August 12, 2013
Interviewed by: David Snow
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Pulling the Lever on Value Creation

“In Africa, private equity is a contract sport–you need to be a lot more hands-on.” In Part 2 of a series on value-creation and exits in Africa, experts from Ethos, TunInvest-AfricInvest and EY discuss the levers of value creation that can be pulled and explore how even minority positions can be leveraged to transform portfolio companies.

This expert conversation is informed by an EY and AVCA study on African PE value-creation available here.

“In Africa, private equity is a contract sport–you need to be a lot more hands-on.” In Part 2 of a series on value-creation and exits in Africa, experts from Ethos, TunInvest-AfricInvest and EY discuss the levers of value creation that can be pulled and explore how even minority positions can be leveraged to transform portfolio companies.

This expert conversation is informed by an EY and AVCA study on African PE value-creation available here.

PE in Africa: Pulling the Lever on Value Creation
Investing
In Africa

David Snow, Privcap:

Today, we are joined by Ziad Oueslati of African Vest Group, Sandile Hlophe of EY, and Ngalaah Chuphi of Ethos Private Equity. Welcome to Privcap today, thanks for being here.

We are talking about adding value in Africa, not many people, or not enough people, are aware that Africa is a land of exits but before you exit you actually have to increase the value of the company, so I’d like to understand how all of you do it and how, Sandile, you see your clients doing it. Maybe we can start with Sandile. As you survey the kind of landscape of private equity portfolio companies, or potential portfolio companies, what are some common challenges that these midsized African businesses face in trying to get to the next level and how can private equity firms help them get there?

Sandile Hlophe, EY:

Great, excellent question Dave. Typically in Africa we see a lot of the private equity buyouts, it’s typically family owned businesses or carve outs or private entities that typically needs to be transformed into a corporation. So a lot of the value add typically that we tend to find is done by private equity about putting in place a lot of  governments around in running the companies, so having regular management meetings, board meetings and then more importantly adding some strategic input and insights by bringing on board a non-­executive directors onto the board to help guide and  run  some  of  the important committees. Also more importantly, supporting the portfolio company around entering a network of other sort of  service providers and ideas to share on how to build a network, and then lastly around the area of social, so  there’s  normally  quite  a  lot  of input investment around the company focusing on those  social aspects in terms of employee benefits, community  benefits,  actually help build the  brand, so those are a lot of the  sort of additions that fall into the whole ESG space. Environmental is actually quite key cause a lot of the PE funds tend to raise their funding from a lot of the sort of DFI type entities that looked for impact around environment commute  and  social.  So  ESG  plays  quite  a  role  and  our  recent study1 found that a lot of PE firms that focus around the whole  ESG aspect they get a better return on the exits in terms of  the investments  that  they’ve done.

1 EY and AVCA study on African PE value-creation available here.

Snow:          Ziad, I’m sure every portfolio company has a different story but can you think of some common levers of value creation that tend to be very important across your investment program?

Ziad Oueslati, AfricInvest:

I think what we try to do in the first instance is really to be close to those investing companies and one of the, we’re investing again into family owned companies is also to beef up the management of those companies. So that’s really where we start working on.

We, as I said, we’re very close to our investing companies, so there is a road map that is put in place from day one on how to improve the management. You mentioned them in all the other aspects and basically on the weekly basis we’d be meeting them with the company, with different departments and trying to put in place those road maps. So for the sixth first months usually we have one board meeting and one business meeting, I mean, that’s the way it works. And that’s the only way to put the pace so people will believe that you’re there to add value but also they will respect you in the future.

Again, we’re dealing about family-­‐owned companies, lifestyle companies most of the time. So most of the families are leaving from the company and that’s really what we start doing. It’s been, I think, positive in terms of return since, if we look at our whole portfolio we had few failures, I mean everybody has it’s failures, but overall I mean the return had been there, the fact that the companies, after we exited have been, are already there and are progressing and developing so we managed to those to make our companies sustainable, hiring more people etc., and those are impact factors or that we follow very closely so if I can share with you on some of the numbers basically on all the aspects, employments, export growth, tax paid, it’s over two times from the period we invest till the period we exit on an average holding period of 4.5 years on average, so that’s what we’ve been able to achieve, and that means that those two aspects go hand-­‐in-­‐hand, I mean financial returns and those impact returns go hand in hand. And there is something that I want to mention. Especially after the Arab spring and the revolution in Tunisia, there had been a lot of strikes after that because people weren’t getting their rights etc., and they can say that in our portfolio basically nothing has happened because we were respecting and we were providing the rights a little bit more of the rights of the work in those companies.

Hlophe In Africa private equity is a contract sport, you need to be a lot more hands on.

Snow: Ngalaah, does your firm, Ethos Private Equity, do some of what Ziad mention as far as sort of making sure you have that first board meeting, making sure you have the corporate governance in place where perhaps under a family ownership it wasn’t all there, does that sound familiar to your approach?

Ngalaah Chuphi, Ethos Private Equity:

Yes that’s quite correct and in fact, in addition to that, because we’re

controlling investors right, from day one before we actually entered the deal we decide what is it that we’re going to do in the deal and we soon as we have now bought the company we enter into the typical 100-­‐day plan where in that the key is reticulate a strategy and agree that strategy with management, whether it’s a three year strategy, a five year strategy and hen after that kind of break you down to exact initiatives that we actually identify that we’re going to do, which ones are you going to do now, which ones you going to do next year and which ones you going to do thereafter and create then the capacity to be able to do that. A lot of those investments are growth investments.

With growth you need capacity to grow, that’s one of the challenges of growth, growth demands capacity and we do integers of a lot of new management into the companies to be able to bolster so if we have a strategy where we want to grow into a new geographic regions as an example, we need to find a champion who is going to drive that growth into that geography and you have to  find somebody who has knowledge of how to actually export those markets. Now more importantly we also bring into place some of the usual stuff that management know but sometimes tend to kind of take for granted or not do  very well. Things like  working  capital management, you’re going to minimize your stocks, you’re going to get your inventory days down, that you’re going to be able to collect sooner, you’re going to be able to stretch your creditors, but sometimes management don’t do that but when we come into play, we focus them on that–

Snow: It’s not a suggestion –

Chuphi:          It’s not a  suggestion, it’s a requirement to do. Then CAPEX, a lot of times when management teams are not under scrutiny a  lot they tend to expand and there isn’t even a point of where the benefit of that spending will come from. So you’ve got to justify every CAPEX you spend and to be able to show a business case of

what kind of returns you will be able to bring with that CAPEX. Someday, you see that CAPEX is more focused, it’s into the areas that will be return for it rather than just a wish that now I want to expand to that, you don’t know exactly whether that will be profitable or not. So it’s the discipline of the day to day running of a business that we bring in so important we get reports every month, we get management reports and sometimes when we are involved in a very strong initiative we put in a project management office in the company and people and sit in the company for them to actually, on a day to day basis make sure things are getting implemented that we’ve agreed. So it’s a very, very active hands on involvement because we are the shareholders of record and it’s important that we have a timeframe for us to extract that value and we do it within that timeframe.

Snow:       Is it more challenging to suggest or require a certain government steps when you’re a minority shareholder? How do you influence the structure and the culture of the company from that vantage point?

Chuphi:     I think and maybe ZIad can talk more about that because while we have a controlling business we do have also a strategy where  in South Africa we can do minority draw. When you address what the aspiration of your partner is, so for example we invested in a company where we were in a minority but the company exit will go through an IPO. We make them fully understand that when you come to an IPO the institutional buy will want sudden things in this company from a governing standpoint. So they look at what is the board structure, what are the committees of the board, what is the ESG stuff, what is the work around, all these things we must implement for this company to be successful at an IPO because all this will be scrutinized. If you have a partner who understand this clearly then they will implement that, but that’s not always the case and I’m sure as Ziad might have some ideas…

Oueslati: Yeah that’s true, it’s much more difficult of course. When we’re a minority shareholder,  before  you  put  the funds,  everything  is possible. He or she will tell you that I’m ready to change to a point that’s many independent board members as you wish, most of the time it happens and they will deliver, but we had few cases where it didn’t happen  and  it  was  a big  fight  actually,  it  happened in  two instances where we had to leave, I mean before even we had completed what we, our mission or what we were planning to do, and one of them took place in Nigeria actually where it’s one of the leading company notebooks and it’s a very nice opportunity but eventually, the manager didn’t want to really change governments, I mean or there was no government let’s say. And we had after one year, actually  a  big  fight,  to  just  exit  of  course  the  IRR  would

have been minimum, I think it was like five, six  percent  so  very low, but eventually we had to exit because you cannot force someone to change, if he or she is not willing to change, even if you have a contract because the shareholder  agreement  is  there, you’re rights are in the shareholder agreement but most of  the time those shareholder agreements we don’t use, they’re just there to show you the road to follow and eventually if he or she does not want to evolve, I think we will form an exit and that’s what we have had to do in two instances actually.

Snow:               Do you think that increasingly entrepreneurs in Africa are aware that a private equity partner might bring this knowledge and these tools to groom the company to look like it could go IPO and is that making private equity and the private equity opportunity look a lot more attractive?

Hlophe: I think we see a commercial and just to add to Ziad’s point I think we funded more and more. The way private equity takes time in getting to understand the magnum  of  the  company,  and  also selling their own exit strategy, which takes management along. You tend to have a lot more success around being able to implement along the changes because typically we found that the business owner, if they’re retaining a majority of control, they also want to see value in the business agreement and at exit. So most of the time what works, and I think Ziad is right, if you have to pull out the contract too late, cause that’s just in shorts. If you have to go to legal roots, it’s expensive for everybody.

So we tend to find that way is the exit thesis is locked in and also has value benefit for  the  other  shareholders  and  the  management  it works.  So  on  the  IPO  side  if  management  has  got  ambitions  and vision of being a lesser company, bring on  board  a  priority  definitely does come along, and that’s what we’re finding more and  more corporates in Africa seeing as a benefit of bringing on board  a  private player  because  a  lot  of  the  corporates  tend   to   be   looking   for expansion  capital,  so  in  their  view  they’re  needing  to   recapitalize their balance sheet. I know you said but have you considered private equity, “Okay, private equity tell me a bit more about it, what’s the value-­‐-­‐-­‐add?” So our study has shown more and more that where you bring a lot of the value-­‐-­‐-­‐add is benefit for the private equity investor and also for the company. So it’s all about getting alignment with management and the other shareholders where you’re minority  or majority around this is the  value  you’ll  add  and  this  is  the  benefit  in the  exit.

Chuphi:          Right. We’ve been around for quite a while. We are in the 29th year of investing, we’ve invested in 97 deals and exited 87cache. So clearly we’ve created a network of people out there that have worked for us and one of the interesting things that I would say why private equity is growing as an asset class in Africa is that there is now a number of people who can act as ambassadors, both on the seller side so they can tell others, “Listen, I sold a business of mine to private equity at a fair price.” That is good for us going in and looking for deals. So we’re not seen as cowboys or anything like that, we’re seen just as a legitimate buyer of the business. And then secondly there’s also a significant number of managers who are partnered with us, been very successful with us because one of the kind of tools of the trade is to make sure that management also participated in the ownership of the business and they’ve been quite successful and therefore these reference points for them also to tell others that listen, working with private equity, and specifically working with people, can be very lucrative for you. And with those kind of combinations then, when you start bringing the idea that IPO or strategic sale positioning yourself is something that there is alignment around.

Expert Q&A

Sandile Hlophe on EY & AVCAs African Exits Report

What are the key findings of the report on the African private equity and venture capital landscape?

Sandile Hlophe, EY: The latest study on exits called ‘Harvesting Growth’ and really, to use the analogy in terms of harvesting any growth, you need to invest, put a bit of effort, fertilizer and watering for that seed. So some of the key insights that our study shows, was that all the exits in Africa happened to be to strategic buyers, more especially, regional strategics – And then number two, the value-­‐add of ESG is always very important because a lot of the companies doing investments in environmental source a lot of government issues. Particularly, they gave better returns in terms of those exits and some of those models were even better than what the index would deliver from a return over a five-­‐year period.

What did the report discover regarding PE exit activity and regional performance in Africa?

We looked at the five-­‐year period between 2007 and 2012 because typically, we find most PE firms have an investment horizon between 5-­‐7 years and in the beginning, we thought that the exits would be centered in the mature market of South Africa. But interestingly, there is a very good spread, so we came in with a total of 118 exits over a 5-­‐year period that we identified. And studied 62 of those, and all have got a very good spread between east, west and southern Africa. So there’s been a good multitude in spread and different sizes north of $20 million USD to $50 and above.

How does your firm provide tailored services to private equity investors in Africa?

So we work hard with private equity and primarily our services  are  broken own really into three categories. The first one would be around the pre-­‐exits, so working with private equity companies in our system and identify potential good targets and assisting with having those initial discussions around looking at the business, what’s the best entry model and where do you source that exit from, that buy from? Number two, during the investment period, we do quite a lot in supporting the private equity firm in creating a lot of that value, in terms of assisting and deferring, typically they need to change their CFO and network of various service providers  and  also connecting our other businesses and most likely in the exit. Part of that work  is helping management in the PE firm prepare the company for an exit  in terms  of saying what is the exit strategy, who are they going to target and how do you actually dress up the bride and actually prepare it for the exit?

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