Africa Finance Forum Blog
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Investing in and building out much needed infrastructure is one of the key challenges facing Africa. The task is vast and complex. But without making significant headway in meeting this challenge Africa’s promising economic renaissance could be imperiled. Africa is enjoying the benefits of a decade long boom in commodity prices which has propelled economic growth. It is hard to imagine this growth can be sustainable or that its benefits can be broadly shared without investment in roads, rail, ports and maybe most importantly power.
Meeting this challenge will need African governments to think innovatively, to push forward boundaries on the development of their financial markets and to ensure they have ambitious and well thought out plans for infrastructure.
Finance remains a crucial constraint. The African Development Bank and World Bank estimate the financing needs to be in excess of $93 billion per year (AICD, 2009). The Programme for Infrastructure Development in Africa (PIDA) study on key regional projects, endorsed by the 2012 African Union (AU) Summit, estimates a need of $68 billion out to 2020 just for that particular list of projects. These numbers are daunting. But the challenge has to be met; the future of Africa demands it.
In meeting these funding needs African governments need to be aware of several emerging and important trends. Firstly, it is increasingly felt that the financing strategy should be determined by African (ie the users of funds) not just by the international community (ie the traditional providers of funds). Secondly, African governments are aware that they can use the global markets as a source of funding at competitive rates and for significant amounts. The global investor base is more open to African credits than ever before. This has been well underlined by the recently successful bond offering by Zambia and by the performance of outstanding issues from the likes of Ghana and Nigeria.
But a clear new departure for the way forward is for Africa to think about how to use its own resources to meet it financing needs. In particular how can African capital markets be developed to provide finance for infrastructure.
One innovative instrument that has been used in other emerging markets is the ‘project bond’. This is eminently suitable for infrastructure finance because many infrastructure transactions are financed using ‘project finance’. Thus a ‘project bond’ is merely a bond instrument that works similarly to a project loan in that the financing is executed directly with the project vehicle or Special Purpose Vehicle (SPV) and the bond is repaid from the cash flows of the project. While the credit quality of the sponsors may in some affect the credit quality of the SPV, a project bond does not rely directly on the credit quality of the balance sheet of the sponsors.
Project bonds have been broadly used in other countries most notably Chile, Malaysia and Korea (Mbeng Mezui, 2012). In each case the government implemented reforms in the pension and insurance sectors to unlock long-term capital. This created a deep pool of institutional investors with demand for low risk, long dated assets in domestic currency. This investor base is ideally suited to buying project bonds or infrastructure investments. That they have a preference to invest in local currency meant that the projects could avoid any currency mismatches between revenues and debt service. In addition to policies to develop an institutional investors base these governments also crucially implemented economic policies that prioritized macroeconomic stability particularly in bringing down inflation and prevailing interest rates. Indeed in Chile the economy undertook broad based indexation which gave long term fixed income investors additional comfort in holding long term assets. That was an innovative solution used by policy makers and financial institutions in Chile and there is nothing to say the same structure needs to be adopted by others. But what is important is to have a long term strategy of seeking economic stability and creating institutions that will accumulate capital and will focus investment on long dated assets.
Alongside policies that can encourage the creation of pension funds is a need to ensure securities market regulations are in place to give investors comfort that their interests are protected and that procedures exist that enable institutions to invest and meet their fiduciary requirements. It is important once securities markets are created that legislation be passed to ensure that issuers provide satisfactory levels of disclosure and that the information given in prospectuses or other documents is transparent and meets the standards of institutional investors. It is vitally important that as domestic African capital markets develop they adopt internally acceptable standards. This is vital to building investor confidence.
Finally, governments must establish professional and efficient infrastructure departments that undertake the work necessary to get projects approved and ready to be taken to the financial markets.
If African governments can successfully implement these various policies not only will catalyze significant volumes of domestic capital into their infrastructure programmes but they will also set in motion the development and greater sophistication of their financial markets. This will be hugely beneficial to those economies as they face the challenges of development in the years to come. Project bonds can be the instrument to catalyze these various changes.
Already many African have in place the institutions and regulatory framework to allow for the issuance of project bonds and other innovative products that finance infrastructure. These should be strengthened and stakeholders should be encouraged to use the domestic capital markets. Alongside this African banks should be encouraged to work across the continent and to augment the capabilities of the capital markets.
International markets are undergoing great change. Many international banks are pulling back from infrastructure. But with supportive policies African countries can ensure they have increasing financial resources from its own markets. This will only serve to make Africa’s recent resurgent growth more sustainable and robust.
Bim Hundal: Chairman Lion's Head Global Partners
Cedric Mbeng Mezui: Senior Financial Economist, African Development Bank
Private equity investment in Africa has been a hot discussion point in the global financial industry in recent times. This has been spurred by the continent’s mouth-watering growth prospects, and obvious low correlation in the developed world - which has suffered a shortage in growth opportunities.
This has undoubtedly been good news for private equity fund managers in Africa. The spotlight on the industry means managers are now speaking to a slightly wider investor base, some of which have little knowledge of Africa.
The discussions are, however, turning out to be more challenging than originally anticipated. A Johannesburg-based fund manager recently shared his surprise at walking into a meeting with a potential US-based investor who was eagerly waiting for him. The investor wanted the manager to show him exactly where he planned to invest the money.
Educating global investors
Indeed education must now be embraced as a core part of fundraising for Africa. For inexplicable reasons, some global investors are still grappling with the concept of Africa being a continent with at least 50 countries, with differing dialects, cultures, and therefore styles of doing business. For some even, Africa is one country.
As such, some global investors need to be educated on the different political systems across the continent. Fund managers often find themselves having to say: “No, we do not think that the Arab Spring will spread to Sub-Saharan Africa, as that is more of a Middle East and North African affair. The dynamics are not the same.”
It is therefore of no surprise that the bulk of the fundraising discussions get nowhere. After expensive and long fundraising trips abroad, many return home with promises of “We will look into this further and get back to you. Don’t call us, we’ll call you.”
Tapping local capital
Needless to say, there should be less dependency on global investors, as Africa is well endowed with wealthy pension funds, insurance companies and private individuals. So why does not Africa follow the footsteps of Brazil for example, which has done exceptionally well in raising funds from its local institutions?
The short answer is, raising funds this way is a tumultuous journey. Those that have succeeded have done so after a lot of longwinded discussions, with managers again finding themselves in the role of education providers. For this group of investors however, the lessons tend to be more around the basics of the private equity asset class, since knowledge of this investment vehicle is still not very widespread in Africa.
The bulk of local pension funds have also been struggling with government regulations that limit investment into the asset class, or discourage investment in funds that would be allocated in part, outside their home countries. However, some say fund managers are also to blame for their struggles to raise money locally. When setting up their funds, a good number rush to structure their vehicles to suit non-African based investors, totally ignoring the recommendations of local institutions. By the time managers think of raising money locally, it is too late – as the fund structures would have already been fixed by then.
Navigating governmental challenges
Furthermore, a good number of African governments have a lot of work to do to encourage the growth of the asset class. South Africa has been at the forefront with efforts to reform, followed by Rwanda, Botswana, Namibia and Nigeria. However the bulk of governments in Sub-Saharan Africa are yet to muster the political will to make it easier for local institutions to partake in private equity. For some reason, a number still rely quite heavily on financing from donors and development finance institutions (DFIs).
The reluctance to grow beyond DFI funding seems to stem from a lack of adequate knowledge of private equity operations – and again we find a new type of actors with a need for training. The murky knowledge of the asset class is reflected in a recent statement made by a vice president of a Southern African country: “We do not want private equity investors, because they are speculators. We want investment from the development finance institutions.”
Needless to say, such mutterings are worrisome. Firstly, private equity capital follows a long-term investment strategy, which makes it difficult to be speculative. Investors tend to hold companies for at least four years, and in Africa, even longer. During this holding period, managers work very hard to add value to the company, as they would be looking to exit with a profit.
The statement by the vice president also indicates a lack of awareness that DFIs are actually the backers of most private equity funds in Africa. DFIs invest in private equity funds in order to develop robust capital markets. DFIs are structured to be the initial risk takers, and are not meant to be the primary investors in any one country in the long-term.
Overcoming deal-making woes
In addition to fundraising challenges, managers also have to deal with deal-making woes. Fund managers find themselves struggling to close deals, particularly for the much sought-after deals of more than $50 million. Deal-making this year has been less than spectacular, with a dismal number of mid- to large-cap deals transacted. Small-cap investors seem to have had more success, but even they struggled to convince entrepreneurs to abandon their majority stake.
The bulk of the problems can be attributed to competition between financial and strategic buyers. Increasingly, competition has been coming from large global companies, looking to tap into Africa for growth. As these purchases are strategic for them, they are usually prepared prepared to pay higher prices for acquisitions. Local companies have also been quite competitive, case in point being the group Tiger Brands of South Africa, which recently acquired 63.5% of Dangote Flour Mills.
Perhaps managers seeking large deals should go back to their roots and consider how Celtel was created – a company which continues to be the foster child of private equity in Africa. As opposed to waiting for a readily created platform, maybe managers need to roll up their sleeves and look at creating businesses from scratch.
A good example of a company born this way is Helios, which created a Pan-Africa telecommunications tower-sharing platform Helios Towers Africa.
Fund Managers also bemoan the fact that they have to spend a lot of time educating entrepreneurs on the workings of private equity, before they can convince their prospects to share with them fairly. The challenge does not seem to be that entrepreneurs do not know what private equity is, but that a number do not fully understand what needs to be in place to accommodate private equity funding. Managers estimate that over 90% of the companies they look at are not ready for investment.
Creating a strong foundation
There is no doubt that the lack of publications on African financial industries means that the broader entrepreneurial base is less educated on the asset class. A number still look to bank loans to finance their growth. One wonders if there should not be a broader strategy by governments and investors to develop a strong information support system, which will not only educate the pension funds and private investors, but also the entrepreneurs.
Needless to say, developed countries have proved that a strong information support platform is central to the efficiency of a financial industry. This creates a platform of informed industry participants that fund managers can tap for both funds and deals.
This will also allow a conduit for global financial journalists to accurately report on the continent, educating global investors that are less familiar with Africa. Until then, fund managers seem to have to continue to live between a rock and a hard place: having to educate investors and governments on one hand, and entrepreneurs on the other.
Gail Mwamba is the managing editor of Private Equity Africa, a UK-based financial publication that covers private equity fund and institutional investing in Africa. (www.privateequityafrica.com).
Her academic background includes a Masters in Business Administration in Finance (MBA Fin), specializing in financial risk management and Mergers and Acquisitions (M&A). Her financial journalism career includes roles at specialist financial publications covering private equity, structured products, FX and risk across Europe, Asia and the US. She has also covered key topics for Africa-focused publications such The Financial Times This is Africa and the Africa Investor.