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By Carolyn Campbell |
Private Equity In Africa - Lessons Learned
Africa represents a colossal investment opportunity. Containing 23 percent of the world’s landmass and nearly one billion people, the continent has exceeded world average growth for the past eight years and is now the fastest growing region in the world. Taken as a whole, African GDP is sixth in the world and should pass Germany in the next few years. Yet the region remains overlooked in terms of investment opportunities such that the supply of capital relative to demand is tilted in favour of investors; as a result, investments can be structured to mitigate risks. Also, the legacy of English and French legal systems prevailing across much of the continent offers significant opportunities for disciplined private equity investors.
Private equity investment in Africa has been active for many years, with solid track records emerging in the last decade. Looking at this history of returns, the most successful deployment of private equity in Africa has applied best practices that have been tested and proven in emerging and developed markets alike. Three important areas of application are identifying risks, defining the path to liquidity, and anticipating changes in judicial and regulatory frameworks. Understanding how these factors affect a company is critical to ensuring that private equity investments in Africa will generate attractive returns over time.
Identifying risks
Every opportunity in private equity comes with risks that must be mitigated, and those in Africa are no exception. Portfolio company risk analysis often begins with local factors, which is specific to each country, industry and currency.
Country risks – Either political or cultural, country risks require fund managers to vigilantly monitor the surrounding region. While this risk has been steadily subsiding in many African countries, with successive democratic elections and improving rule of law, it is often advisable to look for companies that operate across country borders as that will naturally diversify risks specific to a single country. Where politics pose a risk, investments should be structured to transfer country risk outside of the zone or onto the sponsors, who may be more adept at handling sudden developments.
As an example, Ecobank Transnational Incorporated is a Togo-based bank that operates in 18 African countries. It was this regional diversification that mitigated country risk and allowed it to weather the crises in Cote d’Ivoire, Liberia and Sierra Leone over the course of the past decade.
Industry risk – In the simplest terms, industry risk means that some industries are more vulnerable to crisis situations and market fluctuations while others are more resilient. In Africa, the industries that are among the first to feel the shocks of a crisis or downturn are similar to those in the rest of the world – such as consumer goods, transportation, commodities and hospitality/travel. Portfolio managers should assess just how much a company will be directly impacted in various economic scenarios, and how they will plan for secondary complications, such as the loss of a major vendor or client to bankruptcy.
Currency risk – In Africa, currency risk has been characterized by the fact that African currencies have actually appreciated slightly against the U.S. dollar in the past ten years. However, it is still an important consideration as currency depreciation or inflation can significantly change investment yields over a typical three to five year holding period. This risk can be reduced through diversification across currencies and by using hard-currency convertible loans and investing in companies with hard currency revenues, such as those in export industries and companies in primary material export countries.
While the perceived risk in Africa is generally greater than the actual risk, investing across the continent does require a significant level of risk tolerance and an honest assessment of how a company operates within its environment.
Defining the path to liquidity
Exit options are an important consideration when investing in African companies. Only four stock exchanges in Africa have a market cap greater than $50 billion; others do not have the liquidity to absorb IPOs in excess of about $100 million. In addition, local institutions tend to be the primary investors in these markets.
Before investing, fund managers need to consider whether a listing on one or multiple African exchanges – or even on a foreign exchange – is feasible. Examples of African companies that trade on international markets exist. Companies such as Société Internationale de Plantations d'Hévéas, Africa's leading natural rubber producer and exporter, is traded on the Euronext Paris Exchange. This has allowed investors to exit via block sales. Trade sales are also common in Africa, particularly as countries in the Middle East and Asia have increased their interest in the continent.
Africa also offers opportunities to enter into structured investments pursuant to which cash flow is paid disproportionately to one or more investors or one or more sponsors commit up front to repurchase an investor’s stake.
Judicial and regulatory framework
African governments are increasingly backing open-market philosophies, and improvements in regulation have encouraged outside investment. However, inefficiencies remain in the continent’s judicial and regulatory systems. Fiscal conventions standard in other regions of the world may be absent in Africa, and differences in judicial systems must be accounted for in planning.
It is important to consider how various countries approach taxation, repatriation of dividends, and capital gains; accordingly, investors should take local policies into consideration in structuring an investment in a tax-efficient manner. For example, Spencon, a leading construction company in East Africa, operates in several countries throughout the region. Due to the absence of bilateral tax treaties, Spencon faced double taxation on its profits. These inefficiencies were overcome by setting up a holding company in Mauritius to benefit from that country’s bilateral tax treaties with most East African countries.
In West Africa, many nations have signed on to the Organisation pour l'Harmonisation en Afrique du Droit des Affaires (OHADA), a system of business laws that provide for reciprocity in enforcement of judgments. Such systems are becoming more commonplace in Africa, but generally it is advisable to seek impartial jurisdictions, offshore joint ventures, and shareholders agreements.
Applying best practices in corporate governance and requiring world-class documentation from a target company before investment makes sense in any market, and particularly in Africa. Contrary to popular views, Africa has a long history of private ownership and relatively well-developed institutional settings compared with, for instance, Eastern Europe. The continent benefits from UK and French law based legal systems, increasingly sophisticated securities commissions and improved banking oversight. Generally, companies across the continent are eager for capital and are willing to work within the structures set up by private equity investors in order to further their businesses. Largely underpenetrated by private equity capital and poised for continued growth, Africa presents a bright future for private equity.
About the Author
CAROLYN CAMPBELL
Managing Director and General Counsel, Emerging Capital Partners
Carolyn Campbell is a Managing Director and General Counsel of Emerging Capital Partners and was a founding member of the group. ECP is the first private equity firm to raise more than $1.5 billion to invest in companies across the African continent and has made over 50 investments since 2000 (http://www.ecpinvestments.com/).