Investing in Africa: The road ahead

The momentum that was building for Africa-focused private equity funds at the end of 2014 has shown no signs of abating in the first half of 2015.

The year started with news that pan-African player Helios Investment Partners was closing its third fund on $1.1 billion, reportedly the largest fund yet dedicated to African private equity. Development Partners International (DPI) then closed its second fund on $725 million and The Abraaj Group its third sub-Saharan Africa fund on its $990 million hard cap. By May more capital had been raised for Africa than in the whole of 2014.

“What’s interesting about the recent fundraisings from Abraaj, DPI and Helios is the fact that so many different institutional investors from around the globe were interested in these funds, including endowments, foundations and pension funds,” Dorothy Kelso, director and head of research and strategy at the African Private Equity and Venture Capital Association (AVCA), told Private Equity International earlier this year.

These institutional investors, particularly the pension funds, have large cheques to write. At the AVCA Forum in London in April, Vicki Fuller, chief investment officer of the New York State Common Retirement Fund (NYSCRF), announced the $180 billion pension fund’s plans to invest up to 3 percent of its assets – or around $5 billion – in Africa in the next five years. In the last 12 months NYSCRF committed $100 million to Helios Investors III and $85 million to ACA’s fourth fund, which is in market targeting $600 million, both new relationships for the fund.

At the same event, Roselyn Spencer, executive director and chief investment officer at the City of Baltimore Employees’ & Elected Officials’ Retirement Systems, said the US public pension funds “tend to mimic each other”.

“If you already manage money for existing public funds, that’s a big plus in terms of getting additional business from other public funds,” said Spencer, whose fund does not currently invest in Africa.

According to the AVCA’s latest limited partner survey, 50 percent of the 68 global LPs questioned plan to increase their private equity investment in Africa in the next three years, and more than half expect private equity returns from the continent to exceed returns in other emerging markets.

However, Pantheon principal Dushy Sivanithy argues that although many LPs are educating themselves on the opportunities in sub-Saharan Africa, the recent fundraisings are “not quite reflective of some mass take-up of African private equity”.

“I think it’s a couple of very large investors who have moved the needle,” he says.

 
Marleen Groen, senior adviser to StepStone and director at impact manager African Wildlife Capital, says investors are still “by and large very cautious” about investing in the continent, and a number of industry insiders believe the majority of LPs are happy just window shopping.

Janusz Heath, managing director at Capital Dynamics, sees some interesting opportunities in sub-Saharan Africa and “some very able managers”, but “there’s nothing compelling that says you have to be in Africa now or you’re going to miss out”.

Despite increased investor interest, it’s still not easy to raise a fund for the region, says Murray Grant, managing director for UK development finance institution CDC Group’s Africa funds team.

“You’ve got an increasingly sophisticated LP audience who are becoming more au fait with Africa and its track record, and the scrutiny, whether it’s for a first-time smaller fund or the larger, more established funds, is on their track record and on the calibre of the team they are presenting, and the clarity of the strategy as to how they’re going to invest that.”

There’s no escaping that as a relatively new destination for private capital, sub-Saharan Africa’s track record on exits isn’t deep. According to a study by EY and the AVCA, private equity exits in Africa reached an eight-year high in 2014, but this was still just 40 exits. By contrast, firms across Europe exited 2,416 companies last year, according to the European Private Equity and Venture Capital Association.

In the AVCA LP survey, 73 percent of respondents cited a GP’s track record as the most significant factor in evaluating African private equity firms. The lack of track record – or lack of data related to fund performance and strategy – is an issue, says Baltimore’s Spencer.

“Investors in Africa at all levels have to find a way to educate our consultants, the staff, boards, and administrators on their process and firm history. For instance, if we’re hiring a US based manager investing in the US, there are so many sources that we can tap into and get data and information on the companies we’re looking to invest with. Where is that source for investments or funds in Africa? It might be there, but it could be very thin or difficult to find.”

HEATING UP

For some, the robust fundraising figures are prompting fears there may be too much dry powder in funds targeting larger assets, pushing up prices. “Relatively speaking, there is a substantial amount of capital at the larger end of African PE investing,” says Groen, commenting on the multiples paid for large assets. “African investments can be attractive but quite expensive, even with relatively few larger GPs and funds.”

Asante Capital’s Warren Hibbert, who is helping to raise Lagos-based Verod Capital’s debut fund, targeting $100 million, believes there is more value among small-caps where deals are not usually brokered.

“In terms of pricing and debt multiples and EBITDA, it’s as, if not more, expensive than Europe and the US at the large end of the market because there are just so few assets and so many local and international funds chasing them, not to mention strategic acquirers,” he says.

“As it gets more intermediated and as there are fewer and fewer of those assets around, so the frenzy and pricing becomes exponential and generating the requisite return becomes more and more challenging.”

However, Souleymane Ba, a principal on the investment team at Helios, says that although LP interest levels have increased, the amount of capital collected is still not up at levels seen in 2007.

“If you put the amount of capital raised in relation to the funding gap across the continent, an incremental $1 billion or $5 billion is still small,” he says. “The reality is the funding gap is so massive that even all these numbers put together are still like a drop in the bucket.”

Sivanithy agrees that it’s easy to get carried away with the fundraising numbers. 

“We’re talking about four or five funds that have raised quite big numbers, and that’s still an entire continent to invest in,” Sivanithy says. “I think the total capital relative to the opportunity is probably absolutely fine, it’s a question of where that capital is targeted.”

CDC’s Grant agrees that although a lot of capital has been raised this year in historical terms, the market today is deeper than 10 years ago.

“When you look at the pipelines of all of these individual funds, they are all pursuing what I would say are good opportunities,” Grant says. “I think it’s a sort of chicken and egg situation, and you can debate which comes first, is it capital or deals? But actually when there is capital and when it is being looked after by smart people, [they] will genuinely find ways to invest that capital.”

Mustafa Abdel-Wadood, partner and head of the regional fund businesses at Abraaj, argues that large assets for sale are few and far between. The job of the investment team on the ground, however, is to create opportunities.

“If you take the view that you are there to create investment opportunities and drive deal flow, there are a lot of great businesses to invest in,” he says. “But one needs to be proactive in building that pipeline and creating bilateral conversations.”

Similarly, DPI is not seeing a shortage of deals. According to co-founder Runa Alam, the firm looked at more than 500 deals when investing the €274 million DPI I and invested in nine companies. Two years into its investment period, DPI II, which is almost twice as large, has looked at 325 companies and made four investments, with two further deals pending.

“We are already about 25 percent committed, and with the deals in our pipeline we could be around 40-50 percent committed still this year,” says Alam. “It’s not that we’re getting bigger for no reason, we’re getting bigger because I think it’s better for our LPs and our returns.”

Private equity’s engagement in the marketplace will itself create more investable assets, argues Dominic Liber, partner at “profit-with-purpose” financial services-focused investor LeapFrog.

“As PE funds develop, they will grow portfolio companies from $30 million to $50 million, and from $50 million to $80 million, so the overall pool of investable assets will continue to grow in value, and there will be more and more of these larger deals to be done.”

Most industry insiders agree there are few low-hanging fruit left to pick, but that does not mean the opportunities are drying up. “Ultimately, as ever in private equity, it comes down to the quality of the management team and the clarity of the strategy and the ability of management plus investor to execute on that plan. That’s what makes good investments,” says Grant.

It’s also undeniable that some of the major economies in sub-Saharan Africa are facing tough macro-economic headwinds whether from oil prices or currency depreciation. But for some private equity players these obstacles present opportunities.

“Since Africa is all we do, and we have grown up dealing with inflation and currency devaluation, you accumulate a knowledge base of how people behave in those environments, what businesses succeed, which business models work,” says Ba. “As a result, when you have an environment where people are kind of holding fire, you can be judicious as to how you price and structure your capital. That provides the opportunity to structure really interesting deals.”

Short-term challenges can be mitigated by diversification, as well as by targeting sectors less affected by macro-economic issues. As LeapFrog’s Liber argues, the road bumps do not detract from the long-term growth story.

“Whatever short-term fluctuations there are in oil price or currency, the fundamental growth patterns in African economies, and the development of the emerging middle class, is happening anyway,” he says. “And that’s going to keep happening for a long time.”