Private Equity in Africa
During the past few years, Africa has attracted increasing amount of private equity investments. In 2011 private equity investors closed USD3 billion worth of deals in Africa, up from USD890 million in 2010. In 2010, Sub-Saharan Africa accounted for 6% of total emerging markets private equity investment, up from only 3% in 2007. Currently, around 200 equity investors are actively involved on the African market. Beyond traditional development institutions and institutional investors, more global frontier investors are exploring opportunities in Africa, seeking to diversify risk, improve efficiency, and unlock value. Currently the bulk of the equity funds attracted to Africa are ‘specialized funds’ with focus on natural resources, infrastructure and renewable energy sectors. However, funds targeting other sectors, principally those driven by the growing appetite by Africans for quality consumer products and services, are poised to be the main drivers of private equity funds to the region in the coming years. With the global financial crisis that has sharply affected the private equity industry in developed economies, Africa is likely to remain an important market for foreign as well as local private equity investors.
Figure 1 below shows the significant increase of private equity’s fundraising in Sub-Saharan Africa (SSA) from 2006 to 2008 before halving in 2009 as a direct consequence of the global financial crisis. The financial crisis had a more pronounced impact on South Africa’s (SA) private equity market, with inflows declining significantly in 2009. Equity flows to the continent rebounded in 2010 and grew sharply in 2011. However, the South African market has remained in distress, overshadowing the continental recovery. Nonetheless, prospects in other emerging markets in Africa remain favorable.
Africa’s attractiveness to private equity investors
Africa is attracting private equity investors for three primary reasons: recent robust economic growth on the continent, improvements in structural factors, and absence of competition in the African market.
Economic growth: The recent high GDP growth episode in Africa has created an environment conducive for investment and flow of funds to the region. Over the past decade, Africa’s GDP growth averaged 5%, exceeding the world average growth of 4%. Africa is now one of the fastest growing regions in the world with a number of countries expected to exceed 7% over the period 2011-2015.
A diversified range of industries offering a wide array of opportunities is especially poised to benefit from these favorable developments.
Structural factors: The realization of the need to shift from commodity dependence to more diversified service and manufacturing based economies is in response to favorable demographic trends, which have ushered in a growing middle class. The bulge in the middle class and the attendant rise in consumer demand have created an avenue for private investors seeking expansion toward emerging and frontier economies. Furthermore, improvements in the political landscape and upgrading of infrastructure, strengthening of regulatory and legal frameworks and the efforts being undertaken by the continent towards deeper regional and financial integration, have also boosted the interest of private equity fund managers in Africa.
Lack of competition and opportunity for higher returns: Absence of competition in Africa offers the potential for high return generation which is the main incentive for private equity’s risk-seeking strategies. Despite the recent upward trend in private equity flows to Africa, private equity penetration is still low in Africa. For instance, private equity investments represent only 0.1% of GDP in Sub-Saharan Africa compared with 0.4% in India and 0.2% in China and Brazil. Smaller markets and lower penetration rates create significant potential for high risk-adjusted returns. Recent surveys of global private investors have shown that Africa offers the highest risk premium relative to developed markets. A number of private equity companies surveyed reported a return in multiples of 2.5 times on their investments in Africa. This is comparable to returns prevailing in developing Asian markets but higher than the average 1.9 in Europe and the U.S.
Leveraging on increasing wave of private equity flows
Africa can benefit from the rising wave of private equity flows in a number of ways. Chief among them, private equity provides an alternative vehicle of financing that complement traditional sources of long-term funds. Private equity flows could also raise investment standards and create a dynamic market for talent in Africa.
Increasing flow of funds: Africa is characterized by underdeveloped and illiquid capital markets. These factors have previously reduced the region’s ability to accommodate large equity investments and prevented global investors from gaining access to the continent’s recent GDP growth story.
However, as Africa’s economic rise has permeated the global media, this has exposed the continent to global investors. Thus, increased flow of private equity funds would allow African firms gain access to diverse sources of capital to expand their businesses without jeopardizing their financial ability with high levels of leverage. Private equity could become a major channel for accelerating growth in African countries.
Raising investment standards: Private equity investors usually have a long-term investment perspective oriented towards value-creation. This long-term financial commitment and gaining a controlling stake in corporates could help upgrade domestic governance processes and management systems as well as promote environmental and social awareness. Moreover, private equity investors seek reliable accounting information, which is crucial for improving transparency and accountability. Private equity partners can also raise investments standards in Africa by bringing expertise and know-how and providing technical support and networks to portfolio companies.
Market for talent: As for most alternative investments, private equity is a skill-based industry. The need for skilled and experienced people sharing knowledge with local experts would create a dynamic market for talented professionals with a background in financial structuring and deal execution. Foreign partners may also rely on the expertise of local employees with local networks, experience and potential. Private equity industry may also induce skilled diaspora to return to Africa.
The presence of global financial firms in Africa has seen a return of skilled Africans living in the West to return to their countries to take up offers of comparable benefits and advantages as those obtaining in industrial countries. The South African Network of Skills Abroad is an example of an initiative aimed at linking skilled South Africans living abroad with their country. Attracting operationally experienced African diaspora is one of the objectives of many funds in Africa.