In the same week that McKinsey published its follow-up to the 2010 “Lions on the move” report, the Boston Consulting Group released “Why Africa remains ripe for Private Equity” last week. This new report finds that while the continent remains one of the world’s growth opportunities for private equity, to generate the returns investors expect needs funds to consider more flexible investment strategies and new types of corporate targets.
Since the early 1990s, the number of private equity funds active in Africa has grown from around a dozen to more than 200 today, managing funds upward of $30 billion. This rapid growth combined with the downturn in some of Africa’s largest economies has given rise to concerns that a bubble may be emerging in the industry. Today, most private equity funds and other principal investors manage their risk by leveraging local partners, limiting their investments to minority stakes, and typically only investing in profitable companies with proven track records posting annual revenues in excess of $100 million.
“Too many private equity investors are pursuing the same kind of target with the same kind of deal structure,” said Patrick Dupoux, a senior partner and a co-author of the report. “But look beyond the narrow cohort of Africa’s corporate elite and you’ll see that the continent offers real opportunities. Some of the most promising targets in Africa are companies that are still off the radar of most funds.”
The report notes that funds are going to have to become more adept at pursuing alternative investment approaches if they are to be successful at meeting the rising expectations of their investors. As more global institutional investors join the development finance institutions who have been the backbone of private equity investment on the continent, prices for stakes in large African companies will rise, complicating the abilities of private equity funds to deliver satisfactory returns.
The report recommends that private equity investors consider other investment approaches, such as majority stakes, strategic partnerships, and evergreen funds, rather than only funds with timing constraints for divestiture. It also suggests that funds look at a wider range of targets, such as Africa’s growing pool of dynamic smaller companies with significant growth potential.
Despite the current challenges created by the commodity slump, the report finds a number of factors support a positive outlook for private equity on the continent. As well as having strong macroeconomic fundamentals, the amount of private capital under management in Sub-Saharan Africa is very low relative to other regions of the globe, the pool of investment targets is growing and the investment environment is improving.
Significant challenges remain for the industry. Africa’s financial markets are still underdeveloped, however, making it necessary for private equity firms to invest in a strong local presence. Access to information is limited and a lack of investment banks and other middlemen that typically screen opportunities mean funds must be able to originate their own deals and perform their own due diligence. Finding experienced people who can help create value in their holdings by providing management expertise and strategic guidance is also critical.
Developing new investment strategies and building local capabilities will add to costs, but will also help funds develop powerful competitive advantages. As Dupoux says, “Organizations that can navigate Africa’s complex investment environment and add value to companies are likely to gain an inside track on the best deals in what promises to be, over the long term, a significant growth market for private equity.”