from The Africa Report..
May 30, 2013
Research that benchmarks African private equity against the global market for the first time shows the industry is far maturer than analysts had previously thought.
For a long time investors saw the African market as the toddler of global private equity – it would grow up into something promising, but not for a decade or so.
Now a refreshing burst of new research pointing to a good rate of return on investment in African private equity suggests that it has been a precocious adolescent all long.
Two reports released in partnership with the African Venture Capital Association (AVCA) were published in early April at the association’s annual conference in Cape Town.
In the first ever index to benchmark African private equity against the rest of the world, AVCA and US consultancy Cambridge Associates found African funds returned 11.2 percent for the 10 years up to the end of September 2012.
This put African private equity just below the emerging market average of 11.8 percent.
However, Cambridge found that Africa outperformed other markets in the aftermath of the 2008 financial crisis.
“If you go to 2010, Africa was way ahead of the emerging markets, just nobody knew it at the time,” explains Eric Johnson, managing director at Cambridge Associates.
Returns for the 10 years to the end of 2010 were 13.9 percent for Africa, compared with 10.7 percent for emerging markets. In 2008, the difference was even starker – 10.2 percent for Africa compared with 3.1 percent for emerging markets.
“Those earlier fund vintages were actually quite competitive and ahead of a lot of the other emerging markets,” says Johnson.
The second report, from the AVCA and Ernst & Young, analysed a sample of 62 African exits by private equity firms between 2007 and 2012. They found that those investments generated almost double the returns of the Johannesburg Stock Exchange’s Africa All Share Index.
“Private equity outperformed in other markets as well, but this is a really fantastic result for Africa,” says Graham Stokoe, Africa private equity leader at Ernst & Young. He says it proves the private equity model could deliver superior returns in Africa.
“Our industry is a lot more institutionalised and professionalised than one would think, relative to its age,” adds AVCA chief executive Michelle Kathryn Essomé, who points to a world-class generation of fund managers working in the sector.
The report found that there were 22 exits in 2012, the highest number since before the financial crisis.
Private equity managers fundraise from institutional investors such as pension funds and state-backed development finance institutions then create funds that usually have a five to 10-year horizon.
While initial public offerings are a common way to exit investments, liquidity limitations in Africa mean that sales to other companies are more common.
As a result, African private equity funds hold onto their portfolio companies for longer than those in other regions – an average of 5.1 years compared with 4.5 years in Latin America and the United States.
After a boom in fundraising from 2005 to 2007, Stokoe says pressure on funds to exit before their investors need the money back is driving the uptick in exits.
“Europe’s got a much bigger backlog and problem with exiting out of everything in their time horizons on their 2005-2006 funds than Africa,” he says, “but Africa does have a backlog as well, which is definitely going to drive a lot of exit activity in the next three years.”
Some funds can employ options to extend their life if they cannot find a good way to exit their investments profitably. Stokoe says “time will tell” whether this will happen among Africa-focused managers.
There has been an increase in the number of regional companies acting as strategic buyers. For deals of $5m-$20m, 50 percent of trade sales in the period studied came from regional companies.
Multinational companies have been slow to invest, showing most interest in deals worth more than $50m, although Ernst & Young predicts they will be more active.
As a number of global managers start focusing on Africa, such as the US-based Carlyle Group, which is currently fundraising for a $500m Africa-focused fund, they realise the need to create teams with local experience.
They are not, says Stokoe, going in search of large leveraged buyouts, which remain rare on the continent. Developed markets are already moving away from leveraged deals, he says, having “seen the pain of the over-leveraged deals in 2005, 2006 and 2007”.
Development finance institutions have pushed environmental, social and governance policies to the top of the agenda.
The research confirms that this helps to improve returns. Investors who made governance changes to portfolio companies saw relative returns that were almost twice as high as those who did not.
Investors who shared their networks and expertise with their investee companies recorded returns 2.4 times higher than those who did not.