With a large population of over 100 million and rapid economic growth (9% in 2019), Ethiopia offers considerable opportunities for businesspeople and investors. However, the country faces several challenges which need intervention to improve the business environment, including foreign exchange shortages and excessive bureaucracy.
To find out more about Ethiopia’s investment opportunities, Betsy Henderson spoke to Ashenafi Alemu, managing partner of private equity firm Zoscales Partners. The firm invests growth capital in small and medium-sized companies operating in key East African countries.
Zoscales invests primarily in consumer goods and healthcare. Why these sectors, and what other investments opportunities do you see in Ethiopia?
We look at opportunities in Ethiopia through a private equity lens. We have a medium-term investment horizon; we must invest and exit the businesses within five to seven years. Strategic or long-term investors may see things differently.
Our selection of these industries comes as a result of focusing on the fundamental needs of Ethiopia’s society. In Ethiopia, there are 105 million people who will need basic consumables such as food, personal care items and healthcare services. We believe as the economy grows, we will see more people who, for the first time, will use shampoo to wash their hair or give biscuits to their children.
As a result of focusing on these fundamental consumer needs, we don’t invest in niche markets or products that only a few can afford. Rather, we focus on the mass market; not the bottom of the pyramid nor the top end of society, but everything in between.
As a private equity investor, we ask which industries would provide the opportunity to exit whenever we want to exit. This is driven by how many active buyers there are in the region. Most merger and acquisition activity across Africa has been in healthcare, fast-moving consumer goods (FMCG) and financials. The banking and financial services sector in Ethiopia is closed to foreign investors, therefore we focus on FMCG and healthcare because they provide the fundamentals and liquidity.
That said, there are many other investment possibilities in Ethiopia. You can invest in textiles and shoe manufacturing – basically everything the Chinese used to do are now being outsourced to Ethiopia because of its cheap labour and electricity. Construction materials are a huge investment opportunity, too, because there is a construction boom.
Agro-processing is another good opportunity, which we can and do also invest in if there is de-risked primary agriculture in the value chain and we are able to obtain enough crops. There are huge prospects in agro-processing for those with a longer investment horizon.
Telecoms has recently opened up and there will be great opportunities in the financial sector once it opens up to foreign investors. Companies will be able to buy stakes in banks, insurance companies, payment processing companies and mobile payment platforms. For a non-private equity investor, geothermal or wind energy can also be a good investment.
Elaborate on the agro-processing opportunities in Ethiopia.
Agro-processing is appealing when we can use a widely available crop that does not require a great amount of risk to obtain. We’ve found this to be the case with wheat, which we use for our biscuit company. Wheat is natural to Ethiopia and grown by millions of farmers although we have had some recent challenges due to civil disturbances which have pushed up prices. We’ve found we can produce other wheat-based products, such as pasta and macaroni, without the need for a lot of backward integration.
However, going beyond staple crops into something such as avocado processing – which I think holds big potential – requires investment in farming or stringent commercial and technical arrangements with farmers and outgrowers. But there are people who do it. There are also opportunities in edible oil production if you integrate backwards and create your own supply of oilseeds.
Describe some of the challenges of doing business in the country.
The two main hurdles are forex shortages and logistics. That said, there are strategies to overcome both of these challenges. From a macro-perspective, it’s important to keep in mind that the present forex shortage may not always be an issue. For many years, Ethiopia has invested 20% of its GDP into massive infrastructure projects (most of which required US dollars), and this is one of the reasons for currency shortages. As more of these large-scale projects are completed – railways, dams and so forth – they will begin to generate dollars rather than taking dollars. Industrial parks are another good example; they required a significant investment to create but will hopefully bring in much-needed foreign exchange. In the next couple of years, the macroeconomic situation will improve and we’ll see more balance around the trade deficit and currency availability.
Many stakeholders have highlighted import substitution as a significant opportunity in Ethiopia. What is your take?
It is critical to do import substitution for basic consumer goods, particularly those for which we already have raw materials. Ethiopia has a solid agricultural base and cheap labour, and there could be more import substitution in food-based sectors. Light manufacturing and packaging materials are other potentials although they require large investments by private companies and the government to make it work.
There has been a lot of investment in edible oils in recent years and processing plants have been set up by private companies. The government offered some fiscal or other incentives for companies to set up manufacturing plants. However, edible oil manufacturing requires oilseeds. Unless you have large swathes of land given to commercial oilseed manufacturers or growers, collecting these seeds from thousands of smallholder farmers and getting them to a plant will entail substantial logistical costs and challenges. From our perspective, import substitution has to be part of an integrated solution. For it to really work, policymakers have to view opportunities in an integrated manner at every level of production.
Another example is pharmaceuticals; it’s relatively easy technology and requires importation of only the active ingredient. The rest is mixing things, packaging and selling the final product. Yet, it is unusual to find a company able to produce all of these ingredients and do all of this; you need a cluster of pharmaceutical manufacturers and policies that cultivate growth and build an enabling ecosystem.
Are there any sectors in which you would be hesitant to invest?
Again, looking through the lens of private equity, we wouldn’t invest in areas where sophisticated manpower is necessary because getting the right people to run these businesses – technically or commercially – is extremely difficult. We prefer to invest in simple businesses because we’re a financial investor and not an operator.
We try to do things that have less government and political links to avoid risk. We also don’t invest in tobacco or hard liquor simply because we feel it’s morally irresponsible.
What are some of the investment lessons you have learnt over the years?
One of the things we’ve learnt is that the economic model of families who run the businesses we’ve invested in or are about to invest in, tend to be very different from the economic models of private equity. For this reason, we prefer to do transactions that give us control or assure us our economic models are aligned. We’ve found that it leads to complications when it’s not clear who’s in charge.
For this reason, we focus on control deals that allow us to be in charge of the investment. If possible, we take a majority stake, while ensuring that becoming a smaller shareholder doesn’t change the big picture for our partners.
No matter how much value-add we, as a private equity firm, can put into a business, there is no substitute for good management. What we’re doing for future investments is to select a pool of talent and build strong relationships with them before we invest. In fact, when we buy a business, we try to think who would be the right CEO to run it. We’ve found it’s important to make investment decisions based on who can manage that business for us – sometimes this is more important than the quality of the asset. Management is key and we’re seeing this play out in a number of our investments.