – in 2011, for example, 58% of sub-Saharan GDP came from services (and 18% from natural resources).5 Africa has also been helped by significant tariff cuts and the growth of regional trade alliances such as ECOWAS, COMESA, SADC and EAC that have hugely impacted trade liberalisation. This backdrop is now well recognised, but it is still an ongoing economic paradigm shift of massive and generational proportions, and one that is still barely touched from an investment perspective. But Africa’s complexities and idiosyncrasies remain, and opportunities continually appear in new sectors and regions.
Who would have envisaged Mozambique’s gas story, Kenya’s infrastructure and technology opportunities or Ethiopia’s manufacturing ones? Conversely, who would have expected, for example, Zimbabwe to risk recession five years after the promise of dollarisation in 2009; Africa’s newest country, South Sudan, to descend into grim civil war three years after independence;
“Navigating this rapidly changing landscape is an intricate exercise.”
Egypt to “elect” another military dictator three years after ousting the last one, or corporate South Africa having to develop an “African” growth strategy to compensate for life at home. Navigating this rapidly changing landscape is an intricate exercise.
One of the world’s largest private equity firms recently declared “We’re not even in Chapter One of private equity in Africa. It’s more like a prelude. We hope that all the major firms will be there in five to ten years”.6 The private equity story in Africa is really just beginning and the market has, indeed, been characterised by a small number of boutique private equity firms.
The implications of this shift are significant. By definition, the size of global firms means there is a risk of crowding the larger end deals, at least given the current opportunity set. The deals that they look at need to move the needle. But there are other implications: you cannot “do” Africa remotely, so more and more local offices are likely to appear. Local talent, aided by significant returning diaspora, will be valued more highly and the market will be an international one. The effect will be significant: in terms of the capital deployed, the development of regional finance hubs, the required returns and the standards that these large firms will demand. In a few years, the initial public offering (IPO) pipeline will also be of greater importance, resulting in both a challenge and a huge opportunity for local stock exchanges. But this will be accompanied by the ongoing growth of African domestic investment, especially from its nascent sovereign funds, which are already using international consultants to assess African private equity opportunities. Local pension fund demand also looks set to grow, and savings and pension reform has been very significant in places.
This is especially the case with Regulation 28 in South Africa, with the increase in offshore limits for funds from 20% to 25%, and an additional 5% allowed in African markets outside South Africa, but meaningful pension developments can be found north of the Limpopo as well. Gradually, Africa will also become a more mainstream destination for international investors, helped in no small part by the larger global private equity firms driving the market. Recently Investec has seen four sovereign funds, in Asia, Africa and the Middle East, for example, make their first moves in Africa by investing directly into two of their private equity fund portfolio companies. Another aspect of this new phase for private equity in Africa is increased specialisation, focus, and diversification into other private asset classes. While generalist funds are still the mainstay, platform and country or regional-focused funds are proliferating. Infrastructure, infrastructure debt, power generation, green energy, oil and gas platform plays, mining, real estate, “impact” (affordable housing for example), DRC only, Kenya only, Sierra Leone, Ethiopia only, are all examples of the development in focused funds.
Perhaps private credit is one of the most significant developments – an asset class pioneered in Africa by Investec Asset Management in 2008, and one that is a game-changer for African capital markets given the previous absence of this as an asset class on the continent.
This is all symptomatic of an increasingly sophisticated private markets landscape. McKinsey estimates that continent-wide demand for capital should increase by 8% per annum between now and 2018, with 20% growth annually in 10 countries, and reaching $50 billion in the next decade.7 They also, importantly, point out that significant mismatches exist, between capital supply and demand, across sectors and across market sizes and the study concludes that the most extreme sectors are in real estate, infrastructure and small/midcap.
Capital raising and return
profiles for private equity in Africa
Chronic shortages of capital do still exist in the so-called “middle market” private equity space. This is significant, even versus other emerging markets, and makes asset pricing often extremely attractive by global standards. While some valuation is down to risk – for example Zimbabwean platinum mining credit priced at 12% above Libor is probably understandable, as is, perhaps, a Central African Republic FMCG name on 3 times EBITDA – much is not. You can still find Nigerian consumer plays for around 4 times EBITDA and, as another example, within credit, spreads in sensible African countries
are higher than US and European high yield peers, but with much lower leverage and typically senior secured rather than subordinated.
The amount of capital raised by African private equity funds in 2013 was up 43% year on year according to Ernst & Young (to US$3.3 billion, so still not a big number, but currently some US$4.5 billion is being raised) – while emerging markets as a whole, experienced a 7% decline, to US$24 billion.8
Riscura published a compelling study looking at African private equity multiples and leverage versus the US and Asia – the report’s conclusions showed material differences in terms of debt usage, in particular (2x earnings before interest, taxes, depreciation, and amortization (EBITDA) in Africa versus circa 6x in the US and 4x in Asia), and a lack of leverage-dependence for returns – and that leverage number shrinks outside South Africa. Average deal valuations are materially lower in all deal sizes and twice as many deals take place in the 2.5-5x EBITDA range than for the global average. Ernst & Young, in its recent exit study for African private equity, demonstrated that African exits have outperformed European and North American ones over the past three years, though with typically longer holding periods.9 Of course, one can drive a bus through the spreads, but African private equity returns are broadly stacking up well and capital starvation, partly as a result of the relative (sometimes very significant) under-development of bank lending, creates compelling opportunities.
Ernst & Young also concluded that private equity exits “outperform public markets in aggregate, partly because private equity firms add value over and above the simple provision of capital in support of the operational and strategic growth of businesses”.10 African private equity returns were estimated to be 1.6x relative to MSCI Emerging Markets Index and they were 1.9x that of the Johannesburg Stock Exchange. The IFC concurred in its May 2014 report, where it showed private equity funds achieving roughly double the returns of the MSCI Global Emerging Markets Index between 2000 and 2013.11 And there are other issues with Africa’s listed markets: volatility, despite African markets having materially decoupled from global emerging markets, can be very significant and liquidity very low. While there are technically 22 African stock exchanges, liquidity gaps down dramatically after South Africa. South Africa’s US$1.3 billion average daily volume plummets to US$73 million in Egypt, Africa’s second largest exchange, US$24 million in Nigeria, US$23 million in Kenya and US$13 million in Morocco.12
At some point, Africa will experience dramatic changes to these numbers. Angola will have an exchange, perhaps in 2016, and Nigeria may achieve its US$1 trillion target, but it is hard to deploy the same sort of capital into Africa’s listed markets, compared to private equity. Critically, the composition of local exchanges, relative to their country’s GDP, are disconnected. Nigeria is particularly interesting, with energy, historically, being a very small part of the Lagos exchange, but being 40% of GDP (at least before the April GDP revisions), while listed exposure to the Nigerian consumer’s discretionary spending – a huge macroeconomic story – is hard to come by. The same is true for all African markets when you move away from South Africa (which is actually a reasonably representative snapshot of that economy).
On the other hand, aggregated private equity exposure to Africa’s GDP is almost a mirror image of it in terms of sector exposure. Listed market capitalisations (as a percentage of GDP) are predictably very low in Africa – Kenya’s is 36%, Nigeria’s is 21%, Ghana’s is 8%, and Ivory Coast is 31%. India and Brazil, by comparison, are upwards of 60%. And this is before countries, like Nigeria, revise their GDP by the small matter of 89%13 – a recent move that took their number above South Africa – but, of course, this is also a public markets structural “buy” case. Significant private equity activity should, along with burgeoning domestic institutional equity appetite, lead to significant listed market growth.
Why private equity
matters for Africa
Aside from the creation of IPO supply as funds enter their harvesting phases, private equity can have a deeper and more profound effect on the growth of Africa’s markets. In contrast to other parts of the world, the focus is on growth capital – with limited leverage and limited management change being features of African private equity. In 2007, the Economist famously wrote that: “Private equity is routinely charged with all sorts of iniquity. It strips companies of assets and flips them for a fast buck. It loads them up with dangerous amounts of debt, to suck out capital for its investors. It pays scant attention to employees and suppliers. If the markets turn, the volume of condemnation will only increase”.14 This, for many reasons, does not describe what African private equity does – it is largely a far more benign, constructive influence. Leverage as a source of returns is de minimis, especially in Africa, ex-South Africa, some 80% of firms take minority stakes (hence the need to back the right management teams), and the biggest growth driver is, unequivocally, organic revenue growth. Two-thirds of African private equity EBITDA growth comes from this, versus less than half in developed markets, and this is more than the average in emerging markets.
In addition to the growth, rather than buy-out focus of African private equity, there are other factors at work that bode well for the quality of Africa’s economic transformation, not least the core role played by DFIs in African private equity. DFIs, the all-weather investors in this asset class, have played a part in driving the high quality of improvements of environmental, social and corporate governance (ESG) in African companies. Ernst & Young recently noted that “As government-owned institutions, they have had a duty to report back to key stakeholders on where they have invested their capital and the developmental impact this has had. Governments…have maintained pressure on DFIs…to ensure not only that ethical best practices are adhered to, but also that sustainable development is achieved. This has resulted in many of Africa’s private equity funds now being at the forefront of emerging markets in setting the standards for ESG”.15
“Private equity is routinely charged with all sorts of iniquity... If the markets turn, the volume of condemnation will only increase.”
Additionally, international investors want to know specifics about which DFIs have invested in a particular fund – an investment by a DFI is seen as a battle honour on the governance front, an increasingly important consideration for all investors. Whether it is guarding against environmental damage, improving health and safety, hygiene, reporting protocols, properly audited accounts, or establishing community projects, the implications for the quality of Africa’s growth are significant. Moreover, Ernst & Young has demonstrated that there is no trade-off between returns and ESG, and where governance changes are made, firms get very significantly higher returns versus where they are not. This is obviously slightly different to ESG integration in public markets, where the ability to truly influence, at least without significant ownership, is sometimes limited.
At some point, public markets will catch up and fulfil some of the roles currently filled by alternative sources, at least in terms of scale. The onus is on public markets to keep up with the degree of development that is being catalysed by private markets. Of course, the two are intertwined – whether it is in the many Private Investment in Public Equity (PIPE) investments made by private equity or because the public market routes to exit result in, on average, higher returns for PE firms. The latter’s interest in their development is therefore a given, and by far the majority of African exits are currently to trade buyers, something that needs to be rebalanced.
From a generalist investor’s perspective, there are, of course, good reasons to have exposure across the liquidity spectrum and capital structure of Africa’s markets, mindful of volatility and the need for market timing as you move along the asset classes. But the case for private equity, in this complex and vast opportunity, where investors can deploy relatively large amounts of capital and access sectors and markets often unrepresented in Africa’s stock exchanges, is a compelling one.
“Of course, public and private markets are intertwined.”
There are as many Africas as there are books about Africa... wrote the Kenyan aviatrice, Beryl Markham, in “West with the Night” in 1942. The first woman to fly solo across the Atlantic from east to west would have appreciated more than most, the need to be able to skilfully navigate this continent and see it all from 30,000 feet. Well, more like two thousand feet in her 1936 Percival, but the point is clear.
Nick Tims is a Managing Director of Investec Asset Management’s UK Institutional Client Group.
1 IFC Institutional Investor Forum, New York, 6 May 2014.
2 Private Equity Roundup – Africa, EY, 2014.
3 World Economic Outlook Database, International Monetary Fund, October 2012.
4 World Population Prospects: The 2012 Revision, United Nations, Department of Economic and Social Affairs - New York 2013.
5 EY’s Africa Attractiveness Survey 2013. Data originally from: The World Development Indicators, World Bank, 6 Feb 2013.
6 CNBC 23 September 2013, Africa Panel.
7 McKinsey Quarterly February 2014 Uncovering hidden investment opportunities in Africa.
8 Private equity roundup, Africa 2014, Ernst & Young.
9 EY /AVCA Broadening horizons: how do private equity investors create value in Africa? A joint study of private equity exits in Africa by AVCA and EY 2 April 2014.
10 EY/AVCA Harvesting growth: how do private equity investors create value? A joint study of private equity exits in Africa by AVCA and EY April 2013.
11 IFC Institutional Investor Forum, New York, May 6, 2014 – IRRs from 2000 to 6/2011, 12/2011, 6/2012, 12/2012, 6/2013.
12 Bloomberg and African Alliance Securities Research, 31 March 2014.
13 Market capitalization of listed companies (% of GDP), The World Bank, 2012.
14 The trouble with private equity, The Economist, Jul 5th 2007.
15 Y/AVCA Harvesting growth: how do private equity investors create value? A joint study of private equity exits in Africa by AVCA and EY April 2013.