Private equity specialist shares his thoughts on investment in Africa
Emerging markets private equity firm Actis has been active in Africa for a number of years. Peter Schmid, head of private equity at Actis, recently shared his thoughts on Africa’s investment landscape with Goldman Sachs’s Hugo Scott-Gall.
Hugo Scott-Gall: Let’s start with Africa’s consumption. Do you think Africa’s consumption curve could mimic China’s and those of the other BRICs?
Peter Schmid: Yes, I suspect Africa will follow the same upward trend. Consumption has been growing, following the rise in commodity prices. There are basically three countries that are likely to determine the success of Africa in the long-term – South Africa, Nigeria and Egypt. Arguably you could add east Africa – Kenya, Uganda, Tanzania, etc – to that list too. That’s where the big populations are and that’s where the bulk of our deals are done. And if you look at all of them, they’ve got unique advantages particularly around minerals and oil and gas.
Also, critically, those areas are stable. Most of the states in Africa which are now democracies were dictatorships in the past. I am not saying they are entirely free and fair, but it makes a huge difference. Plus, there is increasing pressure on the leadership in Africa to deliver a better life for everyone. That means more cash is trickling down and not ending up in the Swiss bank accounts of the elites. Stability and a desire for a higher quality of life are the two key factors driving consumption.
Hugo Scott-Gall: How easy is it for people to spend their wages then?
Peter Schmid: It’s quite difficult. In Africa, you are starting from a very low base of spending. People speak about $10,000 of annual income – the middle class in Africa would include those earning half of that. Also, it’s pretty much still a cash economy. The consumer base has only recently started to move towards card payments. If you think about the fact that there are 500 million mobile phones, serving 1 billion customers across the continent it’s clear mobile payments are going to become an increasingly sensible solution, and as a consequence a high growth sector. At Actis we expect payments growth to be the next transformational industry this decade, just as mobile shaped the last. With the right infrastructure it becomes easier for people to spend their money, which of course fires up the economy over time.
The current challenge – and opportunity – is actually a lack of supply of goods and services. We see Chinese, Lebanese, and in some case Indian, businesses are bringing in goods and services often at substantially higher margins on their goods than in their home countries.
Hugo Scott-Gall: How could that change? What are the constraints faced by entrepreneurs in Africa today?
Peter Schmid: Africa faces, in my view, two challenges. First, is the lack of infrastructure. South Africa has probably got the best infrastructure on the continent and is certainly more developed. If Nigeria could improve its infrastructure, and the governments are very focused on doing it, it would be a game changer. The country is already growing at around 5% to 6% per annum – although economists are predicting a dip in 2012/2013, yet you could double that growth by putting the right infrastructure in place. That also means that Africa needs to get its regulatory requirements right. Take fuel pricing for instance. Nigeria just had a fuel strike because the government is trying to regularise things and remove the subsidies so that people are prepared to put up the oil refineries and so forth.
The second constraint is a shortage of management and entrepreneurial talent. It’s one of the chief risks we face in our business. Educated, qualified, competent managers are in demand. Until we can change that it’s going to be an uphill struggle. The good news is that more and more corporates are now investing in training local staff.
Hugo Scott-Gall: On this point about human capital, do you think a reverse diaspora is happening? Is talent coming back?
Peter Schmid: Definitely. With the downturn in Europe, western Europe and the US, there’s no doubt there has been a reversing of the diaspora, but so far it’s still a trickle. Africa needs to attract entrepreneurs and multinationals into the region to set up high growth businesses. Over the short term talent in-flow can form part of the solution, but over the longer term systemic investment in education is the answer. The other challenge we see is that it is often the case that the best people in Africa tend to work in the civil service. Making the private sector every bit as attractive as public service would make a sizable difference.
Hugo Scott-Gall: You mentioned China. What do you see as the consequences of China investing so heavily in African resources and infrastructure?
Peter Schmid: One can’t be sure. Currently, Africa needs capital, the Chinese are welcome and the implications are purely positive; governments get tax revenue, employment is created and money flows in. Over the longer term we can see China securing a stronghold on mineral and resources. Meanwhile Indian businesses are building out consumer-oriented businesses with distribution networks into Africa. Over the next decade this trend will accelerate, which can only be good news for Africa.
Hugo Scott-Gall: Does that mean there is a lot of capital chasing scarce quality assets in Africa?
Peter Schmid: Yes, but that has not pushed bid prices up. Buying quality consumer businesses in Brazil, India or China, would cost you a double digit EBITDA multiple. But in Africa you can still buy or control some of these businesses for less. Competition for these assets is relatively limited. That will change.
Hugo Scott-Gall: How would you price risk for African assets? And related to that, do you think foreign investors misunderstand the level of risk in Africa?
Peter Schmid: I don’t think the risks in Africa are very different from other emerging markets. It’s true that in certain countries within Africa corruption is a challenge, but that is not the case for the whole continent. It is easier to become a market leader in Africa than in deeply competitive markets like China and India where you will have 20 competitors snapping at your heels. African assets are cheaper too, as we discussed. We’ve already spoken about the biggest fundamental risk, the talent gap and the shortage of quality managers. Ultimately, many emerging markets share similar macro drivers and it would be an over simplification to say that one region is riskier than another.
Hugo Scott-Gall: If its infrastructure improves, why couldn’t Africa become the world’s manufacturing hub, given its human resources?
Peter Schmid: Manufacturing is a stretch until the management bench strength widens and deepens (although some countries clearly have an advantage here, like Egypt). What Africa can excel at – especially central Africa – is food production. There is no reason why Africa can’t become the world’s food basket. You need world-class farming techniques and processing plants to really get things moving. But, with a serious ramp up and investment of capital agriculture has huge scope to succeed.
Hugo Scott-Gall: Do you think, given the rapid adoption of mobile phones, Africa can develop faster than other emerging markets? Say, China in the 1990s?
Peter Schmid: The growth of mobile payments in Africa has been a really exciting story. The beauty of what has happened with mobile phones is that the continent sort of skipped over the whole fixed line system. Africa has no engrained tradition or accepted status quo for payments, since banking penetration remains low, so there are no established habits to break. With mobile handsets serving around 1 billion customers, the opportunity to innovate and unleash the power of that network is significant.
Building out an effective national and pan African payments infrastructure is one of the foundation stones of any sophisticated economy, enabling access to capital and velocity of money throughout the system. Put simply, secure, flexible payment processing builds wealth. If the world wants to see Africa boom, there needs to be an acceleration in infrastructure investment.
With the West heavily in debt who will shoulder the cost? China? India? Latin America? At the moment, the demand for infrastructure clearly outweighs the supply of capital.
Hugo Scott-Gall: How can you get more foreign investors to provide capital?
Peter Schmid: At Actis we have already seen a tremendous shift from when we were founded in 2004 – when the number of investors in Africa could fit in the back of a Mini – to today when, with European and US markets in trouble, the smart money is piling into the continent.
Increasingly investors are seeing the huge growth potential in Africa realised. This naturally builds confidence. We know that with the right governance, tax incentives, educational structure and fundamental optimism markets can mature rapidly and sustain that growth. Rwanda is a good example of what can be achieved over a short space of time with the right leadership. Similarly, Ghana is a shining example of a well run country, which has invested in infrastructure. It’s been an absolute winner. They have encouraged entrepreneurship and the country has boomed. Individual nations’ success stories matter, but ultimately an investment is judged on its own merits: right sector, right company, right price, and great returns. The more investors see those deals become the norm the more mainstream investing in Africa will become.
Hugo Scott-Gall: And would you say there’s a clear correlation between either doing business, or government cognisance and regulation, and growth rate across most of Africa?
Peter Schmid: Absolutely, absolutely.
Hugo Scott-Gall: Are there any other misconceptions about Africa?
Peter Schmid: I see two assumptions. First, many people perceive Africa to be a single country or region like India and China. This is a big mistake; it is made up of multiple ethnic groups stretched across a vast hinterland and they are very, very different.
Second, individuals are quick to focus on volatility, missing the upside. This continent has a billion plus people, rightly demanding high quality and ever more sophisticated goods and services. It is those twin needs – the build out of domestic infrastructure and domestic consumption that Actis responds to. We see world class banks, security systems, payment processing thriving backed with the right capital.
Third, don’t underestimate the prize: with its rich mineral resources the continent has a constant dollar inflow which is exactly what is needed to take Africa to the next level. Any smart investor who recognises the opportunity stands to make very good returns in Africa, as we have.
This article was first published in Goldman Sachs’s Fortnightly Thoughts