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Private Equity
In the Shadow of Giants
                       INNOVATIVE APPROACHES ALONG
    THE INVESTMENT VALUE CHAIN IN SUB-SAHARAN AFRICA
About the Study
This paper draws primarily on 43 formal interviews and more infor-
mal conversations with a wide range of stakeholders in the African
private equity ecosystem including general partners (GPs) and
limited partners (LPs) (both prospective and currently engaged
in the region), research companies, solicitors, fundraising agents,
recruitment consultants, and development finance institutions (DFIs).
We also consulted a range of press articles, internet sources, reports
and studies of the private equity sector, most of which are listed in
the endnotes.

This opinion piece does not aim to be a fully quantified primary
research report classifying countries or players by future attractiveness or
past investment returns. Rather, we have sought to collate the opinions of
stakeholders in the industry to create an overview of the sector and facili-
tate a better understanding of the challenges they face and the innovative
approaches to the business model they have made.

We have, however, included an appendix containing the list of firms
interviewed with a brief classification to give readers a sense of the
industry landscape and an overview of the sectors and countries most
attractive to those firms.

Private Equity in the Shadow of Giants is aimed primarily at new-to-Africa
actors interested in sub-Saharan Africa rather than the larger scale,
established classic leveraged buyout (LBO) market in South Africa and
elsewhere around the globe, hence the title.

Christoph Andrykowsky, Victoria Barbary and Olivia Toye conducted
this research through interviews from August to October 2011 using
Monitor Group’s and the South African Venture Capital Association’s
(SAVCA’s) extensive network.




                                                         © MONITOR COMPANY GROUP L.P 2011
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Table of Contents
Executive Summary.................................................................... 1

Introduction................................................................................. 6

Africa’s Challenges...................................................................10
      PERCEPTIONS........................................................................... 11

      COST TO SERVE........................................................................ 12

Private Equity’s Challenges.................................................... 14
      FUNDRAISING.......................................................................... 15

      DEAL FLOW ............................................................................ 20

      TALENT................................................................................... 23

Innovative Approaches Along the
Private Equity Value Chain..................................................... 26
      1. FUND STRATEGY.................................................................... 28

      2. FUNDRAISING...................................................................... 29

      3. DEAL SOURCING.................................................................... 32

      4. DEAL EXECUTION...................................................................34

      5. POST-DEAL HOLDING..............................................................35

      6. EXITS................................................................................. 40

      7. COST BASE............................................................................ 41

Where Does This Leave Us?.................................................. 44
      ENDNOTES .............................................................................. 47

Appendix.................................................................................. 49

Acknowledgements................................................................. 52

About the Authors.................................................................... 53




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      Executive Summary
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                     		1
                                                                          Executive Summary




MONITOR HAS BEEN SERVING THE AFRICAN FINANCIAL
investor community for almost a decade and felt that given the recent real and
perceived increased interest in the continent, the timing was appropriate to capture,
aggregate and elevate the financial investment actors’ views and opinions on how
to best benefit from this positive trend in sub-Saharan Africa, home to the globe’s
last large-scale frontier markets.

As numerous recent reports have attested, including our own, Africa from the
Bottom Up, Africa comprises 55 rapidly urbanising, true frontier markets that have
moved beyond pure commodity extraction to a real consumer-led growth play. For
years, sub-Saharan Africa has had a terrible image abroad, with more attention
being paid to the bad news emanating from the continent – civil war, famine, pi-
racy – than the good. But perceptions are now improving and catching up with the
realities that many investors find on the ground: almost under the radar, established
players, even outside the South African market, have made good and consistent
returns. However, the bubble-like interest, despite the hype, has not yet resulted in
a commensurate inflow of capital.

African markets are still challenging to operate in. The cost to serve, execute deals
and deploy capital is still high due to a fragmented, largely unsophisticated market
with a huge infrastructure and talent backlogs, which impedes economies of scale




ELDERS GATHER TO MAKE A DECISION IN CÔTE D’IVOIRE:
In sub-Saharan Africa, the deal-making process is localised and often
family orientated making deal flow challenging.




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     Executive Summary




            and ease of doing business. For private equity players, this manifests itself in three
            core activities:

            •	 Fundraising: Prior to the global financial crisis, private equity
               investment in sub-Saharan Africa was largely the preserve of
               development finance institutions. However, more true frontier
               investors are exploring the region, seeking alternative African
               investment exposure that outperforms the small public markets
               through innovative funding structures. This has improved the
               fundraising opportunities for those GPs with differentiated
               business models. Consequently, the bar has been raised by
               institutional investors and teams have to demonstrate more value
               creation through true operational improvement, rather than just
               market growth or financial engineering.

            •	 Deal flow: Across the region, competition for deals has increased
               with the number of financial investors and renewed interest
               from (African and global) trade buyers, foreseeably turning the
               region into a vendors’ market. However, with the exception of
               the giants – South Africa and Nigeria – deal flow is likely to
               remain in the small- to mid-cap range. In this space, GPs supply
               growth capital to founder-led firms that aim to expand regionally,
               require corporatisation and upgraded governance processes and
               management systems, as they are rarely “investment ready” by
               Western standards. This is exacerbated by the nascent character
               of the industry in much of the region. Consequently, there




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                                                                        Executive Summary




  is an underdeveloped deal intermediary and service provider
  ecosystem. Entrepreneurs rarely seek out private equity as a
  way of growing their business as they are often unaware of
  it, partly because there is an almost complete absence of a
  venture capital industry in the region, which would typically
  feed the deal pipeline from the bottom.

•	 Talent: This remains one of the biggest challenges, both
   at GP and asset level. However, strides can be made by
   employing a complementary blend of skills of returning
   expats with best in class global training and local talent with
   local networks, experience and potential.

To address these challenges private equity players have innovated along the private
equity value chain.

•	 Fund Strategy: Players are increasingly specialising and focusing
   on niches, pointing at a much more sophisticated market
   than the assets under management and market penetration
   would suggest.

•	 Fundraising: New sources of patient capital, beyond development
   finance institutions and traditional institutional investors, are
   entering the scene. Frontier investors, family offices and funds
   from other emerging markets are seeking alternative structures in
   the region to deploy capital.

•	 Deal Sourcing: Just bringing in money is no longer good enough
   for a GP to secure a controlling (but not always a majority)
   stake. In return, vendors are seeking partners with networks and




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     Executive Summary




               capabilities to unlock value. Creating concepts or platforms for
               regionalisation is a theme that many players are using to create
               value in their portfolio companies.

            •	 Post-Deal Holding: Although many actors understand the need to
               be actively engaged with their assets after the cheque is written,
               few of them have cracked the post-deal value-add nut. The
               implementation of value-enhancing changes in founder-led firms
               is still one of the key challenges, for private equity investors in
               Africa, but dedicated full-time (non-deal) operations executives
               are still the exception. Consequently, teams rarely implement
               proper dashboards, balanced scorecards or other cross-portfolio,
               value-based monitoring and post-deal value driving tools.

            •	 Exits: There is a wide range of potential exits, but a strong
               preference to extract premiums from strategic sales to
               multinationals seeking African growth platforms. Some GPs
               are also beginning to implement sophisticated third-party exit
               grooming, signifying increasing market sophistication.

            •	 Cost Base: Execution and post-deal engagement costs in Africa
               are still relatively high. While many investors choose to locate
               in London and partner with African companies, this model
               is unlikely to attract funding in future. The need to find a
               cost-effective way of keeping “boots on the ground” through
               leveraging flexible operating models and local networks is
               becoming more vital than ever.




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                                                                            Executive Summary




Overall, our study uncovered an attractive industry in flux, with increased competi-
tiveness, but sufficient uncharted territory to grow from its still small base. Many
questions need to be answered about the sustainability of many of the innovative
approaches that have been proposed, or whether they are too far ahead of the
curve in terms of investor and investee perceptions and expectations. It will be
interesting to observe which ones will get to scale in their chosen niches.

On balance, the easy deals have been done. GPs now have to be on the ground,
have an operational value-add track record and have a local network to position
themselves as the preferred provider of capital. Financial skills are table stakes; be-
yond that, GPs will require specialised commercial skills to extract value. However,
few GPs include individuals with such experience on their payroll or embed this
expertise in the philosophy of the GP franchise.

In the end, private equity in sub-Saharan Africa is a people business, and whoever
institutes value-driving change the quickest by being closest to the assets is most
likely to win.




© MONITOR COMPANY GROUP L.P 2011
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Executive Summary




Introduction
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                     		7
                                                                                   Introduction




THE LAST TWO YEARS HAVE SEEN A LARGE NUMBER OF
reports in which consulting firms and research houses are proclaiming “now’s the
time for Africa” (lead by Monitor’s Africa from the Bottom Up in 2009). This follows
a wave of growth, development and increasing political stability, albeit from a very
low base, that has engulfed sub-Saharan Africa over the past decade. Since 2000, the
region’s GDP has increased at a compound annual growth rate of 5%. Although it
halved during the global financial crisis, this level was almost restored in 2010.
Assuming no further significant downward spiral in the global economy, the region
is expected to grow by 4.8% this year (5.8% excluding South Africa) and exceed this
rate in 2012 and 2013 (with some sources quoting up to 10% in some sub-regions).1

Much of this growth is driven by private investment as investors wake up to the
increased publicity of finding significant alpha in Africa.2 Foreign direct investment
(FDI) is the most important source of private capital flows to the subcontinent.
Although in 2010 FDI inflows to sub-Saharan Africa as a whole had fallen by a fifth
($10 billion) since their 2008 peak of $48.1 billion, this is still an increase of 150%
in the past half decade. It also hides a significant uptick in certain economies and
regions where there are specific opportunities: the discovery of oil in Ghana saw
FDI inflows increased by 1.5 times, while the expansion of mobile telecoms in the
Democratic Republic of the Congo has seen FDI inflows increase four times to
$2.9 billion.3

It is often argued that Africa’s rapid growth has been driven by the continent’s rush
to exploit the region’s abundant natural resources, such as oil, bauxite, precious
and “rare-earth” metals, diamonds, and 630 million hectares of cultivatable agricul-




AFRICAN BUSHVELD
The untouched beauty and wildlife in large parts of Africa creates ample
tourism and eco-tourism investment opportunities.




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     Introduction




             tural land. While commodities have attracted foreign attention, most notably from
             China, and account for around 40% of FDI, sub-Saharan Africa’s growth is not just
             being driven by primary goods. Natural resources directly accounted for only 24%
             of the continent’s GDP growth between 2000 and 2008.4

             The vast majority of growth is derived from manufacturing and service industries
             including construction, retail, banking and telecoms, which have grown two to three
             times faster than those in OECD countries. This has been driven by urbanisation
             and the African consumer’s rising levels of discretionary income. Although sub-
             Saharan Africa remains the globe’s least urban region, its cities have grown at 3.3%
             annually over the past decade: by 2032, over half the African population will live in
             urban areas.5 With cities driving growth and development,6 Africans are becoming
             more affluent. The number of Africans with discretionary spending power, exclud-
             ing the wealthy elite, more than doubled from 151 million to 313 million between
             1990 and 2010, and is now of comparable size to the same class in India or China.7

             And yet, despite all the hype, private equity investment in sub-Saharan Africa
             remains at modest levels. One of our LP interlocutors commented that “the nature
             of our industry is that there is a lot of looking, but not a lot of dipping into one’s
             pocket. There has been an almost bubble-like interest in Africa, but it hasn’t been
             demonstrated by any huge uptick in investment.” This is underlined by Emerging
             Markets Private Equity Association (EMPEA) data, which shows that fundrais-
             ing for the region lags behind other emerging markets. In 2010, $1.5 billion was
             raised for private equity funds in sub-Saharan Africa (6% of the total for emerging
             markets); that year, China-focused funds raised $7.5 billion and Indian funds $3.3
             billion. Despite the attention sub-Saharan Africa has received recently, in the first
             half of 2011 the region’s funds raised $1.1 billion, largely comprised of Helios
             Investment Partners’ $900 million fund, the largest pan-African fund to date. This
             is dwarfed by the $10.3 billion China-dedicated funds raised during the same period.




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                                                                                                                                                                                                                   Introduction




Private equity penetration in sub-Saharan Africa is also amongst the lowest in the
world; in 2009 it was only 0.16% of GDP, before falling to 0.06% in 2010 (see
Figure 1).
Figure 1: Emerging market private equity investment as percentage of GDP 2009 – 2010
                                                                        ,


                          1.2
                                        1.13
                                                                                    2009
                                                                                    2010
                          1.0
                                                  0.90


                          0.8
  PE Investment/GDP (%)




                                                            0.63
                          0.6                            0.57


                                               0.43                       0.44

                          0.4    0.34
                                                                   0.32
                                                                                                                                                                                                     0.26
                                                                                    0.23
                                                                                                                                               0.21
                          0.2                                                                     0.16                           0.16
                                                                                           0.13                                                                            0.11
                                                                                                                0.10
                                                                                 0.06                                     0.08                                                                                     0.08
                                                                                                                                        0.06          0.06   0.06                 0.04
                                                                                                         0.02                                                       0.04
                                                                                                                       0.01                                                              0.01 0.01          0.01          0.01
                          0.0
                                 United United           Israel     India        Brazil     China         Russia Poland           SSA          South         Japan         MENA           Mexico     South         Turkey
                                Kingdom States                                                                                                 Korea                                                 Africa*


                                Source: Emerging Markets Private Equity Association.
Source: Emerging Markets Private Equity Association
                                *Note: the South African figures are likely to include government and captive player data less likely to be included in the other country figures.
*The South African figures are likely to include government and captive player data less likely to be included in the other country figures


The relatively low penetration points at an early-stage market, with the exception
of South Africa. Returns have, however, been consistent and above average; all
of our GP interviewees expected returns of over 20% in markets outside South
Africa, with established players reporting in excess of this figure. Indeed, one of
our interlocutors told us “if you can’t make 20% in Africa, then you shouldn’t be in
the private equity business”. The longer-established players have consistently out-
performed the local public markets and other emerging regions. As the perception
with reality is catching up, more new entrants are now seeking this alpha.




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Africa’s Challenges
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                       		11
                                                                             Africa’s Challenges




INVESTING IN SUB-SAHARAN AFRICA IS CHALLENGING.
Despite the growth story, African opportunities are often harder to exploit than
that in many other high-growth emerging markets like in Asia and Latin America.
The challenges GPs face broadly fall into two categories: investor perceptions of
the region and the high cost to serve.


Perceptions

Despite the hype around sub-Saharan Africa as an investment destination, it has a
terrible image abroad.8 Coverage of the region and of its prospects has been relent-
lessly negative, even from acknowledged friends and advocates. The “CNN Effect”
has meant that the stories that grab headlines around the world – the civil war in
Côte d’Ivoire, Somali piracy, the HIV/AIDS plague across the subcontinent, and
the recent humanitarian crisis in East Africa – tend to crowd out good news
stories – the region’s growing political stability represented by transparent elections
in Ghana and the recent peaceful change of ruling party in Zambia. Much like the
media itself, investors tend to take more notice of the three minutes they see on the
television news rather than getting into the region and looking and understanding
the market dynamics from the ground up.

Conversely, the opposite is also increasingly true. As Western markets grow only
sluggishly in the wake of the global financial crisis, and European governments
struggle to persuade the markets that they can repay their debts, many investors
are reassessing risk and looking to new markets to find alpha. Such reassessments
make sub-Saharan Africa’s many markets look increasingly attractive on a risk-




POWER LINES IN NAMIBIA:
A large infrastructure shortfall is a major cost to doing business
in Africa.




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      Africa’s Challenges




              return basis. However, this may lead to misperceptions about the relative size of
              the opportunity in some of the sub-Saharan African countries, and about the levels
              of risk.


              Cost to Serve

              Due to is physical size, geopolitical fragmentation and lacking infrastructure, sub-
              Saharan Africa is also a hugely expensive place to do business, both in terms of
              time and money. Largely, this is the result of the major infrastructure shortfall and
              the lack of supporting ecosystems (legal, financial, intermediaries, etc.) across the
              region. On just about every measure of infrastructure coverage, African coun-
              tries lag behind their peers in the developing world, with the differences being
              particularly large for paved roads, flight connections, phone/data main lines and
              power generation,9 which makes doing business challenging, both for “fly-in” and
              “boots on the ground” private equity business models.

              Another factor that adds to the cost of doing business is the diversity and
              atomised nature of the region. Sub-Saharan Africa comprises 49 of the continent’s
              55 states, many of which have populations of fewer than 20 million and economies
              smaller than $10 billion. These countries are characterised by cultural heterogeneity
              from the Islamic cultures of the Sahel, through the French colonial legacy of West
              Africa to the commercial sophistication of South Africa. Such diversity creates a
              complex web of legal and business cultures, which are not easily navigated and can
              limit businesses ability to spread across the continent.

              This diversity is made more challenging to navigate because the investment eco-
              system is underdeveloped or absent. Particularly at the smaller end of the market,
              there are few value-adding intermediaries and other (legal, accounting, banking,
              consulting) service providers. The major effect of the lack of a professional eco-




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                                                                              Africa’s Challenges




system is the high cost of due diligence. This is a “huge expenditure” and creates a
higher risk and abort costs for investors, particularly at the small- and mid-cap level,
for a number of reasons:

•	 Outside South Africa, due diligence firms are not generally
   considered to be particularly high quality, and thus global
   accounting, strategy or risk-consulting firms were often engaged
   to satisfy both GP and LP requirements, at a higher cost than
   the local equivalent.

•	 There is little reliable market and consumer data available in
   Africa, as there is a large informal or cash economy, and standard
   information about companies frequently isn’t available.

•	 As in other emerging markets, smaller companies often have
   two or three sets of financial records, to which GPs needed full
   access before investing. Traditional legal, commercial and
   accounting due diligence is considered insufficient in Africa; GPs
   and LPs need local knowledge about the immediate network and
   political position of investees, for example.

•	 Both UK and US foreign corrupt practice legislation now require
   compliance both going into the asset and in ongoing monitoring
   throughout the investment period.10

Even when this had been navigated and locked down contractually, many
interviewees spoke of the necessity of staying out of court. In many African
countries the courts system can be mercurial, and while the legal contracts are
necessary, they are insufficient to ensure that an agreement is enforced even after
an expensive legal process.




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Private Equity’s Challenges




Private Equity’s Challenges
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                       		15
                                                                   Private Equity’s Challenges




PRIVATE EQUITY COMPETES SIMULTANEOUSLY IN THREE
distinct but dynamically linked markets: the markets for funds, deals and talent. A
superior team and track record create a virtuous cycle that enables smarter execu-
tion and value extraction from the deal flow and thus attracts funding more easily.
In each of these markets, the sub-Saharan-African environment presents specific
challenges to GPs and they have, therefore, had to adapt their models. As such,
we have cut into the topics and trends in Africa using these three markets as the
lenses through which we, and the other actors, perceive the applicable differences
in Africa.


Fundraising

Sources of Funding

One of the distinctive features of private equity in sub-Saharan Africa is the
heavy development finance institution (DFI) footprint both as LPs and direct
investors. DFIs have long been important investors in African private equity,
catalysing commercial investors’ interests and moving the investment agenda
from aid to commercial capital, helping stimulate the local private sector
through for-profit investments. Preqin documents that there are 51 DFIs
actively investing in Africa-focused funds, representing 9% of LPs investing in
the region,11 but our interlocutors suggested that this underplays their influ-
ence, with several suggesting that DFIs provide well over half the value of
LP investment in sub-Saharan Africa.




Finding the right talent is one of the greatest challenges for
GPs operating in sub-Saharan Africa




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      Private Equity’s Challenges




              GPs working in sub-Saharan Africa also have access to impact investors, who
              actively promote the growth and expansion of enterprises that have a development
              impact, while returning at least nominal principal, and have provided hundreds of
              millions of dollars to private businesses in the region.12 Another increasingly im-
              portant source of new capital for GPs is the African diaspora, whose remittances
              play such an important role in capital flows to the region. New vehicles are being
              established that aggregate the economic power of African ex-pats to invest profit-
              ably on the subcontinent.

              Additionally, in South Africa, Namibia, and soon Botswana, changes to public pen-
              sion fund legislation have allowed local pension funds to quadruple their allocation
              to private equity to 10%, which brings their allocation in line with more experienced
              public pension funds in North America. The raising of the private equity allocation
              in these institutions, our interlocutors hoped, would increase their awareness of the
              asset class and open new pools of funds to be deployed in this sector.

              Many GPs are, however, beginning to look elsewhere for funding. Many of those
              we interviewed were approaching family offices and high-net-worth individuals,
              particularly in other emerging markets, as more adventurous, nimbler investors with
              fewer conditions attached to funding. Endowments and foundations, particularly
              those from the US, and sovereign wealth funds also favour the region as they seem
              to have more risk appetite than traditional institutional investors,13 such as pension
              funds, funds of funds and asset managers. For example, we have seen a sovereign
              wealth fund and a specialised family office investment team execute focused
              sector roll-up strategies in consumer packaged goods and fast-moving consumer
              goods across the continent. By contrast, only a few traditional investors have dived
              in to Africa, amid concerns about risk and the maturity of the market.14




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                                                                      Private Equity’s Challenges




Challenges of Fundraising

Since mid-2008, GPs raising funds for sub-Saharan Africa have faced many of the
same difficulties as their peers around the world. Both private and public institu-
tional investors have become more risk averse and have invested less in private
equity.15 A number of interviewees also identified a “certain dissatisfaction with
the private equity model in general” and a requirement for more transparency and
accountability from the fund managers. Even DFIs and government development
agencies, operating in cash-constrained environments, are more aware that they
need to have an impact for every dollar they spend. To attract investors, therefore,
African GPs need to “demonstrate to an investor sitting on the east coast of the US
that, on a risk adjusted basis, they can make equivalent dollar returns by investing
in Africa as against investing in the US or Europe or Asia” by genuinely improving
the strategy and operations of investee companies.

Consequently, investors have raised the bar in terms of strategic sophistica-
tion requirements for GPs, to mitigate risk and maximise returns. Many LPs now
have more stringent track record requirements than they did in 2007. To convince
investors that they are “good, not lucky”, fund managers must demonstrate expe-
rience and consistency in portfolio returns. This can adversely position first-time
fund managers, particularly those without African track records. That said, LPs
do scrutinise individual personnel, requiring a team with all the complementary
skills that good parenting of a portfolio company requires. DFIs and institutional
investors are also looking more closely at GPs’ strategies and business models and
require “carefully articulated strategies that take account of the realities of markets
that have been well researched”.




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      Private Equity’s Challenges




              All these trends affect fund managers equally in other markets, but in sub-Saharan
              Africa, this has been amplified by the macro stereotypes about political risk and
              corruption, and the nascent state of the industry outside of South Africa. The risks,
              many stakeholders in the region believe, are “overhyped”; while there are some
              examples of potentially harmful legislation, such as Black Economic Empower-
              ment in South Africa and Indigenisation in Zimbabwe, nearly all our respondents
              argued that risk isn’t necessarily that much higher in Africa than anywhere else and
              some have the track record to prove it: one of our interlocutors’ firms is stated to
              never have lost or written off an entire asset in Africa due to country risk since the
              firm’s inception in 1948.16

              Fundraising is particularly challenging for South African GPs at present. DFIs are
              less willing to invest in South Africa, because it is now considered a mid-income
              country. Moreover, given the current political situation there is a greater risk premi-
              um placed on South Africa by investors in London and New York, yet the returns
              and GDP growth rate are lower. However, given South Africa’s dominance over the
              region’s GDP, its market depth and the comparative sophistication of its private
              equity industry, it is “difficult to deploy $200 million in Africa while ignoring South
              African investment opportunities entirely”.

              On balance, fundraising constraints in sub-Saharan Africa may be easing; globally,
              Preqin’s most recent LP survey found that investors are “not investing at the same
              pace as in the years before the downturn, [but] the number of investors looking to
              make commitments is steadily improving”. Moreover, Preqin’s survey suggests that
              LPs are looking for returns of 200 basis points over the market; as African equities
              have performed poorly this year (see Figure 2), several GPs we interviewed
              suggested that private equity was an attractive option to those seeking African
              exposure (and to harness African growth) but with substantially higher returns.




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                                                                            Private Equity’s Challenges




Figure 2: Performance of African stock markets January–August 2011

                                INDEX       PRICE      1D Av.     YTD       USD YTD
 North Africa
 EGYPT                        EGX 30         4728.55     0.28%    -33.79%      -35.51%
 MOROCCO                      CFG 25        24018.47     0.16%     -8.30%       -5.17%
 TUNISIA                      TUNINDEX       4513.03     -0.91%   -11.73%       -9.25%

 West Africa
 BRVM                         COMPOSITE       143.11     -2.36%   -10.05%       -6.30%
 GHANA                        ALL SHARE      1128.26     -0.30%   12.93%         9.37%
 NIGERIA                      ALL SHARE     21298.07     -1.11%   -14.02%      -16.09%

 East Africa
 KENYA                        ALL SHARE        73.60     -0.59%   -24.76%      -35.41%
 TANZANIA                     ALL SHARE      1279.83     0.02%     9.96%         0.41%
 UGANDA                       ALL SHARE       964.90     -0.26%   -18.78%      -33.37%

 Southern Africa
 BOTSWANA                     DCI            7287.30     -0.06%   13.63%         8.10%
 MALAWI                       ALL SHARE      4905.96     0.56%     -0.95%       -9.30%
 MAURITIUS                    SEMDEX         1929.58     -0.89%    -1.92%        7.55%
 NAMIBIA                      OVERALL         749.38     -1.68%   -13.59%      -20.33%
 SOUTH AFRICA                 ALL SHARE     29525.83     -1.21%    -8.07%      -15.24%
 ZAMBIA                       ALL SHARE      3799.56     0.26%    15.00%        11.02%
 ZIMBABWE                     INDUSTRIAL      160.58     -0.16%    6.15%         6.15%
 ZIMBABWE                     MINING          160.64     1.11%    -19.84%      -19.84%

 Global Markets
 MSCI EMERGING                                988.05     -0.16%   -14.19%      -14.19%
 S&P 500                                     1165.24     -0.74%    -7.35%       -7.35%
 EUROSTOXX 50                                2080.10     -1.29%   -25.52%      -22.17%
 NIKKEI 225                                  8590.57     -2.21%   -16.02%      -12.15%

Source: FM Capital Partners




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      Private Equity’s Challenges




              Deal Flow

              Deal flow has changed. The easy days of post-Apartheid unbundling of conglomer-
              ates in South Africa are long gone. On the whole, so too are the leveraged buy-outs
              relying on financial engineering and letting underlying growth recoup the debt. The
              tide is no longer raising all ships, even in this part of the world. Good deals are
              harder to find and there is greater competition. Investments no longer just create
              value by themselves; more sophistication is required to source and identify value in
              them, thus investment theses often demand more attention and skills by the GP to
              turn into real returns.

              In 2008 deal flow slowed, almost “constipating” the industry, resulting from
              the financial crisis. Due to limited debt, exits to financial buyers in that period
              had slowed and deals delayed waiting for movements in multiples, as unrealistic
              expectations created mismatches between buyers and sellers. Another challenge
              peculiar to South Africa was that “the listed markets continued to tick over and the
              changes to the Companies’ Act have made it more difficult and complex to execute
              transactions and increased the cost of failure”. This is borne out in EMPEA’s data:
              in 2008, South Africa was responsible for 28 deals, valued at $2 billion; in 2010,
              the deal volume had decreased by two thirds (to only 10 closes), worth only $47
              million. This trend started reversing in 2011, with transactions like Savcio, Tracker
              and Universal indicating a return of high-value deals to the market. Conversely,
              however, the other giant market of sub-Saharan Africa, Nigeria, seems to have been
              less affected. In 2010, it accounted for $188 million (30% of the total value) in only
              six deals.




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                                                                       Private Equity’s Challenges




Another factor that stymies deal flow is that private equity is in its infancy in
the region, with the exception of South Africa; consequently, capital-seeking
businessmen have had little exposure to the asset class, and are often unaware of
it. They do not, therefore, seek it out as a potential exit or as a natural source
of growth capital. The GPs in the region thus have to promote, demystify and
educate vendors about private equity, which can be a lengthy process, termed by
one GP “the education overhead”. This is exacerbated by the fact that there is
an almost complete absence of a proper venture capital industry in the region,
even in South Africa, which means that entrepreneurs are not familiar with the
role of outside investors.

GPs investing in mid-market and early-stage companies across the region seemed
content that there was sufficient deal flow, but many of those looking at larger
companies were struggling to find assets to take large tranches of financing. One
of our interviewees noted that this is partly because big players are seeking only
“belt and braces deals” and limiting their focus for large ticket deals to South
Africa. Consequently, particularly in Africa’s largest market, there is increasing
competition as more international GPs enter sub-Saharan Africa. That said, those
GPs playing in this space, but who took a more entrepreneurial approach, and
broader geographical focus to deal sourcing told us that they had seen “limited
competition, and our current pipeline reflects this fact”. But, in the conventional
private equity space, there are relatively few companies by comparison to China and
India that can take large ticket sizes. Many businesses are still young, founder-run
and have small capitalisations, as until recently, political instability has constrained
companies’ regional and cross-boarder growth. Several GPs who specialised in




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      Private Equity’s Challenges




              small deals noted that many funds that had started out in small sub-$5 million
              deals were “edging upwards to... $10 million, $25 million deals”, so “it’s more and
              more congested higher up the food chain you go”, a trend exacerbated by larger,
              international GPs looking to sub-Saharan markets.

              There is also new competition from investment banks and some highly astute trade
              players. Russian investment bank Renaissance Capital, which operates in six African
              markets, completed 27 transactions in 14 African countries from mid-2010 to mid-
              2011.17 Local trade players also compete with private equity as they have industry
              relationships, access to customers and more trade expertise to pick and choose
              assets. What is more, South African corporations with already established sub-
              Saharan activities have become targets for multinationals eager to gain a foothold
              in the region. A case in point is Wal-Mart’s $2.3 billion bid for South African retailer
              Massmart, which has a growing presence in 14 markets across the region.

              The slowdown in capital deployment is supported by EMPEA data, which shows
              that for the first time since 2006 capital invested was lower than funds raised in
              2010, and that it had hit a five-year low at only $631 million (see Figure 3)  –  a drop
              of over 50% on 2009. Moreover, the data provides evidence for deal flow drying up
              at the top end of the market. In 2008, 50 private equity deals were closed in sub-
              Saharan Africa, with a total reported value of $2.9 billion. In 2010, there were 48
              (only two less), but in value they represented only 20% of the 2008 level, suggesting
              the average deal size shrunk down to a fifth.




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                                                                                                          Private Equity’s Challenges




 Figure 3: Sub-Saharan Africa Fundraising & Investment, 2006 – 2010 (US$B)
              $4

                                               3.4
                                                                                       Funds Raised

                                                                                       Capital Invested
              $3                                                  2.9



                      2.1                                  2.2
                                         2.0
US$ Billions $2

                                                                                             1.5
                             1.3                                                 1.4

                                                                           1.0
              $1
                                                                                                   0.6



              $0
                        2006               2007              2008            2009              2010

Source: Emerging Markets Private Equity Association. Equity Association.
                 Source: Emerging Markets Private



As such, with the exception of the giants  –  South Africa, where the public market
and private equity is much more developed, and Nigeria, given its growth dynam-
ics and size  –  deal flow is likely to remain in the small- to mid-cap space. These
deals are not about financial engineering, as is the case in LBOs; rather GPs need
to supply growth capital to founder-led assets that aim to expand regionally, require
corporatisation, and improved governance processes and management systems as
they are rarely at first sight “investment ready” by western standards. As such, they
require intensive post-deal engagement to realise the value.


Talent

Talent, both at GP and portfolio company level, is the major constraint for private
equity in Africa, almost unanimously confirmed by all players interviewed. Recruit-
ers confirmed that not all skills – Western education, financial acumen, management
experience, African background and operational track record – can be found in one




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      Private Equity’s Challenges




              individual for each position. Rather, recruiters have to construct teams mixing team
              members with some of these attributes and then invest in developing local talent to
              achieve the required blend.

              One investor told us that they were struggling to find an African to head their
              Johannesburg office as suitable individuals were unwilling to leave lucrative jobs in
              international financial centres or managing large international private equity funds
              to manage a smaller fund on their home continent for a necessarily lower salary.
              This, he believed was partly due to the fact that the “true egalitarian private-sector
              boom in Africa is relatively new and... this is the first chance many people have had
              to make real personal wealth”.

              Despite this constraint, talent is to be found amongst the returning diaspora or
              “re-pats”, who some LPs felt were ideal for the business due to their combination
              of developed world experience and sensitivity to local nuances. But while the finan-
              cial crisis might have encouraged some re-pats home, “the infrastructure does not
              yet exist to entice the bulk of the African diaspora back”, thus repatriation has yet
              to reach the levels seen in Asia. Also the banking crisis driven re-pats need to be
              complemented by more operational focused “heavy-hitting” operationally experi-
              enced re-pats, paired up with strong local team members to support them.

              Several LPs we interviewed believed there to be “a severe shortage of good GPs in
              Africa”. This echoes the findings of the 2011 Coller Capital EMPEA LP survey, in
              which nearly half of respondents said that the limited number of established GPs
              was likely to be the single biggest factor to deter them from beginning to invest in
              sub-Saharan Africa over the next two years.18 As one potential LP told us, “we have
              one set of investment guidelines and investment criteria irrespective of geography.
              They mustn’t expect that just because a manager is in a higher-growth economy like




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                                                                        Private Equity’s Challenges




Africa that we’re going to give them any benefit of the doubt that they’re going to
perform as well as any other manager”. This explains the current quasi-absence of
large global institutional investors that still prefer to place their funds in Asia first;
many are interested and observing from the sidelines, until the volume of credible
players is sufficient to spread their bets.

Several of our interviewees pointed out that “there is a huge difference between
those who can do private equity and those ex-investment bankers who think they
can”. The distinguishing factor tended to be those teams that understood
that investing in the growth capital space requires a wide range of operational and
change management skills, beyond just financial structuring and deal execution.




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Innovative Approaches along the Private Equity Value Chain




Innovative Approaches Along
the Private Equity Value Chain




                                                                PHOTO BY PIETERJAN GROBLER
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                                                 		27
                                                                            Innovative Approaches along the Private Equity Value Chain




            DURING OUR INTERVIEWS WE HAVE ENCOUNTERED SUCH
            a wide range of GPs that it would have done little justice to the innovations,
            diversity and richness of their business models to force these into a simple indus-
            try classification (see Appendix). Instead, we have looked to where the particular
            challenges of sub-Saharan Africa have led GPs to innovate along the private equity
            value chain, and to illustrate how these innovations have worked at each stage.



              Figure 4: African GPs’ Innovations throughout the value chain


           Investment Strategy                          Investment Execution

          1. Fund Strategy         2. Fundraising      3. Deal Sourcing        4. Deal Execution       5. Post-Deal Holding     6. Exiting

          • Regional funds         • Pledge funds      • On-the-ground         • Convertibles          • Active, hands-on       • Trade/Strategic
          • Sector-specific funds   • Listed company      networks              • Preference shares       engagement               Sales
          • Value-add funds        • Deal-by-deal      • LP & partner          • Tranche investments   • Capacity building      • IPO
                                                         networks                                      • Insert experts         • Group sale
          • Developing             • Partnership                               • Non-cumulative
            platforms                                  • Proprietary deal        dividends             • Regional expansion     • Secondary sale
                                   • Holding company
                                                         flow
          • SMEs and mid-cap       • Open fund                                 • Liquidation           • Technical assistance   • Sell back to
                                                       • Limited                 preference                                       management or
          • Following South        • Captive             intermediary-                                                            founder
            African companies                                                  • Debt financing
                                   • Merchant bank       generated deal flow
            north
                                   • Higher fees
                                   • Management &
                                     oversight fees

7. Cost
   Base      Recruiting and Human Resources

             Regional Office Infrastructure

             Travel

             Support services: legal services, due diligence, finance (accounting & reporting), IT etc.




            RENEWABLES ARE GAINING MOMENTUM:
            Private equity firms operating in sub-Saharan Africa are finding
            niches to exploit. One of the most popular among our interviewees
            was green energy.




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         Innovative Approaches along the Private Equity Value Chain




                 1. Fund Strategy

              As fundraising conditions have tightened over the past three years, competition for
              funding has intensified. Consequently, new-to-market small, sub-Saharan African
              players are developing sophisticated, differentiated strategies. The most common
              of these amongst our interviewees were sector plays: financial services, health, agri-
              business, and renewable energy. We also observed focused geographical strategies,
              both regional and thematic (e.g. post-conflict economies) which has resulted in
              investments being spread over a wider range of countries. EMPEA data shows a
                                marked uptick in investments in Kenya and sub-Saharan African
    Most of our GPs had         markets outside of South Africa, Nigeria, Ghana and Uganda.
   strategies focused on        These accounted for half the total value of private equity invest-
harnessing the growth of        ment on the subcontinent in 2010, and represents an increase
the African middle class.       of almost three times on both 2008 and 2009. We also noted a
                                number of strategies segmented by market sector, such as ven-
              ture capital and SME investments, and value-add approaches – for example using
              South African networks to link businesses in neighbouring countries to Africa’s big-
              gest market, and backing South African entrepreneurs founding companies north
              of the border. LPs believed this to be an encouraging trend as it showed that “more
              thought was going into” the GP business models and strategies.

                 Most of our GPs were seeking to harness the growth of the “slow but steady
                 moving machine” of the emerging middle class; therefore, one of the most
                 popular strategies was that of developing consumer products or agribusiness
                 companies by buying platforms to expand into neighbouring markets, organically
                 or through roll-ups. One GP told us “we don’t take technical risk”, rather they
                 seek to take proven models to new geographies, either with one portfolio com-
                 pany, or by sharing the knowledge across their portfolio. This strategy primarily
                 involved mid-cap companies, with GPs taking a controlling minority stake of




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                                        Innovative Approaches along the Private Equity Value Chain




around $20 million. These are likely to benefit from changes like the creation
of the East African Customs Union, which makes international expansion easier
and less costly.

We also saw GPs working with venture or early-stage companies using this strategy,
but they preferred a majority stake, usually for under $5 million. The key to making
this model work was either finding an underdeveloped sector, such as healthcare,
or finding a company that had a particularly innovative business model that could
leapfrog existing technologies or products in the market.

All these contrast with the classic model of the long-established, multiple
vintage, larger-scale South African players who think about their capital allocation
north of their borders more in the sense of backing their South African portfolio
companies in their quest to double their non-South African revenue lines, rather
than seeking standalone assets in remote markets.

Regardless of the approach, many of our interviewees believed that while oppor-
tunism had worked in the past, in the current climate it was more important to stay
“consistently on-strategy”, and only buy assets where they had a detailed under-
standing of the economic and political environment in which they were investing so
that they could efficiently unlock the sources of value over the investment period.


2. Fundraising

One of our interlocutors told us that it is “increasingly difficult to justify run-
ning a fund model unless you get to scale” and given the current challenges of
fundraising he thought it would be very difficult to raise another fund. Indeed,
it appears that for many of our interviewees, the traditional closed-fund model




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              was distinctly under threat. This, it was argued, was “a natural evolution for the
              business” and the development of alternative structures was an “important mile-
              stone for the industry”.

              We saw a number of alternative investment structures that actors had developed,
              either through necessity, or through intent:

              •	 Listed investment company using public market funding

              •	 Privately held holding company or conglomerate (on-balance-sheet lender)

              •	 Deal-by-deal fundraising or flexible capital model

              •	 Pledge funds

              •	 Open fund with no close

              •	 Captive funds with a dominant investor

              •	 Merchant or investment bank or principle investment arm

              •	 Wealth managers

              •	 Impact investors

              There were a number of reasons why actors had innovated around the funding
              model. Partly this was a result of the liquidity-constrained environment. With LPs
              reluctant to tie up their capital and expose themselves to the high perceived risks
              of Africa, having a model that provided investors with “liquidity and a real price
              point”, was advantageous because it reduced the risk, but still gave private equity
              exposure. Another benefit that actors saw in these structures was that they gave




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                                       Innovative Approaches along the Private Equity Value Chain




investors “exposure to growing markets that they would otherwise be unable to
access”, thus providing them with added diversification benefits.

There is a clear preference for attracting more patient
capital, hence the emergence of more transparent, open        Sub-Saharan African
funding models that were more flexible about ticket           GPs are innovating around
size, stake size, sectors and holding period. As one          the fund model to
interlocutor argued “the dirty secret of private equity       attract a wider range of
is the seven-year lifespan. You have to sell a perfectly      investors, reduce risk and
good asset at a predetermined point – from an investor        provide liquidity.
standpoint that’s crazy”. As a reflection of the dynamic
nature of the African market, players viewed flexibility as particularly important:
they needed to be nimble, quickly taking advantage of the opportunities that they
found. They also wanted flexibility on holding period. Those actors investing in
infrastructure and property would hold for the longest period, but otherwise there
was a disparity across all other variables, with some players seeking to exit a com-
pany within three years, even an early-stage one, and others feeling that to maximise
the value they needed to hold it for longer.19 Indeed, they wanted to be able to sell
the asset at the best market opportunity, not when dictated by a fund lifespan.

Those GPs who are planning on continuing the classic GP/LP closed fund
model often asked to increase management fees. This is obviously unpopular
with LPs, particularly DFIs, as one told us “if a GP can’t survive on two and
twenty, it shows he doesn’t know the landscape well enough”. That said, some
DFIs are willing to pay higher fees if the fund was below $50 million, if they
are engaging with SMEs, or in post-conflict countries, which they understand
had a greater economic impact and are more resource intensive. That said, all the
LPs we spoke to were concerned that higher fees might represent a flaw in the
sustainability of the GP’s underlying financial model.




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      Innovative Approaches along the Private Equity Value Chain




              An alternative route is to charge investees a “management and oversight fee” baked
              into the shareholder agreement, which enables GPs to engage intensively with their
              portfolio companies without burdening the investors with the additional cost. The
              principle behind such a fee is that the companies should pay for the value-add that
              the GPs bring. However, as both the GPs that follow this model pointed out, it
              only really works if you can make a cast-iron case up-front for that value-add to the
              management of the investee company. Smaller, founder-led companies are gener-
              ally less open to this.


              3. Deal Sourcing

              As in other markets, private equity is “very much a people’s business in Africa”, it
              is “very difficult to address without feet on the ground or partners that you’re truly
              aligned with and truly trust”. Our interlocutors thus emphasised the need to
              spend considerable time in creating and developing “soft relationships” learning
              the local cultural context and getting to know local entrepreneurs. This network
              is vital as “the deals get put together and you get invited; you don’t propose the
              deal if you’re a private equity player. Often the deals get done at a political or
              industry leadership level”.

              Those GPs considered to be successful by their peers were thus those that “really
              know their way around” their chosen region. This allows GPs to get to know the
              “potential investee companies, the market gossip and where the company sits
              within the business ecosystem”. It also enables firms to identify any potentially
              problematic (or advantageous) political affiliations that the entrepreneur might
              have. Good relationships with vendors also prevent GPs from being persuaded to
              “overpay for growth”, which can improve the investment’s performance as “if you
              overpay, it’s difficult to generate the kind of returns investors are looking for”.




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                                         Innovative Approaches along the Private Equity Value Chain




The importance of networks was underlined by the position of South African
managers who were seeking to expand north of the border. Most understand the
need to tap the growth and have a tranche of their fund carved out for ex-South
Africa investments, but many struggle to source deals  – “how deals get done in
those countries is a mystery” due to the “complexity of the relationships” –  and
evaluate risk. South African managers understood that expanding into the rest of
sub-Saharan Africa “requires our senior people to be committed and go to some
of these places”, and that this required “spending money and putting offices and
infrastructure in place”. Rather than make this commitment, many South African
GPs seek to gain this exposure indirectly by encouraging their portfolio companies
to expand regionally. This, as one interviewee pointed out, is “self-serving, but it’s
also valid”. However, “it underestimates inter-country differences, and in that sort
of play, management is an issue”.


Proprietary Deal Flow

Several established players noted that competition for deals has increased notice-
ably in recent years with one telling us “we have faced more competition on deals
in the last six months than in the last six years combined”. In this environment,
the ability of a GP to secure propriety deal flow was considered by many stake-
holders to be a litmus test of quality. Our interviewees believed that creating deals
and “build[ing] your reputation so people come to you” improved performance by
reducing initial asset prices, and demonstrated your skill at finding a good invest-
ment in unusual spaces. There was a certain amount of scorn for managers that
had bought assets that had “been around the block”, or had “wait[ed] for the
opportunity to come their way when shareholder activity unlocks an asset” rather
than going out and creating opportunities. There was also disdain for GPs that
relied on intermediated deal flow. Most of our interviewees believe that these deals
are the preserve of global players (Actis, Bain Capital, Carlyle) or established large




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      Innovative Approaches along the Private Equity Value Chain




              local firms with larger funds because “you need to be the highest bidder”, and most
              GPs, particularly those with smaller funds, are unable to pay over the odds.

              GPs’ views of investment opportunities are coloured by how they are plugged into
              the ecosystem. The most marked example of this comes in the form of attitudes
              towards the Asian family businesses of East Africa. Those GPs who understand
              these businesses and have good contacts there see them as an opportunity to create
              deal flow by building relationships and working with them to develop new busi-
              nesses. Others see them as competitors because they are “shrewd on-the-ground
              operators and they are well-connected with strong relationships with government...
              particularly in resources”.


              4. Deal Execution

              Like private equity practitioners across the world, our GPs rarely take a plain-
              vanilla equity stake in their investee companies. They seek to protect their down-
              side by using convertible notes, preference shares, or investing in tranches,
              particularly in smaller companies. They may also have non-cumulative dividends,
              some form of liquidation preference in-line with other preferred stockholders,
              and standard conversion and dilution provisions.

              Bank financing in Africa is expensive; for example Barclays in Kenya currently
              offers business loans at 14.9% over a five-year period20 – double the equiva-
              lent in the UK – so some GPs investing in SMEs or early-stage companies also
              look to provide investees with some form of debt financing. This sometimes takes
              the form of a shareholder loan for start-ups, mezzanine financing, particularly in
              manufacturing industries that have an expanding customer base, and sometimes
              long-term debt “comparable to a bank”.




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                                          Innovative Approaches along the Private Equity Value Chain




5. Post-Deal Holding

The vast majority of GPs we interviewed emphasised the need to be very hands-on
with their portfolio companies; few of the GPs we interviewed had more than two
investments per partner, and all took the customary seats on the board. This was
also reflected in the composition of GPs’ teams; several noted that they required
a mix of skills that ranged from accounting, legal, and financial to operational
knowledge in engineering and logistics. This would either be present within the
partnership, or they would call in the right skill sets as
the investee business changed, through networks of ex-        Capacity building within
executives or consultants.                                    portfolio companies is
                                                              a vital part of turning a
But outside the venture/early-stage space, GPs prefer         company around.
not to get too close to the running of portfolio compa-
nies themselves, instead helping the existing management to corporatise and grow
the business. Nearly all the GPs we spoke to stressed that when making their
investment decision they back good management ; for one GP “it’s the only thing
we do”. However, in some particularly challenging post-conflict economies or at
the venture capital level, some GPs had taken on managing director roles; one even
had to undertake the stock-take for an early-stage logistics business.

On the whole, however, GPs look to help the existing management to improve and
grow the business. The emphasis here is very much on capacity building within
portfolio companies, particularly in smaller or family-owned businesses where most
of the skill and energy resides in the founder. GPs discovered that in many cases
the “talent is there, but there is not enough”. This often manifests itself in a big gap
between the talent of the entrepreneur (or C-level executives) and the middle man-
agers, who do not lack in “raw talent or integrity” but have less experience. They
“usually require a little bit of deliberate study and understanding” because it’s the
middle managers that are going to implement the changes that need to take place
when turning a company around and looking to become more commercial.




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HELIOS INVESTMENT PARTNERS: BEST-IN-CLASS EXAMPLE OF DEDICATED POST-DEAL
VALUE-ADD CAPABILITIES IN SUB-SAHARAN AFRICA

      One player in sub-Saharan Africa, Helios                     all the way to the middle management
      Investment Partners, has adopted the                         layer, often “peeling off ” into the asset,
      philosophy of integrating commercial                         manning a project management office
      skills into the GP from their first vintage,                 (PMO) that actively implements the in-
      despite being technically “sub-scale” at                     vestment thesis and growth initiatives.
      the time, with economics perceived to
      be too small to carry this capability. The                   Ultimately, however, they are still part
      team has a clear division of labour                          of the GP with similar incentives to the
      between deal execution and post-deal                         GP’s deal executives. This is the critical
      parenting. Although the post-deal or op-                     difference to the more prevalent model
      erating executives do form part of the                       of the portfolio company hiring retired
      deal selection and due-diligence process,                    CEOs as sector-experienced operat-
      their primary role kicks in once the GP                      ing executives only into the respective
      “holds the keys to the business”.                            specific portfolio companies. Aligning
                                                                   post-deal executives’ incentives with
      Operating executives are located on the                      the GP encourages the sharing of best
      ground, close to the assets they nurture                     practice across assets, which can
      and they intervene far deeper than the                       improve asset performance throughout
      board. As in the more sophisticated                          the portfolio and thus increase post-deal
      private equity markets in Europe and                         executives’ compensation. Moreover, it
      North America, they have a different                         enables these practices to be passed to
      background, education and experience                         the GP franchise and thus transfer the
      than fund managers, mostly being drawn                       learning to the next deal or vintage.
      from the top-tier strategy firms or with
      operational improvement experience, as                       This model also facilitates innovation
      opposed to investment banking or ac-                         across the portfolio. Executives
      counting. They end up part of the asset’s                    employed by the portfolio company tend
      management team, coaching and advising                       to adhere to the principles and busi-




                                                                               © MONITOR COMPANY GROUP L.P 2011
                                                                                                      ,   .
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                    		37
                                            Innovative Approaches along the Private Equity Value Chain




ness models that have worked for them                (in terms of carry points and incentives)
in their past careers, which offer                   for the new operating executive. This
good downside protection for the                     invariably puts them on the back foot.
assets. But more progressive players                 They will have to work hard to justify
supplement this with analytics, change               their presence and the cost they create,
management and multi-sector experi-                  in addition to being forced to hire ad-
enced ex-consultants from the top tier               ditional leverage to “move the needle”
strategy houses, to ensure that some                 in the portfolio. Further, they have to
of the more innovative and cutting                   sell themselves to the existing portfolio
edge approaches to value creation                    CEOs, who will naturally feel threatened
get implemented. This is what global                 by more “share-holder interference” that
institutional investors are now increas-             they hadn’t signed up for.
ingly looking for and insisting on.
                                                     One closing comment on the topic of
The Helios model works as it does not                controlling stakes: there is a percep-
create a “second-class citizen” dynamic              tion that the GP needs control to affect
between deal executives and operating                value driving change. Often GPs con-
executives: they are part of the same                fuse effective board control (or majority
team and in the same boat when it                    shareholding) with the ability to affect
comes to shared economics and incen-                 change. By way of a global example:
tives. However, if GPs try and add this              one of the single biggest post-deal or
principle half way through a vintage                 portfolio teams is part of a Special Situ-
or the GP’s history, it can cause con-               ations Fund (owned by a bank) that only
siderable internal friction. Generally by            ever takes minority positions, but is still
then, the GP has been blessed by past                highly effective at instituting value driv-
successes that did not rely on such ca-              ing changes quickly through influencing
pability, and the team’s economics have              and credibly convincing, rather than
been spent amongst the existing deal                 controlling the management teams.
partners that than need to make “space”




 © MONITOR COMPANY GROUP L.P 2011
                        ,   .
38	   PRIVATE EQUITY IN THE SHADOW OF GIANTS
      Innovative Approaches along the Private Equity Value Chain




              Some GPs did, however, bring in heavy-hitting outside expertise, with relevant
              experience. For example, one GP that invested in a bank in Equatorial Guinea,
              brought in an executive that had run a major international bank’s operations in
              Afghanistan. Others sought to source expertise from within Africa – particularly
              South Africa and Zimbabwe – and bring it to other African markets. Indeed, one of
              our interlocutors felt that the flexibility and willingness to move to other countries
              was one of the great strengths of the African talent pool.

              Sometimes, however, this was challenging. The ecosystem of executive search is
              undeveloped in Africa and expensive; GPs thus had to source individuals through
              their own networks: as one interlocutor told us “you can’t suggest hiring a CFO and
              then not have someone in mind”. Moreover, it could be difficult to persuade the
              management that additional people or skills are needed to help grow the business,
              particularly in founder-led firms.

              GPs operating in both the mid-market and larger spaces, sought to help their
              portfolio companies expand their operations regionally. This might be by simply
              leveraging their own network of public and private sector international contacts
              to help the investee enter new markets. In other cases, GPs used synergies
              between the companies in their portfolio to either share best practice or serve as
              clients. In financial services, providing technical assistance and growth capital to
              expand into neighbouring countries often proved enough to grow the acquired
              banks quickly.

              On balance, however, we found the post-deal efforts of African GPs more aspira-
              tional than real compared to their developed-market or even Indian counterparts.
              Few players have adopted a genuine separation of labour between the hunting
              and farming of value, or have real, dedicated (non-deal) operating partners with
              the right mix of operational, change management and analytical skills to institute
              early value driving changes into the acquired targets. Starting with cross-portfolio




                                                                     © MONITOR COMPANY GROUP L.P 2011
                                                                                            ,   .
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                   		39
                                         Innovative Approaches along the Private Equity Value Chain




dashboards and monitoring  –  measuring market externalities as much as financial
performance data  –  to cross-portfolio learning initiatives between executives, and
more innovative portfolio-wide commercial initiatives than just improved working
capital management and the obvious low-hanging fruit in the supply chain. Very
few of the GPs use a value-based management approach where growth initiatives
and board proposals are constantly evaluated against the initial valuation models
built during the deal due diligence.21  Part of the reason is the skill mix of the ex-
ecutives founding the GPs. In Africa often they have more of an accounting and
banking background where in India one finds more ex-CEOs being part of starting
the private equity franchises.

Moreover, sub-Saharan African players have not made as much effective use of
long-term consulting arrangements for that purpose. The KKR-Capstone model
of retaining consulting capacity and “best-in-class thinking on tap” for both port-
folio work and deal execution, has not been followed in the region. Players still
favour the classic fee-based expert, which not only incurs scoping, selection and
contracting costs and delays, but also impedes the institutionalisation of knowl-
edge across the engagements, and certainly does not align long-term incentives
between all three parties (GP/investor, portfolio company and consultant). In par-
ticular, when it comes to seeing through the implementation of slightly longer-term
change programmes, the use of consultants experienced in private equity can lead
to earlier value extraction.

That said, credit must be given to those GPs that are trying, starting with either
part-time operational partners (half deal hunter, half value farmer) on the pay-
roll, or other hybrid models. We found that the effective parenting of founder-led
entrepreneurial assets in Africa, given their scale, stage of development, degree
of corporatisation and openness to use external help, is probably (after fundrais-
ing) the most difficult and least developed activity in the private equity value
chain in Africa.




© MONITOR COMPANY GROUP L.P 2011
                       ,   .
40	   PRIVATE EQUITY IN THE SHADOW OF GIANTS
      Innovative Approaches along the Private Equity Value Chain




              6. Exits

              As the private equity market outside South Africa is very new, there have been rela-
              tively few exits, but as one of our interlocutors noted, “exits are hard to achieve in
              Africa”. GPs thus have to be “very creative” due to a lack of liquid public markets,
              no secondary market and a lack of bank financing for M&A. However, several GPs
              believed it to be advantageous to have the exit strategy planned early as ultimately
              this is the most important part of the investment: GPs need successful realisations
              to build up a track record and thus obtain follow-on funding.

              There was a wide range of opinions on potential exit strategies, with trade or stra-
              tegic sales being at the top of many lists, particularly for companies that created
              industry platforms where some GPs saw them as a target for multinationals to buy
              their way into new markets.

              The most divergent opinions came on using IPOs. For GPs investing at the top end
              of the market, a listing was the obvious exit, either on a local or foreign exchange.
              But views were divided for those investing in mid- and small-cap companies. One
              South African GP told us: “I’m not a fan of IPOs [as an exit], it doesn’t suit the
              African private equity model... it’s not a market for small caps, and is an unattract-
              ive exist mechanism”. Another working with start-ups and early-stage companies
              in post-conflict markets disagreed: “we are quite keen on looking at local listings
              for some of our companies... African stockmarkets have had a very good run and
              they’re looking to some extent overpriced. There’s a lot of money looking to get
              into Africa at the moment and there are very few IPOs... there is an opportunity for
              us to target that over the next few years”.

              In the small-cap universe, another potential exit strategy was aggregating parts of
              their portfolio and selling some of the businesses as a group, or listing to “generate




                                                                     © MONITOR COMPANY GROUP L.P 2011
                                                                                            ,   .
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                    		41
                                          Innovative Approaches along the Private Equity Value Chain




an incremental exit”. This strategy gave those GPs access to markets and investors
that would usually be beyond their reach, and gave a diversification benefit to po-
tential buyers.

More recently we have seen a higher degree of sophistication by the larger South
African players when it comes to value extraction on exit. These players have
engaged external parties in a vendor due diligence fashion up to a year ahead of
envisaged exits to reassess the asset and its remaining runway for value creation.
These “exit grooming” or “corporate readiness assessments” more than pay for
their own cost, as they allow for informed pre-exit choices. In other words, they
identify those pockets of value to be extracted, by when, and which parts of the
future value creation can be credibly marketed and “sold” to the new owner.


7. Cost Base

Practising private equity in sub-Saharan Africa is expensive: deal sourcing, diligence,
communications, and being on the ground is challenging and time consuming. Fre-
quently, GPs struggle to cover costs on standard 2% management fees, particularly
for funds under $100 million: “bigger is beautiful because it helps make ends meet.”
GPs have thus developed several approaches to fund operations.


Flexible Operating Infrastructure

Everyone we spoke to agreed on the necessity of having an extensive local network
and knowledge of the business environment. But many GPs did not think that
this necessitated a permanent in-country presence. Several of the GPs we spoke to
were based in London; as a global financial hub it gives access to a wide range of
potential deals, investors and staff. Moreover, several GPs commented that it was
actually easier to travel to parts of Africa from London than within the region, and




© MONITOR COMPANY GROUP L.P 2011
                       ,   .
42	   PRIVATE EQUITY IN THE SHADOW OF GIANTS
      Innovative Approaches along the Private Equity Value Chain




              this made interacting with investee companies easier. For many, a base in London
              mitigated talent constraints as they could recruit internationally and reduce costs
              on expatriate living allowances that are often needed to attract people to live
              in-country. However, those GPs are quick to explain that this is not a “fly-in”, “suit-
              case investor” model as they still dedicate considerable time to engaging their assets,
              even without a permanent in-country presence.

              Where GPs felt they needed an on-the-ground presence, they sought to minimise
              costs. To provide a low-cost permanent presence, one GP embedded staff in their
              assets, using the portfolio company’s office space and back-office services. In a
              reverse model, one venture capitalist brought his investee companies to him,
              incubator-style, so they were all within a ten minute drive of each other.


              Partnering

              Another model prevailing with “new-to-Africa” London-based players was
              by partnering or coinvesting with a local entity and operational expertise in the
              business of the investee company, rather than providing this themselves. Part-
              ners could be a local private equity firm, a high-net-worth individual or a
              financial institution, sometimes even a blue-chip trade or strategic player. Some
              GPs chose to partner with DFIs as “they have the expertise, the legal frame-
              work is less of a concern, and the political risk is mitigated as they have good
              relationships with the government”. Often these partners would also take equity in the
              investee to ensure that their interests were aligned. Some new-to-Africa GPs used this
              approach as a stepping stone into the region, allowing them to gain experience
              rather than immediately seeking controlling stakes from a distance in the more
              heavily competed geographies.




                                                                      © MONITOR COMPANY GROUP L.P 2011
                                                                                             ,   .
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                   		43
                                         Innovative Approaches along the Private Equity Value Chain




This alternative was adopted either by international GPs with little in-country pres-
ence or by those who were purely (passive) financial investors. Both understood the
need to have operational experience and to engage their investee companies, but
admitted that “we don’t have the local or expertise to get down in the weeds and
actually run the company”. Instead, they engaged with the company through moni-
toring. However, the scope for this model to succeed seems relatively limited, and
was only found amongst captives or government-funded investment initiatives; as
one interviewee told us “why would investors be paying fees for this? Why wouldn’t
you just pay the local guys?”.




© MONITOR COMPANY GROUP L.P 2011
                       ,   .
Where Does This Leave Us?




Where Does This Leave Us?




                               PHOTO BY MARK VANCE
PRIVATE EQUITY IN THE SHADOW OF GIANTS
                                    		45
                                                                        Where Does This Leave Us?




DUE TO THE CONFLUENCE OF CHALLENGING INVESTMENT
environments in sub-Saharan Africa, and the more selective deployment of LP capital
for private equity funds, actors operating in the region have had to be creative, along
the value chain to create compelling business models to attract capital that allows them
to be flexible. This has required GPs to try to “leapfrog” their business model up the
private equity trajectory, adopting more sophisticated strategies than just generalist LBO
or growth funders. However, this may well be too much too soon on several levels.

The sub-Saharan private equity market is still very small with penetration still lagging
markets that have successfully carried such market specialisation. Further, many of
the GPs we spoke to operating outside South Africa are still on their first vintage,
and they have yet to prove that they have cracked the post-deal, active-engagement
nut. The cost to serve in sub-Saharan Africa is high, and with small funds, unproven
funding models, and pressure to keep standard management fees, the jury is still out as
to whether this will be profitable, particularly as returns in sub-Saharan Africa still lag
those of China and India. Conversely, capital seekers are going to have an interesting
time with investors flocking in, but they need to be aware of the true value-add (as
against the aspirational) beyond the face value of money that potential investors bring.

There is also a sense that these models may be too sophisticated for the market. A
dearth of obviously attractive investees and increasing competition for investments in
the region have made conventional deal flow away from the venture or early-stage end
of the market difficult to secure, and both the quantitative and qualitative data suggest
that it is still not easing. Thus penetration of the market is low, and while that leaves
a huge opportunity for private equity deployment, the GPs are not yet, on the whole,
realising it. However there are opportunities if GPs adopt a more entrepreneurial
approach as evidenced by deals such as Helios Towers and Helios’s investment in
Shell’s downstream oil business.


Finding cost-effective and successful methods to nurture growing
companies after the investment is one area on which GPs need to work.




© MONITOR COMPANY GROUP L.P 2011
                       ,   .
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Private equity in_the_shadow_of_giants_12_01_11

  • 1. Private Equity In the Shadow of Giants INNOVATIVE APPROACHES ALONG THE INVESTMENT VALUE CHAIN IN SUB-SAHARAN AFRICA
  • 2. About the Study This paper draws primarily on 43 formal interviews and more infor- mal conversations with a wide range of stakeholders in the African private equity ecosystem including general partners (GPs) and limited partners (LPs) (both prospective and currently engaged in the region), research companies, solicitors, fundraising agents, recruitment consultants, and development finance institutions (DFIs). We also consulted a range of press articles, internet sources, reports and studies of the private equity sector, most of which are listed in the endnotes. This opinion piece does not aim to be a fully quantified primary research report classifying countries or players by future attractiveness or past investment returns. Rather, we have sought to collate the opinions of stakeholders in the industry to create an overview of the sector and facili- tate a better understanding of the challenges they face and the innovative approaches to the business model they have made. We have, however, included an appendix containing the list of firms interviewed with a brief classification to give readers a sense of the industry landscape and an overview of the sectors and countries most attractive to those firms. Private Equity in the Shadow of Giants is aimed primarily at new-to-Africa actors interested in sub-Saharan Africa rather than the larger scale, established classic leveraged buyout (LBO) market in South Africa and elsewhere around the globe, hence the title. Christoph Andrykowsky, Victoria Barbary and Olivia Toye conducted this research through interviews from August to October 2011 using Monitor Group’s and the South African Venture Capital Association’s (SAVCA’s) extensive network. © MONITOR COMPANY GROUP L.P 2011 , .
  • 3. Table of Contents Executive Summary.................................................................... 1 Introduction................................................................................. 6 Africa’s Challenges...................................................................10 PERCEPTIONS........................................................................... 11 COST TO SERVE........................................................................ 12 Private Equity’s Challenges.................................................... 14 FUNDRAISING.......................................................................... 15 DEAL FLOW ............................................................................ 20 TALENT................................................................................... 23 Innovative Approaches Along the Private Equity Value Chain..................................................... 26 1. FUND STRATEGY.................................................................... 28 2. FUNDRAISING...................................................................... 29 3. DEAL SOURCING.................................................................... 32 4. DEAL EXECUTION...................................................................34 5. POST-DEAL HOLDING..............................................................35 6. EXITS................................................................................. 40 7. COST BASE............................................................................ 41 Where Does This Leave Us?.................................................. 44 ENDNOTES .............................................................................. 47 Appendix.................................................................................. 49 Acknowledgements................................................................. 52 About the Authors.................................................................... 53 © MONITOR COMPANY GROUP L.P 2011 , .
  • 4. iii Executive Summary
  • 5. PRIVATE EQUITY IN THE SHADOW OF GIANTS 1 Executive Summary MONITOR HAS BEEN SERVING THE AFRICAN FINANCIAL investor community for almost a decade and felt that given the recent real and perceived increased interest in the continent, the timing was appropriate to capture, aggregate and elevate the financial investment actors’ views and opinions on how to best benefit from this positive trend in sub-Saharan Africa, home to the globe’s last large-scale frontier markets. As numerous recent reports have attested, including our own, Africa from the Bottom Up, Africa comprises 55 rapidly urbanising, true frontier markets that have moved beyond pure commodity extraction to a real consumer-led growth play. For years, sub-Saharan Africa has had a terrible image abroad, with more attention being paid to the bad news emanating from the continent – civil war, famine, pi- racy – than the good. But perceptions are now improving and catching up with the realities that many investors find on the ground: almost under the radar, established players, even outside the South African market, have made good and consistent returns. However, the bubble-like interest, despite the hype, has not yet resulted in a commensurate inflow of capital. African markets are still challenging to operate in. The cost to serve, execute deals and deploy capital is still high due to a fragmented, largely unsophisticated market with a huge infrastructure and talent backlogs, which impedes economies of scale ELDERS GATHER TO MAKE A DECISION IN CÔTE D’IVOIRE: In sub-Saharan Africa, the deal-making process is localised and often family orientated making deal flow challenging. © MONITOR COMPANY GROUP L.P 2011 , .
  • 6. 2 PRIVATE EQUITY IN THE SHADOW OF GIANTS Executive Summary and ease of doing business. For private equity players, this manifests itself in three core activities: • Fundraising: Prior to the global financial crisis, private equity investment in sub-Saharan Africa was largely the preserve of development finance institutions. However, more true frontier investors are exploring the region, seeking alternative African investment exposure that outperforms the small public markets through innovative funding structures. This has improved the fundraising opportunities for those GPs with differentiated business models. Consequently, the bar has been raised by institutional investors and teams have to demonstrate more value creation through true operational improvement, rather than just market growth or financial engineering. • Deal flow: Across the region, competition for deals has increased with the number of financial investors and renewed interest from (African and global) trade buyers, foreseeably turning the region into a vendors’ market. However, with the exception of the giants – South Africa and Nigeria – deal flow is likely to remain in the small- to mid-cap range. In this space, GPs supply growth capital to founder-led firms that aim to expand regionally, require corporatisation and upgraded governance processes and management systems, as they are rarely “investment ready” by Western standards. This is exacerbated by the nascent character of the industry in much of the region. Consequently, there © MONITOR COMPANY GROUP L.P 2011 , .
  • 7. PRIVATE EQUITY IN THE SHADOW OF GIANTS 3 Executive Summary is an underdeveloped deal intermediary and service provider ecosystem. Entrepreneurs rarely seek out private equity as a way of growing their business as they are often unaware of it, partly because there is an almost complete absence of a venture capital industry in the region, which would typically feed the deal pipeline from the bottom. • Talent: This remains one of the biggest challenges, both at GP and asset level. However, strides can be made by employing a complementary blend of skills of returning expats with best in class global training and local talent with local networks, experience and potential. To address these challenges private equity players have innovated along the private equity value chain. • Fund Strategy: Players are increasingly specialising and focusing on niches, pointing at a much more sophisticated market than the assets under management and market penetration would suggest. • Fundraising: New sources of patient capital, beyond development finance institutions and traditional institutional investors, are entering the scene. Frontier investors, family offices and funds from other emerging markets are seeking alternative structures in the region to deploy capital. • Deal Sourcing: Just bringing in money is no longer good enough for a GP to secure a controlling (but not always a majority) stake. In return, vendors are seeking partners with networks and © MONITOR COMPANY GROUP L.P 2011 , .
  • 8. 4 PRIVATE EQUITY IN THE SHADOW OF GIANTS Executive Summary capabilities to unlock value. Creating concepts or platforms for regionalisation is a theme that many players are using to create value in their portfolio companies. • Post-Deal Holding: Although many actors understand the need to be actively engaged with their assets after the cheque is written, few of them have cracked the post-deal value-add nut. The implementation of value-enhancing changes in founder-led firms is still one of the key challenges, for private equity investors in Africa, but dedicated full-time (non-deal) operations executives are still the exception. Consequently, teams rarely implement proper dashboards, balanced scorecards or other cross-portfolio, value-based monitoring and post-deal value driving tools. • Exits: There is a wide range of potential exits, but a strong preference to extract premiums from strategic sales to multinationals seeking African growth platforms. Some GPs are also beginning to implement sophisticated third-party exit grooming, signifying increasing market sophistication. • Cost Base: Execution and post-deal engagement costs in Africa are still relatively high. While many investors choose to locate in London and partner with African companies, this model is unlikely to attract funding in future. The need to find a cost-effective way of keeping “boots on the ground” through leveraging flexible operating models and local networks is becoming more vital than ever. © MONITOR COMPANY GROUP L.P 2011 , .
  • 9. PRIVATE EQUITY IN THE SHADOW OF GIANTS 5 Executive Summary Overall, our study uncovered an attractive industry in flux, with increased competi- tiveness, but sufficient uncharted territory to grow from its still small base. Many questions need to be answered about the sustainability of many of the innovative approaches that have been proposed, or whether they are too far ahead of the curve in terms of investor and investee perceptions and expectations. It will be interesting to observe which ones will get to scale in their chosen niches. On balance, the easy deals have been done. GPs now have to be on the ground, have an operational value-add track record and have a local network to position themselves as the preferred provider of capital. Financial skills are table stakes; be- yond that, GPs will require specialised commercial skills to extract value. However, few GPs include individuals with such experience on their payroll or embed this expertise in the philosophy of the GP franchise. In the end, private equity in sub-Saharan Africa is a people business, and whoever institutes value-driving change the quickest by being closest to the assets is most likely to win. © MONITOR COMPANY GROUP L.P 2011 , .
  • 11. PRIVATE EQUITY IN THE SHADOW OF GIANTS 7 Introduction THE LAST TWO YEARS HAVE SEEN A LARGE NUMBER OF reports in which consulting firms and research houses are proclaiming “now’s the time for Africa” (lead by Monitor’s Africa from the Bottom Up in 2009). This follows a wave of growth, development and increasing political stability, albeit from a very low base, that has engulfed sub-Saharan Africa over the past decade. Since 2000, the region’s GDP has increased at a compound annual growth rate of 5%. Although it halved during the global financial crisis, this level was almost restored in 2010. Assuming no further significant downward spiral in the global economy, the region is expected to grow by 4.8% this year (5.8% excluding South Africa) and exceed this rate in 2012 and 2013 (with some sources quoting up to 10% in some sub-regions).1 Much of this growth is driven by private investment as investors wake up to the increased publicity of finding significant alpha in Africa.2 Foreign direct investment (FDI) is the most important source of private capital flows to the subcontinent. Although in 2010 FDI inflows to sub-Saharan Africa as a whole had fallen by a fifth ($10 billion) since their 2008 peak of $48.1 billion, this is still an increase of 150% in the past half decade. It also hides a significant uptick in certain economies and regions where there are specific opportunities: the discovery of oil in Ghana saw FDI inflows increased by 1.5 times, while the expansion of mobile telecoms in the Democratic Republic of the Congo has seen FDI inflows increase four times to $2.9 billion.3 It is often argued that Africa’s rapid growth has been driven by the continent’s rush to exploit the region’s abundant natural resources, such as oil, bauxite, precious and “rare-earth” metals, diamonds, and 630 million hectares of cultivatable agricul- AFRICAN BUSHVELD The untouched beauty and wildlife in large parts of Africa creates ample tourism and eco-tourism investment opportunities. © MONITOR COMPANY GROUP L.P 2011 , .
  • 12. 8 PRIVATE EQUITY IN THE SHADOW OF GIANTS Introduction tural land. While commodities have attracted foreign attention, most notably from China, and account for around 40% of FDI, sub-Saharan Africa’s growth is not just being driven by primary goods. Natural resources directly accounted for only 24% of the continent’s GDP growth between 2000 and 2008.4 The vast majority of growth is derived from manufacturing and service industries including construction, retail, banking and telecoms, which have grown two to three times faster than those in OECD countries. This has been driven by urbanisation and the African consumer’s rising levels of discretionary income. Although sub- Saharan Africa remains the globe’s least urban region, its cities have grown at 3.3% annually over the past decade: by 2032, over half the African population will live in urban areas.5 With cities driving growth and development,6 Africans are becoming more affluent. The number of Africans with discretionary spending power, exclud- ing the wealthy elite, more than doubled from 151 million to 313 million between 1990 and 2010, and is now of comparable size to the same class in India or China.7 And yet, despite all the hype, private equity investment in sub-Saharan Africa remains at modest levels. One of our LP interlocutors commented that “the nature of our industry is that there is a lot of looking, but not a lot of dipping into one’s pocket. There has been an almost bubble-like interest in Africa, but it hasn’t been demonstrated by any huge uptick in investment.” This is underlined by Emerging Markets Private Equity Association (EMPEA) data, which shows that fundrais- ing for the region lags behind other emerging markets. In 2010, $1.5 billion was raised for private equity funds in sub-Saharan Africa (6% of the total for emerging markets); that year, China-focused funds raised $7.5 billion and Indian funds $3.3 billion. Despite the attention sub-Saharan Africa has received recently, in the first half of 2011 the region’s funds raised $1.1 billion, largely comprised of Helios Investment Partners’ $900 million fund, the largest pan-African fund to date. This is dwarfed by the $10.3 billion China-dedicated funds raised during the same period. © MONITOR COMPANY GROUP L.P 2011 , .
  • 13. PRIVATE EQUITY IN THE SHADOW OF GIANTS 9 Introduction Private equity penetration in sub-Saharan Africa is also amongst the lowest in the world; in 2009 it was only 0.16% of GDP, before falling to 0.06% in 2010 (see Figure 1). Figure 1: Emerging market private equity investment as percentage of GDP 2009 – 2010 , 1.2 1.13 2009 2010 1.0 0.90 0.8 PE Investment/GDP (%) 0.63 0.6 0.57 0.43 0.44 0.4 0.34 0.32 0.26 0.23 0.21 0.2 0.16 0.16 0.13 0.11 0.10 0.06 0.08 0.08 0.06 0.06 0.06 0.04 0.02 0.04 0.01 0.01 0.01 0.01 0.01 0.0 United United Israel India Brazil China Russia Poland SSA South Japan MENA Mexico South Turkey Kingdom States Korea Africa* Source: Emerging Markets Private Equity Association. Source: Emerging Markets Private Equity Association *Note: the South African figures are likely to include government and captive player data less likely to be included in the other country figures. *The South African figures are likely to include government and captive player data less likely to be included in the other country figures The relatively low penetration points at an early-stage market, with the exception of South Africa. Returns have, however, been consistent and above average; all of our GP interviewees expected returns of over 20% in markets outside South Africa, with established players reporting in excess of this figure. Indeed, one of our interlocutors told us “if you can’t make 20% in Africa, then you shouldn’t be in the private equity business”. The longer-established players have consistently out- performed the local public markets and other emerging regions. As the perception with reality is catching up, more new entrants are now seeking this alpha. © MONITOR COMPANY GROUP L.P 2011 , .
  • 15. PRIVATE EQUITY IN THE SHADOW OF GIANTS 11 Africa’s Challenges INVESTING IN SUB-SAHARAN AFRICA IS CHALLENGING. Despite the growth story, African opportunities are often harder to exploit than that in many other high-growth emerging markets like in Asia and Latin America. The challenges GPs face broadly fall into two categories: investor perceptions of the region and the high cost to serve. Perceptions Despite the hype around sub-Saharan Africa as an investment destination, it has a terrible image abroad.8 Coverage of the region and of its prospects has been relent- lessly negative, even from acknowledged friends and advocates. The “CNN Effect” has meant that the stories that grab headlines around the world – the civil war in Côte d’Ivoire, Somali piracy, the HIV/AIDS plague across the subcontinent, and the recent humanitarian crisis in East Africa – tend to crowd out good news stories – the region’s growing political stability represented by transparent elections in Ghana and the recent peaceful change of ruling party in Zambia. Much like the media itself, investors tend to take more notice of the three minutes they see on the television news rather than getting into the region and looking and understanding the market dynamics from the ground up. Conversely, the opposite is also increasingly true. As Western markets grow only sluggishly in the wake of the global financial crisis, and European governments struggle to persuade the markets that they can repay their debts, many investors are reassessing risk and looking to new markets to find alpha. Such reassessments make sub-Saharan Africa’s many markets look increasingly attractive on a risk- POWER LINES IN NAMIBIA: A large infrastructure shortfall is a major cost to doing business in Africa. © MONITOR COMPANY GROUP L.P 2011 , .
  • 16. 12 PRIVATE EQUITY IN THE SHADOW OF GIANTS Africa’s Challenges return basis. However, this may lead to misperceptions about the relative size of the opportunity in some of the sub-Saharan African countries, and about the levels of risk. Cost to Serve Due to is physical size, geopolitical fragmentation and lacking infrastructure, sub- Saharan Africa is also a hugely expensive place to do business, both in terms of time and money. Largely, this is the result of the major infrastructure shortfall and the lack of supporting ecosystems (legal, financial, intermediaries, etc.) across the region. On just about every measure of infrastructure coverage, African coun- tries lag behind their peers in the developing world, with the differences being particularly large for paved roads, flight connections, phone/data main lines and power generation,9 which makes doing business challenging, both for “fly-in” and “boots on the ground” private equity business models. Another factor that adds to the cost of doing business is the diversity and atomised nature of the region. Sub-Saharan Africa comprises 49 of the continent’s 55 states, many of which have populations of fewer than 20 million and economies smaller than $10 billion. These countries are characterised by cultural heterogeneity from the Islamic cultures of the Sahel, through the French colonial legacy of West Africa to the commercial sophistication of South Africa. Such diversity creates a complex web of legal and business cultures, which are not easily navigated and can limit businesses ability to spread across the continent. This diversity is made more challenging to navigate because the investment eco- system is underdeveloped or absent. Particularly at the smaller end of the market, there are few value-adding intermediaries and other (legal, accounting, banking, consulting) service providers. The major effect of the lack of a professional eco- © MONITOR COMPANY GROUP L.P 2011 , .
  • 17. PRIVATE EQUITY IN THE SHADOW OF GIANTS 13 Africa’s Challenges system is the high cost of due diligence. This is a “huge expenditure” and creates a higher risk and abort costs for investors, particularly at the small- and mid-cap level, for a number of reasons: • Outside South Africa, due diligence firms are not generally considered to be particularly high quality, and thus global accounting, strategy or risk-consulting firms were often engaged to satisfy both GP and LP requirements, at a higher cost than the local equivalent. • There is little reliable market and consumer data available in Africa, as there is a large informal or cash economy, and standard information about companies frequently isn’t available. • As in other emerging markets, smaller companies often have two or three sets of financial records, to which GPs needed full access before investing. Traditional legal, commercial and accounting due diligence is considered insufficient in Africa; GPs and LPs need local knowledge about the immediate network and political position of investees, for example. • Both UK and US foreign corrupt practice legislation now require compliance both going into the asset and in ongoing monitoring throughout the investment period.10 Even when this had been navigated and locked down contractually, many interviewees spoke of the necessity of staying out of court. In many African countries the courts system can be mercurial, and while the legal contracts are necessary, they are insufficient to ensure that an agreement is enforced even after an expensive legal process. © MONITOR COMPANY GROUP L.P 2011 , .
  • 18. Private Equity’s Challenges Private Equity’s Challenges
  • 19. PRIVATE EQUITY IN THE SHADOW OF GIANTS 15 Private Equity’s Challenges PRIVATE EQUITY COMPETES SIMULTANEOUSLY IN THREE distinct but dynamically linked markets: the markets for funds, deals and talent. A superior team and track record create a virtuous cycle that enables smarter execu- tion and value extraction from the deal flow and thus attracts funding more easily. In each of these markets, the sub-Saharan-African environment presents specific challenges to GPs and they have, therefore, had to adapt their models. As such, we have cut into the topics and trends in Africa using these three markets as the lenses through which we, and the other actors, perceive the applicable differences in Africa. Fundraising Sources of Funding One of the distinctive features of private equity in sub-Saharan Africa is the heavy development finance institution (DFI) footprint both as LPs and direct investors. DFIs have long been important investors in African private equity, catalysing commercial investors’ interests and moving the investment agenda from aid to commercial capital, helping stimulate the local private sector through for-profit investments. Preqin documents that there are 51 DFIs actively investing in Africa-focused funds, representing 9% of LPs investing in the region,11 but our interlocutors suggested that this underplays their influ- ence, with several suggesting that DFIs provide well over half the value of LP investment in sub-Saharan Africa. Finding the right talent is one of the greatest challenges for GPs operating in sub-Saharan Africa © MONITOR COMPANY GROUP L.P 2011 , .
  • 20. 16 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges GPs working in sub-Saharan Africa also have access to impact investors, who actively promote the growth and expansion of enterprises that have a development impact, while returning at least nominal principal, and have provided hundreds of millions of dollars to private businesses in the region.12 Another increasingly im- portant source of new capital for GPs is the African diaspora, whose remittances play such an important role in capital flows to the region. New vehicles are being established that aggregate the economic power of African ex-pats to invest profit- ably on the subcontinent. Additionally, in South Africa, Namibia, and soon Botswana, changes to public pen- sion fund legislation have allowed local pension funds to quadruple their allocation to private equity to 10%, which brings their allocation in line with more experienced public pension funds in North America. The raising of the private equity allocation in these institutions, our interlocutors hoped, would increase their awareness of the asset class and open new pools of funds to be deployed in this sector. Many GPs are, however, beginning to look elsewhere for funding. Many of those we interviewed were approaching family offices and high-net-worth individuals, particularly in other emerging markets, as more adventurous, nimbler investors with fewer conditions attached to funding. Endowments and foundations, particularly those from the US, and sovereign wealth funds also favour the region as they seem to have more risk appetite than traditional institutional investors,13 such as pension funds, funds of funds and asset managers. For example, we have seen a sovereign wealth fund and a specialised family office investment team execute focused sector roll-up strategies in consumer packaged goods and fast-moving consumer goods across the continent. By contrast, only a few traditional investors have dived in to Africa, amid concerns about risk and the maturity of the market.14 © MONITOR COMPANY GROUP L.P 2011 , .
  • 21. PRIVATE EQUITY IN THE SHADOW OF GIANTS 17 Private Equity’s Challenges Challenges of Fundraising Since mid-2008, GPs raising funds for sub-Saharan Africa have faced many of the same difficulties as their peers around the world. Both private and public institu- tional investors have become more risk averse and have invested less in private equity.15 A number of interviewees also identified a “certain dissatisfaction with the private equity model in general” and a requirement for more transparency and accountability from the fund managers. Even DFIs and government development agencies, operating in cash-constrained environments, are more aware that they need to have an impact for every dollar they spend. To attract investors, therefore, African GPs need to “demonstrate to an investor sitting on the east coast of the US that, on a risk adjusted basis, they can make equivalent dollar returns by investing in Africa as against investing in the US or Europe or Asia” by genuinely improving the strategy and operations of investee companies. Consequently, investors have raised the bar in terms of strategic sophistica- tion requirements for GPs, to mitigate risk and maximise returns. Many LPs now have more stringent track record requirements than they did in 2007. To convince investors that they are “good, not lucky”, fund managers must demonstrate expe- rience and consistency in portfolio returns. This can adversely position first-time fund managers, particularly those without African track records. That said, LPs do scrutinise individual personnel, requiring a team with all the complementary skills that good parenting of a portfolio company requires. DFIs and institutional investors are also looking more closely at GPs’ strategies and business models and require “carefully articulated strategies that take account of the realities of markets that have been well researched”. © MONITOR COMPANY GROUP L.P 2011 , .
  • 22. 18 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges All these trends affect fund managers equally in other markets, but in sub-Saharan Africa, this has been amplified by the macro stereotypes about political risk and corruption, and the nascent state of the industry outside of South Africa. The risks, many stakeholders in the region believe, are “overhyped”; while there are some examples of potentially harmful legislation, such as Black Economic Empower- ment in South Africa and Indigenisation in Zimbabwe, nearly all our respondents argued that risk isn’t necessarily that much higher in Africa than anywhere else and some have the track record to prove it: one of our interlocutors’ firms is stated to never have lost or written off an entire asset in Africa due to country risk since the firm’s inception in 1948.16 Fundraising is particularly challenging for South African GPs at present. DFIs are less willing to invest in South Africa, because it is now considered a mid-income country. Moreover, given the current political situation there is a greater risk premi- um placed on South Africa by investors in London and New York, yet the returns and GDP growth rate are lower. However, given South Africa’s dominance over the region’s GDP, its market depth and the comparative sophistication of its private equity industry, it is “difficult to deploy $200 million in Africa while ignoring South African investment opportunities entirely”. On balance, fundraising constraints in sub-Saharan Africa may be easing; globally, Preqin’s most recent LP survey found that investors are “not investing at the same pace as in the years before the downturn, [but] the number of investors looking to make commitments is steadily improving”. Moreover, Preqin’s survey suggests that LPs are looking for returns of 200 basis points over the market; as African equities have performed poorly this year (see Figure 2), several GPs we interviewed suggested that private equity was an attractive option to those seeking African exposure (and to harness African growth) but with substantially higher returns. © MONITOR COMPANY GROUP L.P 2011 , .
  • 23. PRIVATE EQUITY IN THE SHADOW OF GIANTS 19 Private Equity’s Challenges Figure 2: Performance of African stock markets January–August 2011 INDEX PRICE 1D Av. YTD USD YTD North Africa EGYPT EGX 30 4728.55 0.28% -33.79% -35.51% MOROCCO CFG 25 24018.47 0.16% -8.30% -5.17% TUNISIA TUNINDEX 4513.03 -0.91% -11.73% -9.25% West Africa BRVM COMPOSITE 143.11 -2.36% -10.05% -6.30% GHANA ALL SHARE 1128.26 -0.30% 12.93% 9.37% NIGERIA ALL SHARE 21298.07 -1.11% -14.02% -16.09% East Africa KENYA ALL SHARE 73.60 -0.59% -24.76% -35.41% TANZANIA ALL SHARE 1279.83 0.02% 9.96% 0.41% UGANDA ALL SHARE 964.90 -0.26% -18.78% -33.37% Southern Africa BOTSWANA DCI 7287.30 -0.06% 13.63% 8.10% MALAWI ALL SHARE 4905.96 0.56% -0.95% -9.30% MAURITIUS SEMDEX 1929.58 -0.89% -1.92% 7.55% NAMIBIA OVERALL 749.38 -1.68% -13.59% -20.33% SOUTH AFRICA ALL SHARE 29525.83 -1.21% -8.07% -15.24% ZAMBIA ALL SHARE 3799.56 0.26% 15.00% 11.02% ZIMBABWE INDUSTRIAL 160.58 -0.16% 6.15% 6.15% ZIMBABWE MINING 160.64 1.11% -19.84% -19.84% Global Markets MSCI EMERGING 988.05 -0.16% -14.19% -14.19% S&P 500 1165.24 -0.74% -7.35% -7.35% EUROSTOXX 50 2080.10 -1.29% -25.52% -22.17% NIKKEI 225 8590.57 -2.21% -16.02% -12.15% Source: FM Capital Partners © MONITOR COMPANY GROUP L.P 2011 , .
  • 24. 20 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges Deal Flow Deal flow has changed. The easy days of post-Apartheid unbundling of conglomer- ates in South Africa are long gone. On the whole, so too are the leveraged buy-outs relying on financial engineering and letting underlying growth recoup the debt. The tide is no longer raising all ships, even in this part of the world. Good deals are harder to find and there is greater competition. Investments no longer just create value by themselves; more sophistication is required to source and identify value in them, thus investment theses often demand more attention and skills by the GP to turn into real returns. In 2008 deal flow slowed, almost “constipating” the industry, resulting from the financial crisis. Due to limited debt, exits to financial buyers in that period had slowed and deals delayed waiting for movements in multiples, as unrealistic expectations created mismatches between buyers and sellers. Another challenge peculiar to South Africa was that “the listed markets continued to tick over and the changes to the Companies’ Act have made it more difficult and complex to execute transactions and increased the cost of failure”. This is borne out in EMPEA’s data: in 2008, South Africa was responsible for 28 deals, valued at $2 billion; in 2010, the deal volume had decreased by two thirds (to only 10 closes), worth only $47 million. This trend started reversing in 2011, with transactions like Savcio, Tracker and Universal indicating a return of high-value deals to the market. Conversely, however, the other giant market of sub-Saharan Africa, Nigeria, seems to have been less affected. In 2010, it accounted for $188 million (30% of the total value) in only six deals. © MONITOR COMPANY GROUP L.P 2011 , .
  • 25. PRIVATE EQUITY IN THE SHADOW OF GIANTS 21 Private Equity’s Challenges Another factor that stymies deal flow is that private equity is in its infancy in the region, with the exception of South Africa; consequently, capital-seeking businessmen have had little exposure to the asset class, and are often unaware of it. They do not, therefore, seek it out as a potential exit or as a natural source of growth capital. The GPs in the region thus have to promote, demystify and educate vendors about private equity, which can be a lengthy process, termed by one GP “the education overhead”. This is exacerbated by the fact that there is an almost complete absence of a proper venture capital industry in the region, even in South Africa, which means that entrepreneurs are not familiar with the role of outside investors. GPs investing in mid-market and early-stage companies across the region seemed content that there was sufficient deal flow, but many of those looking at larger companies were struggling to find assets to take large tranches of financing. One of our interviewees noted that this is partly because big players are seeking only “belt and braces deals” and limiting their focus for large ticket deals to South Africa. Consequently, particularly in Africa’s largest market, there is increasing competition as more international GPs enter sub-Saharan Africa. That said, those GPs playing in this space, but who took a more entrepreneurial approach, and broader geographical focus to deal sourcing told us that they had seen “limited competition, and our current pipeline reflects this fact”. But, in the conventional private equity space, there are relatively few companies by comparison to China and India that can take large ticket sizes. Many businesses are still young, founder-run and have small capitalisations, as until recently, political instability has constrained companies’ regional and cross-boarder growth. Several GPs who specialised in © MONITOR COMPANY GROUP L.P 2011 , .
  • 26. 22 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges small deals noted that many funds that had started out in small sub-$5 million deals were “edging upwards to... $10 million, $25 million deals”, so “it’s more and more congested higher up the food chain you go”, a trend exacerbated by larger, international GPs looking to sub-Saharan markets. There is also new competition from investment banks and some highly astute trade players. Russian investment bank Renaissance Capital, which operates in six African markets, completed 27 transactions in 14 African countries from mid-2010 to mid- 2011.17 Local trade players also compete with private equity as they have industry relationships, access to customers and more trade expertise to pick and choose assets. What is more, South African corporations with already established sub- Saharan activities have become targets for multinationals eager to gain a foothold in the region. A case in point is Wal-Mart’s $2.3 billion bid for South African retailer Massmart, which has a growing presence in 14 markets across the region. The slowdown in capital deployment is supported by EMPEA data, which shows that for the first time since 2006 capital invested was lower than funds raised in 2010, and that it had hit a five-year low at only $631 million (see Figure 3)  –  a drop of over 50% on 2009. Moreover, the data provides evidence for deal flow drying up at the top end of the market. In 2008, 50 private equity deals were closed in sub- Saharan Africa, with a total reported value of $2.9 billion. In 2010, there were 48 (only two less), but in value they represented only 20% of the 2008 level, suggesting the average deal size shrunk down to a fifth. © MONITOR COMPANY GROUP L.P 2011 , .
  • 27. PRIVATE EQUITY IN THE SHADOW OF GIANTS 23 Private Equity’s Challenges Figure 3: Sub-Saharan Africa Fundraising & Investment, 2006 – 2010 (US$B) $4 3.4 Funds Raised Capital Invested $3 2.9 2.1 2.2 2.0 US$ Billions $2 1.5 1.3 1.4 1.0 $1 0.6 $0 2006 2007 2008 2009 2010 Source: Emerging Markets Private Equity Association. Equity Association. Source: Emerging Markets Private As such, with the exception of the giants  –  South Africa, where the public market and private equity is much more developed, and Nigeria, given its growth dynam- ics and size  –  deal flow is likely to remain in the small- to mid-cap space. These deals are not about financial engineering, as is the case in LBOs; rather GPs need to supply growth capital to founder-led assets that aim to expand regionally, require corporatisation, and improved governance processes and management systems as they are rarely at first sight “investment ready” by western standards. As such, they require intensive post-deal engagement to realise the value. Talent Talent, both at GP and portfolio company level, is the major constraint for private equity in Africa, almost unanimously confirmed by all players interviewed. Recruit- ers confirmed that not all skills – Western education, financial acumen, management experience, African background and operational track record – can be found in one © MONITOR COMPANY GROUP L.P 2011 , .
  • 28. 24 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges individual for each position. Rather, recruiters have to construct teams mixing team members with some of these attributes and then invest in developing local talent to achieve the required blend. One investor told us that they were struggling to find an African to head their Johannesburg office as suitable individuals were unwilling to leave lucrative jobs in international financial centres or managing large international private equity funds to manage a smaller fund on their home continent for a necessarily lower salary. This, he believed was partly due to the fact that the “true egalitarian private-sector boom in Africa is relatively new and... this is the first chance many people have had to make real personal wealth”. Despite this constraint, talent is to be found amongst the returning diaspora or “re-pats”, who some LPs felt were ideal for the business due to their combination of developed world experience and sensitivity to local nuances. But while the finan- cial crisis might have encouraged some re-pats home, “the infrastructure does not yet exist to entice the bulk of the African diaspora back”, thus repatriation has yet to reach the levels seen in Asia. Also the banking crisis driven re-pats need to be complemented by more operational focused “heavy-hitting” operationally experi- enced re-pats, paired up with strong local team members to support them. Several LPs we interviewed believed there to be “a severe shortage of good GPs in Africa”. This echoes the findings of the 2011 Coller Capital EMPEA LP survey, in which nearly half of respondents said that the limited number of established GPs was likely to be the single biggest factor to deter them from beginning to invest in sub-Saharan Africa over the next two years.18 As one potential LP told us, “we have one set of investment guidelines and investment criteria irrespective of geography. They mustn’t expect that just because a manager is in a higher-growth economy like © MONITOR COMPANY GROUP L.P 2011 , .
  • 29. PRIVATE EQUITY IN THE SHADOW OF GIANTS 25 Private Equity’s Challenges Africa that we’re going to give them any benefit of the doubt that they’re going to perform as well as any other manager”. This explains the current quasi-absence of large global institutional investors that still prefer to place their funds in Asia first; many are interested and observing from the sidelines, until the volume of credible players is sufficient to spread their bets. Several of our interviewees pointed out that “there is a huge difference between those who can do private equity and those ex-investment bankers who think they can”. The distinguishing factor tended to be those teams that understood that investing in the growth capital space requires a wide range of operational and change management skills, beyond just financial structuring and deal execution. © MONITOR COMPANY GROUP L.P 2011 , .
  • 30. Innovative Approaches along the Private Equity Value Chain Innovative Approaches Along the Private Equity Value Chain PHOTO BY PIETERJAN GROBLER
  • 31. PRIVATE EQUITY IN THE SHADOW OF GIANTS 27 Innovative Approaches along the Private Equity Value Chain DURING OUR INTERVIEWS WE HAVE ENCOUNTERED SUCH a wide range of GPs that it would have done little justice to the innovations, diversity and richness of their business models to force these into a simple indus- try classification (see Appendix). Instead, we have looked to where the particular challenges of sub-Saharan Africa have led GPs to innovate along the private equity value chain, and to illustrate how these innovations have worked at each stage. Figure 4: African GPs’ Innovations throughout the value chain Investment Strategy Investment Execution 1. Fund Strategy 2. Fundraising 3. Deal Sourcing 4. Deal Execution 5. Post-Deal Holding 6. Exiting • Regional funds • Pledge funds • On-the-ground • Convertibles • Active, hands-on • Trade/Strategic • Sector-specific funds • Listed company networks • Preference shares engagement Sales • Value-add funds • Deal-by-deal • LP & partner • Tranche investments • Capacity building • IPO networks • Insert experts • Group sale • Developing • Partnership • Non-cumulative platforms • Proprietary deal dividends • Regional expansion • Secondary sale • Holding company flow • SMEs and mid-cap • Open fund • Liquidation • Technical assistance • Sell back to • Limited preference management or • Following South • Captive intermediary- founder African companies • Debt financing • Merchant bank generated deal flow north • Higher fees • Management & oversight fees 7. Cost Base Recruiting and Human Resources Regional Office Infrastructure Travel Support services: legal services, due diligence, finance (accounting & reporting), IT etc. RENEWABLES ARE GAINING MOMENTUM: Private equity firms operating in sub-Saharan Africa are finding niches to exploit. One of the most popular among our interviewees was green energy. © MONITOR COMPANY GROUP L.P 2011 , .
  • 32. 28 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain 1. Fund Strategy As fundraising conditions have tightened over the past three years, competition for funding has intensified. Consequently, new-to-market small, sub-Saharan African players are developing sophisticated, differentiated strategies. The most common of these amongst our interviewees were sector plays: financial services, health, agri- business, and renewable energy. We also observed focused geographical strategies, both regional and thematic (e.g. post-conflict economies) which has resulted in investments being spread over a wider range of countries. EMPEA data shows a marked uptick in investments in Kenya and sub-Saharan African Most of our GPs had markets outside of South Africa, Nigeria, Ghana and Uganda. strategies focused on These accounted for half the total value of private equity invest- harnessing the growth of ment on the subcontinent in 2010, and represents an increase the African middle class. of almost three times on both 2008 and 2009. We also noted a number of strategies segmented by market sector, such as ven- ture capital and SME investments, and value-add approaches – for example using South African networks to link businesses in neighbouring countries to Africa’s big- gest market, and backing South African entrepreneurs founding companies north of the border. LPs believed this to be an encouraging trend as it showed that “more thought was going into” the GP business models and strategies. Most of our GPs were seeking to harness the growth of the “slow but steady moving machine” of the emerging middle class; therefore, one of the most popular strategies was that of developing consumer products or agribusiness companies by buying platforms to expand into neighbouring markets, organically or through roll-ups. One GP told us “we don’t take technical risk”, rather they seek to take proven models to new geographies, either with one portfolio com- pany, or by sharing the knowledge across their portfolio. This strategy primarily involved mid-cap companies, with GPs taking a controlling minority stake of © MONITOR COMPANY GROUP L.P 2011 , .
  • 33. PRIVATE EQUITY IN THE SHADOW OF GIANTS 29 Innovative Approaches along the Private Equity Value Chain around $20 million. These are likely to benefit from changes like the creation of the East African Customs Union, which makes international expansion easier and less costly. We also saw GPs working with venture or early-stage companies using this strategy, but they preferred a majority stake, usually for under $5 million. The key to making this model work was either finding an underdeveloped sector, such as healthcare, or finding a company that had a particularly innovative business model that could leapfrog existing technologies or products in the market. All these contrast with the classic model of the long-established, multiple vintage, larger-scale South African players who think about their capital allocation north of their borders more in the sense of backing their South African portfolio companies in their quest to double their non-South African revenue lines, rather than seeking standalone assets in remote markets. Regardless of the approach, many of our interviewees believed that while oppor- tunism had worked in the past, in the current climate it was more important to stay “consistently on-strategy”, and only buy assets where they had a detailed under- standing of the economic and political environment in which they were investing so that they could efficiently unlock the sources of value over the investment period. 2. Fundraising One of our interlocutors told us that it is “increasingly difficult to justify run- ning a fund model unless you get to scale” and given the current challenges of fundraising he thought it would be very difficult to raise another fund. Indeed, it appears that for many of our interviewees, the traditional closed-fund model © MONITOR COMPANY GROUP L.P 2011 , .
  • 34. 30 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain was distinctly under threat. This, it was argued, was “a natural evolution for the business” and the development of alternative structures was an “important mile- stone for the industry”. We saw a number of alternative investment structures that actors had developed, either through necessity, or through intent: • Listed investment company using public market funding • Privately held holding company or conglomerate (on-balance-sheet lender) • Deal-by-deal fundraising or flexible capital model • Pledge funds • Open fund with no close • Captive funds with a dominant investor • Merchant or investment bank or principle investment arm • Wealth managers • Impact investors There were a number of reasons why actors had innovated around the funding model. Partly this was a result of the liquidity-constrained environment. With LPs reluctant to tie up their capital and expose themselves to the high perceived risks of Africa, having a model that provided investors with “liquidity and a real price point”, was advantageous because it reduced the risk, but still gave private equity exposure. Another benefit that actors saw in these structures was that they gave © MONITOR COMPANY GROUP L.P 2011 , .
  • 35. PRIVATE EQUITY IN THE SHADOW OF GIANTS 31 Innovative Approaches along the Private Equity Value Chain investors “exposure to growing markets that they would otherwise be unable to access”, thus providing them with added diversification benefits. There is a clear preference for attracting more patient capital, hence the emergence of more transparent, open Sub-Saharan African funding models that were more flexible about ticket GPs are innovating around size, stake size, sectors and holding period. As one the fund model to interlocutor argued “the dirty secret of private equity attract a wider range of is the seven-year lifespan. You have to sell a perfectly investors, reduce risk and good asset at a predetermined point – from an investor provide liquidity. standpoint that’s crazy”. As a reflection of the dynamic nature of the African market, players viewed flexibility as particularly important: they needed to be nimble, quickly taking advantage of the opportunities that they found. They also wanted flexibility on holding period. Those actors investing in infrastructure and property would hold for the longest period, but otherwise there was a disparity across all other variables, with some players seeking to exit a com- pany within three years, even an early-stage one, and others feeling that to maximise the value they needed to hold it for longer.19 Indeed, they wanted to be able to sell the asset at the best market opportunity, not when dictated by a fund lifespan. Those GPs who are planning on continuing the classic GP/LP closed fund model often asked to increase management fees. This is obviously unpopular with LPs, particularly DFIs, as one told us “if a GP can’t survive on two and twenty, it shows he doesn’t know the landscape well enough”. That said, some DFIs are willing to pay higher fees if the fund was below $50 million, if they are engaging with SMEs, or in post-conflict countries, which they understand had a greater economic impact and are more resource intensive. That said, all the LPs we spoke to were concerned that higher fees might represent a flaw in the sustainability of the GP’s underlying financial model. © MONITOR COMPANY GROUP L.P 2011 , .
  • 36. 32 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain An alternative route is to charge investees a “management and oversight fee” baked into the shareholder agreement, which enables GPs to engage intensively with their portfolio companies without burdening the investors with the additional cost. The principle behind such a fee is that the companies should pay for the value-add that the GPs bring. However, as both the GPs that follow this model pointed out, it only really works if you can make a cast-iron case up-front for that value-add to the management of the investee company. Smaller, founder-led companies are gener- ally less open to this. 3. Deal Sourcing As in other markets, private equity is “very much a people’s business in Africa”, it is “very difficult to address without feet on the ground or partners that you’re truly aligned with and truly trust”. Our interlocutors thus emphasised the need to spend considerable time in creating and developing “soft relationships” learning the local cultural context and getting to know local entrepreneurs. This network is vital as “the deals get put together and you get invited; you don’t propose the deal if you’re a private equity player. Often the deals get done at a political or industry leadership level”. Those GPs considered to be successful by their peers were thus those that “really know their way around” their chosen region. This allows GPs to get to know the “potential investee companies, the market gossip and where the company sits within the business ecosystem”. It also enables firms to identify any potentially problematic (or advantageous) political affiliations that the entrepreneur might have. Good relationships with vendors also prevent GPs from being persuaded to “overpay for growth”, which can improve the investment’s performance as “if you overpay, it’s difficult to generate the kind of returns investors are looking for”. © MONITOR COMPANY GROUP L.P 2011 , .
  • 37. PRIVATE EQUITY IN THE SHADOW OF GIANTS 33 Innovative Approaches along the Private Equity Value Chain The importance of networks was underlined by the position of South African managers who were seeking to expand north of the border. Most understand the need to tap the growth and have a tranche of their fund carved out for ex-South Africa investments, but many struggle to source deals  – “how deals get done in those countries is a mystery” due to the “complexity of the relationships” –  and evaluate risk. South African managers understood that expanding into the rest of sub-Saharan Africa “requires our senior people to be committed and go to some of these places”, and that this required “spending money and putting offices and infrastructure in place”. Rather than make this commitment, many South African GPs seek to gain this exposure indirectly by encouraging their portfolio companies to expand regionally. This, as one interviewee pointed out, is “self-serving, but it’s also valid”. However, “it underestimates inter-country differences, and in that sort of play, management is an issue”. Proprietary Deal Flow Several established players noted that competition for deals has increased notice- ably in recent years with one telling us “we have faced more competition on deals in the last six months than in the last six years combined”. In this environment, the ability of a GP to secure propriety deal flow was considered by many stake- holders to be a litmus test of quality. Our interviewees believed that creating deals and “build[ing] your reputation so people come to you” improved performance by reducing initial asset prices, and demonstrated your skill at finding a good invest- ment in unusual spaces. There was a certain amount of scorn for managers that had bought assets that had “been around the block”, or had “wait[ed] for the opportunity to come their way when shareholder activity unlocks an asset” rather than going out and creating opportunities. There was also disdain for GPs that relied on intermediated deal flow. Most of our interviewees believe that these deals are the preserve of global players (Actis, Bain Capital, Carlyle) or established large © MONITOR COMPANY GROUP L.P 2011 , .
  • 38. 34 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain local firms with larger funds because “you need to be the highest bidder”, and most GPs, particularly those with smaller funds, are unable to pay over the odds. GPs’ views of investment opportunities are coloured by how they are plugged into the ecosystem. The most marked example of this comes in the form of attitudes towards the Asian family businesses of East Africa. Those GPs who understand these businesses and have good contacts there see them as an opportunity to create deal flow by building relationships and working with them to develop new busi- nesses. Others see them as competitors because they are “shrewd on-the-ground operators and they are well-connected with strong relationships with government... particularly in resources”. 4. Deal Execution Like private equity practitioners across the world, our GPs rarely take a plain- vanilla equity stake in their investee companies. They seek to protect their down- side by using convertible notes, preference shares, or investing in tranches, particularly in smaller companies. They may also have non-cumulative dividends, some form of liquidation preference in-line with other preferred stockholders, and standard conversion and dilution provisions. Bank financing in Africa is expensive; for example Barclays in Kenya currently offers business loans at 14.9% over a five-year period20 – double the equiva- lent in the UK – so some GPs investing in SMEs or early-stage companies also look to provide investees with some form of debt financing. This sometimes takes the form of a shareholder loan for start-ups, mezzanine financing, particularly in manufacturing industries that have an expanding customer base, and sometimes long-term debt “comparable to a bank”. © MONITOR COMPANY GROUP L.P 2011 , .
  • 39. PRIVATE EQUITY IN THE SHADOW OF GIANTS 35 Innovative Approaches along the Private Equity Value Chain 5. Post-Deal Holding The vast majority of GPs we interviewed emphasised the need to be very hands-on with their portfolio companies; few of the GPs we interviewed had more than two investments per partner, and all took the customary seats on the board. This was also reflected in the composition of GPs’ teams; several noted that they required a mix of skills that ranged from accounting, legal, and financial to operational knowledge in engineering and logistics. This would either be present within the partnership, or they would call in the right skill sets as the investee business changed, through networks of ex- Capacity building within executives or consultants. portfolio companies is a vital part of turning a But outside the venture/early-stage space, GPs prefer company around. not to get too close to the running of portfolio compa- nies themselves, instead helping the existing management to corporatise and grow the business. Nearly all the GPs we spoke to stressed that when making their investment decision they back good management ; for one GP “it’s the only thing we do”. However, in some particularly challenging post-conflict economies or at the venture capital level, some GPs had taken on managing director roles; one even had to undertake the stock-take for an early-stage logistics business. On the whole, however, GPs look to help the existing management to improve and grow the business. The emphasis here is very much on capacity building within portfolio companies, particularly in smaller or family-owned businesses where most of the skill and energy resides in the founder. GPs discovered that in many cases the “talent is there, but there is not enough”. This often manifests itself in a big gap between the talent of the entrepreneur (or C-level executives) and the middle man- agers, who do not lack in “raw talent or integrity” but have less experience. They “usually require a little bit of deliberate study and understanding” because it’s the middle managers that are going to implement the changes that need to take place when turning a company around and looking to become more commercial. © MONITOR COMPANY GROUP L.P 2011 , .
  • 40. 36 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain HELIOS INVESTMENT PARTNERS: BEST-IN-CLASS EXAMPLE OF DEDICATED POST-DEAL VALUE-ADD CAPABILITIES IN SUB-SAHARAN AFRICA One player in sub-Saharan Africa, Helios all the way to the middle management Investment Partners, has adopted the layer, often “peeling off ” into the asset, philosophy of integrating commercial manning a project management office skills into the GP from their first vintage, (PMO) that actively implements the in- despite being technically “sub-scale” at vestment thesis and growth initiatives. the time, with economics perceived to be too small to carry this capability. The Ultimately, however, they are still part team has a clear division of labour of the GP with similar incentives to the between deal execution and post-deal GP’s deal executives. This is the critical parenting. Although the post-deal or op- difference to the more prevalent model erating executives do form part of the of the portfolio company hiring retired deal selection and due-diligence process, CEOs as sector-experienced operat- their primary role kicks in once the GP ing executives only into the respective “holds the keys to the business”. specific portfolio companies. Aligning post-deal executives’ incentives with Operating executives are located on the the GP encourages the sharing of best ground, close to the assets they nurture practice across assets, which can and they intervene far deeper than the improve asset performance throughout board. As in the more sophisticated the portfolio and thus increase post-deal private equity markets in Europe and executives’ compensation. Moreover, it North America, they have a different enables these practices to be passed to background, education and experience the GP franchise and thus transfer the than fund managers, mostly being drawn learning to the next deal or vintage. from the top-tier strategy firms or with operational improvement experience, as This model also facilitates innovation opposed to investment banking or ac- across the portfolio. Executives counting. They end up part of the asset’s employed by the portfolio company tend management team, coaching and advising to adhere to the principles and busi- © MONITOR COMPANY GROUP L.P 2011 , .
  • 41. PRIVATE EQUITY IN THE SHADOW OF GIANTS 37 Innovative Approaches along the Private Equity Value Chain ness models that have worked for them (in terms of carry points and incentives) in their past careers, which offer for the new operating executive. This good downside protection for the invariably puts them on the back foot. assets. But more progressive players They will have to work hard to justify supplement this with analytics, change their presence and the cost they create, management and multi-sector experi- in addition to being forced to hire ad- enced ex-consultants from the top tier ditional leverage to “move the needle” strategy houses, to ensure that some in the portfolio. Further, they have to of the more innovative and cutting sell themselves to the existing portfolio edge approaches to value creation CEOs, who will naturally feel threatened get implemented. This is what global by more “share-holder interference” that institutional investors are now increas- they hadn’t signed up for. ingly looking for and insisting on. One closing comment on the topic of The Helios model works as it does not controlling stakes: there is a percep- create a “second-class citizen” dynamic tion that the GP needs control to affect between deal executives and operating value driving change. Often GPs con- executives: they are part of the same fuse effective board control (or majority team and in the same boat when it shareholding) with the ability to affect comes to shared economics and incen- change. By way of a global example: tives. However, if GPs try and add this one of the single biggest post-deal or principle half way through a vintage portfolio teams is part of a Special Situ- or the GP’s history, it can cause con- ations Fund (owned by a bank) that only siderable internal friction. Generally by ever takes minority positions, but is still then, the GP has been blessed by past highly effective at instituting value driv- successes that did not rely on such ca- ing changes quickly through influencing pability, and the team’s economics have and credibly convincing, rather than been spent amongst the existing deal controlling the management teams. partners that than need to make “space” © MONITOR COMPANY GROUP L.P 2011 , .
  • 42. 38 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain Some GPs did, however, bring in heavy-hitting outside expertise, with relevant experience. For example, one GP that invested in a bank in Equatorial Guinea, brought in an executive that had run a major international bank’s operations in Afghanistan. Others sought to source expertise from within Africa – particularly South Africa and Zimbabwe – and bring it to other African markets. Indeed, one of our interlocutors felt that the flexibility and willingness to move to other countries was one of the great strengths of the African talent pool. Sometimes, however, this was challenging. The ecosystem of executive search is undeveloped in Africa and expensive; GPs thus had to source individuals through their own networks: as one interlocutor told us “you can’t suggest hiring a CFO and then not have someone in mind”. Moreover, it could be difficult to persuade the management that additional people or skills are needed to help grow the business, particularly in founder-led firms. GPs operating in both the mid-market and larger spaces, sought to help their portfolio companies expand their operations regionally. This might be by simply leveraging their own network of public and private sector international contacts to help the investee enter new markets. In other cases, GPs used synergies between the companies in their portfolio to either share best practice or serve as clients. In financial services, providing technical assistance and growth capital to expand into neighbouring countries often proved enough to grow the acquired banks quickly. On balance, however, we found the post-deal efforts of African GPs more aspira- tional than real compared to their developed-market or even Indian counterparts. Few players have adopted a genuine separation of labour between the hunting and farming of value, or have real, dedicated (non-deal) operating partners with the right mix of operational, change management and analytical skills to institute early value driving changes into the acquired targets. Starting with cross-portfolio © MONITOR COMPANY GROUP L.P 2011 , .
  • 43. PRIVATE EQUITY IN THE SHADOW OF GIANTS 39 Innovative Approaches along the Private Equity Value Chain dashboards and monitoring  –  measuring market externalities as much as financial performance data  –  to cross-portfolio learning initiatives between executives, and more innovative portfolio-wide commercial initiatives than just improved working capital management and the obvious low-hanging fruit in the supply chain. Very few of the GPs use a value-based management approach where growth initiatives and board proposals are constantly evaluated against the initial valuation models built during the deal due diligence.21  Part of the reason is the skill mix of the ex- ecutives founding the GPs. In Africa often they have more of an accounting and banking background where in India one finds more ex-CEOs being part of starting the private equity franchises. Moreover, sub-Saharan African players have not made as much effective use of long-term consulting arrangements for that purpose. The KKR-Capstone model of retaining consulting capacity and “best-in-class thinking on tap” for both port- folio work and deal execution, has not been followed in the region. Players still favour the classic fee-based expert, which not only incurs scoping, selection and contracting costs and delays, but also impedes the institutionalisation of knowl- edge across the engagements, and certainly does not align long-term incentives between all three parties (GP/investor, portfolio company and consultant). In par- ticular, when it comes to seeing through the implementation of slightly longer-term change programmes, the use of consultants experienced in private equity can lead to earlier value extraction. That said, credit must be given to those GPs that are trying, starting with either part-time operational partners (half deal hunter, half value farmer) on the pay- roll, or other hybrid models. We found that the effective parenting of founder-led entrepreneurial assets in Africa, given their scale, stage of development, degree of corporatisation and openness to use external help, is probably (after fundrais- ing) the most difficult and least developed activity in the private equity value chain in Africa. © MONITOR COMPANY GROUP L.P 2011 , .
  • 44. 40 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain 6. Exits As the private equity market outside South Africa is very new, there have been rela- tively few exits, but as one of our interlocutors noted, “exits are hard to achieve in Africa”. GPs thus have to be “very creative” due to a lack of liquid public markets, no secondary market and a lack of bank financing for M&A. However, several GPs believed it to be advantageous to have the exit strategy planned early as ultimately this is the most important part of the investment: GPs need successful realisations to build up a track record and thus obtain follow-on funding. There was a wide range of opinions on potential exit strategies, with trade or stra- tegic sales being at the top of many lists, particularly for companies that created industry platforms where some GPs saw them as a target for multinationals to buy their way into new markets. The most divergent opinions came on using IPOs. For GPs investing at the top end of the market, a listing was the obvious exit, either on a local or foreign exchange. But views were divided for those investing in mid- and small-cap companies. One South African GP told us: “I’m not a fan of IPOs [as an exit], it doesn’t suit the African private equity model... it’s not a market for small caps, and is an unattract- ive exist mechanism”. Another working with start-ups and early-stage companies in post-conflict markets disagreed: “we are quite keen on looking at local listings for some of our companies... African stockmarkets have had a very good run and they’re looking to some extent overpriced. There’s a lot of money looking to get into Africa at the moment and there are very few IPOs... there is an opportunity for us to target that over the next few years”. In the small-cap universe, another potential exit strategy was aggregating parts of their portfolio and selling some of the businesses as a group, or listing to “generate © MONITOR COMPANY GROUP L.P 2011 , .
  • 45. PRIVATE EQUITY IN THE SHADOW OF GIANTS 41 Innovative Approaches along the Private Equity Value Chain an incremental exit”. This strategy gave those GPs access to markets and investors that would usually be beyond their reach, and gave a diversification benefit to po- tential buyers. More recently we have seen a higher degree of sophistication by the larger South African players when it comes to value extraction on exit. These players have engaged external parties in a vendor due diligence fashion up to a year ahead of envisaged exits to reassess the asset and its remaining runway for value creation. These “exit grooming” or “corporate readiness assessments” more than pay for their own cost, as they allow for informed pre-exit choices. In other words, they identify those pockets of value to be extracted, by when, and which parts of the future value creation can be credibly marketed and “sold” to the new owner. 7. Cost Base Practising private equity in sub-Saharan Africa is expensive: deal sourcing, diligence, communications, and being on the ground is challenging and time consuming. Fre- quently, GPs struggle to cover costs on standard 2% management fees, particularly for funds under $100 million: “bigger is beautiful because it helps make ends meet.” GPs have thus developed several approaches to fund operations. Flexible Operating Infrastructure Everyone we spoke to agreed on the necessity of having an extensive local network and knowledge of the business environment. But many GPs did not think that this necessitated a permanent in-country presence. Several of the GPs we spoke to were based in London; as a global financial hub it gives access to a wide range of potential deals, investors and staff. Moreover, several GPs commented that it was actually easier to travel to parts of Africa from London than within the region, and © MONITOR COMPANY GROUP L.P 2011 , .
  • 46. 42 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain this made interacting with investee companies easier. For many, a base in London mitigated talent constraints as they could recruit internationally and reduce costs on expatriate living allowances that are often needed to attract people to live in-country. However, those GPs are quick to explain that this is not a “fly-in”, “suit- case investor” model as they still dedicate considerable time to engaging their assets, even without a permanent in-country presence. Where GPs felt they needed an on-the-ground presence, they sought to minimise costs. To provide a low-cost permanent presence, one GP embedded staff in their assets, using the portfolio company’s office space and back-office services. In a reverse model, one venture capitalist brought his investee companies to him, incubator-style, so they were all within a ten minute drive of each other. Partnering Another model prevailing with “new-to-Africa” London-based players was by partnering or coinvesting with a local entity and operational expertise in the business of the investee company, rather than providing this themselves. Part- ners could be a local private equity firm, a high-net-worth individual or a financial institution, sometimes even a blue-chip trade or strategic player. Some GPs chose to partner with DFIs as “they have the expertise, the legal frame- work is less of a concern, and the political risk is mitigated as they have good relationships with the government”. Often these partners would also take equity in the investee to ensure that their interests were aligned. Some new-to-Africa GPs used this approach as a stepping stone into the region, allowing them to gain experience rather than immediately seeking controlling stakes from a distance in the more heavily competed geographies. © MONITOR COMPANY GROUP L.P 2011 , .
  • 47. PRIVATE EQUITY IN THE SHADOW OF GIANTS 43 Innovative Approaches along the Private Equity Value Chain This alternative was adopted either by international GPs with little in-country pres- ence or by those who were purely (passive) financial investors. Both understood the need to have operational experience and to engage their investee companies, but admitted that “we don’t have the local or expertise to get down in the weeds and actually run the company”. Instead, they engaged with the company through moni- toring. However, the scope for this model to succeed seems relatively limited, and was only found amongst captives or government-funded investment initiatives; as one interviewee told us “why would investors be paying fees for this? Why wouldn’t you just pay the local guys?”. © MONITOR COMPANY GROUP L.P 2011 , .
  • 48. Where Does This Leave Us? Where Does This Leave Us? PHOTO BY MARK VANCE
  • 49. PRIVATE EQUITY IN THE SHADOW OF GIANTS 45 Where Does This Leave Us? DUE TO THE CONFLUENCE OF CHALLENGING INVESTMENT environments in sub-Saharan Africa, and the more selective deployment of LP capital for private equity funds, actors operating in the region have had to be creative, along the value chain to create compelling business models to attract capital that allows them to be flexible. This has required GPs to try to “leapfrog” their business model up the private equity trajectory, adopting more sophisticated strategies than just generalist LBO or growth funders. However, this may well be too much too soon on several levels. The sub-Saharan private equity market is still very small with penetration still lagging markets that have successfully carried such market specialisation. Further, many of the GPs we spoke to operating outside South Africa are still on their first vintage, and they have yet to prove that they have cracked the post-deal, active-engagement nut. The cost to serve in sub-Saharan Africa is high, and with small funds, unproven funding models, and pressure to keep standard management fees, the jury is still out as to whether this will be profitable, particularly as returns in sub-Saharan Africa still lag those of China and India. Conversely, capital seekers are going to have an interesting time with investors flocking in, but they need to be aware of the true value-add (as against the aspirational) beyond the face value of money that potential investors bring. There is also a sense that these models may be too sophisticated for the market. A dearth of obviously attractive investees and increasing competition for investments in the region have made conventional deal flow away from the venture or early-stage end of the market difficult to secure, and both the quantitative and qualitative data suggest that it is still not easing. Thus penetration of the market is low, and while that leaves a huge opportunity for private equity deployment, the GPs are not yet, on the whole, realising it. However there are opportunities if GPs adopt a more entrepreneurial approach as evidenced by deals such as Helios Towers and Helios’s investment in Shell’s downstream oil business. Finding cost-effective and successful methods to nurture growing companies after the investment is one area on which GPs need to work. © MONITOR COMPANY GROUP L.P 2011 , .