Africa special: The rise of the secondary buyout

A wave of secondary buyouts and a new breed of fund managers could be a sign that the African private equity ecosystem has taken a major step forward.

Of the 48 exits achieved last year, a record high for the continent, 17 were sold to private equity firms and other financial buyers, according to data from the African Private Equity and Venture Capital Association. This is compared with just seven in each of the previous two years.

A rise in the number of investments snapped up by larger firms is good news for the private equity “food chain”, according to Andrew Brown, chief investment officer at Emerging Capital Partners, an Africa-focused private equity firm. A new generation of spin-out and start-up GPs are emerging to target the deals deemed too small for the larger pan-African funds, safe in the knowledge that those larger funds will be there to provide an exit route.

“The bigger funds typically have a minimum deal size which means that they pass up on some interesting opportunities because they are too small,” says Enitan Obasanjo-Adeleye, head of research at AVCA.

“We are seeing fund managers who have left bigger PE firms where they have gained a specialisation in either a sector or region to set up a platform that will enable them to target these smaller deals. They can then gradually scale up with subsequent funds to become something of a behemoth in the market themselves.”

Matteo Stefanel, founder and managing partner of Apis Partners, is among this new crop of managers looking to take advantage of Africa’s overlooked investment opportunities. The former senior partner at pan-African investor Abraaj Group left in November 2013 to set up his own growth equity firm targeting deals of around $30 million.

“Sometimes the colony will lose a bee,” says Stefanel. “They’ll go somewhere else and start up a different colony. That’s exactly what we did.”

Although Stefanel’s own decision to leave was born out of a desire to satisfy his “entrepreneurial bug”, he explained that some of Africa’s newest fund managers had been inspired to launch their own firm after finding that global mega-funds often shied away from deals on the continent that they deemed too risky.

“It’s frustrating for somebody that is a specialist in this region to be faced with this type of answer every time. After a few instances of such frustration they’ll just leave the firm and start something else,” says Stefanel.

However, raising a debut fund anywhere in the world is rarely easy, even with the support of development finance institutions mandated to do just that on the continent. When fundraising as a smaller, younger player, GPs may find it more difficult to find investors without a long-established track record.

The challenge could be exacerbated by the macro-economic headwinds that have scoured the continent’s political and financial landscape over the past few years.

“With the fall in the oil price, and the fall in commodity prices, you’ve really got a multi-speed Africa in terms of the pace of economic growth,” says Brown. Nigeria and Egypt’s well-documented struggle with currency values stand in stark contrast against Côte d’Ivoire’s ascendancy, with the latter expected to enjoy above 8 percent GDP growth in each of the next two years.

Although efforts to devalue the Naira in June 2016 may have improved Nigeria’s growth forecast to 2.5 percent for 2018, this volatility alone could deter investors who are already sceptical of Africa’s potential.

GPs raised $1.95 billion in Africa from the funds closed in 2016, a significant decline from the $4.26 billion raised the previous year, according to Private Equity International data. The 2015 figures were characterised by several uncharacteristically large fund closes, such as Helios III on $1.1 billion and Abraaj Africa Fund III on $990 million, while the past year has instead seen a trend of much smaller raises.

In March 2017, Catalyst Principal Partners held a first close on its second fund on $103 million, with plans to raise $175 million at final close later this year. The same month saw Apis Partners close its debut Growth Fund I on $287 million.

“It’s been a year of aversion to global emerging markets in terms of risk appetite,” says Stefanel. “We found it laborious, we found it time consuming and sometimes we found it stressful, but never difficult, in the sense that ultimately the capital is there for the right idea [and] the right team.”

For those firms that do attract capital, the increasingly well-served private equity ecosystem – helped to a great extent by the glut of capital raised in 2015 – means that if they put in the legwork to create local or regional “champion” businesses, then there will be a number of financial buyers ready to acquire them.

Kenyan coffee chain Java House Group is a case in point. In July 2017 ECP sold the business to Abraaj Group. ECP Africa Fund III had acquired a majority stake in Java House Group in May 2012, and under its ownership the business has expanded from 13 branches in Nairobi to 60 stores across 10 cities in Kenya, Uganda and Rwanda.

“We got 12 non-binding bids [prior to selling] and private equity firms were very well represented,” says Alex Handrah-Aime, managing director of ECP’s Johannesburg office. “There’s a lot of low hanging fruit in terms of concepts but it’s execution that’s the biggest challenge. What you get with a private equity-owned company is an institution that has been primed, that has demonstrated an ability to execute.”

Readying a company for sale could prove harder than it sounds. “The smaller funds are looking to buy businesses which need a lot of work and potential surgery to the management teams,” says Edward King, partner at McLean Partnership, an executive search firm working with private equity firms and their portfolio companies in Europe, the Middle East and Africa.

“It’s a very competitive market. There are a number of portfolio companies all chasing the same high-quality talent. The hires they make will often determine the success of the investment.”

ECP invested in Nigeria-based telecommunication tower provider IHS in November 2011. Since then, the business has grown from 700 towers to over 22,000, which Brown attributes in part to the introduction of “an entire management tier that wasn’t there when we invested”.

Historically, emerging markets such as Africa have had a smaller management pool and less depth of experience. Talented managers and financiers left to find opportunity in the developed world, so the story went.

However, developing private equity markets and economies has attracted a generation of returning, skilled management. Although Ken Kuguru, Java House’s current chief executive, was born in Kenya, he left to study at North Carolina’s Wake Forest University and later the University of Michigan. His career also saw him spend several years working in Shanghai for Philips Automotive.

“You no longer have to rely on expats in order to grow these businesses,” says ECP’s Handrah-Aime.

“These are individuals who have worked abroad [and] have a global perspective… but are returning to where the growth opportunities really are, which is Africa.”

Africa’s burgeoning middle class has long been central to the ubiquitous “Africa Rising” narrative, but this market could remain largely unrealised if buyers are unable to access the goods and services so many hope to sell.

“You’ve essentially got this emerging consumer class, but it is still really price-sensitive,” says Andrew Brown, chief investment officer at Emerging Capital Partners. “You’re talking about relatively small amounts of disposable income on a per-capita basis.”

Discretionary consumer products such as apparel, entertainment and leisure accounted for 15 percent of private equity deals in Africa between 2011 and 2016, according to data from the African Private Equity and Venture Capital Association.

While this figure dwarfs sectors such as utilities and telecommunication services, which represented 6 and 3 percent respectively of deal volume, the discretionary consumer market was responsible for just 6 percent of total deals in terms of value over the same period. This is compared with 21 percent for utilities and 25 percent for telecommunications services.

“The logistics of moving products and goods around the continent is actually very expensive because the distances are long,” says Brown. “When you get there the markets are relatively small and the infrastructure is poor.

“So as a team we’ve identified this as something we think is very important; this strategy of selling pickaxes to goldminers rather than mining for gold directly.”
ECP has already made several investments in the logistics sector, according to Brown. Although these had not been announced to the public at the time of writing, this potentially lucrative market is unlikely to remain quiet for long.