Growth fundamentals for Africa remain, despite lower M&A activity

August 2016 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

The fundamental drivers for growth and investment in Africa remain intact. This is the long-term backdrop against which to view more short-term factors, such as slowing economic growth and a decline in merger and acquisition (M&A) activity.

Significant M&A activity in the commodity, consumer and TMT sectors shows that investors are backing longer-term growth prospects in various parts of sub-Saharan Africa.

The sharp fall in commodity prices, which affects many African economies, is a cyclical decline. When commodity prices rise again, economic activity and growth will turn upward once more.

Since the start of 2016, and in particular the period from January to early March this year, there was very negative market sentiment around three factors in particular: lower global growth, the impact that the Chinese slowdown has been having on commodity prices, and the softness in the price of oil.

This negativity impacted the growth outlook for emerging markets, including appetite for big investments in Africa. There has also been a weakness in the currency market, particularly for emerging market currencies.

As a result of these factors, the decline in African M&A activity seen in 2015 continued into 2016. According to Dealogic, the early part of 2016 peaked with 68 deals worth $5.1bn in February, after 55 deals worth $2bn in January. Then the numbers dropped again, to 45 deals in March, 41 in April and 42 in May, worth $3.3bn.

Four reasons why growth will return

The belief that the downturn in M&A activity in Africa is cyclical and not fundamental or secular is based on the fundamental drivers for growth in Africa.

Firstly, Africa remains among the fastest growing economies in the world. To be sure, the current growth rate and projections for future growth have declined, but African economies are still growing rapidly compared to other regions of the world.

Secondly, the demographics of Africa have not changed. Africa still has a growing population, and trends like urbanisation continue.

Thirdly, the big theme of the last two decades across Africa has been the improving quality of political systems and governance. The recent meeting of the World Economic Forum in Rwanda highlighted that the benefits of good governance are flowing through to economies and people. That secular trend has not changed.

Finally, Africa still has abundant natural resources. Commodity prices have come down, but they are, by definition, cyclical.

Investor interest remains

Investor interest may have dropped in the near-term, but it has not gone away. We are seeing some very large deals in the commodity market in Africa. One example is the recent purchase by China Molybdenum of copper assets in the Democratic Republic of Congo from US company Freeport. That transaction was valued in excess of $2.65bn.

In the consumer sector, there have been investments in two areas – consumer goods and products, and financial inclusion.

In consumer products, we have seen three substantial investments in Nigeria in 2015 and 2016; all of them part of regional expansion plans. Early this year, Olam, which already has operations in Nigeria, Ghana, Senegal and Cameroon, invested a further $275m in wheat and flour milling operations in Nigeria. Kellogg last year announced a $450m investment in food sales and distribution in Nigeria. Finally, Coca-Cola made an investment in juices in Nigeria.

Linked to the theme about the African consumer, is financial inclusion. This addresses the rising wealth of the African consumer and provides access to financial services. In insurance, in asset management and in the banking sector, there are continued interest and investment by global companies and by South African companies expanding into the under-penetrated parts of Africa.

Then there is the telecoms sector. In various parts of the world, and particularly in Europe and the US, telecoms companies are selling their towers and other passive infrastructure to companies specialising in this part of the telecoms business. This is happening in Africa, too, and one of the companies buying these towers is a home-grown African company called IHS, which has a substantial presence in Nigeria and operations in Ivory Coast, Rwanda, Zambia and Cameroon.

Asian companies are buying into Africa

There are some interesting characteristics regarding M&A activity in Africa this year. The activity has been selective, such as where mining and natural resources companies are reassessing their asset portfolios and divesting certain assets.

Asian companies – and Chinese investors in particular – have been the main buyers of these assets. Junior miners are not taking the opportunity to expand their portfolios, because they no longer have the support in the capital markets that they enjoyed five or six years ago.

Another continuing M&A theme is acquisitions in the developed world by companies from South Africa. South African companies are investing outside of Africa, and Steinhoff is one example.

Waiting for commodities to stabilise

When the upturn happens will depend on when commodity prices stabilise. The crude oil price, which people watch closely, is probably about 70 percent above the lows reached this year. This may be due to specific events, but nevertheless there has been a bounce from the bottom.

A second factor will be attitudes to risk. The risk appetite of companies and capital markets has been subdued for the last six to eight months. The slowdown in China and the policies of central banks will have an impact on the view that the markets take toward more risky assets. Not to mention Brexit.

Then there is the fact that some African countries are heavily indebted. This is a big dark cloud on the horizon for Africa, because a credit event in any country could taint the overall environment for Africa.

Markets are interrelated, as is investor risk appetite. So if we were to see a sovereign credit event, or a large credit event, in a particular country in Africa, it is likely to impact the attitude of markets to risk assets across the continent.

Investors have tempered their expectations of Africa, which is good. There is now a sense of realism about the potential of Africa, which reflects the real challenges of doing business on this continent. With that said, investors are not writing off Africa because they realise that the fundamental building blocks of growth across the continent remain in place.

Hasnen Varawalla is the head of corporate finance for Barclays Africa Investment Banking Division. He can be contacted on +27 11 895 6999 or by email: hasnen.varawalla@barclays.com.

Hasnen Varawalla

Barclays Africa