EAC Regional: Commercial Funding Pushing Actis Beyond East Africa?

Thursday, 09 July 2009

After the management buy-out from CDC, Actis remains focused on emerging markets, but has increased its funding from commercial sources and is now looking at considerably larger private equity deals. Rachel Keeler looks at the company’s role in the East African private equity market.   The story of the Commonwealth Development Corporation (CDC), the British government’s development finance institution, offers some insights into the evolution of large-scale private equity in East Africa. CDC was founded in 1948 to finance businesses in Britain’s developing colonies. Many of those were in Africa and South Asia, where CDC became one of the first investors to bet big chunks of cash on risky, largely unknown and poor markets. In the early 1990s, the institution began exploring venture capital, and by 1997 its sole priority was private equity. By then, it was operating in 20 African countries south of the Sahara. By this time, private equity funds had taken notice of Africa. However, most money was migrating to northern or South Africa, with little attention paid to the vast area in between. Small funds began to look at untapped regions like East Africa, particularly for venture capital and boutique SME investments. But CDC and other development finance institutions (DFIs) such as Norfund and the World Bank’s International Finance Corporation (IFC), remained heavyweight players in Africa’s frontier markets handling funds in the eight to ten-digit range. Shifting Away from Development Today, this picture is beginning to change, with both positive and negative implications for East Africa. In 2004, the larger of CDC’s two investment arms, Actis Capital, did a management buyout and became an independent private equity firm. Actis announced it would remain focused on emerging markets, but begin to raise funding from outside the development sphere. Five years later, CDC money accounts for less than half of Actis’ portfolio, with the rest made up from pension funds out of the US and Europe, private foundations, and sovereign wealth funds from the Gulf and elsewhere in Asia. In 2008, CDC’s other investor on the ground, Aureos Capital, followed suit. Aureos had been operating as a semi-independent firm for seven years when it finally announced plans to buy out CDC’s 51% stake last July. For its new USD400m pan-African fund, Aureos has attracted investments from European pension funds and private foundations to add to its government-backed money. The shift by both firms away from development finance sources has produced several outcomes for East Africa. Like many development finance institutions (DFI), CDC commits the majority of its investments by design to low-income countries. By World Bank standards, every country in East Africa fits this bill. Over the years, largely with CDC money, Actis built up its current USD200m portfolio of investments in East Africa, including stakes in: Nairobi’s Junction shopping mall and Nairobi Business Park, Mombasa’s Tsavo Power Plant and Grain Bulk Handlers, Tanzania’s Songo Songo natural gas power plant and gas processing facility, and Uganda’s DFCU bank and Umeme electricity distributor. But with its new focus on commercial private equity (as opposed to development-minded private equity), Actis has begun to shift its activities toward larger markets. This change was “partly driven by overhead, partly by the opportunity space we see, and partly by a desire to grow the business,” says Michael Turner, who runs Actis’ Nairobi office. A new USD2.9b private equity fund, Actis Emerging Markets 3, that closed in December 2008 will target Africa, China, India and Brazil, with nearly USD1bn earmarked for Africa. Much of that money will go into northern or South Africa, plus some for Nigeria, raising the question of how much has really changed in big-money private equity’s approach to the continent. Turner says the decision to make new investments outside of East Africa was largely an issue of scale: The firm has tripled its funds under management over the last four years, and is looking for more efficient ways to invest. It is difficult and costly in terms of overhead to spend a billion dollars a few million at a time. As a consequence, Actis has upped its minimum deal size to USD50m. And East Africa is short of companies that can absorb that much capital - with its 150m citizens, Nigeria is one of the continent’s few national markets outside of northern or South Africa that can attract deals of this size. Potential for Profit Considering this, the question remains: how much opportunity exists in East Africa for large-scale private equity investments driven purely by profit rather than development concerns? Experts say private equity deals in sub-Saharan Africa congregate around three general “sweet spots”: At the SME level, deals range from USD500,000 to USD2m, which is where almost everyone agrees the most opportunities are, and where much fresh interest has been expressed by both small private funds and large DFIs. Most of the funds in this range are still provided by DFIs or other soft funders (see Kenya: SME Private Equity Undeterred by Global Crisis). One step up is the USD3m to USD10m range, where Aureos remains focused. Beyond that lies the USD15m to USD200m slot, where Actis is busy growing. Actis is still seeking out deals in East African sectors that provide good opportunities in large doses. The firm is particularly interested in the region’s infrastructure sector right now, which has been expanding through a series of projects that present the chance for big deals. And funds from its USD150m real estate vehicle, which still focuses on deals in the USD5m range, are going into redeveloping Capital Properties in Tanzania, and one other new project. Despite vying for more development-neutral capital, Aureos is not planning to leave the East African market anytime soon. In fact, very little has changed in terms of investment strategy between Aureos’ USD40m East Africa fund that was launched in 2003 with DFI money, and the firm’s USD400m pan-African Fund that draws on a mix of new institutional investors and DFIs. Across the continent, Aureos has and continues to focus on deals between USD3.5m and 10m to expand companies with great potential for growth: cement, brick, tile, steel and consumer goods manufacturers, housing developers, IT companies and financial service providers. Davinder Sikand, regional managing partner for Aureos’ Nairobi office, says the firm foresees long-term potential in East Africa for all of these sectors. Manufacturers of construction materials are feeding the region’s desperately needed infrastructure expansion and construction boom. Small technology companies service the telecoms boom, while producers of fast moving consumer goods and real estate developers tap solid demand from the growing middle class. Aureos also likes to build regional companies through growth capital and mergers, which works well throughout a continent developing its regional economic blocks; East Africa is a prime example, with plans to launch its common market in January 2010.  Aureos deals are far below the Actis scale, but the firms achieve comparable returns. Actis has an African track record of 25% cash to cash returns, while Aureos is targeting investors for its pan-African fund who look for over 20% net back. It is also important to note that investing as Aureos does in companies whose business is often less capital intense than those operating on the Actis scale creates more employment and economic growth in the long run. Perspectives Other firms have begun operating in East Africa who see similar potential for profit beyond the SME space. Established in 2004, Helios Investment Partners now manages nearly USD700m, with a mix of DFI and commercial money, and deals spread between USD15m and 200m. The firm operates across the continent, and in East Africa has invested in large companies such as Equity Bank where it has built a relationship with local co-investor Trans-Century: Trans-Century began as a private equity club for well-connected Kenyan investors 11 years ago, and has since raised more than USD150m. The firm has invested in companies such as Rift Valley Railways and other funds including Aureos and Helios. Centum Investment, a public company founded in 1967, uses shareholder money to fund minority stake private equity deals in Kenya of up to roughly USD6.5m. A notable trend here is the number of Africa-specific and locally-based funds that have entered the market. Trans-Century’s model for mobilizing local money in Kenya has been successful enough to inspire similar private clubs such as the Baraka Africa Fund. Private equity fund managers in Kenya have also begun eyeing the several billion dollars under management by local institutional investors, such as banks, insurance companies and the National Social Security Fund (NSSF). Many Kenyans would like to see more formal private equity funds set up in the region to lure some of that money away from bonds, the stock market, or in the NSSF’s case, government mismanagement and waste, and into vehicles that can channel funds into growing private companies. The good news about sub-Saharan Africa’s shifting private equity geography is that political risk is becoming less of a deterrent to frontier investment. Actis’ Turner says, “Investors seem to have an appetite for Africa, and seem to have an acceptance of the risks now, much greater than before, and an understanding of those risks.” In large part, Africa has the DFIs to thank for this. The fund managers they brought into the market 20 years ago have learned how to navigate it well. Actis was one of the first to go into Rwanda after the 1994 genocide to invest in the privatisation of the country’s now second largest commercial bank, Banque Commerciale du Rwanda. Turner says he remains on the look out for more deals of this kind. A trend toward privatisation in Africa has also opened up space for infrastructure projects with less government interference. Two thirds of Actis’ infrastructure investments in Africa retain government recourse, but political risk in this area is becoming easier to mitigate, as more leeway is given to private developers with more of a mind for profit than kickbacks. Turner also says fallout from Kenya’s post-election violence has not had had much effect on Actis’ investments in the region. A global survey of institutional investors by the Emerging Markets Private Equity Association (EMPEA) found that the risk premium for sub-Saharan Africa (excluding South Africa) went down from 8.9% in 2006 to 6.7% in 2008. These numbers have been reversed for 2009 because of the global crisis, with premiums rising again to 8.4%. But that trend is similar across all emerging markets. And even though returns are generally lower in sub-Saharan Africa than in Asia or Brazil, managers like to invest in the region as a way to diversify their portfolios. South Africa still commands 40% of funds raised and 70% of those invested for the sub-continent. But in the name of diversification, big money continues to find its way into less developed markets. Aureos’ Sikand says: “An institutional investor from Europe or America will be hard pressed to focus on a single region or country. But Africa as a continent might draw their attention.” Actis’ Turner says many of the commercial investors looking at private equity in Africa now are doing so for the first time. As such, they are “more inclined to invest in more developed markets” – e.g. northern and South Africa – “and leave the Sudans and DRCs of this world for another time.” But with experience built up over the last decade, Turner says many fund managers are able to assure investors that including some of these frontier markets in a larger portfolio can be a good thing. Turner adds that finding both international and local buyers as Actis looks to exit from investments across Africa has not been a problem. And Sikand agrees: “Kenya remains very attractive to corporate buyers – those deals are happening every day. Especially now with the recession going on, we see a lot of companies from the west that didn’t look at these markets previously from the angle of distributing their products here. They are taking a much more active interest now, whereas a few years ago, these markets just were not interesting.“ Share this article with others: Comments (0) Subscribe to this comment's feed Write comment Show/Hide comment form Name Email Title Comment smaller | bigger Subscribe via email (Registered users only) I have read and agree to the Terms of Usage. Add Comment