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September 23, 2018

'Africa Rising' narrative Sparks PE Deals In Africa

Equity town hall branch.PHOTO/file
Equity town hall branch.PHOTO/file

THE Africa-focused private equity industry had a good run in fundraising in 2015. The year brought us the first $1 billion (Sh101.82 billion under present exchange rates) sub-Saharan Africa funds. Still not a massive amount by global standards, but for a region with a still relatively limited track record in private equity investments, this is significant.

Helios, which closed their third Africa fund at $1.1 billion (Sh112 billion) in January 2015, were the first private equity fund manager to raise a $1 billion fund. That was above their initial target. What helped them was that they had a track record. Around 60 per cent of the investors who committed to their third fund had invested in the previous ones as well.

Emerging markets PE firm Abraaj followed closely, announcing that they had raised $990 million (Sh100.80 billion) for a new sub-Saharan Africa fund in March 2015. Like Helios, they had received more investment commitments than they had initially sought.

Also among the large fund managers was Development Partners International which closed their second Africa fund at $725 million (Sh73.82 billion), 45 per cent above target. Emerging Capital Partners started fund-raising for a $750 million (Sh76.36 billion). Limited Partners – those institutions that give fund managers the money to invest – clearly want to participate in Africa’s development.

Smaller funds were also successful in raising second or even third funds. Here, too, LPs like firms with a track record in investing and, ideally, also divesting – selling their stake in the companies they have invested in at a profit.

Some of the large US pension funds have even started dipping a cautious toe into African private equity, as have two Kenyan pension funds. These are Nation Media Group’s Staff Retirement Benefits Scheme that has committed $1 million (Sh101.82 million) to Ascent Capital’s Ascent Rift Valley Fund, before that, Kenya Power and Lighting Company committed $4 million(Sh407.28 million).

I think the 'Africa Rising' story has certainly helped to create some momentum in fund-raising, showing that there are credible investment opportunities, albeit often in challenging environments.

Last year, however, two interesting things happened. On the one hand, we had a bit of a reality check with respect to 'Africa Rising', most notably from rapidly falling commodity prices that have created problems for commodity-export dependent countries. I never really bought the 'Africa Rising' story (it doesn’t account for the endless complexities and nuances of a continent), and so I also don’t really buy the hand-wringing over the presumed end of it. Yes, I certainly think that sub-Saharan Africa remains very vulnerable to commodity cycles, and it has been flagged recently that many countries have not been able to use the boom cycle to diversify their economies and build manufacturing capacity.

But relative to other financial inflows, private equity is still a relatively small player – although it can punch above its weight through the technical inputs, international connections and strategic investors they can bring to an investee company. I expect PE firms to navigate their way through this, and they have a longer-term perspective than, for example, funds that invest in listed equities.

The second issue is deal flow. This is, in principle, nothing new. We are looking at countries where the formal economy is generally still quite small, where company owners are guarded about disclosure, and where a lot of company founders are still not very familiar with what private equity can and can’t do, and how it works.

Competition for deals is often intense, especially with the proliferation of PE funds. In Nairobi, you can’t set foot in a bar any more without falling over an investment banker type or five.

In fact, investment activity last year was relatively subdued, despite the large funds being raised. Especially interesting to me was the sluggish investment activity by some of the global PE firms, proper big players, which had ventured into SSA with exuberant press releases affirming their belief in 'Africa Rising'. What’s their problem? They do large deals, and spending lots of money is actually quite difficult, at least in this environment. Compared to them, companies like Actis – which do larger deals, but have also been around for a lot longer – have been more active.

So this has drawn attention again to PE investments in SMEs – long backed as a policy issue by development finance institutions because of that whole backbone-of-the-economy narrative. However, doing SME PE investments on a commercial basis is tricky: all the due diligence and other work is pretty much similar to what you need to do for a large deal. But your fees and also returns are likely to be smaller. And if you can’t do it on a profitable basis, then you will have to continue to rely on soft money which, in contrast to money just looking for profits, is limited.

Right now, many funds are still backed by development finance institutions to a significant extent. And fund competition in this segment is intense, which often drives up the money spent on company stakes (great for owners, less so for funds and LPs).

So that’s what I’ll be looking out for in 2016: Can the SME funds make money – and can the big boys get into the game at all?

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