State of Private Equity in Africa: Great Potential, Too Little deals

Economic development in Africa has traditionally been at the province of resource-based economy, foreign-aid agencies, local and international, and publicly funded multilateral finance institutions and recently, portfolio investment to boost cash flow in the economy.

But over the last decade, the narrative changed, there was huge direct investment in Africa and was growing and full of potential, until last year, it all changed, due to a weak economy and falling currencies.

Experts believe the growing fund market in Africa is too strong to remain stagnant. The desire by fund managers to diversify their portfolios and to look for exciting opportunities outside the developed and matured market of Western Europe and North America, will drive Africa revival.

For Olufemi Babarinde, associate professor of economics of global business at Thunderbird School of Global Management, the vast swaths of the continent with regards to much needed infrastructure makes the African market quite attractive. “As long as Africa remains underdeveloped, there will always be need for capital for development, which means that the demand for private equity capital in Africa is full of potentials.”

However, despite the continent being loaded with business opportunities for these firms, and the symbiotic development role it can play for the continent, experts argue that Africa private equity investment is relatively small.

According to the African Private Equity and Venture Capital Association (AVCA), 928 private equity deals, with a value of US$22.7bn, were completed in the period from 2010 until the end of the first half of 2016, compared to European private equity activity of $349 billion deployed across 1,989 transactions in just 2016 3rd quota alone and Asia Deal value spiked to $125 billion in 2016 alone.

The staggering disparity between the continent’s private equity deals, a report by the Boston Consulting Group (BCG), titled Why Africa Remains Ripe for Private Equity, shows that Africa remains one of the world’s growth opportunities for private equity investors to generate the high returns that investors expect.

However, the report said that most private equity funds and principal investors tend to invest only in minority stakes, with the goal of better managing their risks by leveraging robust local partners. Also, they overwhelmingly focus on a limited pool of investment targets: profitable companies with annual revenue of more than $100 million and proven track records. The reports also show that too many private equity investors are pursuing the same kind of target with the same kind of deal structure.

The Promise and the Challenges of 2017

Established African firms and new entrants, small and large, are raising a substantial amount of capital for private  investments in Africa. Now global private equity players are looking to relocate to Africa. Many private equity fund buyers have increased their direct investment programs, especially development finance institutions and dedicated African funds.

But the amount of private equity and principal investment capital under management in sub-Saharan Africa remains very low when relatively compared to world standards — a mere 0.1% of GDP that compares with approximately 1% of GDP in western countries.

Financial expert, Kunle Badamosi argues that PE industry in Africa is growing, with the potential to bring about rapid development in the continent no doubt. But to keep fund managers and investors interested in the continent’s PE market and surmount its inherent challenges, African governments must adopt investor-friendly and business-friendly policies, and help change the perceived weak exits environment as barriers to investing in Africa.

“For Africa to fully maximize the opportunities in Africa and earn high returns, Governments must work closely with private equity stakeholders and proffer ways to adapt to the rapidly evolving market and consider more flexible investment strategies.”

“In many cases they are all looking at the same small number of available deals. There is no doubt that the large end of the African private equity market is overcrowded. The small number of deals, combined with extra interest from international firms, especially, but not only, South African, corporate buyers, cause a squeeze in valuation, something recently highlighted by the International Finance Corps report warning the risks of markets being flooded, driving up entry pricing”

Nevertheless a US consulting firm McKinsey & Co. estimated that Africa-wide demand for capital will increase by 8 percent this year through 2018. Angola is on pace to see 20 percent growth over the next decade, and ten African countries, Angola included, collectively could see investment reach $50 billion next year and $100 billion in three years.

Optimism reigns about Africa, despite the challenges that remain, most expect the volume of private equity deals on the continent will increase.