Backgrounder: Private equity in Africa

(UNECA) Updated: 2014-10-14 11:01

I. Introduction

1. What Africa has achieved over the past decade is noteworthy: average growth rates of 5 per cent and inflation in single digits. Moreover, an increasingly stable and predictable economic and political environment has lessened the risks for business investors, thereby giving companies more confidence to exploit profitable investment opportunities in Africa. According to a report published by the McKinsey Global Institute in 2010 entitled Lions on the move: the progress and potential of African economies, the rate of return on investment in Africa today, even adjusting for the real and perceived business risks, is higher than in any other developing region. In addition, Africa has vast reserves of natural resources, including platinum, gold, diamonds, chromite, manganese, phosphates, copper, coal, cobalt, iron ore and uranium. It is also home to about 12 per cent of the world's oil reserves, and has huge swathes of arable land and forests.

2. However, Africa should not only be seen as a source of natural resources. The continent's population of nearly 1 billion represents a burgeoning consumer market. Indeed, according to McKinsey, Africa's combined consumer spending power is projected to increase from $860 billion in 2008 to over $1.3 trillion by 2020, with the number of households with discretionary income set to soar by 50 per cent, to reach 128 million. Such growth is being fuelled by the rise of the middle-income group (it is estimated that the number of middle-class households will increase by almost 50 per cent between 2010 and 2020) and the high rate of urbanization in many countries. In addition, there is an increasingly large pool of well-educated, enterprising English-, French- and Portuguese-speaking workers. These demographic dynamics provide the potential for investments in areas other than natural resources, and private equity investors could easily tap into this huge market for consumer goods and services. In short, Africa is very much in the spotlight and affords tremendous opportunities for investors.

3. There are, however, some caveats to Africa's promise. First, although Africa is a dynamic and growing region, considerable challenges and risks remain. Second, the continent's growth is often couched in figures such as gross domestic product, but what really matters is how such growth is shared out. If growth is not inclusive and broad-based, people will not feel that they are part of Africa's promise. It is true that Africa's population is young and growing, but there are still large segments of the population that do not have enough money to cover their basic daily needs. Third, Africa's story is also about the continent's position vis-à-vis the rest of the world. The continent needs transformation, and with that comes competitiveness. Fourth, one has to be cautious about treating Africa as a single basket: countries vary from one to the other, and differences regarding education, the health system and rule of law matter. Lastly, Africa needs a strong political agenda in order to address challenges such as its infrastructure deficit.

4. What does all this mean for private equity investors? The following sections will attempt to answer that question by analysing the issue of private equity in Africa in terms of the trends, opportunities and challenges, and what Governments need to do to promote and enhance their role in support of national development efforts and Africa's transformation in general.

II. Understanding the asset class

5. Raising capital for investments is one of the biggest challenges facing many African entrepreneurs and economic operators due to, among other things, the very high and uncompetitive rates offered by commercial banks. Businesses traditionally get funding from banks and public equity markets (or bonds and debt markets), but private equity offers an alternative to this. A company with growth prospects that needs funding can approach private equity players who will, after analysing the risk-return potential, provide a combination of debt (sourced from a bank) and equity (which they raise from institutional investors) to that company. The private equity investment horizon is anywhere between 5 and 10 years and at the end of that period, the private equity fund managers have to trade their equity shares, which is known as "exiting". In more developed markets, exiting often happens by listing the company on a public exchange through an initial public offering. Private equity offers the potential, therefore, to fill the funding gaps currently holding back many local companies in Africa.

6. There is an urgent need for a massive capital infusion to finance a number of crucial projects in Africa in areas including infrastructure with particular emphasis on projects under the Programme for Infrastructure Development in Africa (including road and rail networks, energy and water), mineral resource exploitation, agrobusiness, industrial development and economic diversification in general. Investing in such opportunities could be a lucrative venture for private equity players and other investors, while also helping to create millions of much-needed jobs for Africa's growing population and to lift people out of poverty. Agriculture in particular represents an enormous opportunity, because it is so important for Africa and brings in much of the continent's wealth. Examples of possible agricultural investments include agricultural extension services to provide information and know-how, and storage facilities for farmers. Africa also needs impact investing. This is hugely promising because of the political pressure to provide basic services, which means that any group that wanted to support investments in this area would likely get the support of the Government.

III. Private equity deals in Africa

7. About 8 to 10 years ago, the concept of private equity was not well-known in Africa. These days, we are seeing more and more capital coming to Africa, and private equity is being discussed in many forums, which shows that the industry is gaining traction. Data from leading firm Preqin, which tracks private equity trends, revealed that the second quarter of 2013 was one of the strongest private equity fundraising quarters of recent years, with 164 funds securing an impressive $124 billion in aggregate capital. Indeed, statistics from the past three years indicate that there are some significant investments being made in the private equity industry. According to the African Development Bank, investment deals in Africa are reported to have increased from $890 million in 2010 to $3 billion by 2011, an increase of some 30 per cent. Meanwhile, according to estimates by the African Private Equity and Venture Capital Association, $1.14 billion was raised from institutional investors in 2012 for Africa-focused private equity funds, and there are another 50 funds currently in the market that are targeting a similar aggregate amount. Ethos Private Equity alone (a South African fund manager) is reported to have raised some $900 million.

8. Figure 1 shows how private equity deals are distributed in Africa. In past recent years, Southern Africa has dominated, with about 65 per cent of private equity deals, followed by North Africa (14 per cent) and West Africa (13 per cent). Central Africa accounts for just 1 per cent of private equity deals.

9. Not all sectors have attracted private equity investment. Investors have been very careful in

identifying sectors that would easily grow and bring returns (see figure 2). For instance, investors are unwilling to put their money into the health-care sector because of the long term returns.

IV. Challenges of private equity in Africa

10. Despite the positive narrative surrounding Africa as the "next frontier" for investments, investor perceptions in terms of the cost of doing business in the continent remain an area of concern. For one thing, the continent's sheer physical size, geopolitical fragmentation and weak infrastructure continue to make it an expensive place in which to do business. For another, fundraising in the private equity industry remains a major challenge. Foreign investors are always more comfortable when a funding team has managed to attract local money first, but there is a general lack of local investors in the private equity sector in Africa, with the possible exception of South Africa.

Figure 1: Private equity investments by subregion

Southern Africa 65%

North Africa 14%

West Africa 13%

East Africa 4%

Pan Africa 3%

Central Africa 1%

Source: RisCura.

Figure 2: Private equity investment in Africa by sector, between 2006 and 2012

Consumer Discretionary 26%

Industrials 28%

Materials 20%