Established African firms and new entrants, small and large, are raising a substantial amount of capital for private investments in Africa. Now global private equity players are looking to allocate to Africa. Many private equity fund buyers have increased their own direct investment programs, especially development finance institutions and dedicated African funds of funds.
Africa’s private equity story is really just beginning, however. One of the world’s largest private equity firms recently declared, “We’re not even in Chapter 1 of private equity in Africa. It’s more like a prelude. We hope that all the major firms will be there in five to ten years.”
In many cases they are all looking at the same small number of available deals. There is no doubt that the large end of the African private equity market is overcrowded. The small number of deals, combined with extra interest from international — especially, but not only, South African — corporate buyers, causes a squeeze in valuations. Yet the overall picture is still one of an undeveloped asset class in a huge opportunity set, which is particularly noticeable when moving down the deal size spectrum and into the smaller markets. That is the sweet spot for private equity on the continent, something recently highlighted by the International Finance Corp., which also warned against “the risks of markets being flooded, driving up entry pricing.”
By definition, at least given the current opportunity set, global firms’ sheer size can lead to crowding in large deals. Deals that large firms take on should be big enough to move the needle. There are other implications, however. You cannot do Africa remotely, so more and more local offices are likely to appear. Local talent, bolstered by a significant returning diaspora, will be valued more highly, and the market will become more international. The effect will be significant in terms of the capital deployed, the development of regional finance hubs, the required returns and the standards that these large firms will demand.
In a few years the pipeline of initial public offerings (IPOs) will be of increasing importance, resulting in both challenges and opportunities for local stock exchanges. But this will be accompanied by the ongoing growth of African domestic investment, especially from its nascent sovereign funds, which are already using international consultants to assess African private equity opportunities. Local pension fund demand also looks set to grow, and savings and pension reform has been very significant in some places. This is especially the case with Regulation 28 in South Africa, which increases offshore limits for pension funds from 20 percent to 25 percent and allows an additional 5 percent in African markets outside South Africa. Meaningful pension developments can be found north of the Limpopo River as well. Gradually, Africa will also become a more mainstream destination for international investors, helped in no small part by the larger global private equity firms driving the market.
This new phase for private equity in Africa will also mean increased specialization, focus and diversification into other private asset classes. This is indicative of greater sophistication of the private markets landscape. Although generalist funds are still the mainstay, platform and country or region-focused funds are also proliferating. Perhaps one of the most significant developments in Africa on this front is private credit.
New York–headquartered consulting firm McKinsey & Co. estimated in a February 2014 study that Africa-wide demand for capital should increase by 8 percent a year through 2018. Angola is on pace to see 20 percent growth over the next decade, and ten African countries, Angola included, collectively could see investment reach $50 billion ??over the same period. The study also pointed out that significant mismatches exist between capital supply and demand, across sectors and across market sizes. According to McKinsey, the most extreme mismatches are in real estate, infrastructure and small- and midcap funds.
The amount of capital raised by African private equity funds rose 43 percent in 2013, according to Ernst & Young, to $3.3 billion — still not a big number. This year some $4.5 billion is being raised. Emerging markets as a whole experienced a 7 percent decline, to $24 billion. India’s fundraising dropped below Africa’s last year, and India has about eight times as many private equity teams for a market with roughly the same population. Keep in mind that the fundraising numbers are still significantly below the $5 billion raised in 2007 and skewed by funds such as the high-profile tranche Ethos VI. It is valid to say that there is simply not enough capital going in, given the opportunity.
In addition to sparking IPOs as funds enter their harvesting phases, private equity can have a more profound effect on the growth of Africa’s markets. In contrast to other parts of the world, the focus there is on growth capital, with limited leverage and limited management change being features of African private equity.
From a generalist investor’s perspective, there are of course good reasons to have exposure across the liquidity spectrum and capital structure of Africa’s markets, being mindful of volatility and the need for market timing. But the case for private equity in this complex and vast opportunity, where investors can deploy relatively large amounts of capital and access sectors and markets often unrepresented in Africa’s stock exchanges, is a compelling one.
Nick Tims is managing director of the U.K. institutional client group, and Francois van der Spuy is head of private market investments in the frontier and emerging-markets equities team, both at Investec Asset Management in London.