Private equity deals in Africa are financed with far less debt than deals concluded in developed markets. This means that returns have to come primarily from actual profit growth as opposed to leverage.
“On average in Africa, only a third of unlisted investment capital comes from debt, whereas in the developed world it’s around two thirds,” says Rory Ord, Head of RisCura Fundamentals, Africa’s leading provider of independent valuation services.
The main reason for this is the small size of banks outside South Africa, many of which are conservative in their lending practices and lack sufficient capital to participate in major deals. In addition, African banks tend to make excellent returns at low risk from lending to their governments, so their appetite for riskier investments like private equity (PE) has been somewhat blunted. “The fiscal situation in a country like Nigeria, for example, is excellent. With so much money flowing in from oil revenues, the government’s balance sheet is very healthy, much more so than in developed markets.
Typically, the use of debt in PE deals allows investors to leverage their investment and enhance their returns, as debt funding is cheaper than equity. But if you’re only using a small amount of debt, you can’t rely on leverage for returns. The upside of this situation, however, is that investors avoid the additional risk that leverage brings; interest payments still need to be made even if things don’t go according to plan.
“If you’re an investor in Africa, you’re not going to get the return from the leverage that you would if you were investing in private equity in other countries. You have to rely on real growth in earnings to drive the increase in a company’s value when you finally sell.”
This means that private equity practitioners in Africa need somewhat different skills. In developed markets, the focus is towards financial engineering skills such as gearing, structuring debt packages, and optimising the capital structure of the deal. In Africa, on the other hand, PE practitioners need to be good businessmen who get involved in the companies they invest in, assisting strategically, operationally and financially.
“In developed markets, investors are trying to get the most out of the existing asset whereas in Africa they’re trying to grow the asset to create something bigger and more valuable. Interestingly, African PE deals are by and large able to achieve strong returns even without the leverage used in the full PE model that exists in other parts of the world.”
The message to investors, says Ord, is to engage with a private equity fund manager with an experienced team on the ground who understands the risk and financial environment in different parts of Africa. It’s essential to know the local commercial landscape and how to operate in it profitably.
RisCura Fundamentals publishes the annual Bright Africa report, which deals with equity investing across the continent. The Report can be accessed online here.
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