Nigeria's $1000bn stock market ambition

The few years leading up to mid-2008 were giddy times for Nigeria’s capital markets. More and more investors piled into equities as returns kept rising. Banks, unconstrained by lax regulation, were only too happy to support them by providing as many margin loans as they wished. The frenzy came to an end when oil prices plummeted and foreign investors fled the country in droves. The main index on the Nigerian Stock Exchange (NSE), which had a market capitalisation of $110bn in March 2008, lost 70% of its value in the following 12 months.

A crisis of the banks, whose stocks made up most of the NSE, followed. Bad loans soared and the central bank had to inject $4bn into 10 commercial lenders that failed stress-tests in the second half of 2009.

Recovery mode

Market sentiment is yet to fully recover. The NSE’s all-share index traded at about 21,000 in mid-March this year, far below its peak of 66,000 in 2008. Retail buyers, who used to comprise more than 40% of the investor base, are still largely absent. “The man on the street has been wiped out,” says Wale Shonibare, head of UBA Capital, the investment banking arm of United Bank for Africa. “It is going to take a while for them to regain their confidence.”

Local institutional investors are also wary of the equity market. According to analysts, 10% of pension funds’ portfolios are allocated to shares, which is well below the regulatory limit of 25%. Most are instead opting to buy government bonds.

Foreign investors have partly filled the void, and are said to be involved in 70% of trades in the equity market. But their presence alone is not enough to increase liquidity substantially. “Most investment banking firms haven’t grown in the past three years,” says Ike Chioke, managing director of securities house Afrinvest. “Indeed, our market has shrunk as a consequence of an economic environment that has curtailed the trading activity we used to see. In 2008, the stock exchange turned over about N10bn [$63m] to N12bn a day. In 2012 it struggles to get to N3bn a day.”

Little progress was made in the first quarter of 2012. This was partly because of rising violence in the north of Nigeria perpetrated by Boko Haram, an Islamist organisation, and a week-long nationwide strike in January over the removal of fuel subsidies.

Business as usual

Commentators doubt, however, that these two factors will stymie Nigeria’s capital markets for long. Most say that the short-lived strikes increased pressure on the government to carry out its promised reforms of the power and hydrocarbon sectors, while the south of the country – including the commercial capital of Lagos and the oil-producing regions – has been isolated from terrorist attacks.

“Most investors who have decided to come to Nigeria have decided to take a certain amount of violence and political instability into account,” says Kayode Akindele, a partner at 46 Parallels, an Africa-focused fund. “As long as the insurgency does not become nationwide and start affecting things such as oil and gas production, they will take it as part of the trade.”

Despite the slow beginning to the year, many believe that 2012 will mark the start of the capital markets’ revival in Nigeria, with investors finally being enticed by low share prices. Mr Chioke, pointing out that several blue-chip companies are growing their earnings by 15% to 20% annually and producing dividend yields of more than 8%, believes that the NSE is undervalued by 30% to 40% compared with markets such as Egypt, Kenya and South Africa.

Bolaji Balogun, head of Chapel Hill Denham, one of Nigeria’s main advisory firms, says: “If you have a three- to five-year view, it looks like extremely good value.”

Moreover, Nigeria’s banks, which still account for more than one-third of the NSE's market capitalisation and which are crucial to providing credit to the economy, are once again in rude health. Non-performing loans, a large chunk of which were bought by state-owned bad bank Amcon, are now below 5%, while average capital adequacy ratios are above 20%.

Grand ambitions

The NSE and the Securities and Exchange Commission (SEC) have grand ambitions. They aim to increase the NSE’s market capitalisation from the current $75bn, of which $40bn comprises equities and the rest fixed-income securities, to $1000bn by 2016 – a 13-fold rise. “It is an aspirational number and I believe it can happen,” says Oscar Onyema, chief executive of the NSE.

Bankers largely agree, saying that Nigeria’s rapid economic growth, forecast to be almost 8% in 2012, and its population of 160 million – of which more than 60 million are middle class and above – makes the target realistic. “It sounds crazy, but it is very, very possible,” says Mr Balogun.

The NSE and SEC, both criticised for shoddy oversight in the run up to the crash and which have had new management installed as a result, are carrying out extensive reforms to ensure their target is feasible. They have sought to improve corporate governance by clamping down on insider trading and acting quicker to fine or suspend companies that report late and inaccurately.

“Corporate governance was a major problem before the meltdown,” says Oladele Sotubo, chief executive of Stanbic IBTC Stockbrokers, the largest brokerage in Nigeria. “Now, the NSE and SEC are out there enforcing the rules and ensuring that if you are quoted, you have to play the game properly. They have demonstrated that they have zero tolerance. That is sending the right message.”

Listed firms are also being told to improve their investor relations (IR) departments, which have traditionally been neglected by Nigerian boards. “Investor relations cannot be overemphasised, especially from the point of view of the key institutional and foreign investors,” says Akeem Oyewale, head of global sales at Stanbic IBTC. “They need to have access to the CFO or a senior person in IR. The culture is improving, but it is still a long way behind where it should be.”

ETF adds variety

Investors have long complained about the absence of tradable securities other than vanilla equities and bonds in Nigeria. This is changing, albeit slowly. In December 2011, west Africa’s first exchange-traded fund (ETF) was launched on the NSE. The ETF, which was listed by South Africa’s Absa Capital and tracks the price of gold, will be the first of several, says Mr Onyema, who adds that futures and options will be rolled out soon.

Boosting liquidity will be key to the NSE’s attempts to achieve a $1000bn market capitalisation. To this end, in March 2012, the SEC approved plans to introduce covered short-selling and share buy-backs.

Analysts say that while a greater variety of securities and short-selling are vital for increasing liquidity, little will improve unless brokers become more active. Having suffered in 2008 and 2009, most are still too short of funds to act as market makers.

The NSE has long promised to clean up the brokerage industry and appoint official market makers.

If this does not happen soon, many doubt the stock exchange would be able to cope with a substantial growth in bond and equity issuance in the next four years. “Until you can find a solution to the broker issue, and they are doing what they should be doing, which is getting retail investors back into the market, what is the point in having a market capitalisation of $1000bn?” says Mr Akindele of 46 Parallels.

A rising market alone will not enable the NSE to grow to $1000bn. Plenty more companies will have to launch initial public offerings (IPOs) for that to happen. The present composition of the exchange far from reflects the make-up of Nigeria's economy. Agriculture accounts for 45% of gross domestic product (GDP) but less than 1% of market capitalisation, while oil and gas companies, responsible for 90% of foreign exchange earnings, make up just 3% of the stock exchange.

None of Nigeria’s four biggest telecoms providers, which have about 90 million subscribers, are listed. “The most dominant and vibrant sectors of the economy are missing,” says UBA Capital’s Mr Shonibare. “Telecoms has been one of the fastest-growing sectors in recent years. And Nigerians haven’t had the opportunity to buy into that success story on a wide scale. One could say the same about oil and gas.”

Sharing success

Nigeria's government is trying to reform the oil sector and open it up to new investors, which, if successful, will likely lead to a wave of capital markets transactions. The Petroleum Industry Bill (PIB), designed to get more local private sector firms involved in upstream production, is expected to be passed in the next 12 months. Bankers say it will result in large capital raisings by new entrants and could even force NNPC, the state-owned oil company which dominates production through its joint ventures with international firms, to list.

“Our capital markets are supposed to be reflective of our economy. But they are not,” says Mr Onyema. “With the PIB – which will deregulate the oil and gas sector – there is the potential for the NNPC and all the joint ventures to be listed. This would be transformational.”

Plans to privatise the power industry could have a similar effect on the financial markets. Abuja wants to sell 17 generation and distribution companies – some of which could fetch $400m or more – in a bid to end Nigeria’s dire electricity shortages. Bukola Smith, director of project and structured finance at First City Monument Bank, says there will be no dearth of investors. “We think privatisation of the power sector is going to be even [more significant] than the telecoms revolution,” she says. “The opportunities are huge.”

The listing of Nigeria’s main mobile phone operators – Airtel, Etisalat, Globacom and MTN – could in itself triple the NSE’s market capitalisation, according to Stanbic IBTC’s Mr Oyewale. But seemingly none of the companies, all of which, apart from Globacom, are foreign-owned, have plans to launch initial public offerings (IPOs) on the NSE. They have strong cash flows and get cheap funding from local banks. As such, they have little incentive to raise equity, which would in any case dilute their ownership.

Mr Onyema says that some also think the NSE might be too small for them, which he refutes. “They argue: ‘We are big companies and we are not sure the market will be able to soak us up.’ That is an error of judgement on their part. This market is deep enough to take in any company with a good story. If MTN Nigeria launched an IPO today, it would be oversubscribed.”

Politicians and ordinary Nigerians are increasingly vocal about the absence of the telecoms firms and oil producers on the stock exchange. Some say the government could eventually be tempted to make their operating licences conditional on them going public. “I would be very surprised if these companies didn’t see the writing on the wall and begin to look at assuaging two pressures: for wider Nigerian ownership and for them to contribute something to the domestic capital markets,” says Mr Balogun of Chapel Hill. “This is an idea whose time politically is now.”

Afolabi Caxton-Martins, a corporate finance lawyer in Lagos, says there are few legal barriers to the government forcing private sector companies to list. But politicians, wary of scaring foreign investors, want to avoid that outcome. “If the government is determined, it could do it,” he says. “But I do not think it will. It would rather give the companies incentives to list.”

Small companies too

The NSE is not just focusing on Nigeria’s largest companies, however. It also wants small and medium-sized enterprises to launch IPOs. To entice them, new listing rules have been drawn up to make the process more flexible. Companies now only have to produce three years of financial reports, rather than five. And they can float as few as 20% of their shares, whereas before at least a quarter needed to be sold.

The NSE has also established a division responsible for travelling around the country encouraging firms to list. Before, it just waited for applications to be submitted before approaching IPO candidates. As a result of its more proactive stance, the NSE says it has earmarked about 550 companies for IPOs in the next five years, many of which will take place on the Alternative Securities Market, designed for listings too small for the main exchange.

Mr Onyema says one of his main problems is convincing big family-owned businesses, of which Nigeria has thousands, that an IPO can help ensure a long-term future. “We have made the case that while individuals might be running their businesses well, if they want to build a legacy that survives several generations then they have to have proper corporate governance structures in place,” he says. “When you list, you are forced to have these. There are plenty of examples of prominent Nigerian families and individuals with wonderful businesses that crumbled when the key founder moved on.”

Nigerians’ negative perception towards taking their firms public is slowly waning. The $14bn IPO in 2010 of Dangote Cement, founded by Aliko Dangote, Nigeria’s richest man, helped. “Every Nigerian entrepreneur wants to be like [Mr] Dangote,” says an investment banker. “So, when he listed his flagship company it sent out a strong signal that others could do the same.”

Boosting agriculture’s share of the capital markets will be particularly difficult. Although the sector makes up the biggest single element of GDP, it mostly consists of smallholder farmers. But the NSE wants farmers that have taken loans from the central bank to refinance them in the equity market. It says they can do this by forming co-operatives.

“We have to be creative about how we attract agriculture to the market,” says Mr Onyema. “To make critical mass and be big enough for us to pay attention, farmers need to form some kind of grouping. The idea is to work with these entities for 18 to 24 months to prepare them for a listing.”

All set for 2013

Few bankers expect investors to pile back into equities in 2012, which will likely mean IPO volumes will stay muted until 2013. For the moment, most investors seem happiest buying government bonds, which were yielding as much as 16% for a 10-year maturity in mid-March 2012.

But once inflation and bond yields start falling, something many analysts think will happen in the second half of 2012 as the impact of the partial removal of fuel subsidies wears off, returns in the equity market will look more attractive. And corporate bond issuance, which has been stagnant for the past two years, should pick up as companies find rates less onerous and more in line with those they can get on bank loans.

The NSE has plenty to accomplish if it is to succeed in creating a $1000bn market. Much will also depend on factors outside its control, such as interest rates and the government’s ability to push through reforms in the oil and power sectors. But bankers are confident that the next few years for the capital markets will be bright. Foreign investors, while already increasingly bullish about Nigeria, are likely to become even more so once the economy is rebased later this year. This is likely to see GDP, about $250bn today, rise by 30% to 60%, making the economy only slightly smaller than that of South Africa.

Such an increase would, along with the growth of its capital markets, go a long way towards ensuring that Nigeria quickly matures from being a frontier market to one of the world’s most sought after emerging ones.