This article is sponsored by Mediterrania Capital Partners
Making up 90 percent of businesses across parts of the continent, Africa’s small and medium-sized enterprises are vital to the region’s economies. However, they often have difficulty raising finance for expansion, a situation exacerbated by the pandemic. Two-thirds of African SMEs say they have been strongly affected by covid-19, according to a recent report by the International Trade Centre, with 75 percent saying this was caused by reduced sales and 54 percent citing a difficulty accessing materials.
We spoke to Albert Alsina, founder and managing partner of Mediterrania Capital Partners, a North and sub-Saharan Africa-focused firm, about the role private equity can play in developing SMEs – through good times and bad – and what is needed for the industry to continue to grow.
How has the pandemic affected SMEs in North and sub-Saharan Africa?
We see the pandemic as short-term turbulence in a long-term growth market – covid-19 has clearly had an effect, but fundamentals of a growing, young population and an expanding middle class are still there. Africa’s population is set to grow from 1.2 billion today to around two billion by 2050. It is a very dynamic market and these trends create a huge need for healthcare, education, financial inclusion and fast-moving consumer goods. That is why we continue to see a significant amount of opportunity in our markets.
That does not mean the pandemic has not been a challenging time, and much of its impact has been to restrict liquidity and place stress on companies. However, the banking system has been far more responsive than might have been expected. Banks have been quick to grant grace periods on payments and extensions on mortgages and they have provided working capital where needed. Under more usual circumstances, the banking system in our markets is not very well adapted to SMEs, so what we have seen is encouraging.
We see the impact directly through one of Mediterrania Capital Partners’ portfolio companies, Groupe COFINA, a mesofinance business that serves Francophone West African SMEs in Senegal, Ivory Coast, Guinea Conakry, Gabon, Congo-Brazzaville, Burkina Faso and Mali. Although the loans that Groupe COFINA is giving out are protected through SME guarantees, we can still observe some delays in the loan payment collection and there is definitely a significant increase in demand for SME financing.
How have you helped portfolio companies through the crisis?
We were able to react quickly and set up a task force based around three main topics. The first was what could be done to protect portfolio companies’ employees and clients – that is quite a big task as it involves 20,000 employees and millions of clients. This included helping to establish protocols and putting in place health and safety procedures. We were given a lot of support from our investors in this regard – they provided useful tools for doing this.
The second was around what we could do to provide liquidity when everything stopped because of lockdowns. Some businesses were heavily impacted by this, while others benefited, so this involved working to understand the liquidity position of every company. A task force was created specifically for working capital and new strategies were established for accounts receivables, supply chain confirmations and inventory management. Capital expenditure was also assessed to determine which investments needed to be postponed and which could continue. We also added the portfolio companies’ cash-burn ratio to our weekly monitored key performance indicators to understand how long available cash reserves would last, and worked through operational expenses in order to minimise liquidity bottlenecks and their effect on the labour force.
The third strand was to get companies ready for the post-covid-19 market. What future strategies are needed to succeed in the new environment? And how should business plans look? This phase is still ongoing.
Private equity is still relatively nascent across Africa. How significant a role can it play in developing SMEs?
Africa is still some way from having adequate private equity volume and enough firms. As a proportion of GDP, private equity across all African countries is extremely low compared with Asia and OECD countries. We see over 100 potential deals a year and can only invest in two or three of them, yet many of the ones we have to turn down are investable opportunities. Origination is definitely not a challenge for us.
That means there is a big gap. Private equity has a big role to play in developing SMEs across the board and especially in mid-cap companies – it is one of the best tools entrepreneurs can use to boost growth. This is not only through finance, but also by bringing discipline to companies, creating value, identifying the right strategies and drawing on networks to hire the right people.
The pandemic has simply reinforced this because there are not many institutions here, especially government institutions, that can support the region’s best companies in becoming sector or regional leaders.
What needs to be done to foster the growth of private equity in African markets?
The development finance institutions do a tremendous job of supporting private equity, but more of a local investor base needs to be built to put the industry on a more sustainable footing. The issue is that regulations for many local pension funds and insurance companies currently prevent them from investing in private equity – there is some movement on this score, but there needs to be much more.
This becomes still more important when you consider that around 80 percent of private equity money comes from just 20 percent of investors worldwide. Most institutional investors are just too big to put to work the kind of $10 million-$15 million ticket sizes that are appropriate for most African private equity firms. And it is these large investors that often drive investment cycles because they tend to be the most influential. They also tend not to want to pay for fund of funds structures.
Another issue is that African private equity has not had a good track record on exits when compared with other emerging markets such as Asia, although much of the success there has been driven by China. Exits will come, it will just take more time. Mediterrania Capital Partners has had eight exits so far, for example. I think the firms here are maturing and this will start to make private equity in Africa more attractive to investors.
How are firms maturing in Africa?
There is much more focus on how to create value in companies and working to ensure they continue to grow through strategic plans, operational improvement and backing the best management teams – it is not about buying low and selling high. For Mediterrania Capital Partners, for example, maturity is stemming from creating lasting, sustainable value through frameworks such as the United Nation’s Sustainable Development Goals and the Principles for Responsible Investment. And that flows directly into exit value.
How are important are environmental, social and governance considerations?
ESG matters both when you invest and during the holding period, but it matters even more when you come to exit because buyers are looking for sustainable companies. Yet it is far more than that. Our firm has a purpose, in addition to generating strong financial returns, to create a better place for employees and local communities. Indeed, covid-19 has shown us that it is more important than ever to have a purpose beyond making money.
ESG is a very relevant part of our investment thesis. It is systematically integrated into all our processes, all our teams are involved in ESG work and contribute to it – it is part of our daily work. So, while we do not invest in companies that are explicitly ESG-themed, as some do in renewable energy, for example, we use ESG analysis in our due diligence alongside more traditional areas such as market positions. We then work with companies through our investment, ensuring that ESG risks and opportunities are discussed at board level and included in board packs and we continue to monitor this to make sure the right actions are taken.
Can you give examples of how portfolio companies have shifted their strategies in response to the crisis?
We have had to look in detail at business plans to understand where there are risks and opportunities related to the pandemic. One example is a construction company that specialises in large infrastructure projects, such as hospitals, shopping centres and hotels. After discovering that no clients were offering advances, we looked at all the construction sites across Africa to determine how many hotels were being built and it became clear there was a need to shift into other segments, such as focusing more on hospitals and building schools and other essential infrastructure.
We are also investors in a private hospital group in Morocco specialising in areas such as oncology and pathology. This area has been affected by the pandemic because people cancelled their medical appointments and postponed diagnostics and treatments during lockdown and so we are now seeing a lot of smaller hospitals in the market for sale. That has created an opportunity to focus on additional opportunistic acquisitions.
Another example is a fashion retail franchise business that operates across Europe, Africa and Turkey. It has 120 shops and so has been affected by the lockdowns. However, we have put significant resources and effort into building online tools and an online presence.