Private equity may find favour on the continent

In combination with listed assets, it could be a good way for firms to raise funds, writes Evan Pickworth

THE African growth story is one of the hottest tickets in town, but after a lacklustre last year, investors and firms are quickly learning that alternative forms of capital raising are crucial ingredients for a successful strategy.

A major decline in fund raising activity last year and challenges like labour unrest have raised the bar.

High hurdles are being placed in front of junior miners in SA, for example. They are not getting enough capital because of higher credit demands, while analysts note a decidedly bearish tone from institutions after the Marikana tragedy.

African juniors are generally struggling to raise enough money for their developments as the global financial crisis continues to bite.

According to Ernst & Young, Africa-focused private equity funds last year raised less than half of what they did in 2011 — just $1.1bn.

Absa commodities expert Nick Calabrese says one of the biggest risks facing a commodities start-up is maintaining cash flow over the five- to seven-year loan period.

But he says a good resource, sound management, and a compelling business plan can be partnered with a derivatives strategy as an affordable and readilyavailable route even to long-term debt financing. “Locking in a future forward price on 20%-25% of production allows miners to service debt regardless of market swings, without having to raise more equity or increase debt.

“This is a powerful proposition for capital-starved juniors on the continent,” he says.

While African stock markets struggle with slower volumes due to the global crisis, alternative derivatives exchanges are being developed to offer competition to the established big exchange model, and flexible alternatives for investors to structure deals.

Private equity — capital not quoted on a public exchange — is expected to find favour again.

Erika van der Merwe, CEO of the South African Venture Capital and Private Equity Association, says while it is still “early days” for this asset class in Africa, research showed valuations were more attractive than other listed asset classes, while some good outperformances were being registered.

A report last week by Bright Africa shows that on average, private-equity deal multiples in all sizes of businesses are 12% lower than the global average, meaning more attractive valuations. “It is offering wonderful buying opportunities if you look at the valuations, but the question is how long that gap will last — if you wait too long you may miss out.”

With African stock markets underdeveloped, not very liquid and often not representative of underlying economies, Ms van der Merwe says that private equity, in combination with listed assets, could be a good strategy to consider.

A major drive, she says, will come from government infrastructure build and new laws which encourage pension funds to invest in alternative asset classes. They can invest up to 10% in private equity in SA now, meaning stronger pension fund flows can be expected.

Because private equity has a traditional lock-in period of about 10 years, it could become a vehicle of choice for the longerterm projects being developed, as it can be adapted to the longterm needs of investors.

And as investing for environmental, social and governance gains in prominence, Ms van der Merwe expects private equity structures to find favour as the deals already look to these aspects due to their longer-term nature. However, SA’s portfolios remain underweight in private equity. Developed markets exposure is up to 7%, whereas in SA it is only about 1%.

“There is outperformance of this asset class, especially over long-term areas, so why are trustees not allocating?” asks Ms van der Merwe.

The Bright Africa report highlighted what it termed “the challenges of listed equity markets in Africa”, in particular the fact that the majority of African stock exchanges — with the exception of the JSE — do not closely represent the economic sectors that contribute to the gross domestic products (GDPs) of their countries.

For example, the report said Africa’s second-largest economy and stock exchange, Egypt, shows a skew towards financials, which account for 29% of the exchange compared with the contribution of 7% this sector makes to GDP.

In Nigeria, meanwhile, the energy sector makes up 40% of the country’s annual GDP, but is not a significant component of the listed market.

There are early indications that the turnaround for private equity in Africa is starting to happen this year.

Major player Vantage Risk Capital announced last week it had concluded a transaction with Genser Energy Ghana to provide up to $30m of expansion capital to the company.