January 1, 2012
Interviewed by: David Snow
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African Upside, African Downside

Three veterans of the African private equity market share stories of successful deals and bullets dodged across this continent of opportunity. In this third segment of the three-part Privcap series “Private Equity in Africa,” Hurley Doddy of Emerging Capital Partners, Graham Stokoe of EY, and Runa Alam of Development Partners International, share their expert insights, stories of deal success and reasons why they remain very bullish about the future of African private equity.

Three veterans of the African private equity market share stories of successful deals and bullets dodged across this continent of opportunity. In this third segment of the three-part Privcap series “Private Equity in Africa,” Hurley Doddy of Emerging Capital Partners, Graham Stokoe of EY, and Runa Alam of Development Partners International, share their expert insights, stories of deal success and reasons why they remain very bullish about the future of African private equity.

David Snow, Privcap: Hello, and welcome to Privcap.  My name is David Snow, founder of Privcap.  Privcap brings you smart conversations about private capital.

Today, we are talking about private equity in Africa.  We will be sharing stories of success in African private equity investment. Joining us today is a panel of experts in African private equity.

We have with us today, Hurley Doddy, co-CEO of 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.

Snow: So let’s talk about the successes that all of you have seen in African private equity.  We know there’s been many, but I’d like to put some experience behind those successes, some anecdotes.  Can you think of something that you’ve been involved with recently, whether it was a deal or some aspect of deal flow or something having to do with one of your portfolio companies that, to you, really indicated the private equity opportunity in Africa, the success that’s possible when a deal is done the right way.  Runa, do you have anything that jumps out from your recent experience?

Runa Alam, Development Partners International: Sure, actually two things jump out.  First is a company in southern Africa that is in the consumer credit area.  And just to show the opportunity in Africa, this company exists in a space, which the banks have not gone into. So banks in Africa really bank the very high-income people and as well as do corporates and trade finance but they’re not reaching down to the middle class and certainly not to the lower income middle class.  So this company got started and most banks have ROEs of 3, 4% if they’re good.  This company has an ROE of 30%.  It’s been growing, on average, at 30% a year and the multiple that we came in was extremely reasonable.  It’s publically listed, but not very well traded so we structured it into a convertible bond, which allowed us to put in minority protections, etcetera, in the governance of the bond.

And the company, since we invested, already was in about six countries.  It’s now gone into two other countries and is going through two acquisitions to take it into five other countries.  So it’s a success story in that it’s growing pan Africa.  It’s going to many countries, it’s still giving to us very good returns and very good profits. At the same time, it’s indicative of the fact that you can have a business niche or an industry niche in Africa, which doesn’t exist anywhere else just because of circumstances and where the banks are.

Snow: Before you get to your next story, can you talk about just briefly, how did you source that transaction? How did you meet this entrepreneur? How did the entrepreneur understand or decide that he needed private equity capital?

Alam: Sure. There’s two rounds of this, because this is the second time I’m personally investing in the company.  When I was with another firm, we met the entrepreneur because we realized that this niche is actually extremely profitable and growing very, very fast—underserved market. And we did, essentially, a top down analysis.  Who are the people in this niche? And we went to the company through people we know and contacted the company and got into it that way.  This time, it was the CEO calling me, calling us, saying that we need somebody on the board, somebody in private equity who’s willing to work with me to deal with certain issues of gross, certain new countries, etcetera, so it was a call.

Snow: And then you said you had a second opportunity or a second story.

Alam: Second story is also indicative of opportunities in Africa that are unique maybe from other continents in the world and that story is in the FMCG area, which is again, an emerging middle class story.  So big story in Africa, like in the BRIC countries of the emerging middle class.  Emerging middle class wants to buy soaps and packaged foods.  And this company is in the manufacturing of foods, food products as well as on soaps and personal care products.  The opportunity there is that the company exists and does very well in South Africa.  It has good management, has a range of 30 to 40 different products, but it sees the opportunity going north to Kenya and to Nigeria.

So we’re working with the company to make acquisitions.  Again, a platform story but a story in an area where, yes, Africa is growing at 6% a year but the emerging middle class is growing much faster than that and if you find an industry that caters to that, you have a story of rising tide lifts all boats.

Triple-Play Telecom

Snow: Hurley, if someone were to ask you, can you tell me a story that’s indicative of kind of the opportunity of private equity in Africa, what, to you, stands out?

Hurley Doddy, Emerging Capital Partners: There is so much opportunity in a lot of industries.  I was going to talk a little bit about telecom.  That was one the first industries for private equity- the cell phone business. Where Africa started investing.  In 2000, there was something like 25 million cell phones in Africa, so most people have never heard a dial tone and it didn’t look like they ever were going to hear one.  Over the last ten years, something like 400 million cell phones have been added, 450 million cell phones.  It’s really a big growth, but one question looking forward is: What’s the next area and where is it lagging behind?  We’ll talk a little bit about east Africa- the fibrotic cables, the undersea cables.  Pretty much the last major place in the world they went up was in east Africa in kind of 2009.  And before that, all the bandwidth, all the internet, was going over satellite, so it was just very constrained, very slow.  And all that changes when the cables, not only one, but a couple of cables came at the same time.

And as private equity investors, one of the questions for us is, something’s going to change in this market, there’s going to be some growth. What’s the best way to play the growth?  Where can we capture this opportunity and it’s a market we looked at top down and ended up investing in a triple-play company called Wananchi and that’s basically hooking up the cable network in Nairobi.  It’s a very interesting business if you can hook up the cable.  You give people triple-play, you give them very cheap telephone service, very fast internet, as fast as you can get in the developed market at a price that makes sense, and add onto that a paid television.

So this is an area that we can look and see what this did in Mexico, how fast did they grow in the Philippines and get an idea that by the time your cell phone hits 50%, that’s showing you that there’s going to be really good demand for it.  And that’s been very exciting. It’s kind of an area just like cell phones before too, where we can see the impact on the society, see the impact on the countries and really be making a difference to how business is done there and the quality of life there.

We have similar echoing, what Runa was saying about financial services, there’s still a lot of unbanked people there, and the banks themselves have a lot of growth to do. One thing interesting about it, too, is like a lot of things it looks more the way it did a couple decades ago.  We still do banking the old fashioned way, we give relatively low rates on our deposits and we charge higher rates on our loans.  We don’t have a prop desk, we don’t have bond derivatives and all.  There’s still a lot of money to be made, great use to the society to be gathering people’s deposits, to be making loans to businesses that can use these loans. We have a nice business in West Africa that has six different banks in some of the medium sized, some of the smaller countries.  It’s something that we put this group together we bought it from an entrepreneur who didn’t have really the capital to continue to grow it.

Now that we have that we can grow it, bring new investors in and it’ll make a nice collection of banks that when someone’s looking to expand into Africa they’re going to be able to come and get six of these at once, which can be hard to do.  So, yeah, I just wanted to say that is one good thing about this business.  We really can – when we go fly to an airport, you can go and you can see the billboards there of companies that you can say, yeah, we were involved, we helped build these companies, helped create these jobs and really helped, did our part to help the place grow.

South African Niche

Snow: Graham, as you survey your clients that are making private equity investments across Africa, what has stood out lately as being particularly impressive?

Graham Stokoe, Ernst & Young: I guess a transaction I had in mind, a transaction where I’ve actually done a lot of advising on a first investment and a second investment as quite a niche sector, which naturally makes the private equity quite interesting in that you pick these niche sectors. It’s actually in student accommodation in South Africa, entrepreneurial business to X investment bankers, took their profits- their capital, bought a couple- two or three properties and refurbished them into student accommodation, big high rises in the middle of CBD.  That business has now transformed into over 40 properties since private equity came in, brought capital to the party, was able to help this business expand geographically.  Even though it’s still in South Africa, it’s expanded from not only Johannesburg CBD to Capetown, Port Elizabeth, Port Pretoria and really putting capital to work in a niche sector in that it probably provides more accommodation than any one university in the whole of the country.

So it’s probably the biggest landlord in terms of number of tenants in South Africa.  And that’s four years later. And seeing companies in that niche sector is very interesting.

‘Unhygienic’ Deals

Snow: I’m sure that private equity investing in Africa is not all happy stories, it’s not the tree that grows to the sky, the line that only goes up. There’s probably some hard lessons learned.  I’m wondering if any of you can talk about bullets dodged or lessons learned that not only indicates the opportunity in Africa but risks that need to be understood and managed.

Alam: I think whenever we don’t end up investing and we look at it later, there’s a couple of commonalities with those companies.  The first is, as one of my partners calls it, ‘unhygienic’ accounting practices or ‘unhygienic ‘management reporting purposes because that hides a whole multitude of sins. So that the multiple we think we have in profit, it’s really not that.  Or there are liabilities that we don’t know about or there are credits there we don’t’ know about.  So if a company doesn’t have that, we will have to wait and audit them and see where we get to or we don’t do it.

The second one seems to be, Africa’s still a place where you don’t have a lot of information, so you don’t have consultants running around telling you this industry’s this big or this industry will have that much throwing off in revenue.  So the proxy that we use to dodge that bullet is the company cash flowing.  Is the company profitable? Because venture capital is hard enough to do in Europe. It’s very hard to do in Africa.  So those are the two things when we look back at companies we didn’t invest in, that seems to be two common things.

Snow: Graham, I’m sure that bad deals in Africa look like bad deals pretty much anywhere in the world but as you survey kind of disaster stories that you’ve witnessed or heard about, is there any common themes?

Stokoe: I think the biggest thing that comes to mind for me is going through due diligences.  We are independent advisors and as many deals that have gone forward, probably not even numbered but not far from one in every two have gone through due diligence phase and actually the client we’ve advised has actually decided, well, this is too much risk, a bit of kicking the tires and deeply diving into numbers and analytics revealed a whole lot that wasn’t brought to pay potentially over a number of six months of getting to know this company from afar.  When you get into the detail, some skeletons do come out of the closet.  But sometimes you have to see the bigger picture besides that.  Sometimes there are some accounting things that aren’t perfect, but there’s a good business there that you can potentially negotiate the price down and actually fix those and there’s still a good business to grow.  So it’s managing that risk, and what’s the rest of the story?

How are they not telling you a whole lot more that hasn’t been uncovered?  I guess the other thing that I wanted to mention is potentially cyclical businesses.  And we have seen private equity potentially not done as well as had hoped or not done a deal is it’s mostly been in particularly cyclical sectors where other resources have influenced the input into a manufacturing business and that’s had a big impact on margins and stuff.  And therefore, you have to really know that business and what makes it profitable and what’s going to impede those cash flows, which is possibly more of a South African risk in that the more you leverage, the more that potentialities a greater risk with less leverage you can ride through a sort of cyclical down turn.

Snow: Hurley, one of the privileges of being invested in Africa for a long time such as ECP is, you probably have some scars that have been very instructive and educational to your firm so what are some hard lessons that you’ve learned that you have applied to the way you invest going forward?

Doddy: Well one interesting lesson, especially earlier was selling too early. Like I said, when we first started out, not clear if you could get an exit off and you were showing one and, oh, okay, we’re making decent money and you sell that and you sell it to somebody else and the asset keeps on going up, that’s certainly one.

Another point too, it’s kind of the flip side of when we’re investing, we have time, we can take our time, they’re not auctions.  It is not a good – the flip side of that is it’s not a good place to raise money in a hurry.  So as Runo was saying, cash flow is good.  It’s king.  The difficulties have been especially when the world goes into a crisis, anything you have that’s not fully funded is going to be a source of pain and aggravation for you.

The other risk, too, is outgrowing your working capital, just outstripping, growing too fast, expanding too fast and not getting the systems right. So we really do have, to some extent, the problems and the upside of high growth.

Reasons to be Bullish

Snow:  What makes you the most bullish about the African opportunity as you look forward, as you look at the current environment and you think about where your firm is going to be, where your portfolio company is going to be in five to ten years, what kind of makes you feel the most positive?

Alam: There’s two sides. Obviously the LP side, so raising the money, and then the company side and I’m positive on both. On the LP side, when Hurley and I actually started off in private equity in Africa –

Snow: And you were at the same firm at the time.

Alam: And were at the same firm, yeah, when we started out.  The dream was demonstration effect. So a lot of the firms in Africa, virtually all of us, were started by the development institutions like IFC and CDC and FNO, etcetera and the demonstration effect was going to be: show that you can make returns in Africa and attract the classic private equity investor, the pension funds, the endowments, the family offices, the fund of funds, the sovereigns, etcetera.  Well our current fund has that in it. But more encouragingly, there’s more and more of those who are cold calling and who are looking and coming to conferences.  And so I think that classic private equity money is finally coming to Africa and that’s very encouraging.

On the deal side, we’re seeing now more deal flow and more sophisticated management and that’s equally encouraging. And we’re also seeing that the – on the macroeconomic basis, Africa as a region, which is finally standing out because of the high growth, it’s been the fastest growing region in the world in the last two or three years and African companies, I called them, they’ve been IMF’d.

What does that mean?  Well it’s not what happened in Europe in the US.  That means that their macroeconomic policies had been extremely prudent.  Most of them came into the crisis in 2008 with a very good chunk of preserves.  Most oil exporting countries have actually set their budget at a reasonable oil price of 30, $40.00 a barrel and not 70 or 100.  So the bigger story is positive.  We’re seeing more deal flow and hopefully finally we’re going to get some of the bigger classic private equity LPs.

Snow: What makes you feel bullish, Hurley?

Doddy:  I think that’s certainly a good summary.  Just in general, have faith in Africa, in 950 million people there and their energy, the faith in good governance making a difference.  For me, when I first started in business, the effect of Germany and of the Koreas was instructive of what you run a couple of decades of bad governance you can take the same people and one place will be prosperous and one won’t. And if you reverse that, that place will catch up.  This is what happened starting in the 1990s in Africa and we saw that for the entire decade, the last decade, Africa growing twice as fast as the developed markets and I think the trend is bound to continue.  And there will be ups and down on the road but I think the next – that gives me confidence that the next decade is going to be a good one in Africa.

Snow: Final question.  Graham, what makes you excited to be a part of African private equity?

Stokoe: I think for me, it’s just passion about the story and private equity influencing the whole African economy, contributing to the growth, contributing to more great exit stories like Salta a number of years ago and those classic stories of growing these great regional players.  And there’s a whole lot of African interest at the moment and it’ll be just great having private equity on the front of that Africa interest because we are already there. It’s not like the India and Chinese coming in.  It’s been there before, but really positive about the opportunity that exists.

Snow: Well thank you very much for joining us on Privcap today. We definitely will be covering private equity in Africa going forward and when we do, hopefully we can invite all of you back.

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