Private equity and investment in Africa
Yingni Lu and John Battersby
22 July 2011
Is Africa the world's most under-rated investment destination? Could the continent offer better returns on cheaper capital? Could private equity be the key to unlocking the wealth of the world's largest market and the last frontier of growth in an ailing global economy?
These are some of the questions that 100 or so upbeat and hungry investors had in their minds at Private Equity International's two-day Africa Forum 2011, which took place in London in June.
The flow towards Africa of both private sector money and finance from development finance institutions is gaining momentum, and more private equity groups are looking for African investments.
Martin Poulsen of the African Development Bank confirmed this trend and exhibited a dramatic chart of Africa's 10 fastest-growing countries – headed by Ghana and Ethiopia – and visuals which showed how resilient the continent has been in weathering the global economic crisis.
'The 7% club'
Razia Khan of Standard Chartered focused on "the 7% club" of nations who have sustained growth of 7% regarded as the magic number required to double the size of the economy every 10 years.
Sub-Saharan Africa accounts for seven of the 10 with India, China and Vietnam making up the rest. This trend underscores the reality that private equity funds from emerging markets are driven by growth and efficiency at the micro level and escalating urbanisation and consumer demand at the macro level.
The trend towards more concentrated population and consumer demand have driven both urbanisation and infrastructure investment which was historically uneconomical because of scattered populations over undeveloped areas. This has also mobilised the working force and could begin to mirror China's phenomenal development driven by urbanisation and the mobility of labour.
Some might argue that Africa's growth is driven by sky-high commodity prices and is hence unsustainable. But this argument underestimates robust and sustained consumer demand. Also, a rapidly growing middle-class with disposable income is boosting economic growth on the continent.
Standard Chartered's Khan points out that there has been a positive inflow of private equity investment to the continent despite the fact that a drop in Chinese exports had had a negative impact on African growth since the global economic crisis.
Africa has managed to increase overall trade with emerging markets in relation to the over the past two decades. There had been a dramatic confluence of rising growth and falling poverty over the past decade.
Africa's 'perception' challenge
But Africa has a "perception" challenge, when it comes to attracting private equity investment, fed by tired media stereotypes of Africa and sentiment and peer pressure within the investment community.
Risk in Africa is considered higher than in other destinations. But the returns and recent performance suggest otherwise and those who are invested in the continent after talk about Africa as the world’s best-kept investment secret.
Also, there are fewer players in Africa, meaning less competition, better deals for entry and more time for due diligence. Moreover, the capital market is growing and new players are coming in, providing funds with great exit opportunities.
For example, Helios Investment Partners has just launched the biggest-ever, US$900-million, fund targeting Africa. The fund was oversubscribed, with more than 70% of money coming from outside of development finance institutions.
The macro business environment
The macro business environment is not as bad as many people imagine. Even corruption, often cited as major constraint on investment, only 7% to 9% of Africa's GDP is related to corruption, while the percentage is much higher in China (30%) and in South East Asia (average 11%).
Data from DEG Germany's internal rating system shows that the average Africa fund performs as well as average global funds under its own rating system.
Macro-economic factors are less relevant to returns on private equity in emerging markets than selection of the right managers that could deliver the return for investors.
From the aspect of investment diversification: various industry opportunities, low-correlation currencies and liquid foreign exchange provide investors with a good way of diversifying their investment in Africa.
Ralph Keitel, the principal investment officer at International Finance Corporation, confirms that Africa funds are the best performing portfolio for IFC. Perhaps the big gap between risk and "perceived risk" has kept Africa as the best-kept secret for those incumbents to make money.
Of course, there is the historic and political legacy that has kept African countries off the radar of investors, such as the high levels of conflict, poor governance and lack of economic transparency that followed the era of colonialism and apartheid.
'The risk now is acting too late'
However, with more transparency on the continent, "the risk of not going to Africa now is to find it that it is too late to get there", as Lord Boateng, former British High Commissioner in South Africa and a director of Aegis, put it.
Reputation can't be built overnight. Apart from investment and tourism promotion, which is now commonplace, governments in Africa need to learn to engage the media.
Mark Florman, current CEO of BVCA in the UK, uses the weekly report that BVCA publishes on industry achievements as an important tool to communicate the progress on countries' economic development and financial news.
However, there is no one-size-fits-all story for these "7% club" countries in Africa, and it is necessary their country-specific context which also determines the risk involved.
For example, Nigeria is projected as the powerhouse in Africa because of growing population and strong consumer purchase power, whereas the growth in South Africa is driven by the need for infrastructure and energy efficiency.
Not just about minerals
Seven percent GDP growth represents the minimum annual rate required to halve poverty and achieve the the United Nation's Millennium Development Goals.
However, not every Africa country will make it into the "the 7% club". Africa grew on average 6% from 2001 to 2008. It grew by 5% last year and is to projected to grow by 5.5% this year.
Moreover, some investors are shying away from the under-performing countries, led by Libya, Egypt and Ivory Coast, following major political conflicts in those countries, and Tanzania, Madagascar and Swaziland.
But Denny Truell from the Wellcome Trust believes that GDP growth is not relevant when you are assessing Africa as part of a investment portfolio.
Long-term interest in Africa is not only in minerals and energy but increasingly in water and renewable energy. The continent has favourable demography and major opportunities in the huge deficit in health-care provision and transportation.
The question is not whether – but how – to turn this demographic advantage into good economy.
Having bounced back with such resilience from the global crisis, Africa presents an increasingly sustainable opportunity. A weaker or even shrinking economy doesn't necessarily mean failure for private equity investors.
South Africa as a springboard
Many funds are using South Africa as a springboard into the continent, and in recent years some have made major investments in buying out companies or setting up greenfield projects in order to access a broader and bigger Africa market.
Moreover, when the economy becomes relatively mature, sustainable growth would mean moving towards a more sustainable and inclusive way of investment.
"Inclusive growth" was the hot topic at the recent annual meeting of Africa Development Bank in Lisbon following the popular uprisings in North Africa which drew attention to the possibility of using community engagement to minimise risk.
In South Africa, following the national growth path for more inclusive growth, the emphasis is on job creation, beneficiation and joint ventures to ensure that as much investment as possible finds its way into the local economy and meets the government's goal to alleviate poverty and create a better life.
Participation of development finance institutions
For private equity, how to include Environmental, Social and Governance (ESG) into their investment portfolio is critical. Development finance institutions (DFIs) have done a great job in setting the guidelines and providing a model for private equity to follow.
As engaging local communities becomes more useful in minimising risk, participation of DFIs adds credibility by demonstrating that funds have done prior due diligence and considered social risks involved in the investment. The participation of DFIs provides transparency and attracts private money.
Inclusive growth also means leveraging the skills and operational involvement of the African diaspora to support local entrepreneurs in order to attract private capital.
One of the major constraints on the faster sustainable development of the African continent is the lack of intra-African trade and the low levels of regional and continental economic integration.
As the pace of regional integration within the Southern African Development Community (SADC) quickens – a goal that South African President Jacob Zuma has put near the top of his priorities list – the economic rewards for African countries will come in the form of increased foreign direct investment and expanding trade relations.
The evolving free trade agreement between the overlapping regional economic communities of SADC, the Common Market of East and Southern Africa (Comesa) and the East African Community (EAC) is likely to give further impetus to this process.
But at present, intra-African trade represents only 11% of all African trade. Poor infrastructure – energy, transport, irrigation and telecommunication – is a major constraint on increasing the levels of intra-African trade. Ramping up infrastructure construction and maintenance is thus a priority.
Africa will need nearly $500-billion over the next decade to meet its infrastructure needs. This factor alone is likely to define Africa's international relations. Countries that have strong capacity to help build infrastructure will emerge as natural partners with African countries.
Economic factors playing more of a role
Sudanese-born businessman Mo Ibrahim, who established the Mo Ibrahim Foundation to promote good governance in Africa after selling his mobile phone company (Celltel) for £1.3-billion, says that the 11% threshold will neither allow the envisaged development of the continent, nor attract foreign investors to Africa.
"Africa is by far richer than China, but it is by far behind that country as far as development is concerned," Ibrahim said. "The reason is simple. China has established a market with critical size, while we in Africa are still producing entities which cannot attract direct foreign investors."
But there are historical factors. The colonial legacy ensured that export markets were created to serve the colonial masters, and transport and trade routes all led to ports and border posts instead of creating regional rail, road and air links.
In the past, regional integration has been driven by political rather than economic factors which experience has shown it is not sustainable. Gradually, economic factors are playing more of a role as African political and economic governance becomes both more robust and more transparent.
Impact of North African uprisings
There were different views at the Africa Forum on what role the popular uprisings in North Africa would have on investment in Africa.
The African Development Bank's Martin Poulsen doesn't think that events in North Africa will have a major impact on investment in Africa.
While growth in affected countries has clearly taken a sharp dip in the short term, the general view is that they will end up in a better state and that economic activity and growth will resume fairly quickly.
On the one hand, there is increasing political stability on the continent, with 20 elections taking place in 2011. On the other hand, funds that have investments in Africa should factor in political risk and ensure that investments are properly diversified.
What happened in North Africa is like an unpredictable "black swan" event: instead of staying away from Africa, investors should see the continent as providing a more open market, especially after the constitutional elections in Tunisia and hopes of the same in Egypt.
The reconstruction needed after elections and political stabilisation would attract huge investment into the continent. The challenge for private equity investors is whether the current structure of private equity allows them to take a long view.
Although the democratic change in North Africa is considered positive, investors are waiting for the right signal to roll out deals. This wait-and-see attitude in North Africa at present could direct investors' attention to more stable sub-Saharan African countries.
Marching in or already retreating?
Trade partners are important for the success of Africa. "New trade corridors" have been created, such as trade with China, India, Brazil and Turkey. However, even with the huge amount of investment destined into Africa from these countries, China will not replace EU as the number one trade partner of the continent.
There is a perception that China is engaging in neo-colonisation because its imports from African countries are mostly commodities.
But data from the Africa Economic Outlook shows that rather than competing, these emerging partners complement traditional partners in other sectors than natural resources.
Moreover, the trade between China and Africa as a whole is "relatively balanced", because China does import commodities from a handful of countries, but exports capital goods to all African countries.
Unlocked investment force – local capital
No country can be developed without the participation of local capital, which not only provides enough capital, but also acts as a reference point on the ground.
There is a lot of local capital in Africa, but it is difficult to access. There are multi-faceted reasons for the lack of local capital deployment.
Some local investors are less approachable than foreign investors, because they know well how to make profit on the ground. When it comes to entrusting funds with investment in their own country, they demand higher returns.
This has limited the building of a private equity "eco-system" on the continent, which becomes impossible without engaging local institutional money.
How to develop capital market to facilitate the mobilisation of domestic resource is critical, but some countries, such as Nigeria, are on the road to revamp the regulations to allow local capital to mobilise. In Kenya, the capital market has also expanded and the 30-year yield curve is relatively liquid.
Climate change – challenge or opportunity?
Climate change poses a potential threat to the sustainability of planet earth. Africa is destined to suffer a disproportionate degree of collateral damage from climate change despite the fact that – due to much lower levels of development – the continent contributes least to the emissions causing climate change.
But there is also a real opportunity here. Investment in renewable energy on the continent, such as solar, wind, hydro-electric and waves, and innovation focused on developing those sustainable sources of energy, will contribute not only to the creation of a sustainable world but also to the creation of much-needed jobs in various sectors.
As economies of scale shift to community generation, smaller businesses are likely to receive a significant boost from the green sector.
But there are many challenges ahead for private equity investment in the "green" sector in Africa. Stable policy support and subsidies are needed in order to attract investors.
Encouraging 'green' investment
Apart from the aggressive feed-in tariff introduced by South Africa, only a handful of countries, such as Uganda and Botswana, are investigating similar schemes to encourage green investment.
Moreover, the sustainability of the support is equally important as its existence, due to the fact that renewable energy projects are long-term investments with destined life spans of between 15 to 25 years.
Even for developed countries such as the UK, a dramatic decrease in feed-in tariffs has stirred unfavourable responses from investors and stopped many of them from investing further.
Development finance remains a key source to unlock the investment in renewables, but the efficiency of such programmes can be much improved by combining with private equity investments well as newcomers such as China.
For example, the substantial renewable funding programme run by the European Union, the €100-billion Africa-EU Renewable Energy Cooperation Programme, is committed to investing almost one third of its funds (€30-billion) in Africa. In the future, cross-continental partnerships are likely to proliferate.
China, both because of necessity and its history of pragmatic adjustment, is well-placed to become the world leader in developing cleaner and more sustainable technologies to supplement and ultimately replace fossil fuels as the world's primary source of energy.
South Africa is well placed to contribute to this global priority, by vowing to reduce carbon emissions and setting a target of 42% of new electricity generation to be met by renewable energy sources such as solar, wind and wave generation by 2030. In terms of its 20-year plan, nuclear power will account for nearly a quarter of new electricity generation.
This will mean a radical turnaround from the current situation, in which coal provides for 84% of electricity generation. It is likely to prove controversial in a country with high unemployment and underdevelopment and which has to continually reconcile the goal of sustainability with developmental priorities.
But Africa is united as a continent on the response to climate change, and that in itself is a pointer to the opportunities that beckon for private equity to turn the challenges into massive opportunities for a sustainable future for the continent.
Yingni Lu is a London-based development professional specialising in clean technology and renewable energy. She is CEO of EcoLeap and a partner at London-based Forbury Environmental. She also writes for the online magazine ReConnect Africa. John Battersby is the UK country manager of the International Marketing Council of South Africa.