African private equity in 2016: What effect will the global economic climate have?
Low oil and commodity prices, coupled with a strong US dollar, have placed immense strain on African currencies.
In the continent’s largest economies, the South African rand has taken a dive while the Nigerian naira has seen strong depreciation in the parallel market, indicating a possible devaluation by the Central Bank of Nigeria. The Zambian kwacha, Ghanaian cedi, Kenyan shilling, and Angolan kwanza are just some of many other currencies on the continent under pressure, with persisting global conditions suggesting there will be little or no relief this year.
This currency risk has impacted investment into African listed markets, but what does it mean for private equity on the continent?
Rory Ord, head of independent valuation at RisCura, says the industry’s “saving grace” is that private equity capital is committed for a long period of time, with funds having already been raised over the last couple of years.
“A lot of that money is committed and it now has to be invested over the next few years. So there shouldn’t be that much change, despite these conditions. The deals should still happen.”
However, current macro-economic hurdles increase investment risk and lower investor confidence – and Ord says this will likely affect the pricing of private equity deals this year.
“What this means is investors will probably not be willing to pay as much for the deals to try and secure a higher return. So they will want to pay a lower entry price to try ensure that they do get their money’s worth and a good return at the end of the day.”
A year of re-adjusting
He notes that during times of economic changes there is often a disconnect between what sellers expect for their companies, and buyers are willing to pay. The result could mean longer negotiation periods and deals that come with contingency clauses.
“So for example, private equity firms investing into companies may make their purchase price contingent on the results achieved in perhaps the coming year and the one after that – and trying to link their price to these things as much as possible to limit their risk,” adds Ord.
“But the money is there and will be invested over the coming years – I just think this will be a year of consolidation and re-figuring things out. We might see a little slowdown in deal activity, but that would probably then be made up for in the next year.”
Reluctance over Nigeria
There might also be some reluctance by fund managers in brokering private equity deals with naira-based businesses in Nigeria, at least until issues surrounding the exchange rate are resolved, notes Ord.
“If an investor has to go in at say the official rate, and then it immediately gets weakened to the parallel rate – if it is allowed to weaken – then that is a straight loss to the investor,” he explains.
This week the naira hit lows of close to 300 to the dollar on the parallel market, around a 50% difference to the official central bank rate of near 200 to the dollar.
“For investors who actually have the choice over which countries they invest in, I think they will have to be really convinced about the opportunity [of a particular deal] and actually take into account those severe currency risks [before investing in a Nigerian company].
“That is not to say the currency risks don’t exist everywhere else – they really do… But as an investor you probably would rather be investing in a country which has actually got a bit more transparency in the currency.”