By Jason Mitchell
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The Abraaj Group, which has invested $3.2 billion in more than 80 companies in Africa over the last two decades, bought Java House in July for around $100 million from rival private equity group Emerging Capital Partners and Kevin Ashley, the Nairobi-based chain’s executive chairman. ECP received 12 non-binding bids – another sign of investor interest in this sector – for the coffee house chain, which started up in Kenya and later expanded into Uganda and Rwanda.
Some of the most successful PE-backed firms in Africa are concentrating on companies that can benefit from strong demand either in their home markets from domestic consumers or from overseas buyers attracted by a weak exchange rate.
Ethiopia’s Afriflora Sher, for example, owns the world’s biggest rose farm and exports roses and tulips to Europe. In 2014 KKR, the giant global PE manager, invested up to $200 million in the business to finance expansion.
Catalyst Principal Partners, which is headquartered in Nairobi and administers a $125 million private equity fund called Catalyst Fund I, was attracted by the export strength of Chai Bora, Tanzania’s leading tea packaging firm, when it acquired 95% of the firm’s equity from TransCentury, a Kenya-based investment holding company, in 2013.
The reality is that returns have been lower [than the 20% to 25% IRR targeted], given prices paid at the height of the market and African currency devaluations- Simon Denny, Deutsche Bank
Another good example of an investment driven by the potential for exports is the $151 million acquisition of Vlisco Group, the Netherlands-based textiles manufacturer and retailer, by Actis in 2010.
Actis is one of the region’s biggest PE managers and has invested $3.5 billion in 70 companies in Africa, of which more than 50 have been exited.
The appeal of Vlisco, which has two factories in Côte d'Ivoire and Ghana, lay in its popularity in west and central Africa. Actis has helped it to export its products to Europe and developed markets.
Interest in Africa and its many frontier markets took off in the wake of the international financial crisis as investors hunted for high returns. Strong demand for commodities pushed up prices and most of the big African economies were riding high, creating excitement in investor circles for the Africa-rising story. But enthusiasm waned when currency devaluations and commodity weakness took much of the lustre off private equity investments in Africa.
Limited partner investors reported annual internal rates of return, or IRR, net of management fees, of just 4.4% in their African investments over the five-year period to the end of December, according to the Africa Private Equity & Venture Capital Fund Index. Even when South Africa was excluded from the calculation, the returns were still just below 6%.
This compares with annual IRRs of 13.6%, net of fees, for PE funds managed or advised from a UK-based office for the five-year period to 2016, according to the British Venture Capital Association.
Some managers say they have made very high IRRs in the African market, but these appear to be the exception. Development Partners International, a London-based manager that has invested about $1.1 billion in private equity in Africa, reports an IRR of over 25% a year on the investments it has exited.
Others have similarly lofty goals: Mediterrania Capital Partners, a Barcelona-based PE manager focused on the north African market, has a target gross IRR of 25%, while Metier, a Johannesburg-based manager that has notched up 28 investments in sub-Saharan Africa, has a target of 17% to 18%.
“Most managers continue to target IRRs of around 20% to 25% in the African market in dollar terms,” says Simon Denny, head of investment banking at Deutsche Bank in South Africa. “But the reality is that returns have been lower, given prices paid at the height of the market and African currency devaluations.”
Others argue for more realistic expectations.
The African Private Equity and Venture Capital Association – (Avca), the industry’s main trade association, says the returns are better if you only look at exited investments. According to Avca, most PE managers report returns of 2.5 to three times the amount invested over an average holding period of five to six years. Highly successful managers can earn up to seven times, but that is rare.
“It has been a real challenge for managers to make appropriate returns in Africa,” says Ken McGrath, head of the financial sponsors group for Europe, the Middle East and Africa at Barclays.
“Some have managed to do so successfully by investing in companies that have a growth-based model and focus on specific niches, such as data centres or mobile payments, or in businesses with a strong export bias to European markets,” he says.
“Before entering the African marketplace, it is vital for PE managers to ask themselves: can you underwrite a business plan with forecasts that can be achieved? In South Africa, for example, there has been a lot of economic uncertainty, currency volatility, combined with increased regulatory scrutiny, which adds to uncertainty for international PE investors,” McGrath says. “In other parts of Africa, there can be heightened political instability, resulting in global investors being incrementally more cautious.”
Most investors in African private equity have been disappointed with their performance in recent years and the region’s lure has faded.
In 2013, a survey of LPs by the Emerging Markets Private Equity Association ranked sub-Saharan Africa as the most attractive emerging market worldwide; this year, it has dropped to fourth out of 10 behind India, southeast Asia, and Latin America (excluding Brazil). And in an Avca survey last year, only 44% of LPs say that the performance of their African PE portfolio has matched or exceeded their expectations.
“Many investors came into the continent during the Africa-rising period – which lasted until a few years ago – that did not really know the region,” says David Cooke, a partner at Actis.
“They suffered during the commodities downturn and currency devaluations. Now only more experienced investors are entering Africa. To do well here, you must have local insight and local-sector knowledge. This enables you to see the opportunities while others are cautious. It means you can be a bit bolder.”
The PE world in Africa can be divided into distinct regions. South Africa stands out for its financial sophistication. But there is also a north African market centred around Egypt as well as Algeria, Tunisia and Morocco, and an east African market concentrated around Kenya and embracing Uganda, Ethiopia and Tanzania as well.
A west African market pivots around Nigeria but includes Ghana and Togo. A francophone market is developing fast, centred around Côte d'Ivoire and including Senegal.
Private equity has great potential in the region, partly because of the demographics. Africa has a young population that wants to advance economically. There is increasing urbanization and the emergence of a middle class, albeit a lower-income one than in other emerging markets such as Latin America and Asia. Sectors such as private education, private healthcare, financial services, retail and energy should all perform well in that context.
However, most of the main markets in Africa – South Africa, Nigeria, Ethiopia, Egypt and Algeria – have been beset with political and economic woes in the past few years, with currency devaluations in particular delivering the hardest hit to foreign PE managers.
According to Avca, 60% of LPs cite currency risk as the biggest challenge when investing in African PE.
The expanding middle class theme is important for us- J-P Fourie, Metier
Nigeria’s currency, the naira, was effectively devalued by 30% against the dollar last summer and the government has reintroduced a currency peg, making it hard for international PE managers to repatriate any profits from Africa’s biggest economy.
The Central Bank of Egypt devalued the Egyptian pound by 50% against the dollar at the end of last year and allowed it to float, as these were among the many conditions that the IMF set Egypt for it to secure a $12 billion loan. And in South Africa, the rand has fallen from 16.8 rand to the dollar in January 2016 to 13 to the dollar at the end of July 2017.
“As most African PE funds report in foreign currency, exchange rate fluctuations have had an impact on reported returns,” says Enitan Obasanjo-Adeleye, Avca’s head of research.
“Most major currencies in the region saw declines ranging from 20% to 70% between 2012 and 2016,” she adds. “However, managers gain skills during difficult times, and they are becoming more focused on evolving their strategies to create and realize value through various economic cycles. There is increased interest in companies that have a natural hedge, like revenues in foreign currency, for example.”
Andrew Brown, chief investment officer at ECP, agrees: “Evaluating and managing currency risk is a key competence for any emerging market PE manager.”
ECP is one of Africa’s biggest PE managers, having raised $2.7 billion in the last 17 years.
“Currency volatility is significantly lower than it was 15 to 20 years ago,” Brown says, “but it is true that recent devaluations, particularly in Nigeria and Egypt, will have impacted some PE managers’ portfolios. The extent of the impact will vary significantly depending on the type of business.”
“The rule of law is not that great in the whole of Africa,” says Esili Eigbe, head of equities for Nigeria at Exotix Capital, the London-based broker in frontier markets. “Despite all the problems in South Africa, it has the best rule of law among the bigger countries in Africa. Countries such as Botswana and Namibia are very stable but their economies are tiny.”
Eigbe points out that there are great opportunities in South Africa: “We are seeing underperformance in a number of sectors there. But that marketplace is very competitive and that could impact returns. Perhaps Nigeria offers the best opportunities at the moment because it is a big market; you can get scalability quickly there and not a lot of competition exists.”
Ashish Patel, Abraaj’s managing director for east Africa, sees other attractions in South Africa.
“South Africa has the most sophisticated capital market infrastructure in sub-Saharan Africa. This allows opportunities for exits via IPOs more so than in other parts of the continent,” he says. “We are still bullish about South Africa. Incomes are continuing to grow, and that is driving increasing consumption. We see this trend playing out in our partner company, Libstar, which focuses on fast-moving consumer goods market, for example.”
It is possible for PE managers to do well in the African market, but they have to choose the country and sector well, have a clear strategy, have their own solid team on the ground and partner with strong, local managers. They also need to follow through with hands-on execution and have an exit plan that’s well thought out and that has the commitment of the company’s management.
“The key to success in the African market is execution,” says Runa Alam, chief executive and co-founder at DPI. “Investing at the right price is important, but what also matters is having the right management team on the ground. Discipline and following a strategy is vital. Getting the exit right, including the timing, is also essential.”
Despite South Africa’s political and economic problems, niche sectors exist that are growing phenomenally.
J-P Fourie, Metier
“The expanding middle class theme is important for us,” says J-P Fourie, head of investor relations at Metier. “We do platform build-ups to consolidate businesses within an industry and foster organic growth and scale benefits. In South Africa, the education industry is growing fast, for example.”
The fund has invested in the Professional Learning Group, mainly a distance learning business targeted at working adults. It owns the IMM Graduate School in Johannesburg, with seven support centres throughout South Africa. About 1,300 students attend tutorials while a further 3,200 study from a distance.
“Public universities in South Africa cannot keep pace with the growing middle class and the increasing demand for a tertiary education,” says Roland Glass, chief executive at Professional Learning Group. “Private higher education has tremendous growth potential. Global private equity follows the opportunities in this sector closely.”
Metier has also invested in Retailability, a clothes retailer that caters to consumers in the low-income and lower middle-income brackets.
Headquartered in Durban, South Africa, it has more than 180 stores and has expanded from South Africa into Namibia and Botswana.
Ascent Capital, a PE manager based in Nairobi in Kenya, says the rise of the middle class theme is vital to the east African market, as well.
“We like to invest in fast-growing small to medium-sized enterprises,” says David Owino, a partner in Ascent. “These are consumer-facing and could be in manufacturing or services. One of Kenya’s advantages is that it has a diversified economy. It is a big tea and coffee exporter, for example. It has not been hit by the downturn in commodity prices. In the east African market, you should be able to achieve three to four times money back.”
This year Ascent invested $14 million in Kisumu Concrete Products, a Kenya-based ready-mix concrete producer, for a minority stake in the business.
“The main reason for the capital injection is so that we can expand our operations in the Kenyan market and enter into Uganda,” says Vimal Rabadia, Kisumu’s chief executive. “Ascent brings a lot of discipline into our decision-making, it educates us about the significance of good governance and will help us to achieve a faster rate of growth.”
In 2014, Catalyst also invested in Kenya, in a pharmacy retail company that’s now called Goodlife and that has done well on the back of the rise in the middle class. Within only two years, it had rebranded the business, grown it aggressively from four locations in Kenya to 25 in that country and Uganda and made a high return when it sold its stake on to another financial investor.
As a consequence of the global financial crisis, many European companies have started considering Africa as their next growth market- Albert Alsina, Mediterrania Capital Partners
“Returns in our markets are still largely driven by growth in top line – through increased capacity, product or service extension, expansion to new markets – and operational improvements, coupled with sound execution capabilities,” says Biniam Yohannes, managing director at Catalyst. “These drivers are fundamentally sound strategies which will generate attractive returns in the longer term and secure attractive exit options.”
The financial services sector has been an attractive one for PE managers. ECP, for example, invested in Oragroup, the Togo-headquartered parent company of Orabank, seven years ago, and since then it has expanded from operating in five countries in western Africa with the equivalent of €290 million in assets to operating in 12 countries with €3 billion in assets.
Despite all the difficulties in the African market, there are some signs that it has started to normalize and follow the trends already seen in more developed markets. One of these is that LPs in Africa have started to co-invest alongside PE managers in portfolio companies.
Managers say that another sign of the growing maturity has been the entry of some global PE players. This has helped to drive the growth of secondary exits – in other words, the sale from one PE player to another, as shown by the Java House transaction. This had been seen in other global markets but had been comparatively rare in Africa until recently. A further indication of normalization has been the development of the equity capital markets, so that PE players have the full suite of exit options available to them.
That said, the IPO market for PE-backed companies has been moribund in South Africa for the past few years. The last one was Alexander Forbes, the pension manager, in July 2014, which was backed by Actis and raised R3.7 billion ($280 million) during the listing.
Several PE-supported companies have pulled their IPOs in South Africa at the last minute. In October 2015, Waco International, a building equipment rental company, cancelled its planned R3.5 billion share sale after a fatal accident and market uncertainty. Its shareholders included Ethos Private Equity.
The north African markets offer better opportunities for managers that want to list companies. Edita Food Industries, an Egyptian snack food maker in which Actis owned a 30% stake, went public on the Egyptian Stock Exchange in April 2015. Integrated Diagnostics Holdings, an Egyptian healthcare diagnostics company that was backed by Abraaj and Actis, undertook an IPO on the London Stock Exchange in May 2015. Abraaj has now fully exited; it sold part of its stake to Actis and the rest of its equity at the time of the IPO. Actis has kept its 21% stake in the business.
However, for most managers throughout Africa, exiting through a strategic sale or a secondary sale to another PE player is by far the most likely option.
“It is also possible to create a tension between the options to maximize valuations,” he says. “A peer company may not want a rival to undertake an IPO because it itself may want to do one down the road, so instead it will acquire the business and make the arbitrage gain itself, improving its own performance even further.”
Mediterrania Capital Partners agrees the exit strategy with the portfolio company management as part of the deal process. Albert Alsina, founder and chief executive, says his firm considers two main exit routes: secondary transactions and strategic sales.
“Larger private equity firms have seen the benefits of pan-African buy-and-build strategies. To expedite expansion plans, many of these firms are now looking at secondary transactions more openly,” Alsina says. “Secondly, strategic sales. As a consequence of the global financial crisis, many European companies have started considering Africa as their next growth market. In that sense, the Maghreb countries of northwestern Africa are playing a strategic role as the gateway to the continent, with private equity portfolio companies extremely well positioned to open this door.”