Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
AfricaJanuary 31 2011

Private equity firms scramble over Africa's potential

A banking sector ripe for development, family businesses ready to go global and resource-rich nations with cash aplenty have meant private equity firms are buzzing over Africa's untapped potential. The scramble for the continent's middle-class custom has begun and investors are jostling for position.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Private equity firms scramble over Africa's potentialChanges to pension rules in South Africa will benefit the stock exchange in Johannesburg

Enjoying its status as the last frontier for business opportunities, Africa – despite the conflicts, rampant corruption and chronic instability – still has good reason to rejoice.

When the basic data is laid out, it becomes understandable why portfolio investors from across the globe are flocking to the continent. With a population exceeding 1 billion, it remains an attractive market in which many private equity firms are now thriving.

"The opportunities are huge and there are many cash-rich players looking to invest," says Jean-Marc Savi de Tove, Portfolio director at CDC.

CDC is a wholly owned UK government investment vehicle specialising in developing countries, and is one of the Organisation for Economic Co-operation and Development's main sources of data for private sector activity in Africa.

European, Asian and Middle Eastern private equity firms are all looking to the continent, where about $2bn of funds are currently floating around in the region's fastest-growing sectors such as telecoms, consumer goods and infrastructure.

And, while Africa remains marred by negative headlines, it has a capacity to bounce back, allowing new opportunities for investors to emerge. Its consumer goods-hungry middle class is a boon for investors who have already benefited from the continent's appetite for telecoms.

Analysts have pointed out that Africa already boasts more middle-class households than India, which should drive cycles of increased domestic growth to exceed that of the Asian sub-continent.

The private equity industry remains one of the most promising: many Africa-based companies' investments are reaching the end of their cycle and they are looking for new solutions. Not only will private equity firms open up a host of new opportunities for them, but any new listings will improve liquidity on many African exchanges.

South African Expansion

In South Africa, the continent's most sophisticated market, local regulators have allowed pension funds to invest outside the country and take larger stakes in private equity-backed firms. This will boost interest in private equity and push for more transparency within the industry, according to Albrecht Gantz, managing director at South African risk investment consultants RisCura.

South African pension funds used to be restricted to investing about 3% into private equity-backed entities. In December 2010, the South African Financial Services Board increased that to 10%.

The new regulation is an added incentive for fund managers to create private equity firms and "benefit from the opportunities it offers", says Mr Gantz.

Milton Lore, managing director at the African Venture Capital Association, is aware of the challenges that remain. First, there is a lack of accurate industry information to assist investors in making decisions, and second, there are concerns over their options to exit from ventures due to shallow capital markets. Both these factors highlight the need for more information.

On the back of this renewed interest in the industry and the need for a more efficiently run market to emerge, RisCura is looking to launch an African equity index in the first quarter of 2011. This is designed to help the sector develop by providing industry players with relevant data.

The aim, says Mr Gantz, is to ensure more information is made available to fund managers, leading to a speedier fund-raising process. Greater transparency is all-important, as this should increase international interest in the local industry.

Mr Gantz believes the next five years will also see the industry swell with more liquidity on local exchanges when investments reach maturity. "Today, only the Johannesburg and Cairo stock markets are experiencing high levels of liquidity. But with new companies looking to list at the end of their investment cycles, many bourses in southern and eastern Africa will experience a rebound of activity," says Mr Gantz.

Asked whether fund managers would volunteer information for the index, Mr Gantz said that 85% of those quizzed agreed this was a useful tool in the development of Africa's fastest-growing industry. He believes they would provide data.

Private equity firms have about a 10% penetration in African companies, with infrastructure proving the most popular among investors. However, Mr de Tove believes the retail sector is likely to take over from construction, with banks also set to be a target sector.

Financial services shift

Traditionally, private equity investments were heavy on commodities and the mining industry. There is, however, a gradual and visible shift towards financial services.

CDC's Mr de Tove points out that a high proportion of Africa's population is still unbanked, but at some point in the future many will want an account. "Because of the potential for people wanting to open accounts, the industry is rapidly growing and international banks operating in all sectors are looking to the continent, with private equity firms buying up stakes aplenty," says Mr de Tove.

Meanwhile, for Islamic banks, Africa is a blank canvas and a place where operational costs remain low due to the relatively unsophisticated banking sector.

In less than four years, fundraising activity by private equity fund managers increased from $800m in 2006 to more than $2bn in 2010 in sub-Saharan Africa. With commodity prices rising and leading to more cash surplus for many African economies, a lot of capital is available to invest in a raft of new industries, say analysts.

South Africa remains the most important market, with more than 70% of firms operating from there, but other countries are emerging as contenders.

East African opportunity

The East African Community's (EAC's) Common Market protocol, which came into force in 2010, will boost opportunities in the region, particularly for small and medium-sized businesses.

The protocol allows free movement of goods, services, capital and labour in the bloc, which comprises Burundi, Kenya, Rwanda, Tanzania and Uganda. While Kenya is the most developed of the five, international institutions, including the World Bank, have praised Rwanda for reforming its banking sector to a "very satisfying" degree – consequently, it is now more business friendly.

According to Rory Rod, head of private equity at RisCura, the uniform legal framework within the EAC is attracting more private equity firms to the region.

Another area in which private equity firms are making a noticeable entry is in family-owned businesses. These make up a large portion of the business sector of African countries. Seen as efficiently run with relatively low levels of leverage, not to mention high rates of return, Africa's family-run companies are the latest target group for private equity firms looking to get a foothold in smaller industries.

These companies customarily operate in traditional sectors such as farming or hospitality and, with second-generation family members often attracted by careers outside the family business, private equity firms come in and fill the gap. They provide companies, often lacking in corporate management know-how, with the expertise to remain competitive in an increasingly challenging environment.

Development banks

Development banks are also jumping on the bandwagon, investing considerable amounts in private equity firms that aim for sustainable growth.

Many of the development bank-backed private equity firms are looking towards impact investments. These are investments that lead to long-term benefit for the local economy, and have a lasting and positive impact on the country.

These types of funds often receive support from various government-backed institutions, which see them as profitable operations as well as committed to 'the good of the continent' in the long run.

The risk profile of these investments is similar to other venture capital or high-yield debt investments, and the company in question will gain on the reputation front even in the event of a failed project.

There is no doubt the private equity market is set to leave a mark on African markets. With so much still available for the taking and international investors looking at the continent with renewed appetite, the sector is in full expansion.

Local advisory firms are already looking to increase the efficiency of the sector and ensure it operates to international standards. Private equity firms will therefore expect exceptional growth curves over the next few years.

Whether this will this lead to a flurry of IPOs on local exchanges or whether companies coming to maturity will remain within the unlisted sector, time will tell. For the moment, Africa's latest challenge is to make the most of its vast amount of accumulated cash – and private equity firms are its safest bet right now.

Was this article helpful?

Thank you for your feedback!

Read more about:  Africa