African PE is dead, long live private credit!

Investors in the continent’s private equity market should be considering other parts of the capital structure, writes Syntaxis Capital’s Africa head.

It is no wonder then that over the last 12 months, three of the largest private equity managers in Africa have announced or relaunched mid-market credit strategies. The emergence of more credit funds in Africa is not only welcomed but will go a long way to deepen the financial ecosystem on the continent, providing alternative financing options for businesses that have traditionally had limited financing options while also providing a new gateway for institutional investors that may be too risk adverse for private equity commitments.

Since 2008, private equity in Africa had amassed an astonishing $21 billion of investor commitments, much of which has been concentrated in larger funds chasing scarce opportunities and generating disappointing returns. Fierce competition in the few large deals that do occur, has driven valuation upwards over the recent past according to Riscura, with more than 30 percent of reported PE transactions being completed at a greater than 10x EV/EBITDA multiple; high for a continent whose market for corporate control is still nascent.

Overheated valuations and challenging macroeconomic conditions, particularly in the light of subdued commodity prices, has had a negative impact on private equity returns overall and investor sentiment for the asset class in general. According to the latest research from Cambridge Associates and the African Private Equity and Venture Capital Association, net returns are at 5.5 percent, lower than the mid- to high teens promised to investors.

Nonetheless, despite the challenges for Africa’s economies as they transition from resource-dependent to more widely diversified economies, the region will continue to present highly attractive investment opportunities due to projected growth in household spending and increased consumption driven by urbanisation and labour demographics.

There are many established businesses in the lower to mid-cap segment with proven models that are profitable and cash generative, but that are starved of sustainable and tailored medium-term credit from local banks. Entrepreneurs and family businesses in this segment are also at an inflection point of their growth trajectory and are unwilling to cede a significant minority or even control to a PE fund. There is therefore a clear opportunity to provide capital to fast-growing businesses in this segment that are not PE-backed and currently not being serviced adequately by the local banking market.

Unlike PE in Africa where there is too much money chasing too few large deals, there is a significant mismatch between the demand and supply of credit in the lower to mid-cap segment where established and profitable family businesses are crying out for an alternative to equity and inflexible and costly bank financing. According to data from the Emerging Market Private Equity Association, since 2008, private credit has only made up 7 percent of the $21 billion in funds raised for Africa.

Credit provides investors with capital preservation because loans have embedded enforceable protections — priority collateral claims, maintenance financial covenants and undertakings, required conditions precedent to funding, and so on — all paired with active involvement in borrower governance, including board representation and veto rights. With contractual returns properly coupled with equity upside which is significantly less dilutive to the owner than pure equity, there is a potential to capitalise on the significant demand in this segment with tailored financing structures, provided by dedicated and experienced investment professionals, whilst generating attractive risk adjusted returns for investors.

African private equity is – if not dead – then lacking a certain vitality. Long live private credit!

Adesuwa Okunbo is head of Africa for credit firm Syntaxis Capital.