Following the recent and unprecedented global economic crisis, investors have slowly woken to a new dawn, which has presented them with a glimpse of the future.
The governments of the G8 economies, who have long been the senior members of the global economic family, have now broadened their group to include the world’s 20 major economies; a development mirrored in other leading global policy institutions such as the World Bank and IMF. The governments of countries formerly labelled ‘developing nations’ or ‘emerging markets’ have found a voice at these leading forums. Their prior timidity has disappeared, in what Pimco CEO Mohamed El-Erian has described as “cross-border wealth hand-offs… empowering a new set of actors and products when it came to global influence”. Among these formerly shy and reserved siblings, the BRIC economies of Brazil, Russia, India and China have taken a lead. Increasingly, global growth is being driven by these fast-moving economies, rather than by the elder statesmen of the G8. What has surprised many investors however, has been the rise of the forgotten sibling, Africa.
Africa had long been dismissed but it has recently found itself in the spotlight.
As observed by the Emerging Markets Private Equity Association (EMPEA):
“Media coverage of the continent has surged in 2010. Newspaper, magazine and television outlets have significantly raised global awareness of the region by increasing the frequency and depth in which they are profiling Sub-Saharan Africa, partly in response to South Africa’s successful hosting of the 2010 FIFA World Cup. US-based financial magazine Barron’s declared in August that the time has come to invest in the continent, citing a decade of impressive and sustained economic and institutional progress. Furthermore, research houses and consulting firms are also beginning to expand their knowledge base on the region. For instance, the McKinsey Global Institute produced its first report on Africa this year, declaring that reforms over the past 10 years are leading to broad-based and long-lasting growth.”
This year might well be remembered as the climax of Africa’s re-branding strategy. Pioneer investors, who have long enjoyed an arbitrage from the negative perception of Africa, have found their advantage steadily being eroded.
Attractive opportunities
A confluence of positive factors is transforming Africa from a cursed continent into an attractive investment destination for international emerging market investors.
Africa’s Balance Sheet
1\. Superior Asset Base:
• The continent holds 30% of the world’s proven mineral resources, and The Economist Intelligence Unit estimates Sub-Saharan Africa is home to 90% of the world’s platinum and chromium reserves; 67% of phosphates; over 40% of gold; 30% of uranium; and 10% of all oil reserves. Furthermore, much of these resources remain underexploited.
• Africa has almost 600 million hectares of potentially suitable arable land not currently under cultivation, representing about 60% of the world available cropland.
2\. Larger and Younger Population: Its demographics are also extremely young, with 43% under the age of 15, which could potentially develop into a labour force strong enough
to rival low-cost manufacturing hubs such as China and India.
3\. Unprecedented level of restructuring: political stability, profound fiscal reforms, significant multilateral debt elimination are paying off.
4\. Growing Equity Base: Africa’s annual flow of foreign direct investment increased from US$9 billion in 2000 to $62 billion in 2008. Relative to GDP this is comparable to investment flows into China.
5\. Superior Equity Performance: Africa delivered the best return on equity
of any emerging economy (including China and India) in 2006-2007.
Africa’s Income Statement
1\. Absolute Growth of Top Line: Africa is also in a period of growing economic ascendancy, having achieved strong economic growth of 5% since 2000 (adjusted for purchasing power parity). According to World Bank projections, nine of the 15 countries in the world with the highest rate of five-year economic growth are in Africa. This is being primarily driven by:
• Commodities Prices
• Explosive Consumer Demand:
a. Global: the surge in consumer purchasing power across emerging markets led by the BRIC nations
is one clear driver, but Africa in
itself is becoming a bigger client.
b. Local:
• Indeed, on the quantity side, Africa’s middle-class (defined as those with incomes of $20,000 or above) is now greater than that of India. According to McKinsey, in 2000, roughly 59 million households on the continent had $5,000 or more in income—above which they start spending roughly half of it on nonfood items. By 2014, the number of such households could reach 106 million.
• On the quality side, the ‘brain drain’ of the 90s has slowly been replaced by ‘brain gain’ in the aftermath of the global economic crisis, with expatriate Africans returning home and demanding the very best international standards of housing, goods and services, infrastructure, security and governance. There has been a significant shift in structural growth capacity across Africa, analogous to that seen in Asia in the early 80s, Russia in the early 90s and Brazil and India in the mid-90s.
2\. Untapped Prospective Revenue Next
Door: Local businesses are increasingly investing elsewhere in SSA. A 2009 database of Monitor includes 111 deals worth $7.2 billion originating within the subcontinent, with South Africa, Nigeria, and Kenya the most active investors and Uganda, Ghana, and Nigeria the major destinations. By sector, much of this type of investment is flowing into financial services, ICT, and hospitality and tourism.
Cash Flow
Over the period 1990-2008, Asia’s share of African trade has doubled to 28%, while Western Europe’s share has shrunk from 51% to 28%. This change comes with not only better negotiated terms but with larger facilities for the required working capital of the Continent. Furthermore the providers of these new facilities have two key characteristics: they have both excess quantities of dollars and insatiable appetite for natural resources and commodities. By solving Africa’s cash flow problems, they also find solutions to their own problems.
One may think this angle of providing better terms is exploited exclusively by Asia. There is a large pool of non-Chinese mining industrial players securing African natural resources with local governments and providing in exchange financing for infrastructure projects. Arcelor Mittal plans to build rail and port infrastructure in Senegal. While Vale plans to spend $5billion to $8 billion on mines, ports and railways in Guinea and Liberia. Tullow Oil and its partners plan to spend $8 to $10 billion dollars on infrastructure projects and to putting together an oil refinery in Uganda.
Africa versus the West and BRIC
According to Boston Consulting Group (BCG), Africa is outperforming the US and Western Europe in productivity gains. Furthermore, most African countries have levels of debt to GDP five to 10 times better than EU members or the UK.
Africa is comparable to the BRIC nations in many respects.
1\. The continent’s collective GDP of
US$1.6 trillion in 2008, is roughly equivalent to that of Brazil or Russia.
2\. Africa is also home to a billion people, and while its total population is comparable to that of India, since 2010 its middle-class population is greater.
3\. Africa is also nearly as urbanised as China and has as many cities of more than
one million inhabitants as Europe has.
4\. Capital flows to Africa now exceed those of the BRIC countries, with the exception of China. Capital flows and remittances to Africa more than doubled over just a three-year period (2005 to 2008), according to the United Nations Conference on Trade and Development (UNCTAD).
It is important to remember these statistics are comparing a continent with individual countries. Africa consists of 53 independent countries, including one with a population of 150 million (Nigeria) and more than 20 with populations of less than 5 million.
There are more than 20 economies producing less than $5 billion per annum and 15 landlocked regions. Such disparate statistics have provided a smoke-screen, deterring investors from embracing opportunities to unlock value through PE investment.
Opportunity to Capitalise
It is a little known fact it costs US$1,500 to transport a car from Japan to Abidjan, while it costs US$5,000 to transport it from Abidjan to Addis Ababa. Even more absurd is that 50% of all intra-Africa air routes are monopolies served by a single carrier, with 75% served by fewer than 350 seats per week. Journeys between West and Central African capitals are often quicker if routed back through Europe. Such anecdotes serve to highlight serious and sad issues.
Fortunately, a modern African leadership in partnership with institutional and sovereign investors understands Africa’s business model and infrastructure is out-dated. The continent can be described as a casualty of history, having to deal with the legacy of its colonisers. Existing infrastructure, supply chains and trade channels were designed to facilitate the trade of goods, sharing of intellectual property and repatriation of dividends to European imperialists - the parent company. The subsidiaries, or African colonies, were developed to serve the interests of their foreign rulers, not to trade and develop with each other. As Africa regained its independence in the second half of the 20th century, its new leaders were charged with taking over the helm and often subscribed to the belief the easiest way to succeed was to leave things unchanged.
However, today an ever-increasing number of African nations subscribe to a new model, having abandoned ill advised ‘management buy-outs’ (commonly viewed as ‘independence processes’. They must have come to realise these ‘independences’ or ‘buyouts’ were actually financed with debt from the underlying seller. Over time African nations have improved their balance sheets with a new set of lenders providing better terms. Many African countries also control significant reserves of natural resources for which there is fantastic demand on international markets. Fiscal policies have been redesigned, with new multi-lateral trade agreements and a committed effort to improve corporate governance. Africa is increasingly comfortable with its independence and has emerged as a fertile field for investment, which is beginning to attract the attention it deserves.
Private Equity in Africa
While limited integration with the global economic community and a steady inflow of capital and aid has helped Africa weather the recent crisis, Private Equity (PE) investors like us have continued to gain from positive developments in the continent. Recent investments across Africa have yielded both tangible economic returns and socio-structural benefits:
• Improved Telecommunications
(phones per thousand): +328.6% increase over last 10 years.
• Improved Sanitation (% households):
+ 19.3% increase over last 10 years.
• Improved Water (% households):
+ 18.1% increase over last 10 years.
• Improved Electricity (% of households):
+ 43.8% increase over last 10 years.
This has provided the foundations for additional capital allocations; especially from Development Finance Institutions (DFIs) who constitute by far and away the largest group of Limited Partner’s (LPs) backing Africa focussed private equity practitioners. EMPEA have reported that fundraising in Sub-Saharan Africa experienced a notable up-tick through July 2010 with US$1.5 billion raised, already surpassing the full year 2009 total of US$933 million. Furthermore, “the large sizes of many of these Sub-Saharan Africa-focused vehicles point to a return to pre-crisis levels.”
Having considered the risks of private equity investment, the DFIs apply their development mandates by backing private equity General Partners (GPs), and have begun to reap the benefits. For example, the International Finance Corporation (IFC) has announced that across its emerging markets portfolio, which has a strong development focus, Africa has historically produced some of the best returns on a comparative basis. From 2000 through March 2010, IFC has seen a 21.73% return on its Africa private equity portfolio. In fact, they have recently reported that since the crisis: “Africa has been the best performing region for our investments in private equity funds” throughout the world. This is despite the fact that 78% of these investments are typically with first-time fund managers.
Our belief is that African private equity requires in-depth local knowledge, regional specialisation, a strong embedded network of trusted relationships and a detailed and disciplined approach to the investment process. In our opinion, success over time depends on capitalising from cultural proximity and adhering to three essential investment rules:
1\. Due-diligence - more the ‘who’
than the ‘what’, given that impaired assets are easier to repair than weak management with poor governance.
2\. Price and Terms – preferring a return of capital, rather than a return on capital.
3\. Exits – we always look to take cash off the table as soon as the opportunity arises. With the aim being to secure initial target returns whenever liquidity is available.
\- With regards to our third and final rule regarding exits, as African public markets are still relatively illiquid, we continue to prefer trade sales to IPOs, a preference reflected by M&A data from the region and throughout emerging markets. Nigerian M&A activity has lifted it into the emerging markets Top 10.
We expect additional trade sale opportunities to come up in the near-term. Nirmalya Kumar, of the London Business School, says that two things are allowing emerging-market giants to rewrite the rules of M&A: money and flexibility. He adds: “the combination
of rapid growth and extensive internal restructuring has left many companies with plenty of cash in their pockets. Profit margins of 10% are common; double the average
in the West. And because ownership is concentrated, companies find it easier to take risks. Business families and founding entrepreneurs, with large shareholdings
in their companies, are willing to make long-term bets on growth and do not
have to worry about losing control of their companies if their stocks take a nosedive.”
