Business Intelligence

It's a trillion dollar game, played by exuberant high stakes rollers. It's decidedly schizoid: It built the colossal American in-dustrial empire by floating bonds, and geared the spectacular technology boom that funded the stampede of IT geeks into Silicon Valley. Then it spawned the sprawl of acquisitive corporate raiders who stripped dozens of high profile companies to the bone. It has no social or economic agenda. It is unapologetically unpatriotic. Now it’s restless, on the prowl again to feed its insatiable appetite for more high-yield returns.

More than two decades after a high-powered coterie of white-collared stock market wizards declared Wall Street the only money market in town, buyouts, takeovers, and activist investing are all the rage again. I

t’s the new name of the investment game — an intrepid class of private equity bargain hunters who have grown cash flush in the great American property bubble. Now it’s flowing to a place it has never been before. Africa.

It’s still a trickle in global terms — a mere 3 percent of the FDI funding faucet. But the fact of a sudden wave of investment on the tide of opportunistic private equity funds is simply spectacular. Sub-Saharan Africa’s FDI inflows grew from a speck on the global funding landscape in the 1990s to $17bn in 2005 and a staggering $31bn last year, according to a 2006 United Nations World Investment Report. That figure has gotten a lot more bloated by the day with South Africa the leading recipient of about 21 percent of the sub-region’s total inflows, mainly as a result of the acquisition of Absa bank by Barclays Bank two years ago.

Continentally, Egypt was the second largest recipient, followed by Nigeria, Algeria, Chad, Equatorial Guinea and Sudan — collectively representing about 48 percent of cash inflows to the region, mainly in greenfields and early-stage investments from fund managers in the US and Europe.

So no, you don’t have to worry about waking up to find that a huge stake in your mid-sized, or even large, company has been snapped up by private equity or buyout funds. And you probably don’t have to worry about waking up to a thrifty bunch of turnaround strategists out to deploy exotic financial instruments and blow a hole in your comfort zone.
Not yet anyway.

For now Africa is a predominantly greenfields investments, says Panos Voutyritsas, vice president at private equity firm Kingdom Zephyr Africa Management Co.

“With the exception of South Africa and several larger north African economies, the reality is that the sub-Saharan region is much less commoditised than the developed markets in the world, where it’s mostly a matter of price in the buyout game in high profile companies,” he says.

Indeed, it is no exaggeration that Africa is pumping with a deluge of new growth opportunities and local entrepreneurs. So from a capital investment perspective, it’s mostly a matter of spotting a greenfields opportunity, then going for it.

Several key factors are at work, says Botswana-based financial services analyst, Mark Tunmer. First, while Africa still garners its share of bad press — Zimbabwe, Sudan, Nigeria, Somalia and the DRC are seeing to that — it’s attracting more money in and also drawing more talented equity fund managers to the game. At least four private equity managers have recently launched African funds or are preparing to get in on the action. In the past year alone the amount of institutional money raised for buyouts, minority investments and growth financing in existing companies and greenfields investments has been phenomenal. Kingdom Zephyr allocated an initial $122,5mn fund for the continent in December 2004, 70 percent of which has been invested in at least four growth initiatives. There’s still 30 percent of the fund to deploy by the year-end and a second $400mn African equity fund to be raised in due course.

CDC Group, the UK government-backed private equity fund, early this year committed $100mn to Citigroup’s first ever dedicated African private equity fund; Brait is reportedly ramping up sizeable new funds for buyouts in South Africa; EMP has raised $0.5bn for the continent; various Arab interests have been eyeing the continent with war chests of cash; and the word is South African government-backed investor, PIC, is raising $3bn for infrastructure projects that will be ploughed into the continent in the next few years.

Then there’s growing interest in speculative investments from fund managers abroad, mostly in minerals and resources opportunities in Africa, as well as sovereign contingencies. As returns in stocks flagged over the past half-decade in the US, money flooded into alternative assets: hedge funds and buyout funds. High-profile success stories sucked more liquidity in and also drew more talented money managers to the game, and that grew even more capital. Today both hedge funds and buyout funds are by almost every measure as big and powerful as they’ve ever been — and climbing. It is estimated that there are 8000 hedge funds in the US which attracted a combined $27,4bn last year. That brings the industry’s assets to a stupendous $1 trillion, according to Hedge Fund, a US firm that studies the sector. As for buyouts, the average announced buyout fund had almost $750mn in 2005. There are now ten funds larger than $5bn, according to US research firm Venture Economics.

They’re all not scrambling to throw munificent largesse of money at the continent just yet, but there’s certainly a renaissance under way that’s starting to irrevocably shape the future corporate landscape in Africa. “The marketing prospectuses for Africa as a whole are bright,” says Voutyritsas. “Once a critical mass of private equity players enter the African space it’s a one-way road to development. The continent is buoyant and this is jackpot time for private equity players.” The billion-dollar question is this: why the sudden interest in a continent whose development prospects have consistently dipped below the radar in successive annual investment ratings by free-market advocacy groups like the Washington-based Heritage Foundation? I’m contemplating that question with Voutyritsas at Kingdom Zephyr’s lavish Johannesburg offices. The firm’s own history in the continent is a case for guarded optimism, he says. Back in 1994 when South Africa held its first democratic elections, US asset management firm Zephyr got in on the action with Brait’s First Fund. By the end of the 1990s, a well-known Saudi prince — as it turns out, the wealthiest Arab and financial investor notable for wild and pioneering investments that command huge returns — was prowling the continent with a basket of disparate investments that did reasonably well. The two hooked up and Kingdom Zephyr was born.

“It was in those early days when perceptions of the continent were more negative than ever that we had a presence in Africa,” argues Voutyritsas. Meaning? “We tend to believe as a company collectively, and as investment professionals individually, that perception is often different from reality, and the African perception has been negative for many years. Some of us believed that the reality on ground was a lot more promising than overall investment ratings of Africa’s investment climate had us believe. So we took the view that there were profitable opportunities for investment in the continent at a time the eyes of the world were not really on Africa.”

Yet Africa as a whole remains a defiantly testing environment on all counts: the regulatory, legislative, political and, in some instances, macroeconomic condition is still relatively risky business compared with more stable and established markets. But that’s precisely why it’s so attractive, says Voutyrisas. “If we thought Africa was fully efficient, we probably wouldn’t think we could generate the sort of returns we have been generating and expect to generate going forward.” So far, those returns have been exceedingly generous. When cellular operator Celtel was launched, Kingdom Zephyr ploughed $15mn in pure equity into the budding entity and then pumped an additional $5mn six months before Celtel was sold to the Kuwaitis and Zephyr pulled out.

The return on the initial investment was over 2 500 percent. Within the six month period prior to Celtel’s sale, the return on the $5mn investment was about 2,4 times the value of the equity stake. Similarly, in the firm’s Botswana investment the stock price was initially a paltry 1,60 Pula. In a period of just two years the price shot up to 10 Pula.

So why isn’t there a stampede by a slew of foreign fund managers? The thing is only a handful of more astute American and European equity fund managers have a three-to-10 year investment horizon and are well aware that bad press can be a signal that an autocracy is entering its end-phase.

In South Africa, apartheid’s ‘Total Onslaught’ period illustrates the point, says Tunmer: “Market valuations crumbled, but 15 years later substantial profits were realised by those who bought close to the bottom.”

So the apparent perversity of investment in volatile environments makes it necessary to understand the psychographics of international long-term value hunters who are not necessarily deterred by political excesses. However, private equity is generally a quick entry and exit strategy, and, to be fair to Africa, five years or more of positive change has paved the way for most of the current interest.

London researchers now cover key markets from Cairo to Cape Town, an onerous and costly exercise that could not be justified unless numerous clients were demanding service.

Numerous African economic jurisdictions have carried out sweeping reforms and engaged in highly successful, sometimes seamless, privatisation programmes. Others, like Nigeria and Ghana in west Africa, have prompted investor interest by implementing significant financial sector reforms and, in the case of Nigeria, comprehensive change in the pension-fund industry.

Analysis of leading blue-chip companies can be just as positive. Take cash flow, for instance. The Nigerian division of MTN is projected this year to pay to the cellphone operator dividends in the region of $800mn.

Sector analysis also alerts potential investors to opportunities. Once again in Nigeria, banking reform is expected to reinvigorate the financial services industry in a nation where less than 1 percent of a population of 150 million has a bank account.

The second factor that focuses attention most forcibly on African markets is the surge of excess liquidity internationally in the face of low returns in developed countries like the US on the one side, and the incidence of so many equity bargains in Africa on the other. Tunmer reckons the current return on US treasury bonds, for example, is only 4,75 percent. That combined with rising interest rates and hiccups in esoteric bond producers and junk-bond financing, never mind fierce competition for investments, have driven down returns and caused some flameouts in the US. In economic theory, this is a natural market correction. As those ravenous buyout and hedge funds have grown, they inevitably began to eat out of the same bowl. In short: too much money is chasing too few viable deals in large economies like the US.

Unsurprisingly, an increasing amount of money now chases a better return elsewhere.

On average, developed markets are efficient, and whether you believe in efficient market theory or not, it’s common sense that when so many people follow what happens in a particular market, things will more or less be evenly priced — the enigmatic and ever elusive ‘equilibrium price’ where supply and demand curves meet. That’s not quite what’s happened in the US yet, but it’s bound to happen in a saturated market when surplus capital swims offshore.

“That excess liquidity has been the primary driver towards funding new pockets, new niches, of investments that we’ve been seeing in Africa,” says Voutyritsas.

But why Africa? “There’s simply an insatiable appetite for returns,” is Voutyritsas’s stock response. “If you look at emerging markets historically you’ll see that money started flowing into south-east Asia, more recently Russia and Brazil. So if you exclude the developed parts of the world, what was left was Africa.”

Yet, easy bargains are not always apparent to peripatetic bargain hunters in London and New York. The point is most dramatically demonstrated in some African markets — Egypt in 2005 and Kenya in 2006/07 — that have witnessed significant re-ratings, making it more difficult for the non-specialist to find obvious bargains.

In many other jurisdictions, share valuations suggest a substantial mismatch between stock market prices and long-term commercial realities. Take Delta Corp, the brewer and bottler of beers, malts and carbonated and non-carbonated soft drinks in Zimbabwe, which has a market capitalisation of only $300mn. Circle Cement (a subsidiary of the Lafarge multinational) has a market cap of just $35,5mn. Dawn, the listed entity housing Zimbabwe’s most prestigious hotel and tourist lodge properties, is capitalised at about $28mn — yet these days it costs about $50mn to build just one large luxury hotel.

Sound incongruous, even absurd, to you? “Fire-sale prices like this may make some Zimbabweans weep, but they definitely ignite international investor interest,” says Tunmer.

No wonder there are whispers that the clout is due to be wielded not so much by the big players like the Goldmans and Merrills and Morgans in the US, as by private buyout funds and growth investors willing to dig deep into the continent, like Kingdom Zephyr.

That’s not to suggest that the great private equity stampede by sizeable foreign fund managers is not on its way. Right now most African markets, with the exception of South Africa, are not mature enough for the buyout game where exuberant US funds would only move on mid-cap and large chip companies, by African standards, with market values over $10bn.

Still, even with those hints of new supply, the demand side of the business has become so globally competitive that the hunger for a piece of the action may catalyst a foreign equity surge sooner than later.

The buyout game is already hotting up in South Africa where mergers and acquisition (M&A) activity is at an unprecedented high, according a Ernest & Young country review of the 2006 financial year. And, in a sense, it’s already a global game played by global players.

An example is media group Naspers, for which the Citigroup investment bank facilitated a number of M&A cross-border trades in Russia and Brazil, but also raised R1bn of debt finance.

Citigroup together with JPMorgan also ran a $500mn high-yield debt element in the widely publicised ZAR16,6bn mega buyout of glass packaging group Consol. High-yield debt is the new, respectable name for junk bonds in South Africa. Very simply, the yield on the debt is enhanced to compensate for the higher risks investors take compared with the lower risk of investing in investment-grade bonds, explains Citigroup investment banking head Nick Pagden.

So, suddenly, private equity firms which have been a major driver of M&A activity in Europe, the US and Australia have turned to South Africa whose risk profile as an emerging market has changed — but whose asset value has lagged the improvement in market sentiment. And they’re buyouts in the main, says Deutsche Bank CE Herman Bosman. “It is not easy to be a listed company in South Africa — and this has made company executives believe there is a better risk-reward ratio in the unlisted arena.”

It seems, almost out of fear of equity buyouts, they’re re-rating with a view to raising the market price and inhibiting corporate takeovers. But leveraged buyouts are not the game equity players are after in Africa. Decent sized companies by global standards are still in embryo and, with the exception of the Kenyan and Nigerian bourses, there are too few large enough stock exchanges on which to list or de-list from for that matter.

Says Voutyritsas, “Because buyouts are such a phenomenon in South Africa you tend to see listings and delistings and then relistings and then a general recycling of companies all over again. In Africa you don’t see delistings. So the natural exit route for any private equity buyer is either a sale to a trade partner or a listing. What I think you will see in Africa is the concurrent development of the stock market and the private equity market. I can tell you that at least two of our local listings in African stock markets constitute very viable alternatives for the future, so they will start feeding off each other in the future.”

What the rate of equity buyouts does indicate is the presence of foreign equity players in Africa and the very real potential for buyouts on a far greater scale.

This is not all bad news, as the very utterance of equity buyouts intuitively intones. The criticism against private equity by those at the top of the food chain goes something like this: you are taking over a company, you are piling it up with debt, you are curtailing capital expenditure and therefore you are inhibiting its growth.

Are these fears well-founded, or is there a counterpoint to the argument? “You need to see things on a case by case basis,” reckons Voutyritsas. “Overall, it’s a balance between how much debt you are putting on the business and how much you curtail capital expenditure, and then how effectively you streamline it. So there’s a good argument to be made for businesses that are being run inefficiently that have divisions that are non-core that are much better off alone, where private equity guys have come in, strip off the assets and pay down some of the debt. At the end of the day they have created tremendous value because the net result is a leaner and meaner company that gets recycled and normally gets listed on the stock market again. In addition, I would say that foreign investors bring in additional skills and experience from developed markets like corporate governance and the facilitation of cross-border tie-ups.”

The challenge of course is to get local investors to understand this elementary wisdom.

“It’s really a relationship game in Africa. It may be a more expensive alternative for the local entrepreneur to tie up with you but he needs to recognise the value you will add,” he says.

Getting entrepreneurs to understand this is probably reminiscent of junior high school — the metaphor of a progression to graduation is an evolution of knowledge assimilation and maturity that comes with growth. To stretch the metaphor, at this point in time Africa’s in junior high. As opportunities emerge, relatively small investments are made in new ventures that ultimately see a graduation to mega stores in high rise shopping malls, sophisticated ICT companies, retail banking services and sprawling industrial parks. As the opportunities grow in size and scale, they garner ever-increasing attention from high stakes players in the buyout game in London and New York: the private equity players and investment banks that are selling picks and shovels to prospectors.

Right now the opportunities for private equity, other than minerals and oil which have long time horizons for returns, are in manufacturing, retail, services and ICT (mainly telephony), says Voutyritsas, “for the simple reason that services and telecoms are fundamental human needs and there was no infrastructure in Africa for that”.

Which is perhaps why manufacturing has attracted less FDI than services, according the 2006 UN World Investment Report. Most FDI was in the form of greenfields investments in services (mainly retail banking), infrastructure and oil and gas exploration — the latter due to high commodity prices and strong global demand for petroleum.

Fortunately, Kingdom Zephyr’s strategy is to stick with the continent’s natural growth curve by typically funding minority investments and growth financing in $15mn to $18mn deals.

A good example of this business model is the firm’s initial stake in Celtel. Celtel started looking at small markets at its inception because it did not have a presence in any of the major economies in Africa. The opportunity was in small markets that, when grouped together, created a very powerful proposition. Kingdom Zephyr recognised that early on and did very well out of it. That formed the basis for a successful regional investment strategy. “Normally we tend to believe that with the exception of Kenya, South Africa, Nigeria and Kenya — north African economies are larger — what you tend to see in Africa is small markets. So our investment strategy from the beginning was to try to invest in successful business concepts that have a presence in at least one market and then replicate that concept in other markets in Africa to generate critical mass,” says Voutyritsas.

As for competing with the imminent flood of foreign equity storm troopers in the buyout business, Voutyritsas shrugs. “We have nothing against it. We will gradually go there as our funds get bigger. As the investment profile changes, there’s more money to out there to work for you.”

So far Kingdom Zephyr’s been managing fairly small funds. Consider an $18mn investment — not exactly the sort of investment for a mega buyout. It could be if it’s a smaller investment that’s part of a bigger package. “But Africa has so much room for growth,” says Voutyritsas.

He concedes things will change, both on account of bigger, more mature, companies coming off age in Africa that are riper targets for buyouts, as well a lot more anticipated liquidity.

“Once the critical mass of foreign capital looks at Africa, there’s no turning back,” he says matter-of-factly.

“There’s only so much money that will be required for growth, right. I think half the story is excess liquidity and looking for returns. The other half is political tie-ups — you see China all over the continent.”

That’s another story. -Business in Africa Online