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Private Equity in Africa: The Myth of the Weak Exit Environment

Africa’s steady rise continues to attract a growing number of private equity (PE) investors who believe that African markets offer an exciting growth and investment opportunity. Some of the key drivers underpinning this growing perception among investors include improvement in the business environment, fiscal reform and sound economic policies, technological advancement, regional integration and improved cooperation between the public and private sector.

From an external perspective, the improving global economic outlook and China’s ongoing demand for African resources provide a foundation for robust medium-term growth. Combined, these drivers could stimulate the private sector, resulting in job creation, a higher tax base, and a growing African middle class in the long-term.

In the context of Africa’s positive outlook, PE activity on the continent remains robust. According to a report by the African Venture Capital and Private Equity Association (AVCA), the total value of African PE fundraising increased to USD 2.7bn in 2018, up from USD 2.4bn in 2017. The total deal volume reached 186 deals in 2018, up from 171 deals in 2017.

Africa’s PE activity clearly demonstrates the growing appetite to invest in the continent. However, significant challenges remain, particularly regarding the perceived risks of deploying large scale capital in frontier markets. A key concern, particularly among limited partners (LPs), is the perceived weak exit environment. A perception often shared by investors is that the shallow nature of African capital markets makes exiting investments difficult to execute.

However, Africa’s exit environment has remained resilient and more active than many realise. Across sectors and markets there is an increasing number of exit routes. According to a recent PE exit study by AVCA and EY, there have been 403 exits over the last 10 years. 2016 was a record year for exits with 50 exits recorded compared to just 34 in 2007, indicating increasing momentum for PE exits. The number of exits in 2018 dropped slightly to 49, primarily due to fewer exits announced in South Africa off the back of increased political and economic uncertainty.

While South Africa continues to have the highest level of exits, the last two years saw an increase in activity in North Africa (Egypt, Morocco, Tunisia), which made up 22% of exits from 2016-2017. On a per country basis, over the last 10 years, exit activity was highest in South Africa (43%) followed by Nigeria (8%), Egypt (8%), Kenya (6%) and Ghana (5%).

According to the study, a key trend in exit activity is that secondary buyouts (sales to other PE firms) was the most common exit route with 37% of all 2017 exits, up from 16% in 2015 and just 8% in 2008. During 2014-2016, PE fundraising activity hit an all-time high, which is likely driving PE firms to be more active in the secondaries’ market. However, this could suggest that PE firms may be struggling to find new investment opportunities in the market and are having to recycle other PE firms’ portfolios.

Although a healthy secondary buyout market is emerging, it’s still at a nascent stage of development. With the increasing maturity of the industry, more secondary transactions are likely to take place and secondary-focused PE firms are likely to enter Africa.

The study shows that although exits to trade buyers (strategic buyers of existing businesses) dramatically declined from 50% in 2016 to 25% in 2017, 2018 saw a relative rebound in this exit route. Trade buyers represented the highest volume of exits routes in 2018 at 39%, slightly higher than PE and other financial buyers at 37%. Exits to trade buyers has always been a favoured exit route as companies have sought to take advantage of Africa’s growth opportunities.

Although IPOs continue to represent the lowest share of recorded exits, the deepening of African capital markets, coupled with economic growth, has the potential to support the development of the listed space in Africa. According to a report by AVCA and PWC, between 2010 and 2017, PE backed IPOs as percentage of total IPOs averaged just 16% in terms of volume and 23% in terms of value. By comparison, in the US the average is 39% in terms of volume and 44% in terms of value. 2010 saw the largest number of PE backed IPOs by volume and value, with five IPOs valued at USD 1.1bn.

In line with equity capital markets, the JSE leads the African exchanges as the preferred exit destination of PE backed IPOs. The exchanges in North Africa (Egypt, Morocco and Tunisia) are next in line. Interestingly, this is in line with the overall exit activity as South Africa and the North African regions have the highest levels of exits in all categories over the last two years.

Despite the growing opportunity to exit through public listing, the development, size and liquidity of the African exchanges is the reason why this PE exit option has not grown over the last few years. According to RisCura’s 2018 Bright Africa report, Africa’s stock exchanges, except for the JSE, remain stubbornly illiquid. The Egyptian Exchange (EGX) currently has the second highest daily turnover across the African exchanges with a total of USD 72m traded daily, compared to the JSE’s USD 1.8bn.

The next most liquid exchange, by turnover for 2018, is the Casablanca Stock Exchange (CBSE) at USD 17m, followed by the Nigerian Stock Exchange (NGSE) at USD 15m. This represents less than 1% of the trade on the JSE.

The low free float on African stock exchanges also contributes to their illiquidity. The JSE ranks highest in terms of market capitalisation and free-float of 73%. The Ghana Stock Exchange (GHSE) and Namibian Stock Exchange (NSX) have the next highest free float at 66% and 61%, respectively.

Although the CBSE and EGX have the highest market capitalisation (ex. JSE), they have very small free floats of 27% and 25%, respectively, giving them a lower adjusted market capitalisation than the NGSE which has a lower market capitalisation but higher free float of 46%.

Another challenge in Africa is that the cost of trading on African exchanges is substantially higher than developed markets. A significant portion of trading fees is made up of brokerage commissions, and the limited pool of licensed brokers gives investors limited bargaining power on fees. The low volume of trades on these exchanges means that brokers charge more on each trade to cover their costs.

Given the illiquidity and high transaction costs associated with African exchanges, there are also opportunities to achieve exits through international equity markets. An increasing number of African companies, particularly from South Africa, are being listed on international exchanges and this exit route is expected to grow. Of the international exchanges, the London Stock exchange (LSE) leads as the preferred destination for PE backed exits, with total proceeds of USD 600m between 2007 and 2010.

Another viable exit strategy is through a management buyout (MBO) or private sale. Through effective structuring of PE deals, put options or share buyback mechanisms can be put in place. This is a useful strategy if exiting via an IPO or sale to a financial buyer or strategic trade buy is not viable or available. According to the AVCA and EY exit survey, in 2017, exits via MBOs was 20%, up from just 2% in 2016 and 9% in 2015.

As the African PE landscape matures, the opportunities for exits will improve as investors continue to diversify their PE portfolios. Exits via secondary buyout markets and to strategic buyers is likely to remain the primary exit strategy for African GPs. Due to the challenges facing PE backed IPO exits on Africa’s stock exchanges, we expect this strategy to remain subdued over the medium-term. However, as African capital markets broaden and deepen, this strategy will increasingly represent a larger proportion of exits on the continent over the long-term.

– Adam Bennot,
Senior Associate, Unlisted Investment Services, RisCura

* This article first appeared in INTO AFRICA on 6 May 2019

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