Africa Private Equity Insider: A Bubble? Far From it

Written by Anna B. Wroblewska

A recent report by the Overseas Development Institute focuses on the rapid rise of private equity financing in Africa, “with a five-fold growth rate and inflows of more than $50 billion since 2008.” Annual private equity inflows have reached $12 billion. The report’s author goes on to lament the “capital overhang” in the market due to a lack of suitable investment targets and the low economies of scale offered by the “build, not buy” strategy that many African private equity investors have adopted.

So what to make of the news? The Wall Street Journal’s takeaway was that Africa is at risk of a bubble in the space, but in reality the private equity marketplace is far more nuanced than either the report or the broader media might have one believe.

In fact, one of the biggest risks most Africa-focused investors face is the ability to make any investments at all.

The nature of African private equity

“I think there could be some capital overhang, but only in the large cap buy-out space,” Emile Du Toit, head of infrastructure investments with Harith General Partners, told Du Toit said that certain features of the private equity marketplace lead many investors to name-brand Pan-African funds, which tend to pursue only the traditional large buy-out deals that private equity is known for.

While these deals have thus attracted more attention in recent years, Du Toit said, “I do think even in that space fundamentals are still being kept true on.”

But buyouts are only one slice of the African private equity market, and funds looking to diversify into Africa have more to worry about than the potential pricing risks posed by their competition.

“You always have competition,” Romain Py, executive head of transactions with African Infrastructure Investment Managers, told AFKInsider. “Because of the slowdown in Europe and the US people are looking for an alternative region to deploy their capital.”

For Py, an infrastructure investor, there are more investors on the block, but the threat posed by the additional capital and presence in the marketplace remains low. That’s because the ability to actually close deals — and to do so economically — remains elusive for most new entrants to the African marketplace.

“Are they credible? I don’t know,” he said. It’s a sentiment echoed by a recent Foreign Policy piece which explores the myth of the so-called “African Land Grab” by foreign investors. In short, the author found that the commotion surrounding various land deals in Africa often gave way to something resembling ennui.

Another aspect that the ODI report overlooks is the chronic shortage of capital when it comes to other areas of the private equity marketplace, such as infrastructure. Du Toit points to World Bank statistics which suggest that demand for infrastructure in Africa is on the order of about $90 billion annually — dwarfing the entirety of the African private equity marketplace entirely.

Interested investors might do well to take notice. Du Toit echoes sees infrastructure as complementary to the traditional private equity buyout space and the rising focus of growth capital on the continent. “There is some cross-element of benefit for large investors into Africa, since the macroeconomic performance in countries where the large buy-out deals get done are very reliant on an improvement of the infrastructure required to do business more efficiently.”

While the space has attracted generalists, Du Toit also remains skeptical of new entrants. “The risks in infrastructure are substantially different than other areas of the private equity market, and hence require an absolute specialization and expertise in this field.

“We think the emergence of some general private equity players into some of the sectors we typically cover may not play out so well given their lack of experience with project financing for these deals.”

In other words, the risks of capital flooding into Africa may look quite a lot different on the ground than even the ODI could imagine.

Specialization and local knowledge required

For funds that have to learn the basics of African investment from the word go, diversifying into Africa may indeed be a costly experiment. But this doesn’t make the continent uneconomic, even in the growth capital space, which targets smaller firms with lower investments and a more active role in firm development.

Most companies needing financing, says Py, are smaller and family-owned. “What they need is a partner to help them either to expand to become bigger in the region or become pan-African, or they’re looking for certain expertise. But people will come in through minority stakes.” He points how parched African capital markets tend to be, especially in comparison to markets like Europe or the US.

As a result, deals tend to be smaller and more personal. “They’re more relationship-driven,” he said. “People want you because you’ve got a skill set, or your going to help them. So yes, there is small competition — some of it is driving prices, but not necessarily.”

While the extra legwork might seem overly cost-intensive for large pan-African funds trying to get the most value out of each investment dollar– after all, as Du Toit points out, “The cost of managing a true Pan-African fund is extremely expensive due to travel, differing legal systems… essentially covering 54 countries,” — it remains a viable strategy for local funds specializing in local deals.

It’s a sentiment that can apply to growth capital as easily as infrastructure.

Ether way, Py is unfazed. “Sure we see more people. Most of them do not have a presence in Africa; most of them have never done a deal in Africa. I think it’s going to be a tough learning [experience].”

He said, “You will see people come and go.” The specialists, one imagines, will remain.

Anna is the founder and principal of Augury Consulting, a communications consultancy which helps asset managers deliver their message to investors and the public with clarity, impact, and authenticity. She regularly contributes to the financial press under her own byline.