By Khalid Bekhtaoui
“Africa is the story. The big story is Africa. The Chinese and Japanese are fighting over Africa. This is a market of a billion people, of natural resources. Make no mistake, Africa is on the move and it is moving forward.”| Ahmed Heikal, Founder of Citadel Capital
A decade ago, African countries were among the recipients of a general boom in investment in emerging markets worldwide. Several private equity funds made Africa a primary target, and record amounts were raised to invest in businesses there. The 2 largest economies, Nigeria and South Africa, dominated deal values and deal volumes. Carlyle, an American private-equity firm with a US$750 million pot devoted to Africa, bought a majority stake in South Africa’s largest tire retailer, Tiger, in 2014 and subsequent deals have followed throughout South Africa.
The New Kids on the Block
However, sponsors are beginning to look at less-established markets. According to analysts at Morgan Stanley:
“The South African market is becoming mature, the internal rate of return is coming down, and at the same time, the rest of Africa is opening up through political stability, an emphasis on anti-corruption and potentially higher returns similar to what South Africa was offering in the early days.“
For example, East Africa is one region in which private equity firms have taken considerable interest. Kenya has shown consistent annual gross domestic product (GDP) growth of more than 5.5 percent. Tanzania’s GDP grew by 7 percent in 2014.
According to Morgan Stanley:
“What we are seeing is a change in mindset. Before 2000, Africa was a place for foreign aid. Now it is about foreign direct investment (FDI) and investment opportunities.”
This is largely driven by the gradual urbanization and the growth of the middle class and disposable incomes. The result is an increased demand for consumer goods and services, which falls into the “sweet spot for private equity.”
Of course, there are deep structural issues in Africa. Transparency International still rates several African states among the most corrupt in the world. Moreover, the scale of traditional private equity opportunities in Africa is limited. Large funds usually want to buy businesses worth more than US$100 million, but last year there were only 7 deals of this magnitude on the continent.
On average, the deal sizes are smaller in Africa, but the legal complexity is often greater than in North America or Europe. Also, it is important not to equate the opportunities in Africa with those in other emerging markets such as China and India. It is worth remembering that there are several major differences, particularly the fact that Africa is comprised of 56 different countries, each with its own specific investment micro-climate.
Mali is not the same as Malawi, for example. That means a lot of upfront investment work is required in order to understand these individual countries.
Despite these obstacles, the potential rewards are vast. Private equity opportunities that exist in Africa are not possible in the West. Notably, some private equity firms are investing heavily in private health and educational establishments such as universities. In the majority of the developed world, bringing the profit angle into public services is seen as controversial. In Africa, where there is so much unmet need for such services, this means that it is less of a taboo.
On January 12th, 2015, Helios Partners, a London-based firm, said it had raised the first Africa fund worth more than US$1 billion. Investors say there is no requirement for financial manipulation to increase returns in Africa, unlike in Europe and North America, where firms usually take on greater debt to increase their profits. African returns instead accumulate from the companies’ inherent growth potential and their rapidly expanding markets.
The Need For A Different Approach
What this does mean is that private equity funds must follow a different strategy in Africa to the mainstream buyout model that exists in the West and China. Certainly, investors tend to deploy a much more long-term model. Africa’s capital markets are immature. The Nigerian Stock Exchange only adopted Nasdaq’s X-Stream trading platform in 2013.
The 3-year flip or exit via IPO is not something many private equity firms are demanding in Africa.
Analysts at J.P. Morgan argue that:
“It is less common that an exit will be realized within a typical private equity time frame. Estimations of exit periods are likely to take 4-7 years, rather than the typical 3-5 year range in more developed markets.”
Two years ago, an US$8.1 billion investment splurge by the largest private equity funds led to expectations that Africa would feature prominently in their portfolios. This has not entirely panned out, particularly due to the drastic fall in commodity prices. Moreover, despite the recent flurry of fund-raising, only about 1 percent of global private equity goes to Africa. Nigeria, Africa’s largest economy, fell into recession for the first time in 25 years in 2016. Despite this, Africa is host to 6 of the world’s fastest-growing economies in the last decade.
Consumption in many of the region’s countries has been outpacing GDP growth for the past 10 years. Andrew Newington, chief operating officer at Actis Capital, said his fund had no plans to retreat from Africa. “These are big countries and they are growing. We are committed to them through their cycles” he added.
Boldly speaking, the African growth story will be the defining narrative of this century. As globalization accelerates Africa’s development, the continent will finally find its rightful, long-awaited place in the developed world. Private equity investment will play a key role in ensuring that that happens.
Those brave enough to run the risks of investing will need to roll up their sleeves and take an active role in maximizing the potential opportunities. There will be no place for passive investing. The required level of commitment will be necessary, but the potential rewards will be substantial, both for the developed world and for the future of Africa.
Khalid Bekhtaoui is a student at the London School of Economics. The original version of this article was published at the Market Mogul publication.