Control Risks on transition opportunities in Africa

This article is sponsored by Control Risks.

Why are you optimistic about opportunities for investors in Africa over the coming years?

Muriel Dube: Relative to other emerging markets, the African continent is still a very attractive investment proposition. While it may be difficult to contemplate optimism in the face of the uncertainty from the pandemic, the continent should not be viewed as a single whole but rather as individual economies with their own nuances and opportunities.

An example is Rwanda, where a positive investment story is playing out looking at climate-focused initiatives and energy, with a government strategy to achieve universal access by 2024. That also touches related infrastructure because increasingly Rwanda is seen as a regional hub for logistics, tourism and services.

Similarly in South Africa, notwithstanding the recent unrest, there are significant opportunities. As in most parts of the continent, the decarbonisation agenda is huge and countries are seeking ways to leapfrog the path that developed countries have already taken. There is also growing investor interest in public-private partnerships for the delivery of public services in a way that can derive profitability but also fill gaps, such as emergency and disaster relief.

Finally, the sectors that underpin our new way of living under the pandemic, such as online, technology and support services, continue to be of great significance for investors looking at Africa.

Busani Moyo-Majwabu: What is unique about South Africa is that, even with the challenges of investing in clean energy, there is an achievable level of scalability that is currently not possible elsewhere. Those opportunities have traditionally been financed by domestic banks but there is growing interest from development finance institutions.

Rwanda is one of the leading countries in the decarbonisation space and has attracted a lot of attention. It is looking at some interesting financing options to support its transition, such as the creation of a green bank for the provision of alternative financing for green initiatives.

Where are you currently seeing activity from clients?

BMM: The pandemic had a significant negative impact on investor appetite for deal origination in Africa in 2020. What we saw was a slowdown in capital deployment over most of last year as investors focused on stabilising their portfolios, and that lasted a bit longer in Africa than in other parts of the world. Now, we are seeing a lot of pent-up capital among investors, and that slowdown is transitioning into a much faster-paced investment climate today, with deals being closed and clients keen to explore new
opportunities.

A lot of investors with Africa-focused mandates have defined time periods in which to deploy capital and we are seeing more aggressive strategies being employed. They are focused on assets that are less reliant on consumer spending and more focused on defensive industries, like infrastructure, energy, technology and healthcare. Healthcare, for example, recently topped the African Private Equity and Venture Capital Association’s Private Equity Industry Survey for 2021 as the most attractive sector for PE investment in Africa over the next three years.

Henry Smith: The slowdown in capital deployment we saw in Africa during the onset of the pandemic was also seen in other parts of the world, with our GP clients’ focus on cash preservation and crisis management. As we moved into summer last year, we saw far more activity in Europe and North America, and parts of Asia, but that took longer to rebound in Africa. Now, there is a race to deploy capital again because GPs are sitting on huge amounts of dry powder.

A number of the global generalist GPs withdrew from looking at Africa before the pandemic, partly under pressure from their investors to find greater returns in shorter time periods, pushing Africa off the priority list. But our investor clients that remain focused on Africa are those that really understand the sectors and regions they are investing in, and they are often investors that have clear political and social mandates in terms of what they want to achieve. Africa offers many opportunities to deliver on those priorities.

What regulatory and reputational pressures are investors facing when considering deals in Africa?

MD: A big issue is around where the finance comes from and the gap between the regulation of the investor’s origin country and the reality of the investment host country – there is often a disconnect there, which is a well-known tension for emerging markets investors.

There are other gaps around social issues related to diversity, equity and inclusion, and issues around labour rights and human rights with respect to both target companies and their broader value chains. What is clear is that investors increasingly want more visibility at the diligence stage about the nature and risk profile of important third parties as well as key clients, as they take a much more holistic view of ESG risks.

There is also a heightened focus on the values and culture of the management team, which we now see as crucial to performance on social issues in relation to ESG risk. Investors are asking about the track record of management, not just in terms of business acumen but also culture.

HS: We see tensions where different LPs have quite dramatically different ESG requirements that they need to fulfil, not least because of the requirements now set by the EU and similar developments in non-European states. When you have conflicting regulatory requirements that LPs feel they need to follow, that is challenging for GPs to navigate when raising and deploying funds.

MD: From a regulatory point of view, because of the shrinking tax base – in some cases even before the pandemic – we are seeing more focus on punitive fines and bolstering collections. South Africa, in particular, has been ramping up environment-related fines, and the carbon tax regime is also coming into force, which is something we expect to continue here and in other African economies.

Which ESG issues are investors most regularly raising with you in Africa?

BMM: Climate change and environmental sustainability have tended to drive the ESG agenda, in part because many of those have clearly defined regulatory requirements around them. Social factors that were historically harder to quantify are now taking on more significance. Because those are difficult to define, the risks and ramifications associated with mismanagement are particularly high and quite visible.

When properly assessed, social risk can be presented as a value creation opportunity that can result in a more profitable exit and valuation if investors focus on making a positive impact on things like diversity and inclusion and worker rights. There are often significant improvements that can be made quickly, building on best practice from other jurisdictions or industries.

Can investors take any lessons away from the past couple of years?

HS: First, investors and the organisations they have invested in will be held to the values they have set and that have been set for them by their stakeholders, including clients, LPs, NGOs and employees. GPs need to deliver against the promises they have made.

There is growing interest and alignment between stakeholders around what investors need to consider when setting their values, and that allows those stakeholders to work together in ways they have not done before to hold people to even higher standards.

Second, in terms of opportunities, infrastructure assets have been tested over the past 18 months and have largely weathered the economic cycle, with the exception of consumer-facing transport. Infrastructure in its broadest sense, including logistics and technology infrastructure, has proved incredibly resilient and will continue to be a focus for investors in Africa.

Consumer-facing companies that offer vital services that governments cannot or will not provide – for instance, financial technology that allows for greater inclusion – have also demonstrated resilience and value.

Where does Africa sit in the global energy transition? What do you see as the opportunities for investors in renewables and decarbonisation?

BMM: In terms of Africa’s energy transition, what is clear is that over the last 10 years developing nations have accounted for a significant chunk of investment into building clean energy capacity. Prior to the pandemic, up to 2019, around $250 billion had been invested into clean energy worldwide, and around 60 percent of that went towards emerging economies, according to BloombergNEF data. Africa has attracted its fair share, with four or five countries typically featuring in the list of the top 20 countries attracting investment, including Nigeria, Namibia, Senegal, Rwanda and Kenya.

Private capital is driving much of that investment, in part as a result of governments facing fiscal challenges and directing resources towards health and social care over energy and infrastructure. There are challenges that arise with investment in this space though, which private investors are cognisant of. Currency conversion in countries like Nigeria is an issue, because most solar projects there derive their revenues in Nigerian naira and restrictions are in place for conversion to US dollars.

In other markets there are issues around land access and tenure that can cause friction with local communities and require thorough investigation to unmask key stakeholders and understand possible threats to the investment. In South Africa, challenges include quite stringent local content requirements that are rightly in place as part of efforts to create a more equitable society. Those put the onus on investors to work to understand their local partners and whether they should invest alongside them.

MD: Many African economies are fossil fuel-based but there is growing recognition of the need to move to cleaner sources of energy. That must be done responsibly without abandoning industries that are vital to the economy. In the context of the UN Framework Convention on Climate Change, there is a big conversation around what constitutes a just transition, and countries need to be able to do that incrementally without severe social disruption. There is legislation underway to encourage incremental change but also to incentivise reskilling, for example, in the case of the significant labour forces operating in the fossil fuel industry and its related value chains.

Muriel Dube is non-executive director, Busani Moyo-Majwabu is director, and Henry Smith is a partner at specialist global risk consultancy Control Risks. Control Risks has over 40 years’ experience advising private markets investors, corporates, law firms, banks and government entities in Africa, with offices in Dakar, Johannesburg, Lagos, Maputo and Nairobi, and project offices in N’Djamena, Nouakchott and Port Harcourt