It’s no secret that many of Africa’s large economies – the ones most often targeted by private equity firms – have faced some challenging economic times in the last two years. Hit by a dramatic and sudden fall in commodity prices, many of the region’s markets suffered equally dramatic falls in GDP growth. Nigeria, for example, which had been among the fastest growing economies in the world, slipped into recession in 2016 and its currency underwent a significant devaluation. Ghana’s GDP growth rate also fell dramatically, while political unrest in countries such as South Africa and Kenya deterred many investors during 2017.
Yet 2018 has been a something of a calmer year across the continent, with many predicting greater stability, at least for the immediate future. One of these is Peter Baird, managing principal, head of private equity at Investec Asset Management. We talked to him about some of the issues faced by investors in his markets and why he believes we are entering a golden age for African private equity.
What’s your view on the effect of commodity price volatility on African markets?
It has been an interesting decade. Back in 2008 to 2009, it was a time of optimism in emerging markets as developed markets were in turmoil following the financial crisis. We had something of a super-cycle in Africa between 2009 and 2015 as capital flowed here and many people deluded themselves into believing that commodity prices didn’t matter anymore – the prevailing view was that endogenous growth and secular trends of demographic growth, urbanisation, and rising middle classes would drive economic fortunes.
That changed when commodity prices dropped. It was quick and deep and that had a devastating impact on some economies, such as Nigeria. If the fall had been more steady and moderate, I think most countries would have managed better, but as it happened, some of the macroeconomic policy responses made a challenging situation even worse.
So what would you say has been the biggest impact of this?
For investors with direct or indirect commodities exposure or non-dollar denominated currency, the impact has been significant. Yet it has also trickled through to consumer and government spending and has left a dent in investor confidence. There has been a significant pull-back among investors from emerging and frontier markets. The second and third order effects are still working their way through the economies and capital markets.
Yet you believe we are now entering a golden age for African private equity. Why?
The worst is now behind us. Most large economies in Africa are back on track and improving fast. At the same time, business confidence is up. There is a real need and demand for capital for expansion. For private equity firms, this is a great time to be in the market because entry enterprise values have fallen by around two turns of EBITDA. So, when there was a lot of competition for deals, back in 2015, entry EVs were, on average, 9x EBITDA; they’re now closer to 7x EBITDA.
The investors who are still in the market – and we are mid-way through investing our $295 million Fund 2 – are now able to negotiate more favourable terms. It’s also much more possible to source proprietary dealflow than before – so many of the situations were highly competitive previously, but that has changed.
And how do you think this compares with other emerging markets?
I think it’s possible to find great businesses at lower valuations in African countries than many other comparable markets. These are businesses that can achieve the same kinds of growth possible in more popular markets – there are many of the same secular trends – but Africa just isn’t getting the same love from investors currently.
Over the last five years, investors have focused much more attentively on markets such as China, Vietnam, Malaysia and Southeast Asia more generally. As a result, there is a lot more untapped potential here in African markets.
Given the size of the African continent, and your desire to source proprietary deals, how do you choose where to focus?
We tend to take a regional view and that focuses on four clusters: South Africa and its neighbours; the East African Community countries; Nigeria and Ghana; and Morocco and Egypt. Taken together, these regions represent around 90 percent of Africa’s GDP. In each of these regions, there are many high-quality private sector businesses, there is a well-embedded and professional advisory community and debt markets function well.
These clusters also benefit from having markets that are large enough to build and grow attractive regional champions. Our recent investment in, for example, Botswana-based retailer Kamoso, which has expanded across southern Africa, demonstrates this pattern well. It has strong regional growth prospects.
And if you think about the East African Community trade bloc, it has a population of 250 million people, so there’s a lot of potential to build substantial East African champions over five to 10 years. That will be highly attractive to strategic buyers.
So how much interest are you seeing among strategic buyers for these kinds of regional champion?
There are some local players large enough to acquire, but in terms of international strategic interest, it’s still early days. It’s starting to build, but I’m realistic – it will take time for activity to flow through. There’s often a lot of talk about East Asian and South Asian buyers looking to Africa, for example. That’s particularly the case for East Africa, given the geographic proximity between the two regions. Yet much of that is hypothetical currently and will remain so until investor confidence picks up again. We do see some interest from US and European trade buyers, but secondary buyouts are more common currently as most talks with trade from these regions tend to be more opportunistic approaches or exploratory.
What about IPOs – some of these have not gone to plan recently in Africa, have they?
Yes, there were a lot of hopes pinned on a number of large IPOs for 2018, such as mobile communications group MTN, which is under regulatory pressure to list, and a number of telecom towers businesses, such as IHS Towers, Helios Towers Africa and Eaton Towers. Some of these have simply pushed back plans to 2019 and so the general feeling is that, if they do go ahead, they will open up the IPO markets for other companies. I think once we see some successful IPOs get away, listing prospects will become greater for some companies.
How can firms return capital to investors in that case? Does this rely mainly on secondary buyouts?
We are very much focused on returning capital to investors early as the long hold periods characteristic of many African private equity portfolios is a source of frustration to some LPs. That’s why we focus on cash generative businesses – it means that we can sometimes partially exit portfolio companies through dividend recapitalisations. That’s quite unusual in Africa, but we have secured two so far.
We’ve also managed other exits in the last 12 months. For example, we sold a SADC retail business to a local partner, giving us a full exit. We also sold a Nigerian consumer goods business back to the management team – it had been performing well, even despite the troubles there and so we generated a good return. And finally, we negotiated the pre-payment of a South African mezzanine investment. In all, I’d say our experience shows it’s possible to exit investments using less common paths than the usual secondary buyouts, international trade or IPO paths.
Within the regions you focus on, would you say there are any stand-out countries for opportunity and why?
There are some very good opportunities in Nigeria now. It’s about 12-18 months behind Ghana in terms of recovery (and Ghana is doing very well now), and we’re seeing an improvement in Nigeria’s macro-economic policy, which is leading to more foreign direct investment and over time, its reliance on oil for exports will diminish. Yet it’s also a market where risk capital is scarce right now and the banking system is in disarray, so there is a lot of opportunity for private equity investors who understand the market well.
Northern Morocco is also a great market at the moment. The economy is booming and the region is seeing high growth in human capital and has a strong geographic location in that it is within easy reach of Europe. I think it has the potential to become the Mexico of Europe – it has strong expertise in precision engineering and other manufacturing for export to the EU. That’s why we invested in SJL last year, a cross-border logistics and transport operator in Tunisia, Morocco, Spain and France.
African markets have a strong track record for leapfrogging more developed economies in terms of tech – how much does that present an opportunity for you?
We are very focused on this area. We see huge potential for investments taking advantage of new technologies. In some cases, this is industry formalisation, such as in fintech or retail where new technologies can assist in creating regional champions.
In other cases, there’s a real opportunity for new industry formation through the adoption and combination of new technologies within existing sectors. In education, for example, mobile communications, the availability of broadband across the continent and new payment systems now enable companies to cater for the almost infinite demand for education among Africa’s populations. Distance learning is a rapidly growing sector that meets this demand in very remote locations, for example.
Can you give an example of this from your portfolio?
Our investment in Mobisol is a great example of the intersection of technologies creating investment opportunity. It’s a company that addresses the need for energy in off-grid households across East Africa through the provision of solar capacity that uses mobile technology. It also recently launched new software that helps pay as you go energy providers (who are often users of Mobisol products establishing businesses to sell energy to other customers) track system performance and payments.
This article is sponsored by Investec Asset Management. It appeared in the Africa Special published with the September 2018 edition of Private Equity International.