Unlocking investment in Africa: could private equity be the key
Personal Notes : Not only Africa is the most underrated investment destination, but its Sahara desert holds the key to rendering the energy, and thus the water and food issues irrelevant in a future context. Read on.
Is Africa the world’s most underrated investment destination? Could the continent offer better returns on cheaper capital? Could private equity be the key to unlocking the wealth of the world’s largest market and the last frontier of growth for the ailing global economy?
The flow towards Africa of both private sector money and development finance from Development Finance Institutions (DFIs) is gaining momentum and more private equity groups are looking for African investments.
There are fewer players in Africa, meaning less competition, better deals for entry and more time for due diligence. The capital market is growing and new players are coming in, providing funds with great exit opportunities.
In June, London-based Helios Investment Partners launched the biggest-ever US$900m fund targeting Africa. The fund was oversubscribed with more than 70% coming from outside DFIs.
Data from the internal rating system of the German DFI, DEG Germany, shows that the average Africa fund performs as well as average global funds.
Macroeconomic factors are less relevant to returns on private equity in emerging markets than the selection of the right managers.
Africa also provides investors with a good way of diversifying their investment, with various industry opportunities, low-correlation currencies and liquid foreign exchange.
At the Africa Forum 2011 organised by Private Equity International in June, Ralph Keitel, principal investment officer at International Finance Corporation (IFC), confirmed that African funds were the best performing portfolio for IFC. Perhaps the big gap between risk and ‘perceived risk’ has kept Africa as the best-kept secret for those incumbents to make money.
Not every African country will make it into the ‘the 7% club’, the GDP growth required to double an economy’s size every 10 years. Africa’s GDP grew on average 6% from 2001 to 2008; GDP grew by 5% last year and is projected to grow by 5.5% this year.
But Denny Truell, chief investment officer of the Wellcome Trust, believes that GDP growth is not relevant when you are assessing Africa as part of an investment portfolio.
Long-term interest in Africa is not only in minerals and energy, but increasingly in water and renewable energy. The continent has favourable demographics and major opportunities in the huge deficit in health-care provision and transportation.
The question is not whether – but how – to turn this advantage into good economy.
Inclusive growth’ was the hot topic at the recent annual meeting of Africa Development Bank in Lisbon following the popular uprisings in North Africa, which drew attention to the possibility of using community engagement to minimise risk.
In South Africa, following the launch of a National Growth Path for more inclusive growth, the emphasis has been on job creation, beneficiation and joint ventures to ensure that as much investment as possible finds its way into the local economy.
DFIs have set the standards among private equity investors on environmental, social and governance priorities.
As engaging local communities becomes more useful in minimising risk, the participation of DFIs in deals has added credibility by demonstrating that funds have done prior due diligence and considered social risks involved in the investment.
Inclusive growth also means leveraging the skills and operational involvement of the African diaspora to support local entrepreneurs in order to attract private capital.
The long view
Events in North Africa are like an unpredictable ‘Black Swan’ event. Instead of staying away from Africa, investors could see the continent as providing a more open market, especially after the constitutional elections in Tunisia and hopes of the same in Egypt.
The reconstruction needed after elections and political stabilisation could attract huge investment into the continent. The challenge for private equity investors is whether the current structure of private equity allows them to take a long view.
Although the democratic change in North Africa is considered positive, investors are waiting for the right signal to roll out deals. This wait-and-see attitude in North Africa at present could direct investors’ attention to more stable sub-Saharan African countries.
No country can be developed without the participation of local capital, which not only provides enough capital, but also acts as a reference point on the ground.
There is a lot of local capital in Africa but it is difficult to access. Some local investors are less approachable than foreign investors, because they know well how to make profit on the ground. When it comes to entrusting funds with investment in their own country, some can demand higher returns.
Although South African private equity funds have managed to harness large pools of domestic capital, they are the exception rather than the rule.
This has limited the building of a private equity ‘eco-system’ on the continent, which becomes impossible without engaging local institutional money.
Some countries, such as Nigeria, are on the road to revamp the regulations to allow local capital to mobilise. In Kenya, the capital market has also expanded and the 30-year yield curve is relatively liquid.
As economies of scale shift to community generation, smaller businesses are likely to receive a significant boost from the green sector.
But there are many challenges ahead for private equity investment in the green sector in Africa, which needs policy support and subsidies in order to attract investors.
Apart from the feed-in tariff introduced by South Africa, only a handful of countries such as Uganda and Botswana are investigating similar schemes to encourage green investment. Sustainability of support is a big concern, due to the fact that renewable energy projects are long-term investments with designed life spans of between 15 to 25 years.
Even for developed countries, such as the UK, a dramatic decrease in feed-in tariffs has stirred unfavourable responses from investors and stopped many from investing further.
Development finance remains a key source to unlock the investment in renewables, but the efficiency of such programmes can be much improved by combining with private equity investment as well as newcomers such as China.
For example, the substantial renewable funding programme run by the European Union, the €100bn Africa-EU Renewable Energy Cooperation Programme, is committed to investing almost one third of its funds (€30bn) in Africa.
In the future, cross-continental partnerships are likely to proliferate.
China, both because of necessity and its history of pragmatic adjustment, is well placed to become a world leader in developing cleaner and more sustainable technologies, which will supplement and ultimately replace fossil fuels as the world’s primary source of energy.
South Africa is well disposed to contribute to this global priority, by vowing to reduce carbon emissions and setting a target of 42% of new electricity generation to be met by renewable energy sources such as solar, wind and wave-generation by 2030. In terms of the 20-year plan, nuclear power will account for nearly a quarter of new electricity generation.
This will mean a radical turnaround from the current South African situation in which coal provides for 84% of electricity generation. It is likely to prove controversial in a country with high unemployment and underdevelopment and which has to continually reconcile the goal of sustainability with developmental priorities.
Yingni Lu is a London-based development professional specialising in clean technology and renewable energy. She is CEO of EcoLeap and a partner at London-based Forbury Environmental. She also writes for the online magazine ReConnect Africa. John Battersby is UK Country Manager of the International Marketing Council of South Africa. Africa Forum 2011 was convened by Private Equity International. Africa Report was media partner.