Private equity (PE) as an asset class has received reasonable prominence in Africa in recent times. New records are being set both at the levels of fund raising and sector diversity of investments. Africa is becoming increasingly investor-friendly.
The attraction of PE to Africa is driven largely by factors such as: the huge market size – Africa is home to over 1 billion people; relatively young population – about 60% are below 40 years of age; favourable demographics – rising middle class, increasing urbanisation, increasing disposable income, etc; improved democratic rule and governance, increasing public sector reforms, reducing incidences of civil unrests and wars; and the mobile technology revolution in Africa driving increased efficiencies, productivity and reducing cost of doing business. In a continent with weak infrastructure (outside of South Africa), mobile technology applications have been successfully implemented across several consumer facing sectors such as financial services, healthcare and education to drive penetration, financial inclusion, communication, logistics and process efficiency. These factors have contributed greatly to increased investor interest in Africa.
Exit options in Africa
Typical exit options include: trade sales; secondary buy-outs; IPOs – public listing on capital markets; management buy-outs or buy-backs; and sale to stock market mainly for private investments in public entity (PIPE) transactions. In addition, given downside risk issues usually associated with early-stage and owner-managed businesses, many PE houses have adopted self-liquidating quasi-equity instruments with equity kicker options.
From 2007 to 2012, Africa has recorded well over 600 successful exits. According to the KPMG and SAVCA Venture Capital & Private Equity survey released in June 2013, South Africa recorded about 536 exits during the same period. Of the total number of exits in South Africa during this period, about 65% were management buy-backs while 13% were secondaries to another private equity firm or financial institutions. Disposals through trade sales were the most popular in value terms while secondary sales were the next most popular method of disposal.
As the economies of many African countries show significant improvement evidenced by robust GDP growth due to factors noted above coupled with the economic slow-down in the developed economies, it is not surprising that many foreign companies are looking into Africa. A good opportunity for entry is PE- backed companies with relatively good corporate governance principles, clean financial records and good track records of sustainable performance.
Listed below are select examples of exits recorded in 2012:
- African Capital Alliance (ACA)’s sale of its stake in MTN Nigeria to South African-based diversified holding company Shanduka
- Actis and others: sale of Savcio to Alstom
- Actis’ IPO of Ugandan energy distribution company Umeme
- Aureos’ sale of Zambian agribusiness company Golden Lay to Phatisa
- Citadel Capital’s exit from National Petroleum Company Egypt to SE Dragon Energy
- ECP’s sale of Anvil Mining in DRC to MMG Malachite
Challenges of PE exits in Africa
As PE investments continue to grow in Africa, the challenge of exits has always been raised as the missing part of the jigsaw puzzle. Proponents of this view have highlighted several challenges such as: relatively weak financial markets (with the exception of South Africa) suffering largely from pricing, informational and transactional inefficiencies; relative illiquidity of most capital markets in Africa; low level representation of companies on the capital markets; and complex and inconsistent legal and regulatory frameworks in many jurisdictions. These factors have resulted in some cases to the increase in the holding periods for many PE investments in Africa.
Based on available statistics, the proportion of exits in other parts of Africa is growing steadily when compared to volume of exits in South Africa in spite of the challenges noted above. This indicates that successful exits in other African regions can be achieved with the right strategies even in spite of the limitations of the financial markets in these regions.
Key strategies for achieving successful PE exits
Deal sourcing in Africa is driven largely by deep understanding of local markets, strong local relationships and networks. If used well, it will not only ensure exclusivity during the acquisition process but can guarantee reasonable entry valuation and lay solid foundations for a smooth relationship with the portfolio companies throughout the investment life cycle. Deals that are done through auctions tend to be competitively priced and in the process, create unnecessary distraction for management. In addition, structuring the deal to achieve a perfect alignment of interest with management and existing shareholders will provide the necessary incentive to grow the business profitably and therefore create value during exit.
Embedding strong corporate governance principles
One of the major challenges for many businesses in Africa is the prevalence of weak corporate governance principles. Many successful businesses grew from small family holdings with close family ties. As the businesses grow, proper governance principles and practices are usually not embedded. Best practice governance principles are crucial for success, especially in the areas of proper constitution of the board with experienced professionals, board committees, independent directors, regular meetings and proper documentation of minutes, and the evaluation and ratification of management decisions.
In addition, maintaining robust and clean financial reporting systems, complying with all legal, tax and regulatory requirements while operating in an environmentally sustainable and socially responsible corporate organisation are key to capturing significant portion of the value at exit. PE investors are generally recognised to add value in this area through enforcement of sound governance principles and practices in their portfolio companies.
Business cycles and market conditions are crucial in the determination of exit timing. Firstly, given that PE firms typically have between five and seven year holding periods, it is important that the exit is timed when benefits from governance, expansion strategies and earnings growth have started to accrue to the portfolio companies.
As many sectors experience market shifts, consolidation and regulatory changes, it is important that PE firms keep abreast of these developments to understand the impact on the business and their exit plans.
PE firms can also collaborate with key operators and capital market regulators in the local markets to help improve governance and efficiency through local capacity building and implementation of best practices.
Value uplift and earnings growth
In Africa, PE investors have to look beyond capital and financial leverage to create value in portfolio companies. There is a greater need for broader value leverage in Africa due to insufficient local management capacity. Achieving alpha returns in Africa means that PE investors will have to juxtapose a myriad of value levers such as exit multiple arbitrage, operational and profit improvements, mergers and acquisitions to gain market share, hold strategic stakes in value chains and expand into new markets especially as many successful local companies look to diversify their footprints through regional expansion. As noted in the recently published KPMG and Director Bank report, Working with portfolio companies, “if value leverage is important, how many PE houses have the knowledge and contacts beyond capital, deal making and financing skills? PE firms have to engage operating partners and/or industry advisors to act as personal coaches to management. Knowing how to find solutions to problems and execute a growth plan successfully are pivotal to realising a successful exit.
Management capacity and continuity
The importance of good management that is adequately incentivised is felt both during and after the investment holding period. If management has done a good job in growing the business profitably, then there’s a better chance of achieving a successful exit once there’s an assurance of management continuity. Management incentives have to be carefully structured to prevent value leakage during exit (through unhealthy collusion with potential buyers) but also to ensure that motivation for continuity is sustained. This also includes a clear succession plan as well as a robust and stable board.
Planning and starting early
The exit process usually takes between three and six months and may be longer depending on local regulatory requirements. It is important that preparation for exits commence at the beginning of the investments. This ensures a clear understanding of the requirements and mechanisms for exits by all stakeholders. Having the exit discussions/agreement and ensuring alignment of interest at the investment stage will contribute to building trust and avoid unpleasant tension between shareholders and the PE investors before and during exit.
The exit strategy needs to be constantly evaluated along the dynamics of the market situation and opportunities for value add. Africa is now part of the growth strategies of many foreign companies as the impact of the global economy bites harder and growth slows in many OECD countries. Also, many companies in the emerging markets of Brazil, China and India are jostling for a foothold in Africa’s rich natural resources for input raw materials and huge market for infrastructure and consumer facing sectors. Consequently, opportunity for trade sales abound but it is very important that the PE firms leverage on the global network of professional services firms to achieve a much-broader and diverse potential buyer universe. These multinationals often pay premium for control and market entry cost which is sometimes not the case for IPOs. Exit through IPO has to be carefully executed to create competitive tension between local and foreign investors during the book building process as local investors understand the local market and don’t see a need for premium, except for significant market share gains and synergies.
Adequate preparation even before the formal disposal process is crucial for success. Undertaking an independent diagnostic or exit readiness review of the portfolio company one or two years before the disposal process will ensure prompt identification and resolution of potential value leakages. Key processes such as a comprehensive vendor due diligence, evaluation of the buyer universe, pricing considerations, management and efficiency of the data room process, optimal transaction structuring and adequate preparation for negotiations are all factors that will guarantee a successful and an efficient disposal process. The ultimate objective of private equity investments is to achieve a successful exit.
In spite of the challenges and contrary to popular beliefs, with proper planning, adequate preparation, strong corporate governance principles, strong management and use of experienced advisors, successful PE exits can be achieved in Africa. Well-run businesses with strong growth prospects will always find a buyer.
Dapo Okubadejo is the head of corporate finance and financial advisory services at KPMG in Nigeria.