By KENNETH BARRY and PREETI NANA
Private equity in Africa has come a long way since the early 1990s, which saw development financial institutions investing in government-initiated development projects across the continent.
The period that followed was characterised by the emergence of a limited number of South African focused private equity funds, which over the next decade started to invest more widely across the continent.
By 1997, there were twelve private equity funds that had collectively raised US$1 billion to invest in Africa.
As we fast forward to 2019, the African private equity ecosystem has significantly matured with over 1022 African private equity deals, with a total value of US$25 billion, being reported between 2013 and 2018, including the first billion dollar sub-Saharan African funds, Helios Investors III and Equatorial Guinea Co-Investment Fund.
In terms of sector focus, information technology (19%), consumer discretionary (15%), and consumer staples (13%) accounted for almost half of the total number of private equity deals in 2018, while communication services (which includes deals in telecommunication services) was the largest sector by value.
Information technology’s share of private equity deal volume has grown significantly in recent years, accounting for 19% of private equity deals in 2018 (compared to only 10% in 2016).
With the new narrative of ‘Africa Rising’ that pervaded the media from 2000 and in the aftermath of the 2008 economic crisis, private equity funds increasingly turned to emerging markets for levels of growth that were unattainable elsewhere.
Although certain countries on the continent have experienced headwinds in recent years (in particular, in 2016 when growth came to a halt in South Africa and Nigeria entered a recession, the two economies being the largest in Africa and accounting for the vast majority of private equity activity in the region), one thing we can be certain of is that African private equity has significantly evolved over time.
Many features typically reserved for private equity transactions in Europe and North America are becoming increasingly prevalent in African private equity.
Stronger exit opportunities exist
In the past, a key concern for private equity funds and their Limited Partners regarding African private equity investments was the quality and availability of exit routes. Illiquid domestic exchanges and political and foreign exchange risk have historically contributed to a limited number of exit paths.
However, with the maturation of the African private equity market, the number and scope of exit opportunities have notably improved with the African Private Equity & Venture Capital Association (AVCA) reporting a record number of private equity firms in Africa exiting in 2017 and 2018 (52 and 46 respectively).
- Trade sales dominate exits
Trade sales to strategic investors continue to be a common exit route, constituting over 39% of exits in 2018. This is expected to continue to be the case in the next twelve months.
A notable feature of the evolving market, is the increased prevalence of auction sales, such as the sale of Brandcorp in June 2016 by Ethos Private Equity to The Bidvest Group.
Given the increased competition for quality African assets in recent years, it is likely that auction processes will become increasingly common.
- Secondary transactions
After trade sales, secondary buyouts (sales to other private equity funds and financial buyers), such as the sale by LeapFrog Investments of its stake in Ghana-based pension trustee Petra Trust to pan-African investment firm African Capital Alliance in 2018, account for the next largest proportion of exits, at 37% of deals surveyed in 2018.
With strong fundraising by domestic, international Africa-focussed and global funds, we expect that secondary buyouts will continue to be a growing feature in the African private equity market.
As the quality of assets and deal sizes gradually increase over time, we would also expect to see more sophisticated secondary transaction structures, such as ‘portfolio’ deals that package up several assets together to be sold to another fund, or deals which involve the breaking up of larger investments into smaller divisions for sale.
- Initial public offerings (IPOs)
Although public listings remain one of the most attractive exit routes in the global private equity industry, the converse has historically been true in African private equity.
Fragmented regulation, political uncertainty, underdeveloped capital markets and low levels of market capitalisation compared to the developed world, result in low usage of IPOs as a private equity exit route – only 3% of all 98 private equity exits in Africa during 2017 – 2018 took place through IPOs.
Despite the aforegoing, Vivo Energy’s IPO on the Premium Segment of the London Stock Exchange in 2018, with a secondary inward listing on the Johannesburg Stock Exchange, and the launch by Jumia (the largest e-commerce operator in Africa) of its IPO on the New York Stock Exchange in 2019 indicate that viable IPO options do exist.
A number of initiatives have been introduced to improve the attractiveness of IPO markets, including:
(i) the East Africa Community stock markets integration project,
(ii) the introduction of the Growth Enterprise Market Segment by the Nairobi Securities Exchange; and
(iii) new mechanisms to trade and settle ordinary shares of London listed or dual-listed Nigerian companies.
As such initiatives come to fruition, we expect that exit options on a limited number of exchanges will become more viable.
Increasingly sophisticated features and capital structures
- Equity and debt instruments
The illiquidity of domestic capital markets, as described above, presents challenges for companies seeking funding. The small size and conservative nature of many African banks has resulted in African private equity deals being significantly less leveraged than equivalent deals in the developed world.
Accordingly, the primary source of funding in African private equity has historically been equity finance with a simple capital structure.
As the market matures and aims to close the funding gap, mezzanine debt is becoming a key component in the capital structures of African companies, and there are a number of dominant South African funds in the mezzanine debt market.
While specific forms of ‘mezzanine debt’ in a European context are generally clearly defined, in African countries it refers more broadly to subordinated debt or unsecured senior debt.
A number of private equity funds have raised credit funds specifically targeting these types of investments in Africa. Going forward, we expect to see an increasing number of such funds being established.
The challenges posed by the African financing market and the increased complexity of companies’ investment needs, means that we also expect to see an increase in the use of tiered capital structures, with a broader range of share classes and debt instruments, including convertible instruments, loan notes, warrants, high yield instruments, and payment in kind notes.
- Warranty and indemnity insurance
Private equity has been a driving force in the increased use of warranty and indemnity (“W&I”) insurance on global M&A transactions, particularly on the buy-side. Such policies are beneficial for buyers with limited recourse against sellers who have poor covenant strength. It also allows private equity and institutional sellers to achieve a clean break and distribute proceeds to their Limited Partners.
Historically, insurers’ have been wary of emerging markets, however, AIG reports that this is a growing area. Before offering W&I insurance, insurers assess the legal, political and regulatory risks in the relevant jurisdiction, and reflect the level of risk through pricing and exclusions.
We expect that the trend to take out W&I insurance, and the increased appetite to underwrite W&I policies on African private equity transactions, will continue.
Despite some recent headwinds in certain African regions and sectors, the outlook for private equity investments in the continent is undeniably positive.
According to a 2018 AVCA report, 53% of limited partners interviewed indicated that they plan to increase their allocation to private equity in Africa over the next three years, with limited partners, overall, indicating their belief in the long-term attractiveness of Africa; especially, when compared with developed markets.
KENNETH BARRY is a Partner and PREETI NANA is an Associate at White & Case LLP, London, UK.