Nigeria: achieving private equity exits in today’s market

May 2021 | EXPERT BRIEFING | PRIVATE EQUITY

financierworldwide.com

Nigeria has attracted more private equity (PE) investments in the last decade than previously, particularly in its fast-moving consumer goods (FMCG), technology and financial services sectors. According to the African Private Equity and Venture Capital Association (AVCA), PE investments into Nigeria accounted for 68 percent of PE deal value and 55 percent of deal volume in West Africa, between 2014 and 2019.

Nigeria is also recognised as Africa’s most attractive country for PE investments, underscored by the fact that within the same period, West Africa boasted the highest volume (24 percent) of African PE deals by region. However, PE exits in Nigeria between 2016 and 2017 accounted for 6 percent of exit activity in Africa. A successful exit from a PE investment in Nigeria requires careful contemplation of several exit options, especially considering the global economic recession resulting from the coronavirus (COVID-19) pandemic.

PE investors generally hold on to their investments in Nigerian portfolio companies for an average of five to eight years before exiting. In recent times, the pandemic, decline in oil prices and devaluation of the naira have occasioned market illiquidity, uncertainties in the valuation process, and heightened foreign exchange volatility. These factors have significantly impacted the timing of PE exits from portfolio companies, engendering longer investment periods.

Furthermore, difficulty in scaling operations, especially with regulatory uncertainties within certain sectors, has also impacted PE exits. Most PE investors in Nigeria are willing to ride the tide of market illiquidity and wait until the markets stabilise before divesting their interests. However, some other investors are liquidating their investments to reallocate assets, gain liquidity, exit distressed industries, reduce funding liabilities, hedge their investments and manage key limited partner (LP) relationships. This calls for a consideration of the most appropriate exit strategy for PE investors in today’s market.

At present in the Nigerian market, there are several exit options open to PE investors. These options include secondary sale, initial public offering (IPO), management buyout (MBO), sale effected via a scheme of arrangement and share redemptions. Each exit option comes with a string of considerations to bear in mind. Across Africa, exit options lean toward secondary sales to trade and financial buyers. For example, according to the AVCA, in 2019 there were 43 exits from portfolio companies in Africa, with 44 percent of these constituting a sale to trade buyers and 23 percent being sales to financial buyers. Similarly, in the first half of 2020, 13 exits were reported with financial buyers representing 54 percent of total exit volume and trade buyers representing 31 percent.

The most common exit option from Nigeria by PE investors is secondary sales to trade buyers, PE firms and other financial buyers. PE firms that have utilised secondary sale as an exit route include Actis, in its exit from C & I Leasing to Peace Mass Transit in 2021 and African Capital Alliance, in its exit from Cornerstone Tower to Everty in 2019.

Globally, IPOs are one of the most attractive exit routes in the PE industry. However, the converse is the case with the African PE market, particularly the Nigerian market. According to data from the Securities and Exchange Commission (SEC), only about 319bn naira (approximately US$797m) was raised through IPOs in Nigeria between 1999 and 2019. These include both PE-backed and non-PE-backed IPOs. The dearth of IPOs in Nigeria may be attributed to macroeconomic conditions in the country, including the weakening of the naira and shortage of foreign currency, now accentuated by the effects of COVID-19 and the stringent listing requirements of the Nigerian Stock Exchange.

Investors seeking to exit via an IPO have had to postpone their exit or consider alternative exit routes. An example is the Interswitch Group, backed by Helios Investment Partners and TA Investments, which has had to suspend its plans twice in the last four years to raise $1bn through a dual listing on the London and Nigerian stock exchanges.

MBO is another exit option open to PE investors in the Nigerian market, albeit an option that is rarely explored. An MBO involves the sale of a portfolio company to its management team or senior employees. It typically requires the approval of the management of the company making the acquisition, sector-specific regulators in certain instances, and the SEC when a public company is involved. In the current macroeconomic conditions, an MBO may only be viable in industries that thrived during the pandemic. The management team of businesses whose profits plummeted during the pandemic may be averse to executing an MBO until such businesses become profitable.

Furthermore, a scheme of arrangement between the portfolio company and another company is also an exit option open to PE investors in Nigeria. In making an exit, PE investors that own controlling shares of an investee company may require the company to undertake a scheme of arrangement under which the company’s shares are transferred to a financial investor or trade buyer. This exit option, which involves the Nigerian courts, may be utilised in situations where the portfolio company has a fragmented shareholder base, and where the acquirer desires to acquire the entire issued share capital of the portfolio company.

According to global fund adviser Triago, GP-led fund restructurings accounted for most PE secondary deal activity in 2020. Generally, this involves existing LPs being given the option to sell all or a portion of their fund interests to an acquirer or to roll their pro rata interest in the fund into a special purpose vehicle set up to purchase the assets of the fund. GP-led restructuring, where managers roll assets from an existing fund into a new vehicle, accounted for more than 52 percent of PE secondaries deal activity in 2020, according to Triago. This provided liquidity for LPs in the difficult COVID-19 environment and may also serve as an exit strategy in today’s market.

Where a PE investor holds redeemable preference shares in a portfolio company, the redemption of these shares provides an exit strategy for the investor to recoup its investment in the company. Redemption rights are usually priced at a premium, providing a higher return for investors even where the fair market value of the shares at the time of redemption is about the same price as at the point of the initial investment.

However, this return is usually less than the returns from a mature exit of a high-performing investment. Nevertheless, the exercise of its right of redemption may provide partial or complete liquidity for the PE investor. It must be borne in mind that this exit option is subject to compliance with the provisions of the Companies and Allied Matters Act, 2020 (CAMA), which requires that redemption of the redeemable preference shares be made either from profits available for dividends or the proceeds of a fresh share issuance undertaken specifically for redemption by the portfolio company. The exercise of redemption right is more useful in an underperforming portfolio that has a near-zero potential to offer investment multiples to the PE investors.

Irrespective of the exit options being explored by a PE firm, certain key considerations are imperative. First, is exit timing. Exit is the last step of the PE investment process and is critical to it. A poorly planned, poorly timed, or poorly executed exit can turn a good deal into a mediocre one. The global economic depression precipitated by COVID-19, the devaluation of the naira and current foreign exchange volatility create unfavourable conditions for PE exits.

Nonetheless, exits may be needed when the PE investor is at the end of its fund lifecycle or if the investment was made in a sector where the prognosis for recovery is bleak. Aligning management of portfolio companies is also integral to a successful exit, more so in the current climate where a lot more is required from the management team in executing a successful exit. A thorough understanding of the contractual and regulatory requirements specific to the proposed divestment is also pivotal to a successful exit.

The most utilised PE exit option in Nigeria is secondary sale to a strategic buyer, and this is likely to continue as strategic buyers consider making acquisitions. Exit through a secondary sale may be consummated either through a sale of direct portfolio companies or a sale of interests in limited partnership funds. In considering a secondary sale, one should look to various factors, including restrictions, if any, on the transfer of shares in a portfolio company in its articles of association, shareholders’ agreement or the fund’s governing documents, checking especially for drag-along rights and clawback provisions, and material adverse change clauses in contracts to which the investee company is a party.

Depending on the sector in which the company operates and the turnover of the portfolio company, sector-specific approvals and merger clearance from the Federal Competition and Consumer Protection Commission (FCCPC) may also be required to successfully effect a secondary sale. In relation to tax considerations, it is noteworthy that gains accruing from share sales in Nigeria are exempt from capital gains tax.

According to McKinsey, announced PE exits dropped almost 70 percent globally in May 2020 compared with May 2019. Notwithstanding these trends, we envisage a resurgence of exit activities within industries, such as the e-commerce, e-learning, fintech, telecommunications, healthcare, and healthtech sectors that have thrived despite the COVID-19 pandemic.

To achieve PE exits in today’s uncertain market, PE investors must approach the exit stage with careful planning and adopt an exit strategy that reduces risk and maximises returns.

Anu Balogun is a partner and Olayanju Phillips is an associate at Olaniwun Ajayi LP. Ms Balogun can be contacted on +234 1 270 2251 or by email: abalogun@olaniwunajayi.net. Mr Phillips can be contacted by email: ophillips@olaniwunajayi.net.

Anu Balogun and Olayanju Phillips

Olaniwun Ajayi LP