There is, perhaps, no deal that illustrates the opportunities and challenges that private equity faces in sub-Saharan Africa than Investec Asset Management’s investment in OK Zimbabwe.
The supermarket chain was initially identified as an attractive investment opportunity by Investec AM’s public equity team, sent there in 2010 after the country abandoned its currency amid rampant inflation in favour of the US dollar – creating the first building block of economic stability which investors needed. OK Zimbabwe was privately-owned, so the public equity team passed it on to their private equity colleagues, who were immediately interested.
“OK Zimbabwe was very attractively priced at the time,” says Nick Tims, a managing director at Investec AM in London with a focus on its African private markets business, though he declines to disclose details. “The potential is significant in a country which has very high education levels and fabulous infrastructure, and dollarisation has transformed the economy.”
Zimbabwe saw a spurt of growth between 2010 and 2012, although, at around 4 percent, economic expansion since then has been a little below the African average of about 5 percent, according to the World Bank. Another crucial consideration: there are few retail chains in sub-Saharan Africa, outside South Africa, says Tims.
“So they’re real trophy assets which are of extreme interest, in particular to South African retailers who need to expand beyond South Africa.”
But although dollarisation was a necessary first step to stabilisation, the country has since stumbled. Infighting in the ruling Zanu-PF party, including the expulsion of the deputy and eight cabinet ministers in 2014, has stoked fears of chaos when Robert Mugabe, the 91-year-old president, leaves office.
Tims says he wants to see the political and economic situation improve, but adds that “you have got to look through the political situation to the immense potential of the country” and Investec AM is still looking for consumer opportunities in Zimbabwe.
There is another problem: the prices of attractive assets have been bid up rapidly as more investors have come into Africa. According to the African Private Equity and Venture Capital Association (AVCA) there was $8.1 billion of private equity transactions in Africa last year, almost three times the value in 2010, when the OK Zimbabwe stake was bought.
Tims estimates that investors would now have to pay “low double digits” for a supermarket chain in a stable market outside South Africa, though he argues that these prices can be justified by the prospect of high growth.
To many investors, the most rewarding market in sub-Saharan Africa is the consumer super-sector. Henry Gabay, London-based co-founder and chief executive of Duet Group, an asset manager and private equity investor specialising in emerging and frontier markets, outlines the broad macro argument for this.
“In Europe, underlying GDP growth expectations are low, and private equity is all about buyouts, financial engineering and asset stripping,” he says. “In Africa GDP growth is high, and 70 percent of the population is below the age of 30. If you’re going to sell food, beverages or clothes, which of these continents is going to buy more?”
Gabay and others also like healthcare – a classic example of a sector that gains as countries growth wealthier. He cites the grisly but compelling statistic that less than 1 percent of global health spending but 24 percent of the global disease burden is in Africa.
Geographically, private equity firms dipping into Africa to find good deals for their global funds have tended to concentrate on suitably-sized companies based in the larger markets – particularly South Africa and Nigeria. Firms with their own Africa funds are casting their nets more widely, because they can target smaller companies.
“A lot of the African franchises are part of much larger funds, but Carlyle has raised its own dedicated Africa fund, so our deals are right-sized for the African continent,” says Marlon Chigwende, managing director and co-head of Carlyle’s $700 million sub-Saharan Africa buyout fund run from Johannesburg and Lagos.
“The beauty of the Carlyle model is that I’m not trying convince my US and European colleagues that we should invest in Tanzania or Zambia, and I have a dedicated team on the ground here that can invest in those and other countries.”
The attraction of the consumer sector, as well as of sub-Saharan Africa in general, is increased by the fact that African business owners have become more accepting of private equity. They have even become more open-minded, say general partners, toward ceding controlling stakes or even outright buyouts.
“The trend is changing rapidly,” says Jacob Kholi, Accra-based partner and regional chief investment officer for sub-Saharan Africa at Abraaj Capital, which has just closed its third sub-Saharan Africa fund at $990 million.
“Promoters, owners and sponsors are becoming amenable to buyouts. Others are looking for growth capital. The new generation have experience in the US and Europe, so they’re very open to partnerships and joint ventures. Some of the younger generation is not even interested in the family-owned business, because it has its own business ideas.”
This new generation is more prone than its predecessors to return from the US and Europe largely because the politics in their home countries have become more stable. Among the biggest changes has been the greater acceptance of foreign direct investment (FDI).
“In our key markets there are no restrictions,” says Kholi. “Governments realise the need for private-sector participation so there’s been significant improvements in the frameworks for attracting FDI, with various incentives for foreign investment.”
Kholi also notes that many African countries have signed double taxation treaties with low-tax jurisdictions, which make low-tax foreign investing much easier.
“Most governments in sub-Saharan Africa welcome FDI, and a few are constantly looking at reforms to encourage private equity and venture capital in their countries because a number realise this is an engine for creating jobs and growing the economy,” says Ponmile Osibo, research analyst at AVCA in London.
He cites the Fund for Agricultural Finance in Nigeria, an agriculture-focused investment fund with capital from the German development bank KfW, as well as the Nigerian ministry of agriculture and the country’s sovereign wealth fund.
Aside from the more welcoming attitude toward FDI, investors point to improvements in general political stability. “The risks in Africa are exaggerated. There’s been huge progress in democratisation,” says Gabay of Duet. He estimates that 44 of Africa’s 54 countries have “very strong democracies”.
Sceptics might argue that democracy does not eradicate all deep-rooted problems. However, Kholi puts the case for why it helps. “Democracy does not necessarily eliminate corruption, but it can lead to changes because if people and institutions are seen to be corrupt, ultimately voters will vote them out,” he says.
Many investors downplay the importance of politics, but not the need for good management and the difficulties in finding it.
“Alignment between investor and founder’s interests, and depth of mana-gement expertise, are probably the two most challenging issues we face,” says David Cooke, Johannesburg-based director at Actis, the private equity firm specialising in emerging markets. “What some people might think are the key macro risks are far less important, such as politics. If things go wrong it’s usually problems at the micro level, such as not being able to get the right marketing talent into the business.”
There is broad agreement that management in sub-Saharan Africa is getting better, despite the difficulty in finding leaders with the ability to keep companies growing after the initial explosion in sales that follows a good business idea.
“We see highly entrepreneurial managers across the continent, but they don’t have that experience of what it takes next,” says Cooke. “How are they going to triple the size of the business again in the coming years?” He looks at companies’ strengths and weaknesses.
“For consumer goods businesses, management will often be very good at the front end, but what has often not been done well is HR and IT systems at the back end of the business,” he says. “They can drive growth rapidly, but that starts to stumble if they haven’t developed broader management expertise along the way.”
The sentiment is echoed by Murray Grant, managing director at CDC Group, the UK development finance institution. “You can find very clever people anywhere in the world. Trying to find very clever people who have experienced what it takes to grow an organisation at 15 percent a year, which is what you need to achieve private equity returns, is harder,” he says.
It’s the ability to improve management, however, that attracts multinational trade buyers. This is a key consideration, given the relatively small size of Africa’s secondaries market and the limited opportunities for initial public offerings. IPOs accounted for only 4 percent of African exits between 2007 and 2014, according to AVCA, with South Africa’s Johannesburg Stock Exchange regarded as the only highly liquid exchange on the continent.
Listings on exchanges outside Africa remain relatively rare, though Tims of Investec AM predicts that within the next two years “we could well have certainly three or four big ones that will be listed in London or dual-listed in London and Johannesburg”.
There have been some large and successful trade sales to multinationals, such as Walmart’s 2012 acquisition of Massmart, the South African retailer. General partners argue that they play an essential role in preparing the ground for multinationals.
“Trade buyers like the idea of investing in Africa,” says Cooke of Actis. “But the low level of governance and health and safety standards makes it challenging for them to invest. That’s where we have a great opportunity, in installing these standards and then selling them on.”
The evident attraction of Africa to multinational trade buyers is one of the biggest reasons behind international private equity firms’ strong interest in Africa – but is the deal flow enough to keep them all happy?
“Funds are in danger of getting too big, given the paucity of deals of appropriate size for those funds,” says Tims. “If you’ve raised a billion, there are lot of people after the same small number of deals that you’re looking for.”
His solution: to search primarily for lower deals, for stakes worth $15 million to $60 million. “The competition is much less, the deals are often proprietary, and valuations are still broadly pretty compelling,” says Tims. “You can still find consumer plays in this space on EBITDA multiples of five or six in classic FMCG.”
Private equity firms can, at least, take advantage of the growing international interest in sub-Saharan Africa by buying into the hotels that these new international dealmakers stay in. The pricing in this sector is also lower than in some of the more popular consumer fields.
Jean-Charles Charki, founder of Iota, an advisory firm specialising in Africa, says a client is about to sign a deal to buy a hotel in a major African capital. With a price of under $20 million and the potential, after the year it takes to restore the hotel to its former glory, for $6 million to $7 million in free cashflow, he thinks that the buyer can pay for the investment in three years.
Charki sees similar opportunities in most big African cities because of the huge supply-demand imbalance. He cites the example of Kinshasa, the capital of the Democratic Republic of Congo. “It has a population of 15 million people and 600 hotel rooms you would consider acceptable, so the minute there’s even the smallest gathering, the capital is running out of rooms.”
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