December 2019 Issue
For many companies, the question of whether to invest in emerging markets has long been a complex one. While these markets may provide strong returns and faster growth than some developed markets, they are also fraught with risk. And as many emerging markets have begun to slow in recent years, the question has become more pointed, particularly as geopolitical concerns and global financial conditions have increased uncertainty.
For the private equity (PE) industry, however, Africa has offered some attractive investment opportunities. According to DLA Piper, between 2012 and 2017, 953 African PE deals worth US$24.4bn were reported. Firms such as IFC, CDC Group, Actis, Helios, DPI and ECP were engaged in dealmaking across the continent. Headline deals recorded in 2018 included TPG Growth’s $48m investment in Cellulant (the largest investment across Africa’s digital payments space to date), the Carlyle Group’s $40m acquisition of online travel agency Wakanow and LeapFrog’s investment in ARM Pensions.
Nigeria has seen increased interest in indigenous funds and ‘Africa-focused’ funds managed by foreign investors, especially development finance institutions. “In December 2018, the UK’s CDC Group invested about US$15m in CardinalStone Capital Advisers’ Growth Fund (CCA) and announced its intention to invest a further US$4.5bn across Africa over the next four years,” says Adedoyin Afun, a partner at Bloomfield Law Practice. “Beta.Ventures, an early stage VC fund manager in Nigeria, was recently approved by a foreign funder backed by European Development Finance Institutions (EDFI) for a yet-to-be-announced US$3m to US$5m investment in its Beta Ventures Fund II, which is targeted at early-stage tech-enabled companies operating in Nigeria. There has also been increased investment activity in indigenous funds by foreign private investors through family offices and nominee and trust arrangements.”
Though venture capital has attracted more attention in Africa over the last decade, PE activity has remained robust. “The African PE market is relatively stable, with transaction attractiveness surveys highlighting evolving gross domestic product (GDP) growth in counties like Ethiopia and Ghana, and the benefits of business policy and commodity price improvements in countries like Nigeria,” says Dan Agbor, a senior partner at Udo Udoma & Belo-Osagie. “Macroeconomic recovery, net export growth, political stability, reduced inflation and favourable fiscals have impacted the realisation of African investments over the medium-to-long term.”
However, there are headwinds affecting the industry. African PE can be a daunting prospect for those new to the continent. Due diligence, early liquidity options and carefully diversified portfolios are just a few considerations firms should evaluate before investing. Furthermore, currency risks, such as foreign currency shortages and exchange rate fluctuations, may add to uncertainty.
Furthermore, the African PE market is being compressed by perceived political risk and instability. “Realisation on the continent has slowed and stabilised, with the current status quo expected to persist,” notes Ashford Nyatsumba, a partner at Webber Wentzel. “While the outlook on deal flow and exits in South Africa, for example, remains positive, previously expected growth frontiers such as Nigeria, Kenya, Tanzania and Rwanda have not delivered on the promise initially expected. Much of this is down to changed economic and political policies in these jurisdictions.” Indeed, Africa has been ranked as the worst emerging market for realisations, with 40 percent of investors citing a weak exit environment as a deterrent, according to the 2019 Emerging Markets Private Equity Association (EMPEA) Global Limited Partner Survey.
Historically, exits have been a sticking point for the African PE industry. Interest from strategic buyers has decreased in recent years, according to the EMPEA, though secondary sales have picked up over the last decade. However, it can often take longer to exit in Africa, compared to other, more developed markets. According to the African Private Equity and Venture Capital Association’s (AVCA’s) 2018 Limited Partner Survey, 65 percent of limited partners (LPs) view limited exit opportunities in Africa as a key challenge for GPs over the next three years.
Historically, the volume of exits, along with the quality of available exit routes available in Africa, have been key concerns among LPs. In 2018, exits to trade buyers accounted for 39 percent of all exits, while secondaries and private sales accounted for 37 percent and 22 percent of all exits respectively. That IPOs accounted for just 2 percent of all exits in 2018 is also reflective of Africa’s relatively underdeveloped capital markets.
Secondary sales to PE firms and sales to strategic investors remain the preferred exit routes across Africa generally. “The majority of exits are seen in South Africa, where investor sentiment has improved in recent times, Nigeria, which is currently experiencing a ‘wait and see approach’ to PE, and Kenya,” says Mr Nyatsumba. “Also, jurisdictions like Egypt and Ghana, and more recently Ethiopia, are beginning to display signs of growth. International development finance institutions continue to represent the most active private equity fund investors in the region.”
“African PE can be a daunting prospect for those new to the continent. Due diligence, early liquidity options and carefully diversified portfolios are just a few considerations firms should evaluate before investing.”
The rising number of secondary sales does indicate a maturing African PE industry. “In 2017, PE and other financial buyers were the main exit route, representing 35 percent of the total number of exits,” says Enitan Obasanjo-Adeleye, a director and head of research at the AVCA. “An example is African Capital Alliance’s sale of Wakanow to The Carlyle Group in 2018. IPOs remain an uncommon exit route, but there have been a few recent examples such as Helios’ partial exit of Fawry on the Egyptian Stock exchange this year, and their listings of Vivo Energy last year, and more recently of Helios Towers Africa on the London Stock Exchange.”
Generating returns
The realisation of investments, though improving, remains a challenge. “Economic stability, diversification, strategic sector restructuring, implementation of ease of doing business policies, and streamlined regulatory and compliance processes remain crucial to sustained investment realisation,” says Mr Agbor. “Management teams’ investment strategies must factor in infrastructural challenges, foreign exchange liquidity, commodity price movements and geopolitical factors that are peculiar to the African market. These strategies are key to achieving investment success, however there are other factors to consider, such as ethical and strategic alignment with founders and key shareholders, allocating appropriate human and financial resources to due diligence and navigating regulatory and compliance requirements with experienced local and international advisers.”
Firms must consider exit strategies as early as possible in order to be successful. “The exit strategy will significantly affect the relationship between the business owner and the investor,” says Ms Obasanjo-Adeleye. “Therefore, even before investment, PE firms should make sure that their exit strategy aligns with the interests of the other stakeholders.”
There are, of course, other strategies available to firms. “Management teams can limit their foreign exchange exposure by adopting investment strategies which prioritise investments in companies whose operations are largely resistant to foreign exchange fluctuations, such as companies with receivables in the currency of the investment, or companies which utilise locally-sourced raw material,” suggests Mr Afun. “From a Nigerian perspective, management teams ensure that the invested capital flows into the country via the set foreign investment regime to guarantee repatriation of returns on investment in foreign exchange. Management teams can also prioritise investments in sectors which are not heavily regulated, or which rely significantly on government support. At all times, management teams should measure their exposure to political risk and adjust their strategy as may be necessary. This may require diversification of their investment portfolios to diverse sectors of the economy.”
Exits
More must be done to facilitate exit activity in the African PE market. In the coming years, many African jurisdictions are expected to strengthen their investment frameworks, with the introduction of investor-friendly policies and forward-thinking regulation.
“With Africa as a whole representing a ‘new’ frontier for Chinese investment, this is set to increase competition and create a number of new exit avenues for traditional PE investors and firms,” points out Mr Nyatsumba. “Furthermore, global trends such as Brexit and increased US protectionism are set to make Africa a fertile ground for PE deal flow for investors seeking new or untapped opportunities in markets less subscribed in search of greater yields and profit margins. This will, of course, be counterbalanced by the inevitable risks and challenges associated with doing business in Africa, such as corruption, political instability and heavy natural resource-based economies.”
Current exit trends are expected to prevail, with the option of multi-track exit processes being adopted, timing and regulatory considerations as well as the limited capacity and size of most African capital markets continuing to restrict IPO exits in the short to medium term. “Macroeconomic uncertainty in countries like South Africa may also impact on exit volumes in the short term,” says Mr Agbor. “Overall investor optimism in the continent, however, remains relatively strong in the long term.”
Trade or strategic buyers have been the main exit route in the region, according to the AVCA, typically representing between 40-50 percent of exits. In 2018, trade sales accounted for 39 percent of total exits; of those, 50 percent were to multinational strategic buyers.
Though IPOs will remain low, Ms Obasanjo-Adeleye expects to see the occasional exciting dual or offshore listing for larger companies. “Listings are interesting because they provide an opportunity for price discovery, though they are also more subject to market sentiment,” she says.
“We expect a continuation of the trend toward sales to strategic buyers,” says Mr Afun. “We also expect an increase in buybacks by founders of investee companies, either by obtaining leverage or from personal financing. There have been some exits by way of secondary sale to other private equity investments and we expect that this trend will also continue. We do not anticipate an increase in exits through management buyouts or IPOs, as exits through these means are historically rare. We anticipate higher exit volumes due to the rise in competitive bids, among other factors.”
Africa will continue to offer attractive opportunities, particularly in the infrastructure space, which requires significant investment. According to the African Development Bank (AfDB) the continent’s minimum infrastructure needs – for countries to sustain the growth of their economies, population, income level and replace ageing infrastructure – is between US$130bn and US$170bn per annum. Infrastructure investments should be a priority as, according to the World Bank, Africa’s urban population is set to double over the next 25 years. Foreign direct investment, notably from China, has begun to enter the region and the infrastructure space, but much more is needed.
However, Africa will not be immune to the volatility and uncertainty influencing the global economy. According to a recent AVCA report, several PE firms have amended their exit plans due to political or currency risks. Across Africa, however challenges lie ahead and firms must be prepared.
© Financier Worldwide
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Richard Summerfield