Structural and Regulatory Changes Underpin the Continent’s Economic Recovery

The Russian/Ukrainian war and its related global impact may have a mixed effect on the economic recovery in Africa, which is being driven by worldwide economic trends such as elevated commodity prices, a relaxation of lockdowns, and increased global trade. With further increases in commodity prices having a positive impact, increased inflation and further possible roll-backs in globalisation weigh on the recovery.

Even during this difficult time, several positive structural and regulatory changes on the continent are nurturing the green shoots of economic recovery. These include the continued development of the African Continental Free Trade Area (AfCFTA), as well as the unification of exchange rates in Sudan, fuel subsidy reform in Nigeria, and the opening of investment into the telecommunications sector to the private sector in Ethiopia. Although some of these reforms are threatened in the short-term by significant political pressure resulting from inflation, long-term benefits will remain.

With high economic growth and significant tailwinds for long-term investment, balancing against elevated medium-term risk, global investment firm RisCura’s new research Bright Africa Private Equity 2021 suggests a lasting, long-term upward growth trend in private equity (PE) investment on the continent over the last decade is likely to continue. Figures also indicate a normalisation of pricing in the current year, partially due to the slow pace of commitments during the pandemic period.

While PE investment growth has resulted in temporary mismatches in the supply and demand of capital, Heleen Goussard, head of alternative investment services at RisCura, says there has been a shift in the market resulting in more attractive prices for assets.

“Despite heightened medium-term risk outlook, this speaks favourably to future returns, with investors entering the PE market at equilibrated prices, allowing them to earn appropriate market-related returns over the investment period.”

To gauge supply levels, the new research analyses fundraising and dry powder levels for PE funds — reflecting the capital raised by investment funds — as well as deal-making activity, which provides indirect evidence of all capital available in the markets and supply of investable assets. This analysis has revealed some interesting changes.

Lumpy nature of fundraising contributes to market mismatches

Before the remarkable contraction in 2020 and 2021, PE fundraising activity across Africa grew consistently between 2016 and 2019, with total 2019 PE fundraising value reaching USD3.88 bn, the second-highest year of fundraising since 2010.

These fundraising highs were the result of a handful of large funds achieving their final closes in those years and it is this lumpy nature of fundraising in the market that further contributes to the dramatic contraction in fundraising levels. However, the sharp decrease experienced in fundraising is expected to gradually recover in the short- to -medium-term, along with the post-Covid-19 economic recovery and the growth in the industry will decrease the impact of the lumpy nature of fundraising.

Another factor that has contributed to the lumpy nature of fundraising, has been the large proportion of Infrastructure themed funds that were raised in the last five years. With several large Infrastructure funds being close to reaching fundraising targets, this trend is likely to continue. The attractive historic risk and return profile of Infrastructure investments, have made these investments increasingly attractive. Institutional investors across the continent are exploring this investment opportunity, and thus we expect the demand for investment funds will continue to grow.

This Infrastructure investments do not only offer investors attractive returns in their own right, but the flow-through effect this investment may have bodes well for investment returns in other sectors as well.

Another growing trend is the number of private credit funds that are raising capital. Private Credit’s self-liquidating nature and limited competition from other capital suppliers in the market have attracted attention from local and international investors.

Dry Powder reduction stabilises pricing

Using fundraising data and the average deployment period, the research estimates the African PE industry’s dry powder – the amount of committed but unallocated capital firms have on hand – to have averaged around USD8.51 billion until 2018, reaching recent highs of USD9.56 bn in 2019.

As with fundraising, dry powder levels declined to about USD6.5 bn by June last year. The recent decline was due to investment funds continuing to draw on committed capital – to invest in new businesses and support existing investments through the pandemic – without the corresponding flow of commitments from Limited Partners (third party investors of PE funds) through fundraising.

The committed capital model, however, can only delay the efficiency of markets. Prolonged decreases in fundraising and risk outlook are filtering through to pricing but there is hope for a recovery as the post-pandemic economic slowdown improves.

“In the interim, firms are grappling with how to deploy funds and manage the impact on returns. This reduction in dry powder should however contribute significantly to stabilising private equity pricing going forward” Goussard adds.

Deal-Making Activity on the Rise, but at Lower Values

In 2021, notwithstanding the dramatic drop in funding, and the change of risk and growth outlook, research data shows that deal activity in Africa reached new highs, albeit at lower transaction values.

Total PE transaction activity increased steadily by 20% from June 2018 to June 2019, tapering to 9% in the following year. It then rebounded strongly between June 2020 and 2021, resulting in a 19% increase. The average transaction value between 2016 and 2019 was USD 40.44m, shrinking to USD 11.1m in the 12 months that followed. Activity in on-line retail and information technology sectors has been high, which is reflective of international trends.

This trend is currently mirrored in Africa’s Venture Capital industry, an important source of supply of investments to the continent’s private equity industry. The exponential increase in activity in the last five years will, over time, improve the supply of investable companies in Africa and help diversify economies.

“Despite erratic fundraising and volatile risk and growth conditions, exemplified by current global geo-political events, long-term market trends in African private equity have remained constant,” says Goussard. “Our research shows that the significant amount of committed capital has had a stabilising effect on pricing, which survived short-term changes in funding levels and risk profile.”

However, Goussard says that the committed capital model can only delay the efficiency of markets. “Decreases in fundraising and risk outlook have filtered through to pricing currently resulting in attractive pricing for private assets.”