This article is sponsored by Development Partners International
Headlines from across emerging markets shout about economic instability. From Turkey to Indonesia to Argentina, over the past year the media spotlight has focused on currency devaluations, rising inflation, dwindling foreign capital inflows and impeded growth. However, it would be a mistake to lump all emerging markets together and assume these levels of volatility apply to economies in Africa, says Runa Alam, chief executive officer and co-founder of pan-Africa investor Development Partners International.
Many emerging market economies have had a tough year. Why are African economies different?
When you read the press you might assume every emerging market economy is in decline and perhaps the worst performers are in Africa. But that’s not correct. African economies have actually been quite stable since the beginning of the year. From a macro perspective, Africa differs from other emerging markets in key ways. African economies are less dependent on exporting to Europe and the US and more dependent on trading with each other.
Like other emerging markets, African countries have suffered currency devaluations, but that happened back in 2015 and 2016 at the bottom of the commodity cycle. The only exception to this is South Africa, which has stronger links to other emerging markets through its stock market and capital flows. Combined with the domestic political situation there, growth is currently muted.
The picture in Africa is the opposite to the rest of the world. Collectively, African markets remain high growth – the continent is the second-fastest growing economic region in the world – surpassing developed and many emerging economies. This growth is underpinned by strong demographics, a young population and one of the fastest urbanisation rates globally.
More Africans will reach working age in 2035 than in the rest of the world combined. The continent benefits from natural resources including oil and rare minerals and is leapfrogging into new technology.
Debt levels in Africa are among the lowest globally. Many countries do not have much leverage outside of the very large corporates. In the US and Europe asset prices have reached levels as high as pre-crisis 2008. In Africa it’s the opposite. Valuations have remained stable in the African stock markets for 10 years, despite volatility across commodity and FX markets, demonstrating confidence in the African growth opportunity. The leverage amounts and pricing/valuation risk are both low.
How is investor appetite?
Following the US Federal Reserve’s decision to reverse course and cut interest rates, which is being followed by central banks around the world, money supply is expected to remain strong over the next two years. Asset allocators are looking globally, including at Africa, trying to think about how to generate higher returns.
Africa should be very much in the limelight when they think about diversification. African equity is uncorrelated to US private assets like buyouts or real estate. Historically, it hasn’t been front of mind because of lack of expertise in these markets.
“If you have a pan-African strategy, there are always investable regions and countries and you benefit from the ability to hedge your sovereign, macro-economic and currency risk exposure”
Are they still worried about currency and political risk?
Currency and sovereign risk are always the first set of questions investors ask but they move beyond that fairly quickly. Too many people in the market approach Africa as a single country; this is clearly wrong with the continent being made up of over 50 very distinct countries. It is not one sovereign risk.
If you have a pan-African strategy, there are always investable regions and countries and you benefit from the ability to hedge your sovereign, macro-economic and currency risk exposure. During 2015 and 2016 when most of African currencies devalued against the dollar and inflation rose, Francophone African economies did not. Their currencies are pegged to the euro. Inflation remained low and growth rates hovered above 6 percent.
In other markets, the crisis showed that companies and funds can grow despite currency devaluation.
It might take a business a year or two to recover depending on growth rates, but then it still has three to five years to demonstrate growth and the chance to deliver a very decent top quartile equity return. Growth among many African companies can be high, up to 125 percent a year. There are rising numbers of experienced and institutionalised managers in Africa that have gone through two or three cycles and they have shown they can deliver returns.
Dealflow is the highest I’ve seen in 20 years operating in Africa, while competition in the market remains comparatively low. That’s a big change. Companies are growing and the demand for capital is rising.
In contrast, the level of private equity dry powder focused on Africa is down, although interest from strategic investors and family office capital remains strong when one is looking for exits. Private equity funds have been slower coming back to market and some managers no longer operate in Africa. The result is that pricing for private equity deals is flat or falling.
We’re actively investing this year. Over the past 12 months, we’ve closed five deals. Our most recent acquisitions were in January when we invested in International Facilities Services. The business operates across the continent and specialises in delivering services such as catering, laundry, maintenance and housekeeping to remote locations. Its clients operate in sectors like hospitality, natural resources, shipping and mining. We invested $35 million through African Development Partners II to support acquisitions and working capital.
Given the number of markets and economies within your remit, what sectors and geographies are you drawn to?
In terms of geographies, most dealflow will continue to come from the larger countries, including Egypt, Algeria, Morocco, Senegal, Cote D’Ivoire, Ghana, Nigeria, South Africa and all the Southern African Development Community and Common Market for Eastern and Southern Africa countries, starting with Kenya, Tanzania and Uganda. However, over a five-year investment period, smaller markets have typically generated at least one deal for us to look at, and many of our portfolio companies grow regionally or throughout Africa.
Certain markets have more dealflow so we spend more time there, but we are truly pan-African. Investments in Fund I were dispersed throughout the continent, Fund II invested more in North and Francophone Africa.
In Fund III, again we’re seeing opportunities in our pipeline throughout the continent, but this time there are more multi-country, larger companies and more platform deals. With a bigger pool of companies to look at, there’s better choice in terms of a company’s growth trajectory, profitability, management ability and institutionalisation, as well as value. We believe in investing in blue-chip high-growth businesses that are reasonably priced. That can only be achieved when you have the whole continent to look at.
In terms of industries, we look at those that benefit from the emerging middle class and draw on Africa’s positive demographic and urbanisation trends, its resources and access to new technology.
That thesis has meant we’ve invested in companies that performed defensively during the crisis of 2015-16 – demand for products did not fall below supply – and that generate high growth in times of stability as the consumer base expands and spending rises.
DPI has been investing for more than a decade. How has the corporate landscape changed?
There’s been 20-plus years of economic liberalisation and privatisation in Africa. The proportion of GDP contributed by the private sector has increased significantly across the continent since the 1990s.
Government spending is no longer the predominant economic driver. Today you would be hard pressed to find any country where the private sector isn’t the main driver. This means there are more investible industries, highly sophisticated management teams and entrepreneurs, and larger companies today.
What’s been the role of private equity?
Private equity managers have been active in Africa over that timeframe. Development finance institutions supported the industry as a way to fuel private sector growth, both with capital and hands-on coaching of management and by introducing new ideas, governance, commercial strategies and technology.
Private equity is motivated not to lose money. The returns DFIs have achieved demonstrate to the rest of the world that the private sector in the region is investible. After 20 years, there’s a track record and institutionalised companies.
Impact is gaining traction in private equity. Are more impact-defined investors looking at Africa?
Africa is the one region where the word impact doesn’t quite differentiate funds. The reason is the whole industry was created by DFIs. When they funded GPs in the late 1990s there was a contractual agreement to implement high-level environmental, social and governance programmes.
Most funds have very robust ESG capabilities and have done this for 20 years. I view ESG as a necessary underpinning for any impact work. ESG makes sure there is no harm done in the community and it reduces operational risk on the commercial side.
Every fund that I’ve been associated with has had impact reporting requirements for decades. Over time, funds have developed their own tools to both show intentionality and measurements. When you have a commercial fund that targets a commercial equity return but still does and reports all the things that impact means, you don’t need to have a separate industry. Larger funds touch the lives of more Africans with new jobs, training, delivering needed products, creating new companies in the supply chain, and so on.
Has your reporting changed at all?
From inception our reporting demonstrated our ESG and impact results. Every year that goes by, reporting gets more sophisticated in terms of the work we’ve done. That comes from experience and active development of toolkits and annual training.
We also report against external sources like the International Finance Corporation’s recent impact guidelines and the UN’s Sustainable Development Goals.
In most parts of the world, and especially Africa, there has to be customisation and specialisation. Over the years funds have upped their game in terms of impact work, results, measurement and reporting.
You recently announced the exit of telecom tower management company Eaton Towers. How does that sale reflect changes in the African market?
The recently announced sale of our stake in Eaton Towers to American Tower Corporation for an enterprise value of $1.85 billion was one of the largest private equity exits ever in Africa. Eaton Towers owns and operates more than 5,500 towers in five markets: Burkina Faso, Ghana, Kenya, Niger and Uganda. It sold its South African assets to ATC in 2016.
The latest transaction exemplifies the theme of increased interest from multi-national strategic investors in Africa. ATC is one of the leading owners and operators of wireless infrastructure in the world.
As companies grow, they have the option to list if there is a local market, or on the London Stock Exchange or Johannesburg Stock Exchange, which is the 20th largest globally. But it’s a mixed picture in terms of whether exchanges are up or down and in Africa they’ve been largely flat for more than 10 years. Exits to strategic buyers will always be a place for private equity funds to look, and family offices and sovereign wealth funds are buying private equity portfolio companies as well.