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Private Equity in Africa –
A Niche Strategy With Potential

Along with rapid economic growth, private equity activity in Africa has soared over the past decade and is most likely to be a fast-growing and profitable investment. But even though attractive returns can be achieved, such investment is only suitable for a selected group of investors.

While Africa is known for its richness in natural resources and the prominence of its agricultural sector, the continent’s strong economic growth is currently boosted by its buoyant consumer sector. Gross domestic product (GDP) growth is forecast between 5.5 percent and 6 percent by 2017 by the International Monetary Fund, figures far above the developed world’s. Africa’s demographic dividend – a young and fast-growing population which could double by 2050 – is likely to continue to spur consumer spending over the medium and long term. These are some of the reasons why Africa is drawing increasing interest among private equity investors. The continent now ranks ahead of both Brazil and Russia in terms of attractiveness for private equity investments.
A Niche Market
Globally, about 25 percent of private equity capital is invested in emerging markets. Of those 25 percent, roughly 4 percent went to Sub-Saharan Africa in 2012. Hence, on a global scale, private equity in Africa is still a niche strategy. The share of private equity as a percentage of GDP usually increases with an economy’s state of development. For Africa, private equity penetration is still low compared to the US or the UK: about 0.1 percent in Africa compared to around 1 percent in developed markets. The average deal size amounted to 24 million US dollars during the third quarter of 2012. This figure is much smaller than the average deal size in Brazil, India, China and in developed markets. This in turn means that investors can access investment opportunities in Africa with far less capital input and achieve diversification with a smaller capital base than in other markets. Unlike more developed markets, where buyouts make up the majority of transactions, Africa has traditionally had a higher number of venture capital funds. But the amount of growth capital has been steadily increasing over the past few years. As the African economies mature and the number of companies in later stages of their life cycle grows, Credit Suisse expects the number of buyouts to rise sharply.
South Africa Still Draws Most Interest
South Africa continues to attract the highest volumes of private equity investment in Africa. This is hardly surprising considering its economy is fairly advanced and diversified, accounting for the highest share of the continent’s GDP. It is actually one of the few African countries with a GDP per capita above 5,000 US dollars. South Africa’s economy is, like other African countries, growing fast, making it well suited for private equity investments. However, private equity funds have discovered the potential of other African countries. Egypt, Morocco and Mauritius are also characterized by fairly diversified economies, while Algeria, Nigeria, Libya and Angola’s main potential stems from their oil exports. In Nigeria investment opportunities come from the country’s banking and financial sector. Private equity investments in these countries are therefore likely to increase in the medium term.
Impact of Regulatory Changes
While pension funds have traditionally invested large sums in private equity in developed markets, local African pension funds are still restricted from investing in this asset class. Such restrictive regulations are, however, about to change, (soon) allowing African pension funds to invest in private equity. Outside Africa, the European Union’s (EU) Alternative Investment Fund Management Directive (AIFMD) may put African funds at a competitive disadvantage when marketing their funds to European investors. The AIFMD directive restricts the marketing activities of funds with a domicile outside the EU to European investors. To be able to develop further, Africa will therefore have to rely on capital inflows from the developed world outside the EU. But the often perceived lack of transparency is often a hurdle holding back foreign investors from providing capital. The situation is currently improving as many African countries have recognized that they need to accommodate their corporate governance practices in order to attract capital.
Convincing Performance
Private equity has clearly outperformed publicly listed shares by a wide margin over the past decade. Private equity has achieved an internal rate of return of 23.1 percent annually between 2002-2012, 7.2 percent more than the FINDI Total Return Index. Even investments made in the boom years 2006 to 2008, have done well and are valued 1.5 times above cost (value-to-cost ratio). This is a far better performance than the investments made over the same period in developed markets, which are not even valued at 1.1 times above cost, a value increase of less than 10 percent since the investment was made. Private equity investments made in Africa in 2009 and 2010 were already valued above cost as of December 2011, revealing that break-even levels have been surpassed quickly, which is a positive sign. In developed markets, many investments made in 2009 and 2010 are still struggling to break above cost.
But Don’t Forget About the Risks
Despite all the hype, investors should not forget about the risks involved. The perceived lack of transparency, deficient corporate governance practices, the risk of political unrest, as well as less developed capital markets are still a concern. However, to attract capital African countries have been forced to tackle these issues and the situation is beginning to improve. For the time being, private equity funds with local investment teams, experience in the region and flexibility in their approach have an edge over their competitors.
Only Suitable for Selected Investors
While Africa is likely to continue to post strong grow rates in the medium and long term, the continent’s private equity activities are still at an early stage. As Africa’s businesses are less mature and public markets less developed, private equity is a good – and sometimes the only – way to tap into Africa’s (growth) potential. Such investments are, however, very risky. Private equity in Africa is mainly suitable for experienced investors with an existing private equity portfolio. Even in these particular cases, African private equity should be a complementary rather than core part of these private equity portfolios.
Source – «Credit Suisse»

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