There are two things playing on the minds of those investing in Africa at the moment, be they limited partner or fund manager: currency devaluation and commodity prices.
“Private equity activity is invariably linked with the macro performance of every economy we operate in,” says Jacob Kholi, partner and head of sub-Saharan African investments at The Abraaj Group.
“What is going on in Nigeria [for example] is definitely having an impact on what we are doing in that country. Clearly we have companies that operate in that economy that have to buy foreign exchange, for instance, and the difficulty in accessing it impacts activities.”
So far in 2016 fundraising certainly hasn’t been the success story of years past; just $1.2 billion has been raised by six funds so far this year, compared with $3.7 billion by nine funds in 2015 and $3.7 billion by 16 funds in 2014, according to PEI data. This is partly because some of the continent’s major players – Abraaj, Development Partners International, Helios Investment Partners, The Carlyle Group – raised in those previous years, buoying the fundraising figures. Between them, Abraaj, DPI and Helios accounted for $2.8 billion of the capital raised last year.
However, there are other established faces struggling to make headway with their fundraisings due to the onslaught of macro challenges. African Capital Alliance is still seeking commitments for its fourth fund, a 2014-vintage targeting $600 million, and Emerging Capital Partners is still on the road with its fourth fund, a 2013-vintage targeting $750 million.
Fundraising, then, is not an easy story for African fund managers. The prevailing “Africa rising” narrative that has been bolstering optimism for the last few years has given way to concerns about the sustainability of the market and the lack of track record.
While currency volatility may also be a challenge for existing holdings, now is a good time to put money to work.
“In the midst of all these challenges there are some fantastic opportunities. It allows us to look carefully and select the right target,” Kholi says.
A more pressured environment helps to make private equity a more attractive option for corporate owners and founders.
“Commodity price reductions and depreciation of currencies has caused a real tightening of liquidity in the region,” says Alykhan Nathoo, a partner at Helios.
“The public equity markets have been largely shut as an avenue to raise capital and the debt markets have been really constrained as banks are nursing losses to the commodity sector. Also, international banks have started to withdraw more generally from Africa and other emerging markets, more due to regulatory reasons. What this has meant is private equity has been one of the last resorts for capital raising.”
The result for fund managers is better pricing and more opportunities, with Nathoo going as far as to say Helios is seeing more dealflow than ever before.
“From a private equity standpoint, it’s been a really fertile environment,” he says. “We’ve also seen higher quality businesses that we weren’t able to access historically because there was no pressure to sell them.”
Ponmile Osibo, research manager at the African Private Equity and Venture Capital Association, says for the most part commodity prices have not had a direct effect on GPs. However, “it has thrown up some opportunities where the market dynamic has shifted”.
One such example is Helios’s acquisition, alongside energy commodities trader Vitol, of a 60 percent stake in Nigerian energy group Oando’s downstream operations, which includes 400 service stations and more than 600,000 barrels of storage and terminal capacity.
“The real catalysts for that transaction were debt obligations that needed to be resolved at the holding company, and therefore providing an opportunity to invest in the Oando downstream business,” Nathoo says.
The macro headwinds have also had an effect on competition, adds Kholi. “It’s limited the level and scale of competition for deals in Nigeria,” he says, adding that some investors are taking a blanket ‘wait-and-see’ approach, while others are valuing businesses below market to account for the ongoing challenges.
“There are not too many investors chasing the deals, which then gives an advantage to those investors who are entrenched on the ground.”
Better entry prices can, of course, have a negative impact on exit prospects. Although 2015 was a record year for private equity exits across Africa – with 44 portfolio companies successfully offloaded – average hold periods have increased as firms wait for the right time to sell amid macroeconomic uncertainty. The average hold period in 2015 was 6.1 years, up from five years in 2014 and a low of 3.9 years in 2008 and 2009, according to data from the AVCA and EY.
“We’ve heard about disparity in pricing between the buyer and the seller because they’re pegging to two different values. Some GPs have [held back] on pulling the trigger on deals,” says Osibo. “Even though 2015 was a very strong year for exits with a record number of African PE exits, [GPs] have held back on some exits in the first half of 2016 because pricing has been in flux and reduced interest from trade buyers for some assets.”
Investors hunting for strong returns are not able to just rely on buying at the bottom of the cycle. For one thing, nobody knows if we’re there yet. As well as negotiating attractive entry prices, dealmakers need to give serious consideration to identifying long-term trends and spreading risk.
“We look out for companies with the potential to grow cross-border, and therefore spread their risk,” Kholi says, using Abraaj’s 2013 investment in Fan Milk International alongside Danone as an example. A manufacturer and distributor of frozen dairy and non-dairy products, Fan Milk operates across six West African countries.
“You also have to focus on what we call defensive sectors, or sectors that in addition to being defensive usually fit into basic necessities, like food, water, healthcare, education. Some of these grow at 25-30 percent per annum.”
Osibo adds: “When you look at education and healthcare, there is significant unmet demand for investment in these sectors. In a number of countries the government and the private sector are unable to meet the demand created by a young population and increasing urbanisation.”
Abraaj also uses creative structures to help it overcome some of the challenges related to currency.
“The fund would typically provide a guarantee to a local bank to provide funding to the company in local currency thereby [removing] the exchange rate impact,” Kholi says.
However managers seek to address or circumvent the macro challenges, successfully navigating these stormier seas is vital to ensure the long-term sustainability of the private equity industry in Africa.
“This is what we’ve learned in the other regions where we work. Even if we’re not in a GP, we want absolutely everybody to do well because in these very nascent markets, one bad story coming out impacts absolutely everybody who’s fundraising,” says Anne Fossemalle, director of the equity funds team at development finance institution European Bank for Reconstruction and Development.
“So far, it’s looking quite good.”