Limited partners were not queueing up to talk to Private Equity International about investing in sub-Saharan Africa this year. In fact, most of our entreaties were met with radio silence or a polite but firm dismissal on the grounds that the region is “not a focus area”.
And lack of LP enthusiasm is evident in the fundraising numbers. So far this year, just $290 million has been raised by four funds, according to PEI data, a significant drop off from the $1.95 billion raised for eight funds in 2016 and a far cry from the $4.26 billion raised by 11 funds in 2015. This year has also seen a 50-50 split between funds closing on target and those closing below. In contrast, 60 percent of funds closed in 2015 beat their target.
Ranked the most attractive of 10 emerging markets in the 2013 Emerging Market Private Equity Association global limited partner survey, in 2014 it slipped to third place, behind Latin America and South-East Asia, where it remained until this year, when it dropped to the fourth spot.
Let’s be clear, though – investors are not tripping over each other in a stampede for the exit either. Just 6 percent of respondents to EMPEA’s survey said they plan to decrease or stop investment in sub-Saharan Africa in the next two years, while 21 percent said they planned to expand their investment there.
Unsurprisingly, the two factors EMPEA LP respondents cited as most likely to deter them from investing in sub-Saharan Africa, with 51 percent and 44 percent respectively, are political risk and currency risk.
“The decade of strong macroeconomic growth across Africa has been superseded by more patchy growth in the smaller economies [such as] Kenya, Côte d’Ivoire, while the biggest economies, South Africa and Nigeria, have slowed,” says Murray Grant, managing director of intermediated equity at UK development finance institution CDC Group.
“The overall market is therefore more challenging, particularly when currency headwinds are factored in.”
Even if LPs are able to get comfortable with all other potential risks to their capital, currency is the one thing that cannot be foreseen, and as Janusz Heath, managing director and head of emerging markets at Capital Dynamics, puts it, “the one area which can suddenly knock the returns out of skew”.
INTO THE UNKNOWN
“[Currency is] something you cannot account for,” Warren Hibbert, managing partner at placement agent and advisory firm Asante Capital, which is in the midst of raising two Africa funds, tells PEI.
“You can judge and diligence an opportunity to assess the quality of the management team, their portfolio, their structure, the mechanisms they use to drive value. Currency is always going to be a complete unknown. You’re beholden to incredible volatility in some cases, regardless of how well you’ve picked the manager.”
The fact that major currency volatility is of particular concern in the two largest countries for private equity investment – South Africa and Nigeria – makes it even harder for fund managers to navigate.
“There is an overall hard currency returns challenge across the continent – especially when cross referenced to Europe or North America,” Grant says.
“It shouldn’t come as a surprise that without access to affordable leverage, without deep capital markets and the depth of M&A that brings, and now with currency headwinds, that the median returns (not top quartile) are not meeting investor requirements.”
Those requirements, says Hibbert, come to one to one-and-a-half turns above what they can achieve in their own backyard.
Grant adds: “If you’re a pension fund in Europe or North America and you have choice of where to put capital, your investment committee is going to expect a risk premium from Africa for the same asset class.”
Developed market limited partners have also been put off by large international GPs who tried their luck on the continent and decided it wasn’t for them.
“At the large end of the scale, internationals entered Africa with great fanfare and then beat a hasty retreat and that doesn’t send a strong message to the global LP universe,” Hibbert says.
“That’s basically a telegraph back to all LPs saying ‘we can [invest] everywhere else, but we’re retreating from Africa because we’ve burnt our fingers and you can’t make returns here’.” This has LPs questioning whether the market is deep enough to sustain the larger funds. Data provider Dealogic recorded just four transactions above $100 million last year and only two in 2015. So far this year, there haven’t been any – although it’s important to keep in mind there may have been larger transactions with undisclosed deal values completed in these periods.
What’s more, a major concern for LPs is whether fund managers, particularly at the larger end, can achieve full and clean exits for their assets. As yet, they have not sufficiently demonstrated this. As Baker McKenzie partner Scott Nelson notes on p. 24, the next 12 to 24 months will be crucial in this regard.
But it’s not all doom and gloom. Everyone PEI spoke to praised the calibre of the Africa-based GPs investing across the continent today, and stressed that top quartile managers are able to deliver on, and even stretch far beyond, their promises to investors.
“Next year’s going to be a massive fundraising year for Africa,” Hibbert says, noting that several large players are due to return to market. This will only help the smaller managers also trying to raise capital.
“It will turn the searchlight more towards Africa because you’ve got more people beating the drum. It’s only a good thing when you’ve other strong groups in the market at the same time, but the challenge remains in finding consistently strong groups.”
Heath adds: “It’s a complicated market with a lot of noise in it, but equally huge demographic opportunity if you back the right people. But it is going to have lots of ups and downs.”
There’s no doubt the African landscape is rife with challenges for private equity investors, but it’s also replete with opportunities. The managers best able to turn those dynamics to their advantage will come out on top in the next fundraising cycle.