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Investing against the flow

By By Peter Guest | Published:  28 December, 2009

Private equity is proving a popular vehicle for private and public investors in Africa as it demonstrates development benefits and high returns

According to research from the Emerging Markets Private Equity Association, fundraising for sub-Saharan African funds grew from $800m in 2005 to $2.2bn in 2008. Perhaps more surprisingly, fundraising in the first half of 2009 held up well despite the economic downturn curtailing GDP growth across Africa to just over 1 percent. EMPEA’s figures also point to a diversification of the funding base – in 2006, only 4 percent of the limited partners surveyed by the trade association were invested in African funds, compared to 38 percent in 2009.

While private equity companies echo the line of many corporate and financial investors in Africa that the past decade of reforms and high growth rates make the continent an important destination for capital, this pace of fundraising is still counterintuitive. Portfolio investors in general fled from African markets in 2008 and returned very cautiously in 2009, and listed equity funds fell victim to constrained capital in international centres. Institutional investors pulled out, leaving stock markets across the continent suffering from a lack of liquidity.

Private equity in developed markets was seen to be struggling. In the US, first half 2009 fundraising was down to around 35 percent of 2008 numbers, according to Dow Jones Private Equity Analyst. Peter Schmid, head of Africa for private equity firm Actis, points to a growing awareness of the structural shift in the global economy to explain why investors’ appetites for emerging markets in general are increasing. To a large extent, economic growth, which is the main driver of returns, is to be found in emerging markets, where populations are increasing and consuming middle classes are evolving.

This is likely to have been the case for the past five or more years, but the economic downturn has widened the gap between developed economies and the major emerging markets, such as India and China. The latter, in particular, has begun a robust recovery. Mr Schmid believes that this will be reflected in a rebalancing of investors’ portfolios, with a greater allocation given to emerging markets.

Where Africa fits in is perhaps less clear. Although managers like Mr Schmid will always advise investors to diversify broadly across emerging markets in order to mitigate against risk and volatility, the frontier nature of Africa’s markets means that they are not automatically considered by investors.

“China and India are high growth, very exciting, but the problem with some of those markets is that you’ve got a situation where there is a lot of competition and… I think the risk of business failures in those markets is higher because of that increased competition,” Mr Schmid says. “In India, the number of private equity funds is enormous. Every deal is competed by 10 or more funds, which means that pricing is particularly high.”

The ability of fund managers to do deals in India is constrained, Mr Schmid says, not just by pricing but by the viability of the country’s stock market, which offers another route for companies to raise capital. Africa’s stock markets, barring a minority, are underdeveloped. Private equity is a valuable source of capital for growing companies in markets where banks are less active, and the opportunity set is both strong and relatively easy to access. “You are able to buy market-leading businesses in Africa at half the entry multiple that you would pay in any other emerging markets, and on top of it, those companies have very little competition, so your margins and your return on capital deployed is substantially higher than in most places in the world,” Mr Schmid says.

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