By Andy Smith, CEO, Sandown Capital
According to Preqin’s 2022 Global Private Equity Report, the total size of the global private equity (PE) and venture capital (VC) asset pool is already well above US$5 trillion and is expected to surge to more than $11 trillion by 2026. However, as it stands today, global allocation of this asset pool to Africa is well below 1% and falling in real terms.
As a former head of investment research and emerging markets (EM) fund manager with 25 years of public and private markets experience, I continue to find it anomalous that the majority of the world’s largest institutional investors have yet to commit materially higher proportions of their assets under management (AUM) to African alternative investment strategies and, more specifically, to African PE.
In this note I assess why such lack of investment exists and comment on why I believe the investment outlook for African PE is now much more favourable given a myriad of positive macro-economic factors and a raft of compelling opportunities which have surfaced in the wake of the Covid-19 pandemic.
Explanations cited by major institutional investors as to their continuing reluctance to invest in African PE essentially boil down to three factors:
1) Poor historic US$ returns from existing PE firms,
2) a relative lack of choice of sizeable funds with strong track records, and
3) elevated perceptions of business and/or financial risk.
Digging deeper, the reasons for poor returns in African PE begin to become much clearer when both general partners (GPs) and limited partners (LPs) explain the factors that they have had to contend with, which include:
- Ever present FX headwinds and political uncertainty,
- Poor market timing – especially investing on the wrong side of the commodity cycle,
- Entering deals with poor corporate governance,
- Inadequate legal frameworks exacerbated by ineffective regulation,
- The inability to freely and cheaply move capital in and out of many countries, and
- Better return versus risk profiles across other geographies.
Notwithstanding such factors, and whilst fraud and corruption are often cited as key reasons to ‘stay away’ from African PE, one has to question the effectiveness of existing players’ investment processes including the nature and timing of exit strategies. The failure of The Abraaj Group is a case study in itself. It is up to you, the reader, in the face of compelling long-term investment opportunities across Africa, to judge whether such factors are legitimate reasons for poor performance or simply ‘excuses’ trotted out to disguise relative failure.
By definition, the lack of investors’ historic commitment to Africa has led to many of the biggest institutions lacking in-depth experience – a thorny problem exacerbated by the relatively shallow talent pool across Africa and the understandable desire of local portfolio managers to chase better career prospects abroad. Equally, many of the world’s largest asset managers are now measured in terms of their performance on a shorter-term basis than ever before which, in turn, tends to drive risk aversion and a tendency to continue to participate in ‘momentum trades’.
Africa comprises almost 1.3 billion people today. By the year 2100 the UN predicts that an additional 2.4 billion consumers will live on the continent. Consumption as a driver of economic growth, driven by long term positive demographic trends, are generally well understood. Yet custodians of the world’s largest pension funds which, conceptually, should have a long-term view have not yet stepped-up. On the other hand, the development finance institutions have continued to dominate the inward allocation of foreign capital to Africa, principally because of their longer-term focus and a political imperative which promotes initiatives to address poverty, education, climate change, food security, energy and infrastructure to name a just few investment themes.
At some point, the ‘J’ curve of inward investment into Africa has to reach a point of inflexion and attract a bigger proportion of asset allocation. However, for this to occur, key questions surround market timing and risk perception. Interestingly, the US tech giants including Amazon, Microsoft, Google and Meta seem to be waking up to the demographic opportunity. Their collective investments in Africa over the past two years, whist still comparatively small, have dwarfed their commitments over the past decade. A positive sign. Equally, and from a macro perspective, EM assets typically underperform heading into an interest rate hike cycle but outperform thereafter. Over the past six months, markets have shifted from pricing in three Fed hikes this year to between six and seven, amid rising inflation. This suggests the near-term outlook for EM assets may be turning net positive.
So where are the biggest PE opportunities ?
When the first wave of the Covid-19 pandemic surfaced in March 2020, South Africa’s Johannesburg Stock Exchange (JSE) fell almost 35% in less than a month but subsequently staged a remarkable ‘V-shaped’ recovery, recouping all losses and rallying to an all-time high in January 2022. Notably, many of the small and mid-cap stocks on the JSE failed to fully participate in the recovery and remain moribund, cash-starved and with limited access to both public and private capital markets to fully exploit their growth strategies.
Our analysis suggests that the most intrinsically undervalued listed equities across the major public African markets carry a disproportionate quantum of debt at often punitive interest rates and with short-term maturities. Whilst the risk of default is baked into some share prices, market dislocations have created real valuation anomalies even factoring in extremely high equity risk premiums which are (rightly) being priced in.
Many such companies employ not hundreds but tens of thousands of Africans. SMEs that should be the engine-rooms of job creation are being starved of cash. The collapse of sell-side coverage over the past decade has also exacerbated the problem of accurately valuing listed equities. In summary, PE firms that are prepared to put in the hard-yards to evaluate such investment opportunities should take a look.
Andy Smith is CEO of Sandown Capital, a private equity fund established in partnership with Peresec and based between Johannesburg, Dubai and London. Sandown’s mandate is to invest in sub-Saharan African consumer, fintech and clean energy sectors with a unique ‘public-to-private plus growth capital’ strategy. Contact: [email protected]