December 1, 2011
Interviewed by: David Snow
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African Deal Flow

“It’s hard not to have a rosy view of Africa when you see deal flow increasing every year,” says Runa Alam of Development Partners International.

Deals are the core focus of the second program in Privcap’s three-part series on private equity in Africa. In “African Deal Flow,” three investment veterans share insights into private equity dealmaking across a continent of opportunity. Along with Alam, Hurley Doddy of Emerging Capital Partners and Graham Stokoe of EY discuss the robust deal flow in Africa and how investors there are sourcing opportunities.

“It’s hard not to have a rosy view of Africa when you see deal flow increasing every year,” says Runa Alam of Development Partners International.

Deals are the core focus of the second program in Privcap’s three-part series on private equity in Africa. In “African Deal Flow,” three investment veterans share insights into private equity dealmaking across a continent of opportunity. Along with Alam, Hurley Doddy of Emerging Capital Partners and Graham Stokoe of EY discuss the robust deal flow in Africa and how investors there are sourcing opportunities.

David Snow, Privcap: Hello and welcome to Privcap.  I’m David Snow, founder of Privcap.  Privcap brings you smart conversations about private capital.  Today we’re going to be talking about private equity in Africa.  Our conversation today is all about African deal flow.  Where does it come from, what are the exit opportunities, and how can private equity firms succeed in a very diverse opportunity?

We have with us a panel of experts in African private equity.  Joining us today are Hurley Doddy, co-CEO of the Emerging Capital Partners; Graham Stokoe, associate director of Ernst & Young; and Runa Alam, co-founding partner and CEO of Development Partners International.

This program is sponsored by Ernst & Young.

The private equity opportunity in Africa is a big one.  It’s diverse.  Africa is growing.  It’s growing in a number of different places and for a number of different reasons.  But to be a good private equity investor, you actually have to source opportunities to take advantage of all that growth.  So I’m interested in hearing from all of you: What are the sources of good private equity opportunities in Africa?  How do they differ from what someone might be used to in a more developed market?

Maybe we could start with Runa.  Where do you get the opportunities that your firm acts on?

Runa Alam, Development Partners International: Sure.  Somebody accused me yesterday of having a rosy view of Africa.  It’s hard not to do that when you see deal flow increasing every year.  And that’s really been the bottom line, which is that we look at over 200 deals a year and end up doing maybe two or three a year.  And that’s a nice percentage to choose from.

Where do they come from? Really, we have a system where we are from– 85 percent of us are Africans and from all different parts of Africa. They have ties back to different regions, different countries. Most of our deals come from people that we know, and really, somebody is thinking about what to do with their company. And so in the process of that they usually want money, but they also want some guidance as to whether they should expand outside the country or should they develop a new product, and we get brought into the conversation.  And really, that’s how it goes.

The interesting thing recently is that that conversation is now coming from multinationals coming to Africa. They’ve been all over the world and now they’re thinking about, “Well, how do we do Africa? So let’s go talk to a private equity fund. If they advise us to do something, they’re going to be aligned in interest because they have to put up their money alongside our money.”

Snow: Hurley, where do you get your deal flow?  How varied is it?

Hurley Doddy, Emerging Capital Partners: Well, I would agree with Runa there. There is good deal flow in Africa.  One thing that we don’t have a lot of is auctions in Africa. You don’t have the Wall Street or London kinds of banks running processes too much, where you have to put in a bid next Thursday. It is a combination. Certainly a lot comes from our networks. We have been doing this for well over a decade now, and we’re on the ground and have a lot of contacts.

Some of it as well is from a top-down process. One advantage we have in African in private equity is we can see the models that have worked in other places. They are emerging markets that are a little ahead of Africa– Eastern Europe or India, for instance. And you can see how the cell phone industry took off. And once that reached a certain level of penetration, broadband or pay television. What’s happened there and what the next step is going to look like. Shared infrastructure, fiber optic cables, cell phone towers.

We have that advantage of being able to see what is going to happen as some of those trends and then it allows you to go top down and look in the various regions and identify some players early that you can put money into. So both of those methods are very important in terms of finding deals.

Snow: Graham, have you seen some recurring themes lately as far as how your clients are coming across opportunities to invest?

Graham Stokoe, Ernst & Young: I guess one thing I thought about when hearing this question is that a lot more international, global players, not only from the U.S. and Europe but India and China, are looking at Africa a lot more.  Not necessarily in the private equity space, but there’s just a lot more interest in Africa.

And Hurley mentioned this: There’s hardly any auction process. In South Africa we are starting to see more auction processes for the first time. Maybe we’ve seen a few more VDDs that we’re doing that just didn’t happen three or four years ago. So it is evolving a little.

But I think in a sense it’s really being out in the market, having the contacts, having the diverse contacts and the network, and finding out and probably tracking the companies longer. That should actually decrease the risk of private equity from African private equity vs. our –

My first three years in transaction advisory in the European market, you had a month, two months.  You had auction process, you know, Jeez.  You know, these guys were making decisions on that short timeline, that short amount of information.  Whereas the African deal timeline, actually from when you start looking at a company to when you actually conclude it could be months or possibly even longer than a year.  That’s how long you’re courting before you actually put on the ring and marry that company for a couple of years.

Alam: Yes, I completely agree with Graham in the sense that some of our deals can take two years to get done.  Not because we’re being slow, but because we have the opportunity to work with the company to reduce the risk.  So we can say, “Change your accounting firm.  Get an audit done.  Think about shutting down this division.  Think about changing your CFO.”  And once we feel that the risk profile– so not just the upside, but also the downside– is commensurate with what we’re willing to do, then we will go ahead and consummate a deal.

This highlights something that’s very interesting in Africa, which is that Africa has the same GDP and same number of people as the Indian subcontinent.  But really, the last count that a fund-of-funds did, there’s 67 private equity funds, but really just a handful or so who are really large and have the pan-African footprint.  Versus India, which has 200 such companies.  And so there is little private equity and little equity in Africa.

So we have the opportunity to have proprietary deals.  We have the opportunity to really work with a company and develop the company before we invest without having somebody just come and say, “Well, I bid twice as high and I’m not going to give you any hard terms and let’s just get the deal done.”  So that’s very much a favorable private equity market.

Management Talent

Snow: Let’s talk about the fact that there are deals, but in reality, companies are run by people.  So I’m interested in the challenges that all of you face or have seen in matching the right human capital with great businesses, great start-ups, great existing businesses. Hurley, what does it look like across Africa as far as finding managers who can help you get a company to the next level?

Doddy: That’s a good question. First of all, I would say that it’s important to realize that in the African private equity industry, many of the investments are significant minority investments and not control investments.  Typically if you go and take over a Cameroonian insurance company that’s been successful and is growing, your first reaction shouldn’t be, “Let’s get rid of those managers and we’ll bring our own Cameroonian insurance guys in.”

So a lot of it is assessing the current management and then their growth plans and how are you going to beef up those teams and help them expand.  In general, we are looking, as Runa said, we’re not looking for dozens and dozens of deals. We’re looking for a few good deals, and there’s certainly enough good managers out there to run those companies. And as I said, a lot of it is beefing up those teams in order for them to be able to handle the challenge of doubling or tripling their business.

Stokoe: We’ve been fortunate enough at this stage to be picky.  Private equities have been able to choose those good companies with good managers. I mean, maybe another question I could ask Runa and Hurley is how many investments have you made where you’ve actually had to change the CEO? I can’t think of too many that I’ve come across, and that means we’ve been fortunate to be able to select the best of the companies.

Snow: Well, that’s a good question.  In U.S. private equity, CEOs get changed all the time, and you always hear private equity guys say, “The sooner the better.” Has that been the case with any of your investments?

Alam: Not really. I mean, we’ve had a rejiggering of positions in one company, but that’s because the company was migrating to a new area of business. But generally, as Hurley said, it’s not a continent where you have a lot of ready-made CEOs so that, you know, “This one doesn’t work, let’s put in someone else.” The companies are unique.

The companies are unique also because they’re geographically in different areas, so a CEO let’s say of a bank in East Africa might not just be able to be a CEO of a bank in Nigeria. In fact, I think it would be very difficult to have that happen.

So CEOs are not commodities. Neither are CFOs in Africa. So the selection of management is absolutely critical from the beginning. One of the key things, mantras, in private equity globally is management, but it’s even more so in Africa.

Snow: Well, it sounds like by the time you get to the point where you want to invest in a company, probably the management is most of the reason for the success, right?

Doddy: Yes, I think that is a fair statement. As I said, there have been some managers who haven’t performed that we’ve had to change. There’s also the normal life cycle of the company. Typically the person who ran it as a start-up might not be the person who runs it when it’s an eight-country operation and they have to be at the headquarters managing. If you have someone who really wants to go and get down in the weeds, they might not be the right person. So there is that natural evolution to a more corporate structure that you have in any place. But in general, you’re backing the managers and adding to what it is they’re doing.

Alam: The exception might be in family-owned businesses, and that’s true globally. In Africa, if the next generation is not going to be in the business, then of course there’s going to be a change of management. So the father founded it and then you professionalize the business. And that’s a role that private equity does play. So we would have to find a CEO that also has chemistry with the owner and see how we rejigger the whole team and how it works. So in that, there of course will be a change.

Exit Dynamics

Snow: Let’s talk about a very important subject, and that is exits. You invest in a company, you hope it goes well, and then eventually you realize that value by selling it to someone else or to the public. I want to start with a question about local capital markets across Africa. How important are they for the success of a deal? Or is it possible to make money investing in a company based in a country where the capital markets really are not supportive, but of course you have the broader world, too, in which to realize an exit?

So Hurley, how important are capital markets to the success of a deal?

Doddy: That’s a good question. At ACP we have over 20 exits. We’ve returned about $850 million to investors. The local capital markets are really just one of kind of five ways that we get out. There’s obviously a good market in South Africa.

Other markets that you could think of listing the right company would include Egypt and Morocco, Nigeria, to a lesser extent Tunisia, Kenya. When you get much below there, you’re not going to have a local market exit. In those particular markets, if you have the right company and by that I mean typically a profitable, dividend-paying company, because that’s still going to be important to those investors– and it’s the right size, you can think of a local market exit.  And we’ve been successful in that.

I wanted to point out that the international markets, there’s a fair amount of companies that are listed on international markets whose business is in Africa.  Some of them are in London, you get some in Paris. When you get the more natural-resource companies you get Toronto and Australia as well. And that’s for us, historically, equally as important as the local markets have been.

Snow: Graham, what can you tell us about capital markets and exit opportunities in Africa for private equity firms?

Stokoe: I would expand on Hurley’s point in that I just see taking good African companies to the international markets. I just think there’s just a wealth of need and actually want for growth, for growing companies, given where the developed world is at the moment. So call it an elephant in the room. I really don’t see there being a problem exiting good African companies, particularly the regional, decent, medium- to large-size companies that are regional, number one, and number two players in the international capital markets.

And then in terms of other exits, as I mentioned earlier, the international strategic players, the trade buyers, not only in developed markets but also India and potentially China, maybe to a lesser extent, are also interested in taking part in African growth.  I just think that there’s a lot more attention on Africa, which means I don’t see a huge concern with exits.  It’s maybe just that they haven’t been this multitude.

But then you need to look at where Africa is in its maturity.  There’s just this girth of activity over sort of six, seven, and eight, and the number of the sort of mature private equity ECP- 15, 10, 15, 20 years ago.  But there’s been just a massive growth sort of four or five years ago, and that load of exits are still going to happen.

Snow: What do you see as being the most frequent exit route over, let’s say, the next five years? Is it multinational corporations attempting to establish footholds in Africa, or is it other?

Alam: I’m not sure there’s going to be a predominant one. I think the stock markets will continue to provide exits. It’s important to mention, also, that there are smaller stock markets. Like for instance, again, Botswana. And in that stock market, while it’s not very liquid, over a period of time you can exit a $40, $50, $80 million stake.  So it’s possible to exit other places.

It’s also interesting to mention that some of the stock markets Hurley referred to, is how large they are. Africa is a $600 billion market. Even Nigeria is now $40 billion.  That’s after a big plunge. It was a much bigger market cap. I do think, though, that trade exits will become more and more important, and it won’t be just multinational. It will be also African countries, from another country.

So Nigerian banks buying a regional bank, let’s say in East Africa. North African minerals and mining companies, which there are some, looking to Francophone Africa to buy assets. And as one knows, Europeans and Americans are also there. And of course, a lot of talk about Chinese and Indian companies. And I would say that the Indian companies are going across many more sectors, while the Chinese companies we’ve seen have been more concentrated in the natural resource area.

Doddy: I was going to add, just to echo a couple of those points. One thing is when we started in 2000, it wasn’t clear whether you could exit, even if the thing did well. I think experience shows over the last decade that if you have a good, profitable company that’s growing in Africa, someone is going to want to buy it. There’s just no question about it.  A couple of people are going to want to buy it.

As both Graham and Runa said, the number of outside players has grown.  It’s not just the Europeans that you’re going to sell it to, or the French. The Indians are comfortable at this level of economic development. They’re used to that. People who make $5 a day, they know how to market to them. They are comfortable giving that a try.

The Middle Eastern guys, they’ve got capital. They don’t have a lot of people in their markets.  Their natural place to look is to North Africa. And as we said, this whole regional area is growing, and I think the trade sale percentage probably does sneak up over time.

The other important exit is back to the original sponsors and owners of the company. As the companies get bigger, they get more successful, they generate cash, they generate the ability to borrow. Often those sponsors themselves will make a bid to take back the equity that they sold in order to help grow the business.

Alam: One thing I will say also about Africa is because there is less equity chasing deals, we’ve had the opportunity actually to really structure deals in a very tight way. What do I mean by that? We can put inputs a lot of the time. We can have convertible bonds. We can have convertible preferred, so that we can actually get part of the exit just from the current income, off the bond or the preferred dividend.

And then if things don’t work out in the way one expects, there is an opportunity then to, as Hurley said, sell back to the company. The bigger exits and the better exits will always be off the stock exchanges and the trade sales, and that’s what we aim for. But you can put a floor in and take some of the risk out by structuring the deal in a very tight way.

Capital Competition

Snow: I have one more question.  You mentioned all these groups around the world that have this interest in Africa for all kinds of reasons. We’ve got the natural resources play. The Chinese and Indians are very interested. Multinational corporations, Europeans– isn’t that going to bring a lot more competition to the private equity proposition, which is, “Hey, would you like some capital, would you like some expertise?” Are you beginning to see some of that competition from non-private equity entities for deals?

Alam: We bid on a deal in South Africa and it was bought away by an Asian company, so definitely. Slowly, very slowly. It’s nothing that’s earth-shattering at the moment. But of course in the future that has to happen.

Doddy: You know, obviously, a market like South Africa, that’s going to happen more. The companies have higher standards of governance. When you get to Nigeria or Central Africa, we are probably in a better position to go in and put the companies in the right shape and professionalize them and change out the auditors and grow it into something that will then be bought. The multinationals will consider doing it, but in general we would be ahead of them there.  In South Africa and Egypt, yes, someone could just come in and make a bid.

Snow: Graham, what are you seeing by way of competition for deals that would otherwise have gone to private equity firms?

Stokoe: Definitely much more competition from internationals, as I mentioned earlier. Not just U.S. and Europe. Quite a bit, and I think someone mentioned it earlier, India has quite a broad sweep of industry sectors they’re looking at. The Chinese are more focused, I guess, on resources.  But they’ve done banking deals, they’ve done other deals.

Snow: Well, what’s the edge that private equity firms can maintain?  If it’s not just about money, what do you say is the advantage of an investment from your firm?

Alam: It’s very clear. It’s local knowledge and it’s being willing to work with a company that may not be up to the standard of a corporate who doesn’t want to do that work. So environmental and social governance, a lot of governance work.  Growing the company so it’s big enough to be interesting. So just growth of product lines, growth geographically, and fundraising. A lot of companies need fundraising but don’t quite want equity. So maybe fundraising and a little bit of debt or a little bit of mezzanine.

Changing and broadening out- not so much changing, actually- broadening out the management. And just professionalizing the whole thing.  So when a corporate looks at it, there’s less work to do. It’s again, as I keep saying to lots of people, 1960s private equity. Going in there, taking a mid-size company and making it into a large, professionally managed, good-looking company.

Doddy: Just to amplify Runa’s point there.  Another reason for them to go with us is because they’ll grow a few more years and get an even better price when you sell. If the ultimate exit is to sell it to a multinational and you think you’ve got three or four good-looking years of growth ahead of it, we’ll help you do that. We’ll help you grow, we’ll help you get there, and then you’ll be making much more when you get out. That can be a powerful argument to the entrepreneur.

Snow: And of course from your perspective, you’d like to be part of those good-looking years of growth.

Doddy: We’d like to join in and partner with them and enjoy that growth as well.  Exactly.  Everybody wins when we didn’t sell today.

Snow: Well, this is a fascinating topic.  We’re going to pause for now, but thank you very much for being part of this and thank you for talking to Privcap today.

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