Africa was the most popular emerging market destination for private equity investment in 2013, with sub-Saharan Africa attracting $1.6 billion – the most in five years.

The Emerging Markets Private Equity Association (EMPEA), based in Washington, says its members ranked Africa as the fifth most popular investment destination in 2012. Last year, however, it shot to the number one spot, attracting more investment flows than Brazil, Russia, India and China.

The case for investing in the rest of Africa – besides SA – has been well documented. Higher economic growth rates than developed countries, increasing urbanisation, favourable demographics, an improving political outlook and a growing middle class are among the compelling reasons. These trends have contributed to the huge demand for infrastructure across the continent, from power supply to roads, railways and ports.

Some $90 billion to $100 billion investment in infrastructure is needed each year for the next decade to close the continent’s infrastructure gap, according to estimates.

Governments, banks and development finance institutions cannot supply the level of funding needed to build the infrastructure and fund consumer demand, which is where the private sector can play its part in the African growth story.

Private equity in particular has followed the rise of the African consumer, says Rory Ord, head of fundamentals at RisCura, an investment advisor specialising in emerging markets. ‘Private equity investment has tended to follow where the capital is required, and it is following the rise of the African consumer, the growing middle class and urbanisation, and even, to some extent, industrialisation,’ he says. The history of private equity in Africa shows it started with a developmental objective, Ord explains.

The first private equity invested on the continent came through development finance institutions such as the African Development Bank and the UK development finance institution, CDC, the oldest private equity investor in Africa.

‘They found you could achieve developmental objectives and get a good return on capital, as well as create jobs and develop industries,’ he says. On the back of their success, other development finance institutions began investing in Africa in the 1990s, and they were later followed by institutional investors, Ord says.

 

‘Private equity, on the other hand, gives investors more balanced exposure to the GDP composition in Africa’

ERIKA VAN DER MERWE, CEO, SOUTH AFRICAN VENTURE CAPITAL AND PRIVATE EQUITY ASSOCIATION

The 2008 financial crisis dampened enthusiasm for private equity investment on the continent, but it appears Africa’s massive growth potential is increasingly becoming a drawcard. The EMPEA found that nearly 54% of private equity fund managers surveyed last year planned to begin or continue investing in sub-Saharan Africa over the next two years. 

They also ranked sub-Saharan Africa as the number one private equity investment destination, according to the EMPEA’s report titled Global Limited Partners Survey: Investors’ Views of Private Equity in Emerging Markets 2013.

Respondents – 49% of whom are based in North America – said that besides economic growth and the demographics, they were attracted by the ‘increase in fund managers with a track record, significant investment opportunities, the dynamic of low-entry valuations and fast-growing markets’.

Private equity is an attractive alternative to listing on local exchanges that, with the exception of the JSE in SA, offers limited investment choice.

Erika van der Merwe, chief executive of the South African Venture Capital and Private Equity Association (SAVCA), says most African exchanges are skewed towards the financial sector. ‘Private equity, on the other hand, gives investors more balanced exposure to the GDP composition in Africa, and more balanced exposure to emerging African consumers, than listed equity,’ she says.

Ord says private equity allows for investment in smaller companies. ‘It gives investors a wider exposure to sectors and companies at different stages of development,’ he says. Equally important, however, are the benefits it brings to the companies on the receiving end of the investment.

EY’s Africa private equity leader, Graham Stokoe, says the skills and knowledge gained is as important as the cash. ‘Private equity is not just about capital, it’s about the intellectual capital and networks it brings that can take African businesses to the next level,’ he says. As private equity is a very hands-on investment approach, investors may implement corporate governance, create boards and teach management about strategies and planning, says Stokoe.

This investment of both capital and expertise might be expected to create a pipeline of larger businesses ready to list on exchanges. Stokoe, however, says this is not that common.

‘An EY study shows that the companies might look at listing, but less than 10% of private equity businesses to date have gone on to list,’ he says.

Instead, private-equity investment enables many smaller companies to become regional players, and sometimes even pan-African businesses, says Stokoe. SA businesses often acquire them to expand the rest of their African operations. Private equity investors tend to invest in the number one or two companies in their sector or region to help them grow faster. ‘It’s not about investing in the corner café. Private equity doesn’t focus on SMEs in general, so it is not going to drive the small business sector,’ says Stokoe.

Nevertheless, private equity is a powerful tool in the development of a thriving business sector in Africa due to its medium- to long-term investment horizon. Van der Merwe says that private equity is a fairly illiquid asset class invested for on average 10 years, making it particularly suitable for those with a sustainable investment mandate.

EY’s Attractiveness Survey Africa 2013 maintains that foreign direct investment (FDI), which includes private equity, can serve as a catalyst for growth and development on the continent. Besides being a source of longer-term capital and tax revenues, it plays a crucial role in direct and indirect job creation. Investors help develop local suppliers, with local sourcing policies in turn creating extended supply chains of domestic providers.

FDI will drive broader private sector development across Africa. ‘This is critical, because it is the private sector [both foreign and increasingly domestic enterprises] that will ultimately lead the structural transformation required to sustain and accelerate Africa’s growth,’ the EY report states.

EY’s attractiveness survey Africa 2013 maintains that foreign direct investment can serve as a catalyst for growth

While SA private equity funds are increasingly doing deals in the rest of Africa, the majority of the continent’s activity still takes place in SA, says Ord. This may start to shift as changes to pension fund and foreign-exchange regulations allow trustees to allocate up to a tenth of their portfolios to private equity and 5% to the rest of Africa.

The Government Employees Pension Fund (GEPF) – through the Public Investment Corporation – is one of the few SA pension funds that has committed to investing in the rest of Africa, adopting the pioneering approach to include private equity in its investment plans, says a RisCura report titled Bright Africa.

It’s the largest pension fund in Africa and has earmarked 5% of its holdings for long-term investment into Africa. Based on the fund’s size of about R1 trillion, this allocation amounts to around R50 billion, according to the paper titled Investing in Africa: A Practical Perspective for the SA Institutional Investor by Zeenat Patel, Donovan McKay, Nick Janse van Rensburg and Nimisha Bhagwan. The GEPF’s African focus supports its developmental mandate.

The fund ‘has an appreciation of the opportunity to boost returns by investing in Africa, which in turn will boost African growth and thereby benefit SA. It’s a virtuous cycle’, says Van der Merwe.

Compared to the developed market, particularly the US, private equity funds in Africa are small. But the number is growing.

According to the paper, ‘confidence in African private equity was demonstrated when between 2006 and 2012, 81 private equity funds with a main focus on Africa closed to new fund raising, and by the end of 2012, 45 funds had opened with a target of raising $12 billion’.

Global private equity firms have recently started showing more of an interest in Africa, says Ord. ‘But they are taking a cautious approach by investing in African-based fund of funds, not in hands-on investments. They feel they don’t have enough knowledge for direct investments,’ he says.

Stokoe says only the Carlyle Group to date has set up an Africa fund and actually has a team on the ground in Africa, with offices in Johannesburg and Lagos, Nigeria. It is raising capital for an around $500 million fund.

By Gene Michelson
Image: David Maclennan