Going Against The Grain: Early Bets On A Few African Countries
An investor called me and asked, “One question for you, where would you take a risk in Africa today?”
The COVID-19 crisis has the globe in a massive selloff, creating significant dislocation in the capital markets. But what does this mean for Africa’s private markets?
Most African debt transactions will not be public bonds but rather private credit lending. In a similar fashion, private equity is a dominant player in African equity markets.
For that investor, here are the African economies to bet on in the next nine months — albeit with different investment strategies.
The Ghanaian economy is in an odd position. The country sold sub-Saharan Africa’s longest-ever Eurobond (with an average life of 40 years for the $750 million tranche), in the first week of February as part of a $3 billion offer.
Due to the oversubscription of nearly five times, pricing was reduced to 8.875 percent from the initial discussion of 9.4 percent. Less than two months later, Ghanaian corporates are feeling the pressure of public debt and equity markets as global investors punish players with local assets, especially oil and gas companies suffering under the weight of sub-$30 per barrel pricing.
The Bank of Ghana is already requesting banks and other lenders to seek approval before declaring and paying dividends on 2019 earnings to slow the exiting of capital in the midst of the COVID-19 crisis and easing of reserve rules.
West Africa’s second-largest economy will also feel greater pressure with general elections in late 2020. The country has a history of fiscal challenges in the run-up to polls, with many investors being quite cautious with their cash this cycle. However, with asset prices low, it is hard to imagine buyers sitting on the sideline.
South Africa’s troubles are well-documented — a contracting economy (recession), power outages, and low business confidence coupled with the spread of COVID-19. All these troubles help to explain the series of restructuring discussions that have consumed the construction and consumer/retail-oriented sectors in the last 12-to-18 months and are now consuming most state-owned companies. All this begs the question: why look to South Africa for an investment opportunity?
South Africa will draw the attention of many distressed investors. An enduring recession will likely lead to an investment downgrade for the country, which ostensibly will be followed by the massive outflow of investor capital and the availability of underpriced assets That reality should be juxtaposed with the great things about South Africa.
This is one of Africa’s two biggest economies — alongside Nigeria as its primary competition. It also ranks high by gross domestic product per capita with a strong consumer base and an educated labor force. The combination of cheap assets and a consumer base willing to spend is a good start when looking for upside returns. That said, any investor will have to take a view on whether the country can solve its power issues with state-owned utility Eskom and address its pocket-burning investment in South African Airways.
A lack of liquidity in the Egyptian market undercut economic gains in 2018 and 2019 as international capital remained relatively slow to re-enter the market. The devaluation of the Egyptian currency (around 48 percent), in order to access IMF financing, hit locals hard in the pocket and short-circuited investments by international parties. As one investor described it, simply imagine your portfolio company having its topline revenues devalued by 50 percent.
Over the past two years, the Egyptian economy has nevertheless been resilient and showed many signs of revival. Many observers expected the country to hit full stride in 2020 with little signs of macro tightening and an opening for private sector revival. Then the world seemingly stopped.
Egypt remains a sleeping giant in many ways. As Africa’s third-largest economy, it passes under the radar with the noise around its politics overshadowing thoughtful economic discussions. The non-political version of the economic story in the country is interest rates were trending towards a pre-devaluation level and fiscal untightening was coming. Once the country overcomes COVID-19, which will require economic tightening in the short term, Egypt should have an economic uptick, with valuations trending towards pre-currency devaluation levels.
Kenya is another big African economy that will see assets underpriced due to a global price drop. Nothing suggests the fundamentals are trending down or that the growth story is not true. The market has been ticking upward, particularly having gained speed in late 2019 with the repeal of the interest rate caps implemented in September 2016.
The Central Bank of Kenya also cut its rate by 50 basis points to 8.5 percent at the end of 2019. Prior to COVID-19, the Central Bank of Kenya likely would have cut the rate by another 100 basis points before the end of the second quarter of 2020.
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It is not clear whether this will be the same outcome in the current market environment. Lending markets will require more private participation in the short term (during COVID-19) to account for a slow local bank lending market and non-existent public debt market. Private equity capital will equally be in need with more favorable asset prices as the liquidity needs grow beyond the limited capacity of both the private and public lending markets.
Morocco – Tunisia – Ethiopia
All the capital providers with an appetite for smaller-scale lending will find opportunities across the African continent. Yet the greatest focus should be on Morocco, Tunisia and Ethiopia, where capital will be limited as local banks tighten their lending in the short term.
Furthermore, with business coming to a halt, you can expect most SMEs in these countries to turn to private equity capital to bridge their balance sheets beyond the limited private credit available from both local and global markets for such smaller economies. Growth rates in all three countries, especially Ethiopia, will look to rebound on the back of strong local consumer growth and the increased cross-border activity — trade, tourism and financial markets.
Kurt Davis Jr. is an investment banker with private equity experience focused on Africa, the Middle East, and Turkey. He earned an MBA in finance, entrepreneurship and operations from the University of Chicago and a J.D. in tax and commercial law at the University of Virginia’s School of Law. He can be reached at email@example.com.