FW moderates a discussion on investing Africa between Lwazi Bam, the chief executive of Deloitte Africa, Hurley Doddy, a co-chief executive of Emerging Capital Partners (ECP), and Maryam Haque, a senior director of research at EMPEA.
FW: How would you characterise current investment opportunities in Africa? What makes the continent attractive to investors?
Bam: Africa presents some very exciting opportunities, as it is often said that Africa represents one of the last growth frontiers in the world. The rapid economic growth, prior to the drop in oil prices, experienced by many leading African economies created opportunities beyond the traditional resources sector. In the last decade there has been a diversification of opportunities specifically looking to take advantage of the growing middle class. While the timing of the recovery of the oil price remains unpredictable, it is encouraging that the IMF expects Sub-Saharan Africa’s economic growth to be at about 5.8 percent in 2015. This compares very well to the IMF’s global growth projection of 3.8 percent for 2015. It is hoped that with an increasingly stable continent, these growth figures will continue to accelerate. The recent peaceful elections in Nigeria, the continent’s largest economy, should contribute significantly to positive sentiment towards the region. Improved political governance throughout most parts of Africa, coupled with improving macroeconomic fundamentals and rising consumer spending from a growing middle class, continue to be key to a sustained and accelerating growth scenario. A report released by Deloitte at the end of 2014 titled ‘Africa: A 21st Century View’ indicates that Africa’s middle class is expected to increase to more than half a billion people by 2030. This is likely to continue creating more opportunities in the consumer related sectors. So we expect that the continued growth in the middle class will spur greater demand for everything including internet connectivity, power, water, energy, food, retail and entertainment products.
Doddy: Over the last 15 years, we have witnessed how the African continent, from an investment standpoint, has been steadily maturing, offering a growing number of investable sectors and countries and viable asset classes. Private equity, for example, is a longstanding component of Africa’s economic landscape. It is an asset class that can offer deals at low valuations and provides access to sectors that are less well represented on the continent’s often embryonic stock exchanges, such as fast-moving consumer goods and services. Africa presents the sophisticated investor with a significant and broad range of opportunities. Rapid urbanisation, along with increased GDP per capita, is creating a sizeable consumer class across Africa. This has led to growth in a number of industries and sectors creating an ample environment for private investment.
Haque: While development finance institutions have been a major source of capital for private equity and have been active in Sub-Saharan Africa for quite some time, other international institutional investors have been looking more closely at Sub-Saharan Africa for the past few years. According to EMPEA’s 2013, 2014 and 2015 ‘Global Limited Partners Survey’, the region ranked as one of the top three most attractive emerging markets for GP investment, and ranked higher than each of the BRIC markets. Private equity fundraising totals reflected this sentiment and hit an annual record $4.1bn in 2014. Private equity is a relatively young asset class in the region compared to other emerging markets, and as a percentage of GDP, private equity investment remains small at just 0.12 percent in 2014. Since public markets are relatively shallow in Sub-Saharan Africa, PE offers investors access to opportunities in a variety of sectors, such as infrastructure, financials, consumer services, consumer goods and healthcare, which serve the growing middle class population with more consumer spending in many of the African economies. Furthermore, private equity plays a vital role in providing much-needed access to finance for SMEs in the region, where bank loans have been difficult to come by for businesses.
FW: To what extent has the shallow economic recovery seen in many developed markets expedited the focus on investment opportunities in Africa?
Doddy: Africa’s fundamentals present promising growth opportunities, driving investor interest in the continent. Growth in Sub-Saharan Africa is projected to increase by 4.4 percent in 2015, despite the global slowdown following the financial crisis. According to The Economist, six of the world’s 10 fastest growing economies of the past decade are in Sub-Saharan Africa. This provides global investors looking to diversify their portfolio with an opportunity to achieve growth as developed and even established emerging markets experience volatility.
Haque: Private equity is a long-term asset class, and a lot of stars have to align in any market before investors are willing to commit capital despite the many investment opportunities. As some developed markets and some emerging markets have experienced slower economic growth, exposure to Africa can provide diversity to investors’ portfolios. However, and perhaps more importantly, the local investing environment – pool of fund managers, investible universe of companies and legal and regulatory frameworks– factors into investment decisions. On all of these levels, the private equity landscape in Sub-Saharan Africa has been maturing, presenting investors with compelling investment opportunities. For example, South Africa has historically constituted the majority of private equity activity geographically, but over the past few years, Kenya, Nigeria and Ghana have accounted for an increasing share of deal activity. In 2014, Kenya surpassed South Africa for the first time in terms of deal activity. Also, the pool of fund managers active in the region has strengthened, with local players who have raised follow-on funds, established global players and first-time funds all looking to access opportunities in the region. Both the macro and the micro trends have helped to increase the attractiveness of markets in Africa as a private equity destination.
Bam: The focus on investment opportunities in Africa has been driven by a number of factors. Asia dominated the growth story for the last two decades, yet there is an expectation that Africa represents the next wave of growth similar to what was experienced in Asia. And yes, with many European countries continuing not to grow, investors are looking for more exciting returns. Over the past decade, the countries that have spearheaded investment into Africa have been China and India. We are now starting to see a lot more attention from the western companies, firms that would have previously considered African investments as being too risky. The US/Africa summit hosted by president Obama in Washington was perhaps the most prominent recent display of interest in African opportunities. Emerging market investment allocations to Africa continue to increase and the continent is now attracting a more diverse range of foreign direct investment (FDI) than it has in the past. Private equity players are also starting to take note of opportunities on the continent. Data from the EMPEA shows that private equity managers raised $4bn for Sub-Saharan Africa-focused investment vehicles in 2014, the highest annual total since the organisation began tracking the data in 2006.
FW: Which sectors are generating high levels of inbound investment? Do infrastructure projects feature prominently? Have any recent, high-profile investments grabbed your attention?
Haque: The consumer goods and consumer services sectors together accounted for more than one-third of the number of private equity deals completed and one-quarter of capital invested in 2014. Also, the financial sector has consistently attracted a large share of deal activity. In the EMPEA’s 2015 ‘Global Limited Partner Survey’, the financial sector ranked highest in terms of LPs’ most desired sector exposure in Sub-Saharan Africa, for which three-quarters of respondents registered an interest. With growing consumer spending, sectors across the spectrum – from power and utilities to infrastructure, agribusiness and point-of-sale and services – need capital to keep up with demand. Over the past 15 months, some of the largest investments in the region have featured prominently in these industries. This has included deals worth in excess of $200m for Nigeria-based mobile telecommunications company IHS, South Africa-based alternative electricity generation company Lekela Power, Cameroon-based utilities company AES Societe Nationale d’Electricite, and Ethiopia-based flower company Afriflora, which represented global investment firm KKR’s first transaction in Sub-Saharan Africa.
Bam: The World Bank has previously reported that in order to support the economic growth in Africa, an amount of $93bn needs to be spent on an annual basis. It is therefore no surprise that infrastructure projects feature prominently. The third annual Deloitte African Construction Trends report released recently showed that investment in African mega projects surged 46 percent to $326bn last year, from $222.7bn in 2013. Energy & power accounted for 37 percent of the number of mega projects undertaken in Africa in 2014, followed by transport at 34 percent, mining at 9 percent, real estate at 6 percent, water at 5 percent, oil & gas at 4 percent, mixed use facilities at 2 percent and health care at 1 percent. While resource rich countries such as Nigeria, Angola and Mozambique remain prime destinations for FDI in Africa, the continent’s manufacturing and services sectors are also attracting an increasing share of new greenfield FDI projects. Interestingly, the economic slowdown in China is also prompting many Chinese companies to seek new and more diverse growth opportunities in Africa. Data from the Chinese Ministry of Commerce shows that the nation’s outbound FDIs to Africa increased from $317m in 2004 to $2.52bn in 2012. China’s investment in Africa is also becoming more diverse.
Doddy: Industries driven by underlying demographic shifts such as the rise of the consumer class, Africa’s natural competitive advantages – including agribusiness and significant ongoing supply/demand imbalances, low penetration rates and unaddressed markets – continue to encourage inbound investment. With a consumer class that has increasing disposable income and wants to spend, consumer retail becomes attractive, along with financial services and ICT/telecom, both from a retail perspective and from an infrastructure perspective.
FW: What considerations should investors make when structuring and financing deals in Africa, to maximise ROI?
Bam: It is not easy to give a list of homogenous factors that need to be factored in, as each country is different. It is, however, very important to appreciate that while there are a number of common features that cut across many African countries, each is still unique. A thorough understanding of the business environment is necessary. Recently, there have been cases reported of entities that invested in greenfield mining operations. While great care was taken to assess the viability of the mine, the entity failed to factor in what would happen if the government was unable to deliver the railway line required to transport the goods to the harbour. This example illustrates how important it is to take a broader view, beyond the viability of a standalone project, when structuring or in modelling deals and to factor in a lot of exogenous factors.
Doddy: Finding the right partners and ensuring that there is a proper alignment of interest, as well as identifying viable exit options, should be primary concerns for investors in Africa. Most investments in Africa are growth equity as low cost local currency debt is generally not available. Investors must therefore look for strong growth opportunities and fund managers who can help companies take advantage of the opportunities available on the continent. Recently, we have seen an increasing focus on co-investment among investors who are looking to tailor their investment portfolio, enhance the performance and gain access to a new space with a trusted manager who has demonstrated a strong track record while employing international best practices. Exposure to dealmaking when co-investing alongside fund managers gives investors the opportunity to expand their internal capabilities, acquire valuable experience in direct investments, and gain exposure to geographies and industries they may not have access to otherwise. It also allows investors to strengthen their fund manager relationships and build up their internal knowledge of the deal process and execution, making them an attractive choice of partner for managers. The biggest considerations when entering into such a partnership are the establishment of strong and trusted relationships, as they determine the long-term success of the investment.
FW: What are the key challenges and issues likely to face investors? In your experience, are due diligence and risk management processes typically robust enough to evaluate an African investment?
Haque: Political risk and the limited number of established fund managers, as well as currency risk, have been the main deterrents for investing in Africa, according to the EMPEA’s 2015 ‘Global Limited Partners Survey’. However, investors who are active in emerging markets must understand the risks inherent to exposure in these markets in order to be successful. Savvy investors who can mitigate these risks and navigate these challenges are in a prime position to capitalise on the potential opportunities and financial returns accessible in the region.
Doddy: Despite increasing interest, entrance barriers into the African private equity market are significant. Unlike in developed private equity markets such as the US or Western Europe, investors cannot rely on brokers delivering or introducing fully active investment opportunities. Instead, we believe it is critical to be locally based. This is essential for both deal sourcing, transaction execution and due diligence, and ultimately being able to work with your portfolio companies to deliver value. Furthermore, ESG performance has become a key component for any private equity investor in Africa. Investing in companies that are not only high performing, but also adhere to high ESG standards, mitigates risk and increases value.
Bam: While challenges vary from market to market, there are some common themes that clients seem to encounter when investing on the continent. These include capital controls which can restrict access to foreign currency and curb a firm’s ability to repatriate profits out of a particular jurisdiction. Concerns over political instability in some markets and the more recent threats of terrorism in certain growth markets have also emerged. However, one of the biggest and most underreported issues cropping up on the continent is regulation. Deloitte’s 2014 CFO survey showed that bureaucracy is becoming an increasingly problematic barrier to doing business in Africa, with financial stewards in Southern, East and West Africa all citing red tape among their top three industry concerns. Due diligence by professionals with experience of doing business on the continent is invaluable.
FW: What steps can investors take to mitigate the risk of fraud and corruption? Where do common red flags lie and what protections are available?
Doddy: As Africa enters the global private equity map, sophisticated investors are insisting on greater systemic standards for fund managers, to mitigate risk and maximise returns. Many investors now have more stringent requirements relating to track records and institutionalised back offices and reporting than they did in previous years. Whilst this may make it harder for first-time managers to raise capital, seasoned managers with track records on the continent can meet these requirements, ensuring investor confidence allowing them to tap into larger investor pools. We generally find investments through a top down process of identifying the most promising company in a target industry and then using strong local relationships to make a direct approach. This allows us to generally avoid auction processes and gives us time to do more thorough due diligence and background checks before investing.
Bam: Sadly, corruption still seems to be one of the main sources of frustration for businesses operating in Africa. Deloitte’s 2014 Africa CFO survey showed that no less than 64 percent of South African respondents rated it among the top five political concerns in the country. While it is heartening to note that this is an improvement on the 83 percent figure recorded in the 2013 survey, corruption still topped the list of five biggest political worries in the country, trumping the education, skills shortage, the effectiveness of government spending, policy dialogue between business and government and nationalisation threats. Across the Southern Africa region, 67 percent of CFOs rated corruption among their top five political concerns, while in East Africa the figure was 73 percent. In West Africa, corruption was identified as by far the biggest sociopolitical concern with no less than 77 percent of CFOs highlighting it among their top three political concerns. Certain countries have stronger institutions than others when it comes to dealing with corruption. The vibrancy and independence of the press and judiciary are usually strong indicators of whether a country has powerful public mechanisms to deal with fraud and corruption. The existence of such institutions and whether or not a country is a well-functioning, vibrant democracy are all strong indicators of a country’s predisposition toward corrupt behaviour. The fact is that there are many successful businesses that operate in Africa, businesses that operate ethically and have been able to mitigate these challenges and constraints.
FW: How would you describe the legal protections, including investment treaties, available to investors into Africa? Are dispute resolution and enforcement processes improving in the region?
Bam: There are over 400 bilateral investment treaties in Africa that typically provide for compensation where investments are expropriated or where the investor does not receive fair and equitable treatment in a particular country. They have become a popular way to get around the fact that many countries do not have adequate levels of investor protection due to a weak rule of law, but have not been without controversy either. Some high compensation awards, and the perceived inability to ensure foreign investments also benefit the country and society, have begun to put some states off around the world and led to a desire to terminate treaties and create a new foreign investment law. Regional trade has also seen the rise of more treaties between African countries, with Mauritius having signed with 17 African countries. These treaties differ from country to country and if investments are not covered, investors will need to approach the local courts for redress. The risk remains that if a country does not have a treaty, a company would need to structure the investment through a country that has a treaty in place. Investments can be restructured to take advantage of the protection afforded by a treaty. Some of the earlier treaties struck do not offer adequate protection, while others offer a full gamut of protection. Investors would need to check the terms very carefully as some of the wording may exclude compensation for anything other than expropriation, for example. Many African countries are creating more business-friendly environments, but a trend being set in motion in South Africa – which is also in play in about 40-50 countries globally – is to develop just one investment policy as opposed to relying on a multitude of bilateral investment treaties. The idea is to create a universally applicable investment protection regime and to terminate investment treaties. This change is not without controversy either, as the fear remains it could deter foreign investment.
Doddy: African countries typically have well established and longstanding legal codes, many of which are based on French or English law and date from the colonial period. In recent years, African governments have made an effort to improve foreign investors’ protections. They have entered into many BITs and related agreements with non-African countries, offering protections to investors outside of Africa making investments into Africa. For example, Egypt has entered into over 100 investment treaties, with both developed and developing countries, while Nigeria has entered into more than 20 such treaties, including with France, Germany, the Netherlands and the United Kingdom. These recently agreed treaties are more detailed and specific than earlier investment treaties providing further protection for investors. Within the continent, various countries including Nigeria, Rwanda and South Africa have begun to step up their dispute resolution capabilities, establishing arbitration centres of their own. Mauritius is already recognised as a leading location for international arbitration and has also established a right of appeal to the UK Privy Council, for parties who may be dissatisfied with the outcome of an arbitration. Nevertheless, most of our agreements with our local and international partners are written under UK, French or US law given the slow moving legal systems in many African countries.
FW: How do you expect investment in Africa to develop over the next 12 months or so? Is the region set for an influx of capital to fuel growth?
Haque: According to EMPEA’s statistics, private equity fundraising reached $4.1bn in 2014 and broke annual records for the region, and fund managers have already raised $1.9bn in 2015 through the first quarter – accounting for 22 percent of total capital raised for emerging markets, second only to emerging Asia. Q1 2015 also posted the highest quarterly fundraising total for Sub-Saharan Africa since the global financial crisis. About 60 Sub-Saharan Africa-focused funds are currently in the market and the highest percentage of limited partners – 36 percent – in EMPEA’s 2015 ‘Global Limited Partners Survey’ expect to begin or expand investing in the region over the next two years. It remains to be seen how the high interest and expected influx of capital will play out over the next few years, but private equity activity in Sub-Saharan Africa shows no signs of slowing down.
Bam: The ‘Africa: A 21st Century View’ report indicates that the continent’s gross domestic product is expected to grow by 50 percent to $3.7 trillion over the next five years. The next 12 months will be critical to that longer-term growth trajectory. It is safe to say that Africa remains on the cusp of what will be a long-term economic transformation. Roughly 60 percent of Africa’s population is aged below 25 years and this youthfulness will play a critical role in transforming the continent’s future by bringing a more innovative and entrepreneurial mindset toward doing business in Africa. We also expect governments to accelerate their own capital expenditure plans, for instance the South African government has earmarked approximately $67bn for capital projects over the next three years, with $27bn expected to be spent in 2015/16. In addition to their own efforts, a number of governments will also be looking to involve private investors in plugging their infrastructure funding gaps. Kenya, for example is looking to establish public-private partnerships to address a gap of over $44bn in funds needed to build new ports, roads and railways and to improve water and electricity supply over the next five to eight years. The outlook over the next 12 months is relatively positive. We are seeing an emergence in many economies and stability of many governments compared to the recent past all of which signifies positive momentum. By the same token, the IMF forecast that Sub-Saharan Africa’s economic growth will accelerate to 5.8 percent in 2015, from 5.1 percent last year, is further evidence that the continent’s economic growth impetus remains intact.
Doddy: Private investment in Africa is likely to grow over the next 12 months. Research by the African Private Equity & Venture Capital Association has shown that many investors expect to increase their exposure to emerging market private equity this year. We are also witnessing an increase in intra-African investments, which is set to deepen the pool of available capital for Africa-focused private equity funds. Recently lifted restrictions on South African pension funds have allowed up to 5 percent of the country’s Public Investment Corporation’s funds to be invested in the rest of Africa. Nigeria is actively encouraging its pension industry to do the same. We expect that private equity will continue to focus on the consumer driven sectors, such as financial services, retail and consumer goods. Other sectors such as utilities, agribusiness and infrastructure will also attract investment, as privatisation and regulatory changes gather pace across the continent.
Lwazi Bam has been chief executive of Deloitte Southern Africa since 1 June 2012 and was appointed chief executive of Deloitte Africa on 1 June 2013. He is a member of the Deloitte Global Executive and has previously served on the Deloitte Global Board Risk and Strategy Review Committees. Mr Bam has held a number of roles including serving on the Deloitte Southern Africa Board, holding executive responsibility for the firm’s strategy and Corporate Finance, and Head of Mergers and Acquisitions Advisory. He can be contacted on +27 11 517 4322 or by email: firstname.lastname@example.org.
Hurley Doddy is founding partner and co-CEO of Emerging Capital Partners (ECP). With seven funds and over $2bn under management, ECP is a leading private equity manager focused exclusively on Africa. With 30 years of private equity and finance experience, Mr Doddy provides a breadth of finance and transaction experience to the firm and is active with all phases of the investment process. He serves on ECP’s executive committee and the funds’ investment committees.
Maryam Haque is the senior director of research at EMPEA, where she leads the research and data programs, overseeing on-going data collection, analysis and dissemination to provide insight on private equity trends in emerging markets. Ms. Haque is a frequent contributor to industry research and global media outlets as well as the lead researcher and author of EMPEA’s ‘Global Limited Partners Survey’, an annual study that assesses the views of investors on the emerging markets private equity asset class. She can be contacted by email: email@example.com.
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