Private Equity: The African Adventure

Private equity is becoming an increasingly important factor in Africa’s economic development. It is also rapidly becoming the favoured channel for international investors to dip into one of the most exciting regions, in terms of growth, of the world. Private equity is also of particular value to Africa as it provides local companies with the means, and often the know-how, to expand and thus create more jobs and more wealth for their countries. This month’s Cover Story makes a detailed examination of the PE phenomenon as it obtains in Africa, provides a key to understanding what PE is all about and profiles some of the more prominent funds now operating on the continent.

The news that global private equity giant, Carlyle, was appointing a top team and launching a sub-Saharan Africa fund to be run from Johannesburg and Lagos marks a milestone in a highway with many voyagers. Carlyle, with $16.6bn in assets under management in emerging markets, is ranked as the world’s second-largest private equity group in 2010. But according to research house Preqin, nearly 80 private equity funds are currently raising capital to invest in African businesses, including mining.

A few years ago, many global investors might have considered Africa off limits. Now private equity investors, multinationals and banks are building their operations across Africa to find business opportunities and stake their claims on “the final growth frontier”.

Despite all the talking, the amount of money actually being raised and invested is still lagging. Total fund-raising for African private equity funds in the first six months of 2011 was $1.06bn, slower than in the same period in 2010. Fund-raising for all emerging markets private equity funds was $22.6bn, according to the Emerging Markets Private Equity Association (EMPEA), more than double the activity of the first half of 2010, as international investors hunted for new markets. In the first half of this year, 70% of funds were raised for China, India and Brazil, compared to a 50% slice in 2010, and yuan-denominated funds for Chinese investors and government agencies contributed to the rise.

Private equity should be a key ingredient for growing Africa’s private sector. It brings long-term risk capital; most activity in Africa is growth capital (see profile page 23), backing existing operations, helping companies grow in existing markets and expand across borders and into new products.

Growth investors develop and support talented managers and are active in the companies they invest in, boosting capacity, marketing and encouraging progress. Getting top private-equity returns depends on sustained work in finding and winning the best deals, useful and strategic management inputs, and inspired exits from the investments.

Sarah Alexander, chief executive of the US-based Emerging Markets Private Equity Association, writes: “In the developing markets in which EMPEA operates, private equity is often the only finance option available, and it is the most efficient, driven by professional investors who manage the funds, select companies they believe will prosper for the long term, and bring corporate governance regimes that are generally lacking in these markets. By doing so, these funds help create jobs and scale companies into the next tier of the economy.”

Nearly four out of five of the fund managers investing in Africa are based outside the continent but there is an advantage to being local and many of the top investors have networks of offices on the continent.

Success depends on close links between the investee company and its private equity investors, who might be direct investors or fund managers (usually called ‘General Partners’ or ‘GPs’). Simon Harford, a partner at leading emerging markets fund manager Actis, told African Banker there is a full-time focus on adding value to the investee companies: “We ensure we have the right management in place, we also bring synergies and cross-border relationships.”

Top private equity investors include the development finance institutions (DFIs) such as the International Finance Corporation, UK’s CDC, France’s Proparco, the Netherlands’ FMO and Germany’s DEG. Other leading fund managers include Aureos, Actis and Emerging Capital Partners (ECP). Helios Investment Partners is one of the first continent-wide fund managers set up and run by Africans. Although South Africa has a long history of private equity, in the rest of the continent, pioneers were Egypt’s Citadel Capital, Tunisia’s Tuninvest-Africinvest and Kenya’s TransCentury.

Investor attitudes changing

Private equity funds into Africa usually only raise about 1% of global private equity funding worldwide. Private equity moved higher on the radar in 2005 when Kuwait’s Mobile Telecommunications Co (MTC), which later renamed itself Zain, acquired pan-African telecommunications provider Celtel International for an enterprise value of $3.4bn. Many private equity investors achieved at least 250% return on their investments – for example, AIG African Infrastructure Fund said it had received approximately $214m, or 4.3x its $50m investment. Luca del Conte, director of capital markets at GMP Securities, recently described it thus: “The deal ticked all the boxes in terms of what describes a successful private equity enterprise”.

Attitudes are growing more positive among investors worldwide. In a survey by Coller Capital and EMPEA, nearly 30% of global private equity investors (Limited Partners or LPs) plan to expand their PE investments in sub-Saharan Africa (SSA) and nearly another 10% plan to start investing over the next two years. This puts SSA ahead of Turkey, the Middle East and North Africa regions, Russia/CIS and Central and Eastern Europe.

However, there are structural problems to be overcome: 47% of LPs said there were too few established fund managers in SSA and that this is a primary deterrent; political risk was a concern of 39% (highest in the world after Russia/CIS, 63%); and about 25% said the scale of opportunity to invest in SSA is too small (second to Middle East and North Africa, where 33% were concerned). Only 14% of respondents said they were discouraged by the difficulty of exiting their investments and 2% said valuations are a problem (58% said entry valuations are overheated in India and 45% said the same thing for China).

Erwin Roex, partner at Coller Capital, commented: “In reality, where competition is increasing in emerging market PE, it tends to be concentrated within a handful of sectors or a particular tier of the market where deals are large enough to attract global funds. Investors recognise there are still plenty of opportunities for skilled managers to supply value-added capital and to create returns for LPs.”

Raising private equity funds is often difficult – an experienced manager in known markets can take up to two years to reach a fund-raising target, or give up. It can be even harder for many African fund managers who have little or no track record; in addition, many investors know too little about their business environment.

International investors such as IFC and CDC Group play a key role in building the skills and capacity of African fund managers by backing the growth and development of funds, particularly of African groups such as Helios, Grofin and Amani Capital.

Some funds help growth by appointing Local Investment Partners (LIPs) to assist in identifying investment potential, for instance, Netherlands-based Social Venture Capital (Sovec) partners with Fidelity Capital Partners and Oasis Capital (Ghana) Ltd.

However, new EU regulations will make it harder for African fund managers to approach European investors from 2013. EMPEA’s Alexander says: “The EU alternative investment fund management directive (AIFMD) makes it virtually impossible for small private equity funds in developing countries, which invest in small companies, to continue to operate in north Africa, sub-Saharan Africa, southeast Asia and other target regions where the UK, and the EU more broadly, seek to create jobs and sustainable businesses. The cost of compliance with a directive designed to regulate hedge funds will simply be too high.”

In addition, CDC is increasing its role for direct and co-investments after a review by the UK government’s Department for International Development, while continuing investments via funds.  Under these circumstances, substantial support for African GPs could switch to the US.

According to EMPEA research (Preqin gives a figure of $2.7bn, down from $3.4bn in 2009 and $11.4bn in 2007, but includes more mining investments) a total of $1.49bn was announced in fund raising for PE investments into SSA for 2010. This is up 56% on 2009 (while most emerging markets registered declines) although it is behind the SSA peak of $2.2bn in 2008. Although 2011 started slowly with inflows of only $156m in the first quarter, but in the second quarter Helios Investment Partners announced in June this year that they had raised $900m for Helios II fund. The total raised for the first half of $1.06bn is 5% less than for the first half of 2010.

Helios’ COO, Henry Obi, told African Banker: “We have been very pleased with the investor appetite and this is the largest fund we have ever raised, and also the largest fund dedicated to sub-Saharan Africa ever raised.

“The fund had well over $1bn of demand and its closure underscores the confidence investors have in our investment strategy and our ability to invest in the African market, particularly as it comes at a time when several other Africa-focused funds are struggling to raise capital.

“We have enjoyed strong support from a broad range of endowments and foundations,” said Obi, “funds of funds, corporate pension funds, sovereign wealth funds and development finance institutions across the SA, Europe, Asia and Africa. In addition, the fund has by far the largest proportion of private sector (ie non-development finance institution money) of any Africa-focused fund. The regional split of our investors by capital commitments is as follows: US, 54%; Europe, 24%; Africa, 15%; rest of world, 7%.”

Others currently raising funds include Bob Geldof for his $750m-$1bn 8 Miles fund, Och-Ziff and Mvelephanda for African Global Capital II ($1bn), Carlyle ($750m), Ethos and Nigerian GP African Capital Alliance.

International private equity investors prefer to invest into specialised funds and these are starting to evolve for Africa (see list). African investments are also a growing part of global private equity portfolios: to take two examples – top US firms Warburg Pincus and Blackstone Group have stakes in Kosmos Energy, Blackstone owns Sithe Global Power (hydroelectric project in Uganda) and Warburg Pincus has invested in India’s Metropolis Healthcare which is expanding into the rest of Africa from South Africa.

Specialists

There are also increasing numbers of funds that aim for social impact as well as financial returns. A key target is boosting the ‘missing middle’, the small and medium enterprises which are often the drivers of economic growth and job creation in developing countries but are choked back by lack of capital and management expertise.

Jacana Ventures is a UK impact investor seeking to take stakes in African fund managers and help them specialise in SME investments, including in-depth technical support. Its first investments have been Kenya’s InReturn Capital and Fidelity Capital Partners in Ghana. Summit Development Group of the UK is raising a $125m fund to invest into banks which will finance SMEs and lower- and middle-income business people.

Private equity could also play a major part in developing the infrastructure of the continent. Some of the biggest African private equity funds are managing long-term investments in the continent’s infrastructure: African Infrastructure Investment Fund 2, managed by Old Mutual and Macquarie, aims to invest up to $1bn into toll roads, thermal power, wind power, ports and social infrastructure. South Africa’s Harith is managing a 15-year fund, the $630m Pan African Infrastructure Development Fund.

According to Actis’ Harford: “Private equity has an important role to play in funding infrastructure but, by definition, infrastructure is long term and often based on links to governments; they must create the right enabling environment and the long-term regulatory certainty necessary for infrastructure investment.

“Returns, especially in cases such as power where the public sector is the user, have got to be predictable and sustainable. There is no room for unethical behaviour in the awarding of contracts. Actis is a big provider of capital to power, including generation and distribution, and there is significant variation between countries when it comes to the extent to which they have created good environments.”

Executing deals

In 2011 so far, Nigerian banks and financial services have been hot – Helios and Adlevo Capital invested $110m into payments processor InterSwitch, ACA Capital led a $750m Union Bank transaction and Vine Capital Partners recapitalised Afribank.

In August, IFC and six international financial institutions announced $164m in financing for Kenya-Uganda railways. Egypt’s Citadel Capital and Compass Capital took over an Egyptian pharmaceutical company in a bid to turn it around. Leapfrog Investments from the US took a $14m stake in Kenyan holding company Apollo Investments to help it expand insurance in East Africa. According to EMPEA, 18 equity investments totaling $256m were completed in sub-Saharan Africa during the first half of 2011, down from 25 transactions (totaling $186m) in the first half of 2010 and a full total of 48 transactions totaling $631m for the full year. This compares to China and India, which accounted for 68% of the total invested from January to June with $5.8bn invested in China and $3.8bn in India.

Helios’ Obi says the current African investment climate is highly attractive: “This is driven by a number of factors including strong economic fundamentals and a significantly improved socio-political environment, and a huge resource wealth – both in terms of natural resources, and attractive demographics. Additionally, asset prices are relatively low considering the growth prospects, with the increasing domestic liquidity and capital formation acting as a buffer against global capital-market volatility.

“Investing in Africa presents many opportunities but with that, come challenges. These include the ability to execute transactions in a difficult operating environment where high-quality management talent is scarce, supply chains are weak, and the general state of infrastructure is poor. In addition to this, macro-economic (including currency) and political risks need to be considered, along with the traditional risk factors specific to certain industries, companies, management teams and broader financial issues.”

A recent article in the Wall Street Journal noted that private equity managers pay about five to six times earnings before interest, taxes, depreciation and amortisation for firms in large African markets and three to four times in smaller ones, compared to prices in Europe which are often above 10 times earnings.

While competition is increasing to get involved in top buyout deals, it is much less so than in Europe and the US. Obi added that although competition for deals is increasing, Helios is not getting drawn into auctions: “The combination of the investment team’s excellent network of contacts across the region, the relative infancy of Africa’s corporate finance market, and the traditional African business environment based on personal relationships, has historically resulted in significant proprietary deal flow for Helios.”

Getting out

Exit options are evolving for when investors want to sell their equity holdings. In recent years, African private equity exits have included listings both on domestic exchanges and on international stock exchanges such as NYSE Euronext and London Stock Exchange, which claim better access to international investors.

For instance, ECP used NYSE Euronext Paris to exit its shares in rubber producer Société Internationale de Plantations d’Hévéas in 2007 at 3.4x cost and a year later exited Ecobank at 3x cost through multiple listings on the Nigerian and Ghanaian stock exchanges and the Bourse Régionale des Valeurs Mobilières (BRVM).

Trade sales are another option as multinational companies, including from India and China, are increasingly keen to buy into leading African companies. South Africa’s Horizon Equity Partners said in January that it achieved returns of 14x its investment when it sold financial data company Peresys for $56.4m to expanding Australian group IRESS in a trade sale. Another alternative, which is also useful for SME investors, is to structure deals so that management can buy the private equity investor out, for instance at a pre-agreed price which achieves the investor’s target rate of return.

Key challenges will include ensuring that fund manager capacity continues to grow, as this is vital to success in private equity investments. The African Venture Capital Association in August announced an agreement with the British Venture Capital Association to boost its capacity for research and training fund managers and other professionals in Africa’s private equity industry.

Private equity is set to be one of the most important channels for Africa’s development, and it is important that African policy-makers concentrate on making the environment stable and level to encourage private sector investors to take long-term views.

Harford comments: “Africa needs capital to grow but it particularly needs business catalysts. Private equity is an active, engaged, thoughtful investor and that is particularly valuable when you consider what the African private sector needs to develop.

“Private equity must speak more as a group in order to engage with governments and regulators, helping them understand private equity, which is relatively less well-known outside South Africa. In Africa we adopt more of a growth model; this is different to what they might have seen of private equity in the US and European markets, where it has tended to be more a leveraged buyout model.”

South Africa’s Minister of Finance Pravin Gordhan told a conference on private equity in Africa that there needs to be constructive dialogue between regulators and the investment industry to create a balance of entrepreneurial and sustainable development.

Before the August downturn, Preqin forecast that in 2011 $8bn-$10bn could be raised for African private equity. If regulators support the trend and as Africa’s PE track record and attractive returns get known, the prospects could be huge for private equity to provide targeted capital to back the continent’s anticipated growth.