The Rise of Private Equity in Africa
What LPs are looking for
February 25, 2014
Africa’s economic growth over the last three years has been growing at approximately 5% a year, and according to the IMF’s economic outlook for Sub Saharan Africa, it is expected to rise to 5.5% this year and 6% next year. It is no wonder then that more and more international investors are now eyeing up private equity opportunities on the back of the continent’s consumer boom and ever-improving regulatory systems.
More and more, global investors are considering private equity (PE) as a more intelligent option over Africa’s public equity markets, due to its consumer opportunities, rising middle class, and limited global competition from other PE players.
Although PE has played its part in Africa’s success story over the last decade, the continent’s accelerating economic growth is enticing an influx of new PE investors and economic activity, with general partners (GPs) and limited partners (LPs) in particular, cashing in on the vast untapped opportunities.
The value of investments in Sub-Saharan Africa rose by 38% in the first half of 2011 compared to US$1.7 billion in the first six months of 2010. Additionally, African PE funds raised more than US$1.7 billion in the third quarter of 2011, with South African funds representing only 10%.
According to Ernst & Young, opportunities in Sub Saharan Africa, outside of South Africa, are beginning to pique international interest, helped by the widening of investment options open to PE investors, which includes investments into the financial services, technology, telecommunications, agriculture, consumer products, and infrastructure sectors.
The report also confirms that the last five years has seen a higher proportion of capital directed towards Sub-Saharan Africa’s frontier markets, such as Nigeria, Ghana, and Kenya.
Law firm Freshfields Bruckhaus Deringer has published its latest report on Africa’s merger and acquisition sector, revealing that investment into Africa is becoming more focused on the consumer-led industries, including the telecoms, retail, and food and drink, rivalling the better-known investment sectors, such as natural resources. Mergers and acquisitions (M&A) totalled US$3.8 billion across 71 deals in 2012, up from US$1.9 billion, and 33 deals in 2003, the report notes.
Adiba Ighodaro, Investor Development Partner at private equity firm Actis, says that investor interest has developed considerably in the last 12 to 18 months, and additionally, there has been more of an understanding about how to participate in private equity funds in Africa, as well as the types of opportunities that exist and where the GPs are.
Ms. Ighodaro adds however that many of these deals are made on the back of an industry interest, opposed to an interest in a particular part of Africa.
“Private equity commitments coming in from the US, for example, are already being made and in comparison to when we opened the office in 2000, there are many more GPs investing in Africa now and it’s similar to what we’ve seen happen in Brazil over the last 24 months with the huge amounts of capital rushing in there, although I don’t think we’ll see quite this level of interest in Africa yet,” Ms. Ighodaro says.
“Increasingly too the BRIC countries are becoming interested in our Pan African network and it’s growing market share, so we have that appetite to capitalise on. A lot of these companies have portfolios of where they want to invest and it seems to be industry specific.”
Alex-Handrah Aimé, Managing Director at pan-African private equity firm Emerging Capital Partners (ECP), agrees that the African PE industry has grown substantially in the last five years and that the sector will continue to evolve. However, she adds that the PE industry in Africa still has some way to go.
“The African private equity industry has changed and evolved since ECP begin investing in 2000. We are encouraged to see increasing interest from potential limited partners. There have been a number of changes suggesting the industry is deepening and maturing, such as the introduction of regional funds, for instance in East Africa, or on a country level, as in Nigeria.”
“There are some investors that are beginning to look at sector-focused funds but it’s not clear that the markets are deep enough yet to support this. You also have several big international investment houses who are now seriously reviewing the African opportunity, which we view as a positive development for the industry,” Ms. Aimé adds.
Runa Alam, CEO at pan-African private equity firm Development Partners International LLP (DPI) agrees, saying that the continent’s rising growth rates are making many more companies ‘investable’, which for DPI , is something that is crucial in its investment strategy.
“As a firm we rely on this as we don’t invest in start-up early stage businesses. Another change we have seen is the growing interest from investors towards Africa, although, how much of that is turning into actual investment is hard to tell. Start up companies are often funded by friends and family and then once they grow to a bigger size and are in need of capital in order to continue their growth, DPI would get involved.”
DPI opened its doors in 2007 with six partners who had more than 70 years worth of experience between them. The firm’s first fund, the African Development Partners I (ADP I) fund, was euro-denominated (US$400 million with US$560 million of co-investment), and was deployed after four years.
The firm’s ADP I portfolio grew 19% on the top line and 20% on the net income line in 2012, and this year it is expected to continue growing to produce a return of US$50 million in distributions by the Autumn, predominantly from profits (dividends) from its companies. The fund is now invested in nine portfolio companies and the DPI aims to have between eight to twelve companies at any time, while “anything less than that is unlikely to be diversified”, Ms. Alam says.
“The real opportunity in Africa however”, she adds, “is that such a growth and profit orientated portfolio was bought at 1.3x price to book for the financial companies and 4.4x Enterprise value/ EBITDA for the other companies. There are very few places in the world that one can still put together an investment portfolio like this.”
PE Sector Draws
According to South Africa-based analytics and consultancy agency RisCura Fundamentals, since 2006, there have been 158 African private equity deals, with 28% including companies in the consumer, industrials, materials and energy sectors.
ECP’s Ms. Aimé says that the consumer story in Africa has been, and will continue to be, quite a significant, with 25% of ECP’s deals falling into the telecoms sector, spanning both the retail side as well as the power space. Another 25% has been in the financial services sector, with participation from banks, insurance and reinsurance companies, Ms. Aimé confirms.
“The rest of our portfolio is quite broad across a range of sectors. We have done agri-business deals, including helping to refurbish and redevelop a fertiliser companies in Nigeria, Notore, and retail investments, such as with the Nairobi Java House, a prominent east African restaurant chain.”
Ms. Aimé adds: “There are many opportunities across a range of industries, but where a PE firm chooses to focus really depends on the investment mandate and the target investment size. Across the spectrum, you have for example the infrastructure, energy and construction sectors, which are typically large-ticket size deals; conversely, outside of South Africa, there are many industries that are at an earlier stage of development, with few players that can absorb more than US$50-60 million of equity. Therefore, there are a number of private equity investment firms targeting investments in this size range.”
For Development Partners International, its strategy is primarily investing in companies that are benefitting from the growth of the emerging middle classes.
“Our strategy is primarily, investing in companies that are benefitting from the growth in the emerging middle class. Within ADP I, we own a pharmaceutical company, an FMCG company, a bank , a consumer credit company, an insurance company and a modular housing and commercial construction company” Ms. Alam says.
“We anticipate a timeline of between three to seven years from when we invest in a company to exit. Towards the end of the investment period the deal has to start making sense in the shorter time frame as we try to avoid extending the life of the fund.”
For the majority of African private equity funds, exits are seen through trade sales, and Actis’ Ms. Ighodaro explains that this will continue to be the case in the near future.
“I believe that trade sales will be the main point of exit for the time being. Capital markets have grown significantly over the last few years and we have been able to IPO a few businesses in West Africa and we can always have that as an option but it’s not one that we would count on as an exit strategy.”
She adds that as interest grows in Africa, generally from institutional investors and corporates who are increasing interested in growing by expanding more in Africa, there is a strong appetite for acquiring businesses with good governance.
Ms. Alam explains that DPI expects to have more industry sales than IPOs, although with South Africa and Nigeria, she adds, there is the option of using the stock exchange for exits.
When considering investment options, and particularly in in Sub-Saharan Africa, one factor that should not overlooked is acquiring on the ground expertise.
Ms. Aimé says that the investment barriers when entering Africa are significant and that it is crucial that PE participants have experience when considering deals on the continent. ECP, she says, spends considerable time understanding the market, the sponsors, and the management team. Indeed, getting comfortable with the latter two is a crucial aspect of the preparatory deal stage.
“The barriers to entry into African private equity are significant; as a GP, you need to demonstrate significant investment experience. In particular, it is important that you have experienced multiple investment cycles and know how to execute across turbulent markets. This is critical for developing exit strategies and ultimately achieving above-market returns.
It is also critical that you have an on-the-ground network. Unlike in developed PE markets such as the US or Western Europe, you cannot rely on brokers delivering or introducing fully active investment opportunities.”
Ms. Alam agrees: “Due diligence is very intense. We move fast but we follow strict processes. The key factors are: local knowledge; knowledge of and chemistry with management, investors and board of the investee company; and careful comercial, accounting and financial due diligence using both local and global accounting firms.”
The Future of PE in Africa?
The future of the PE market in Africa looks strong. Ernst & Young’s sector report confirms that the number of new foreign direct investment projects in 2003–2007 increased from 280 to 460 projects a year, to between 600 and 850 projects a year during 2008–2010. Meanwhile FDI projects into Africa are projected to hit US$150 billion a year by 2015.
Ms. Ighodaro says that Africa is way behind in terms of penetration than any of the other markets, so in this sense it has the ability to absorb a huge amount of capital.
However, this will not be without its challenges. She adds that political risk is a natural concern in Africa but hopes that the media’s influence and coverage over certain political situations will not deter investors.
“We’re hoping that investors will do their own research into Africa and not rely too much on the perceived risk. “
Ms. Aimé agrees that Africa’s economic success is not widely played out in the global media, and neither is Africa’s consumer expansion and corporate development.
“We are seeing huge corporations moving into the continent, such as General Electric and Walmart, and they are spending billions on infrastructure. India and China appreciated and seized the African opportunity story sooner. It’s really the US companies that are finally coming to the table to understand and explore the vast market potential that Africa represents.
The growth and positive developments are self-evident on the ground. The infrastructure has improved dramatically; the rising disposable income; the desire for and access to consumer goods, all these bode well for Africa’s continued development. We think there’s a lot more to be told about Africa frankly,” Ms. Aimé adds.
“Without overselling the story, as it is still a complicated market, we’re optimistic about the opportunities for private equity.”