Capital V, January 2017

Private Equity: the choice of Africa

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Over the last few years, emerging markets have evolved into a critical pillar of global investors’ strategies. Private Equity firms and other investors turned to emerging markets as an engine of growth. For a few years now, the African continent is seen as a growth driver for Private Equity. It is currently the world's fourth most attractive destination for investment, while just five years ago Africa ranked near the bottom of the list.


Why invest in Africa ?

Although there has been a substantial slowdown in growth, in a global context, Sub-Saharan Africa will remain one of the fastest-growing regions in the world for the foreseeable future.

For a decade fostered by an increasing middle-class and favorable demographics, Sub-Saharan Africa`s average GDP growth rate was close to 6%*. In 2015, growth slowed substantially to 3.4%*, and for the year just ended, it is set to be a bit lower. Some of the key economies — including Angola, Nigeria and South Africa – are under pressure and are likely to remain so over the next year. Although economic growth across the region is likely to remain slower than the past decade, the main reasons for a relative slowdown are not unique to Africa. The negative factors impacting African economies are the same as those weighing down the global economy: a general slowdown in emerging market economies, and in particular the rebalancing of China’s economy; ongoing stagnation in most developed economies; lower commodity prices; and higher borrowing and capital costs.

While some economies struggle, the International Monetary Fund’s most recent forecast indicates that the overall Sub-Saharan African economy will be growing at more than 5% per year until at least 2020. According to the latest AVCA’s** Limited Partner Survey, Private Equity investors exhibit a general high confidence towards investments in Africa: 57% of LPs plan to increase their allocation to Private Equity in Africa over the next three years, 66% would be willing to invest with a first-time General Partner in Africa and 58% predict that their return will exceed 2.5x over a ten-year period.

Despite current uncertainties, long-term outlook for economic growth and investment in Africa remains positive.


What to know before investing

Even though African investments often suffer from a misperception of risks, especially over-estimated by investors with no exposure to the continent, a common set of barriers and challenges should be kept in mind when investing in African Private Equity.

Macroeconomic factors and political risk remain on the top of the list of those challenges. AVCA’s Limited Partner Survey reveals that currency risk is the biggest challenge to LPs when investing in Africa. Africa’s demographics is possibly one of the most important political factor. Young populations, with little memory of past historical drama, may bring political instability when job creation cannot keep up.

Usual risks inherent to Private Equity industry are also enhanced in Africa. General Partners hesitate to invest in opportunities, even in the ones which seem matching their strategy, due to the lack of information and transparency in the market. In these conditions, dry powder may take time to elapse in a market where small deals prevail. When it comes to divesting, General Partners have to deal with a shortage of exit options. IPO`s are relatively rare, even though progress has been made in linking the stock exchanges of Nigeria, Ghana and Ivory Coast. This explains that African Private Equity funds tend to hold their portfolios for a longer period. In addition, the market still relatively young, Limited Partners may face difficulties to find a General Partner that checks all the boxes of their expectations, especially when it comes to experiences of the market and performance track records.

Eventually, local regulatory frameworks may also be an obstacle. Multiple tax jurisdictions and legal restrictions on financial operations, whereof access to local capital such as domestic pension funds, exchange controls, local content requirements and ownership restrictions, slow down the development of Private Equity in the continent. Regional integration is progressing but there is still a long way to go. International regulation has however a positive impact, especially with regards to fight against bribery, anti-money laundering, transparency and corporate governance.


Luxembourg, the next European hub to invest in Africa?

Africa attracts Foreign Direct Investments (FDI) from a diverse and growing group of investors. In 2015, the US retained its position as the largest investor in the continent, despite a 4.0% fall in FDI projects. Historical investors including the UK, France, the UAE and India expressed renewed interest in Africa. New investors also came up in the ranking, especially Luxembourg, which became among the largest 15 investors in 2015 (source: fDi Markets).

Luxembourg is indeed gaining a foothold in the African market. The Grand-Duchy is in negotiations to increase the number of double-tax treaties with African countries and benefits from its proximity with European Institutions, such as the European Investment Bank. This may be a comparative advantage when African LPs see the participation by known or respected LPsas a significant factor when evaluating African GPs.

Over the past ten years, Luxembourg has passed a series of laws very favorable to the Private Equity industry represents a reliable alternative to historical players in the African Private Equity market.