It is still difficult to assess the full impact of the global financial crisis on Kenya, but concerns that private equity investors would now pull back have not materialized, at least not in the SME sector where several new funds are entering the market. Rachel Keeler takes a look at the latest developments.
Kenya’s private equity market has been on a happy growth curve since 2002. New funds here inspired by the success of private equity abroad are now welcoming international money, supplemented by a domestic effort that has been inspired by investment groups like Trans-century. Kenyan fund managers have never sounded more optimistic. They say the industry is growing, local money mobilising, and diaspora experts coming home. In this article we examine new SME private equity market trends. A closer look at the large players will follow in a separate piece.
Global Financial Crisis
It is still difficult to assess the full impact of the global financial crisis on Kenya, not the least because it intermingles with the fallout of the political crisis in early 2008. However, concerns that capital flows to Kenya would come to a halt have not yet materialized: Eline Blaauboer, investment director for the TBL Mirror Fund, a new venture capital fund set up in Kenya in 2007, says she sees resilient, even growing investor interest from abroad: “Institutional investors have less money to spend, but for private investors we actually see a lot of appetite.” Individual investors who have pulled their money out of crumbling western markets are looking to emerging market finance for stability and opportunity. Kenyan companies present good investment bets – they are expanding along with the economy, which, while feeling the slowing effect of the crisis, is still registering positive growth.
The African Development Bank recently projected a (probably overly optimistic) 5% growth for Kenya in 2009, and commented that Kenya’s strong, diversified economy may lead East Africa into quicker crisis recovery than other African regions. Private equity requires long-term direct investment, so the industry will be less affected by the panicked exit of short-term capital from the Kenyan market. Still, investors across the board are now more conservative with their bets, which could keep money away from risky venture capital funds. On the up side, downsizing and layoffs abroad mean much of the young Kenyan Diaspora is coming home. Financial professionals are sure to bring high quality training, experience and professional and capital connections home with them that will inject new energy into the market here. 2.5% to 3% are a more realistic estimate for the 2009 GDP growth, and Kenya’s political risk has increased considerably since early 2008, despite or possibly because of the grand coalition government. However, even if Uganda’s and Tanzania’s economy are expected to expand at a faster 5% in the current calendar year, they are both heavily donor dependent and Kenya’s private sector is known for its comparative strength and resilience.
Fresh Meat
A new wave of private equity funds has been gaining force in Kenya since the economic turnaround began with the end of the Moi era in 2002. The raging (at least pre-crisis) success of private equity in America and Europe has certainly inspired expansion here, but there has been a structural shift, with new funds focusing on smaller deal sizes. Fund managers argue that the small and medium enterprises (SME) sector is an underexploited capital niche between microfinancing and corporate affairs – a missing middle that presents risky yet lucrative opportunities for investors looking to enter the market.
Established players such as Actis Capital have scaled down their activities, and new funds have stepped up to take their place. The Acacia fund – originally managed by Aureos Capital – recently came to the end of its 10-year lifespan, was bought out for USD10m and reinvented by Swedfund, the Swedish state’s venture capital company. Some insiders say the Swedes could be betting on the chance to take Acacia public. Aureos has stated it wants to focus on bigger deals – that the Acacia foray into venture capital funding was too tedious for its corporate profile without the support of technical assistance facilities. But most of the new funds that have entered the market are focusing on just that: small-scale SME and start-up financing, with investment deals ranging from USD50,000 to USD2m.
Among the new funds to watch are:
• TBL Mirror Fund: With a EUR6m capital base provided by individual investors from the Netherlands and UK, this venture capital fund invests between EUR100,000 and EUR1m in pure equity to young, fast-growing SMEs. TBL currently has funds invested in KenCall, a Kenyan call centre, and Meridian Medical Centre, which operates six health clinics in Nairobi. The fund is still raising money, and hopes to draw in funds from the FMO, the Dutch development bank, and other institutional investors by the end of 2009.
• Fanisi Fund: The Small Enterprise Assistance Funds (SEAF), a global firm specialising in emerging market private equity, announced plans last September to establish this new SME fund in Kenya, Tanzania and Uganda. Ayisi Makatiani, a Kenyan private equity expert, will be managing the fund with help from Norfund, the Norwegian development organisation.
• Africa Technology Media and Telecoms (ATMT) Fund: This fund has a USD100m capital base and was launched in 2008 to fund ICT and telecoms in East Africa. The fund is managed by East Africa Capital Partners and funded in part by the US government. It has already invested USD40m in the Wananchi Group, a leading internet and entertainment company in Kenya.
• Kibo Fund: this new private equity fund launched May last year by CIEL Capital in Mauritius with a EUR 30m capital base is now investing across East Africa. The fund will focus on what CIEL calls “high potential sectors”: tourism, banking and finance, BPO and telecoms, property, energy and natural resources.
• Incentivised debt lenders: Grofin East Africa, Business Partners International (BPI) and InReturn Capital all offer cashflow-based lending along the private equity model but without actual equity investment. They specialise in risk capital and business development assistance for SMEs.
Growth Prospects
Kenya’s private equity market is growing, but still highly underdeveloped. Few funds exist relative to the business opportunities in the market. Tony Wainaina, a private equity specialist who recently left the Kenyan investment company Trans-Century Ltd. to pursue new fund structuring opportunities, says: “We are probably where the US was in the 60s or early 70s when you had fledgling start-ups, early stage companies that had very good entrepreneurs behind them, had sound ideas, but were only able to source capital from angel investors.” Most Kenyan entrepreneurs continue to turn to family and friends for start-up capital, and many enterprising ideas are shelved when these informal networks fall through.
Wainaina says he sees the greatest potential for growth in the market in domestic capital – from high net worth individuals as well as middle class professionals who are already pooling their savings, hiring advisors and looking for investment opportunities. As already mentioned, this trend will increase as more enterprising Kenyans return home from abroad. Kenyans need to have structured investment vehicles available to them, with experienced managers who know how to navigate the risks involved in private equity and venture capital. Local experts say the business development side of venture capital is also lacking in Kenya. This is partly a human resources/labour issue - Kenya still does not have quite enough experienced professionals to go around - and partly an incentive issue, as most management consultants in Kenya are focused on the corporate sector where the big money calls.
High Returns
With the right risk mitigation and business development expertise, Wainaina says returns on private equity can consistently outshine less risky investments such as bonds and public securities: “30 to 40% year on year is very, very possible and it has been done.” Dividend yields are often a healthy 10 – 15%, compared to the 3 – 4% earned on average at the NSE. According to Wainaina, “It’s the capital appreciation giving [private equity funds in Kenya] the biggest upside. The challenge is always going to be how they exit, and how they realize this capital appreciation.” To that end, Wainaina wants to see a secondary market developed as soon as possible. Public listing should not have to be the end game for these companies. Many can be sold to foreign corporate investors like Google (which has recently taken a stake in local companies) looking to establish a footprint in the market.
Most funds in Kenya take a generalist approach guided somewhat by the interests and expertise of their investors. But a few sectors are favorites, with good growth potential across East Africa: ICT and telecoms, services (cleaning, repair, maintenance, etc.), fast moving consumer goods (FMCG), agribusiness and value added coffee and tea. Demand for all of these industries is driven by East Africa’s robust emerging middle class and, in tea and coffee, by sound export performance.
Environment: Political Risk and Regulatory Framework
The experts say political risk in Kenya has had a relatively negligible effect on the private equity market. TBL’s Blaauboer promised her investors she would stay out of tourism, and aside from questions regarding her personal safety, they did not seem all that concerned. Kenyan fund managers shrug their shoulders and say every African country has risk, and venture capital is by nature a risky business, so investors are generally less squeamish. Despite the political turmoil, investors still see Kenya’s economy as holding great potential for growth in the long run. Ultimately, political ups and downs are much more detrimental to the short-term trading markets than to long term business growth investments. Blaauboer also points out that East Africa is more stable as a whole than hot zone regions like West Africa. Investors assume that if push comes to shove, they can move their money out of Kenya and into Uganda or Tanzania.
Every successful venture capital market in developed economies has begun with a government boost. Unsurprisingly, the Kenyan government has yet to rise to the task, and fund managers say there is a lot to do: create tax incentives and tax holidays, fast track business incorporation and trade licenses, and generally make SMEs easier to establish and invest in. In this regard, improved enforcement for debt collection will be key. Many SMEs in Kenya still have a hard time getting big clients to pay. The new East Africa Venture Capital (EAVC) association will be an important force to lobby government on these issues. The association will be a regional chapter of the African Venture Capital Association (AVCA), based in Nairobi, and hopefully functional by the second half of 2009. The AVCA has in the past initiated “policy suggestions” on behalf of the industry, but without a strong local presence this nudging has largely come to naught. The new EAVC may also help with the regional market-specific research required for PE firms to know exactly what they need to demand.
Perspectives: SME Focus
So why SMEs? It is somewhat striking how uniform the focus of new funds in Kenya has been on small enterprise. Traditional private equity strategy suggests the more money you drop on one deal, the better. This is sometimes a matter of rat race prestige, but it also makes due diligence sense: it takes just as much time to feel out a small company for investment as it does a large one.
But in Kenya, big companies and the deals that come with them are simply fewer and farther between, whereas there are plenty of SMEs and entrepreneurs to go around. And, especially for new funds with smaller capital bases, start-up ventures and small growing companies present good opportunities even if they require more work - both a challenge and an opportunity in an emerging market like Kenya: Many individual investors actually look for the chance to work closely with entrepreneurs from their own fields of expertise. This hands-on approach also helps mitigate the risks associated with venture capital while maintaining the promise of big returns. In emerging markets, this willingness by investors to cultivate nascent enterprise is important to overall economic growth. Kenya’s economy is operating far below its production possibility and new business is vital. The key is to make sure new activity is growing efficiently and addressing the correct gaps in the market. The personal interest factor driving many new funds could work against this, but as long as the funds are operating on expected rates of return, at this point any growth is a positive thing.
And, surprisingly, many fund managers here say that for individual investors private equity can be a very emotional thing. So if an individual has a personal interest in Africa, or in Kenya, they will invest here over another market that objectively may exhibit less risk or a better outlook. Of course emotional guidance has its limits and comes with an injection of sense – investors with a crush on Kenya also recognize the economy’s business potential, and even if Somalia strikes them as more romantic, they probably wouldn’t dream of putting their money there.
However, the SME focus is not entirely driven by private commercial considerations: Donor governments have long structured their interventions around SME promotion, and as a consequence, government money coming through development banks that do not operate on a traditional bottom line represents a huge chunk of private equity funding here. The Dutch FMO, Norfund, Swedfund, the American Overseas Private Investment Corporation (OPIC), and the World Bank’s International Finance Corporation (IFC) are all prominent players. Various non-profit development organisations also support venture capital funds. This focus represents a shift in development aid where donor governments try to supplement traditional programme and budget grants or loans with mechanism that more closely mimic the private sector.
The danger comes in what kind of expectations these institutions hold and the influence they wield – and whether they create an even playing field for purely commercial players. The international Acumen Fund, with an office in Kenya, has taken this development finance concept the furthest by devoting much of its funding only to “pro-poor” activities, an approach that can create conflicting incentives: Profitable enterprises are not restricted in their expansion by the availability of more soft funds. Other fund managers say they are happy to accept public money and put it to good use. But they take offence at the notion that venture capital must be tweaked for the poor. Venture capital is by definition socially responsible, they say, and particularly so when focused on profitable job-creating businesses.
On the other end of sources of capital are Kenya’s many casual investment pools that hope to transform into private equity firms. One of Kenya’s largest investment companies, Trans-Century began as an investment club for rich, connected and in-the-know Kenyans: most of the fund’s 30 or so founders were ex-CEOs of blue chip companies with lots of money and the experience to know how to invest it. With the same idea, the Baraka Africa fund has emerged over the last five years driven by finance and industry professionals with an eye for acquisition. The real question is whether the growing number of younger, less experienced, middle class clubs will make the leap into private equity, too. Many of them currently pool money for real estate and stock market purchases, but might be hard pressed to muster the cash that serious equity pursuits require. Still, there is clearly a lot of ambition, and bridges are forming as these groups move into SME financing through family connections. The next obvious step for those with enough money is to introduce the sophistication and objectivity required to fund business ideas not presented by someone’s brother or mother. Fund managers like Tony Wainaina, with the expertise and vision to spare, are bent on making sure this happens.
|
Subscribe to this comment's feed
Show/Hide comment form
USD 
GBP
EUR 
AUD
CAD
JPY