Profits and pitfalls on private path into Africa

Private equity has been drawing investors’ interest as an effective vehicle to access the African growth story, fuelled by a phenomenal rise of the middle class and expansion of private consumption. While stockmarkets across the African continent are, with a few exceptions, still in an early stage of development, there are a range of factors fuelling investor interest in private equity. 

Favourable demographics, more widespread adoption of democracy, with Nigeria’s latest elections a significant example, liberal economic policies, better corporate governance and improving education levels are driving high levels of economic expansion. Five of the world’s 10 fastest-growing countries are African, including Ethiopia, Mozambique, Tanzania, Ghana and Nigeria, with GDP growth rates between 7 and 8 per cent, according to the Economist. 

Although private equity in Africa is still a relatively new sector, African fund raising has been particularly strong during 2015. While 10 to 15 years ago, investors would have focused on natural resources and mining, today financial services, telecommunication and consumer businesses are considered the more attractive plays. 

“Much of African growth is consumer-driven, as demand increases for services such as telecommunication, banking, healthcare, fast-moving consumer goods and education,” says Eduardo Gutierrez, partner at Development Partners International (DPI), an African private equity specialist which has raised $1bn (€880m) for two funds during the past six years.

Financial services, in particular, are seen as a major investment opportunity, as the vast majority of the continent is still unbanked, with most banks under-capitalised and unable to cope with demand. Insurance services could also benefit from rising levels of GDP per capita. 

In telecoms, the latest wave of developments has seen private equity companies acquiring stakes in telecommunication towers from operators. Advanced services enabling customers to pay their bills through mobile phone, and huge growth of e-payment services are clear signals of the “leapfrog effect” in Africa. 

“Mobile payment is more advanced in Kenya than in the UK,” says Ms Maty Ndiaye, director at London-based Duet Africa Private Equity. The $5.5bn alternative investment house has invested in a number of private equity ventures, such as Ethiopia’s Dashen Brewery, and has just set up a sub-Saharan Africa hotel fund in partnership with construction firm Bouygues.

Contrary to popular perception, commodities have accounted for just 25 per cent of GDP expansion in Africa over the last 10 years. Private consumption, on the other hand, rose by $568bn from 2000 to 2012, which is larger than in either India or Russia, according to consulting firm McKinsey. Consumer-facing industries are expected to grow a further $410bn in Africa from 2012 to 2020. Sectors such as food, beverages and retail will benefit the most, says Ms Ndiaye. In particular, “organised retail”, including supermarkets, is forecast to grow significantly to meet consumers’ changing needs. 

Building material and cement is also on an upward trend, as the percentage of people living in cities is predicted to rise from 40 per cent today to 60 per cent by 2050. Average per capita income of urban dwellers is 80 per cent higher than the country average, according to Accenture and the UN Population Division.

The focus of the majority of African firms is to inject growth capital into companies looking to expand, explains Hurley Doddy, founding partner at Emerging Capital Partners (ECP). The pan-African private equity firm has raised more than $2bn through its three funds, since launching in 2000. 

The ability to spread out across different countries is one of the reasons enabling growth in African companies, he says. With more than 50 African cities with 1m plus people, business models that work in some cities can be successfully exported into nearby regions. However, despite progress in this space, more could be done by governments to eliminate trade barriers or double taxation, to make it easier for businesses to expand and achieve scale across regions.

Among others, the firm has invested in mobile phone tower company IHS in 2011, Africa’s biggest and the tenth largest in the world with more than 20,000 mobile phone towers, and in Java House, the largest restaurant chain in East Africa.

“Family offices are increasingly interested in these types of direct investments,” says Mr Doddy, explaining that the minimum investment in the fund is $5m but varies according to specific deals. 

On the ground presence is important, as is finding good local partners and managers. Typically these are Africans who have worked and lived abroad, looking to return home to put the acquired experience into practice. 

The focus on African PE has clearly been raised over the last few years but execution remains the biggest risk. “You need to make sure you have the right people to execute your business plans,” says Duet’s Ms Ndiaye, explaining the importance of training a local management team to reduce risk at exit stage. 

Moreover, relative lack of infrastructure can represent major barriers to implementation of business plans. “There is a big gulf in Africa, particularly among big private equity firms between the appreciation for the macro opportunity and confidence in managing the micro reality and the risks associated with engaging on the ground,” notes Brian Menell, CEO of the Kemet Group, a company investing in and managing mining and other natural resource projects across the continent. 

“But the scale and diversity of opportunities in Africa is quite unique and given its immaturity, the potential upside in African private equity is much higher than in better traded and more competitive environments.” 

However, large banks such as Credit Suisse, JP Morgan and HSBC declined PWM’s request to comment on this topic, indicating this asset class is still perceived as niche. This can be an issue for global heavyweights.

“There is huge need for infrastructure in Africa and huge interest in it. The challenge for us is to find opportunities in size,” says Mark Haefele, UHNW chief investment officer at UBS Wealth Management, explaining that in the alternatives space, clients are recommended to buy baskets of assets.

However, growth capital – which in private equity means taking a stake in a privately owned asset that is well past the start up stage to finance future growth – is at the lower end of the risk-return spectrum of private equity, given lack of dependence on leverage, explains Andrew Lee, head of alternative investment strategy at UBS Wealth Management. 

Selective growth capital strategies in specific emerging markets are attractive to the Swiss bank and a focus on longer-term investment horizons allows sophisticated investors to be contrarian, he says.

In the private equity space, Pictet prefers developed markets, mainly Europe and the US, while selecting a handful of managers in China and Latin America. Indeed, the development of private equity in Africa is still at the early stage and lacks a proven ‘eco-system’, such as established teams, particularly important considering the average 10 year investment horizon.  

“We look for managers who have a proven ability in both acquiring, owning and exiting companies, across multiple deals, across bull and bear markets and in various industries,” says a partner at a Swiss-based alternative firm, managing assets for the group’s private banking. This is difficult to achieve in Africa, acknowledges the partner. 

Unlike Europe or the US, where “the rules of the game” are certain, one of the risks in frontier markets is that governments claim significant tax revenues on gains made by private equity firms, particularly foreign ones. 

“While some countries are very painful to deal with, because of high taxation and risk, the risk of governments claiming back tax revenues on capital gains is getting lower and lower,” says Jean-Charles Charki, co-founder of  IOTA Group, an Africa-focused advisory firm. 

The idea that “whimsical governments” can decide to tax investors randomly might be true in countries such as Zimbabwe, where the currency has plummeted to such an extent that it is to be phased out, but Africa is made up of 54 countries, which should be approached differently, he says.

“High-growth countries do not necessarily offer the best deal opportunities,” says Mr Charki. “The secret is to look for those disconnected from the government, not too sizeable, in the consumer retail business and priced well,” he says, admitting these are also what most project investors are going for. 

Mr Charki favours businesses in distribution and food processing, picking up in countries like Nigeria, where ready meal sales are booming. Interesting investment ideas are also linked to consumer-related products in extractive industries. An oil producing company has to provide food and accommodation and a whole range of services to its team for 20 to 30 years, says Mr Charki. As oil majors are looking to reduce capital expenditure, outsourcing has increased, opening up a number of possibilities.

“One reason why there are still a lot of opportunities in Africa and those investing will get very good returns is precisely because there are still people who have negative views about Africa and there is not too much capital chasing investments across the continent, compared to other emerging markets such as Latin America or China,” says ECP’s Mr Doddy.  “Keep in mind you need to buy low in order to sell high.” African investments also offer diversification benefits in portfolios, because of low correlation with other markets. 

Those who have never been to Africa may not realise the sheer scale of developments taking place, he says. “It took a while for people to think of China as a booming industrial place, rather than a bunch of farmers growing rice, and it’s the same with Africa.”