PE in SSA - Monitor SAVCA 2011 PDF

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 informal 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 facilitate 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 Groups and the South African Venture Capital Associations (SAVCAs) extensive network.
MONITOR COMPANY GROUP L.P 2011 , .
Table of Contents
Executive Summary ................................................................... 1 Introduction................................................................................ 6 Africas Challenges ..................................................................10
PERCEPTIONS .......................................................................... 11 COST TO SERVE ....................................................................... 12
Private Equitys 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
III
Executive Summary
PRIVATE EQUITY IN THE SHADOW OF GIANTS
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 globes 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, piracy 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 CTE DIVOIRE: In sub-Saharan Africa, the deal-making process is localised and often family orientated making deal flow challenging.

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
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

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.
Executive Summary
Overall, our study uncovered an attractive industry in flux, with increased competitiveness, 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; beyond 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.
Executive Summary
Introduction
Introduction
THE LAST TWO YEARS HAVE SEEN A LARGE NUMBER OF reports in which consulting firms and research houses are proclaiming nows the time for Africa (lead by Monitors 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 regions 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 Africas rapid growth has been driven by the continents rush to exploit the regions 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.

Introduction
tural land. While commodities have attracted foreign attention, most notably from China, and account for around 40% of FDI, sub-Saharan Africas growth is not just being driven by primary goods. Natural resources directly accounted for only 24% of the continents 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 consumers rising levels of discretionary income. Although subSaharan Africa remains the globes 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, excluding 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 ones pocket. There has been an almost bubble-like interest in Africa, but it hasnt been demonstrated by any huge uptick in investment. This is underlined by Emerging Markets Private Equity Association (EMPEA) data, which shows that fundraising 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 regions 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.
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
0.43
0.57
0.44 0.32 0.23 0.26 0.21 0.13 0.06 0.02 0.16 0.10 0.08 0.01 0.16 0.11 0.06 0.06 0.06 0.04 0.04 0.01 0.01 0.01 0.08 0.01
0.4
0.34
0.2
0.0
United United Kingdom States
Israel
India
Brazil
China
Russia Poland
SSA
South Korea
Japan
MENA
Mexico
South Africa*
Turkey
Source: Emerging Markets Private Equity Association
Source: Emerging Markets Private Equity Association. *Note: the South African gures are likely to include government and captive player data less likely to be included in the other country gures.
*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 cant make 20% in Africa, then you shouldnt be in the private equity business. The longer-established players have consistently outperformed the local public markets and other emerging regions. As the perception with reality is catching up, more new entrants are now seeking this alpha.
Africas Challenges
Africas Challenges
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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 relentlessly 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 Cte dIvoire, 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 regions 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 Africas 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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Africas 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, subSaharan 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 countries 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 continents 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 ecosystem 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-
Africas Challenges
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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 isnt 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.
Private Equitys Challenges
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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 execution 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 influence, 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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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 important 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 profitably on the subcontinent. Additionally, in South Africa, Namibia, and soon Botswana, changes to public pension 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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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 institutional 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 sophistication 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 experience 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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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 Empowerment in South Africa and Indigenisation in Zimbabwe, nearly all our respondents argued that risk isnt 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 firms 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 premium placed on South Africa by investors in London and New York, yet the returns and GDP growth rate are lower. However, given South Africas dominance over the regions 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, Preqins 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, Preqins 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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Figure 2: Performance of African stock markets JanuaryAugust 2011
INDEX North Africa

EGYPT MOROCCO TUNISIA EGX 30 CFG 25 TUNINDEX
PRICE
4728.55 24018.47 4513.03
1D Av.
0.28% 0.16% -0.91%
YTD
-33.79% -8.30% -11.73%
USD YTD
-35.51% -5.17% -9.25%
West Africa
BRVM GHANA NIGERIA COMPOSITE ALL SHARE ALL SHARE 143.11 1128.26 21298.07 -2.36% -0.30% -1.11% -10.05% 12.93% -14.02% -6.30% 9.37% -16.09%
East Africa
KENYA TANZANIA UGANDA ALL SHARE ALL SHARE ALL SHARE 73.60 1279.83 964.90 -0.59% 0.02% -0.26% -24.76% 9.96% -18.78% -35.41% 0.41% -33.37%
Southern Africa
BOTSWANA MALAWI MAURITIUS NAMIBIA SOUTH AFRICA ZAMBIA ZIMBABWE ZIMBABWE DCI ALL SHARE SEMDEX OVERALL ALL SHARE ALL SHARE INDUSTRIAL MINING 7287.30 4905.96 1929.58 749.38 29525.83 3799.56 160.58 160.64 -0.06% 0.56% -0.89% -1.68% -1.21% 0.26% -0.16% 1.11% 13.63% -0.95% -1.92% -13.59% -8.07% 15.00% 6.15% -19.84% 8.10% -9.30% 7.55% -20.33% -15.24% 11.02% 6.15% -19.84%
Global Markets
MSCI EMERGING S&P 500 EUROSTOXX 50 NIKKEI 225
Source: FM Capital Partners
988.05 1165.24 2080.10 8590.57
-0.16% -0.74% -1.29% -2.21%
-14.19% -7.35% -25.52% -16.02%
-14.19% -7.35% -22.17% -12.15%
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Deal Flow Deal flow has changed. The easy days of post-Apartheid unbundling of conglomerates 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 EMPEAs 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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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 Africas 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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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 its 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 mid2011.17 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 subSaharan activities have become targets for multinationals eager to gain a foothold in the region. A case in point is Wal-Marts $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 subSaharan Africa, with a total reported value of $2.9 billion. In 2010, there were 48 (only two less), but in value they represented only 20% of the 2008 level, suggesting the average deal size shrunk down to a fifth.
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Figure 3: Sub-Saharan Africa Fundraising & Investment, 2006 2010 (US$B)

$4 3.4 $3 2.9
Funds Raised Capital Invested
2.1
US$ Billions $2
2.2 2.0 1.4 1.0 0.6 1.5
1.3 $1
$0
2006
2007
2008
2009
2010
Source: Emerging Markets Private Source: Emerging Markets Private Equity Association. Equity Association.
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 dynamics 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. Recruiters 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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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 financial 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 experienced 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 mustnt expect that just because a manager is in a higher-growth economy like
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Africa that were going to give them any benefit of the doubt that theyre 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.
Innovative Approaches along the Private Equity Value Chain
Innovative Approaches Along the Private Equity Value Chain
PHOTO BY PIETERJAN GROBLER
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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 industry 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
1. Fund Strategy Regional funds Sector-specic funds Value-add funds Developing platforms SMEs and mid-cap Following South African companies north 2. Fundraising Pledge funds Listed company Deal-by-deal Partnership Holding company Open fund Captive Merchant bank Higher fees Management & oversight fees
Investment Execution
3. Deal Sourcing On-the-ground networks LP & partner networks Proprietary deal ow Limited intermediarygenerated deal ow 4. Deal Execution Convertibles Preference shares Tranche investments Non-cumulative dividends Liquidation preference Debt nancing 5. Post-Deal Holding Active, hands-on engagement Capacity building Insert experts Regional expansion Technical assistance 6. Exiting Trade/Strategic Sales IPO Group sale Secondary sale Sell back to management or founder
7. Cost Base
Recruiting and Human Resources Regional Ofce Infrastructure Travel Support services: legal services, due diligence, nance (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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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, agribusiness, 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 markets outside of South Africa, Nigeria, Ghana and Uganda. Most of our GPs had These accounted for half the total value of private equity investstrategies focused on ment on the subcontinent in 2010, and represents an increase harnessing the growth of 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 venture capital and SME investments, and value-add approaches for example using South African networks to link businesses in neighbouring countries to Africas biggest 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 dont take technical risk, rather they seek to take proven models to new geographies, either with one portfolio company, 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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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 opportunism 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 understanding 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 running 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 milestone 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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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 investors, reduce risk and is the seven-year lifespan. You have to sell a perfectly provide liquidity. good asset at a predetermined point from an investor standpoint thats 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 company 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 cant survive on two and twenty, it shows he doesnt 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 GPs underlying financial model.
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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 generally less open to this. 3. Deal Sourcing As in other markets, private equity is very much a peoples business in Africa, it is very difficult to address without feet on the ground or partners that youre 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 dont propose the deal if youre 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 investments performance as if you overpay, its difficult to generate the kind of returns investors are looking for.
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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 its 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 noticeably 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 stakeholders 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 investment 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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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 businesses. 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 plainvanilla equity stake in their investee companies. They seek to protect their downside 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 equivalent 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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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 Capacity building within the investee business changed, through networks of exportfolio companies is executives or consultants. a vital part of turning a company around. But outside the venture/early-stage space, GPs prefer not to get too close to the running of portfolio companies 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 its 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 managers, 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 its 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 Investment Partners, has adopted the philosophy of integrating commercial skills into the GP from their first vintage, despite being technically sub-scale at the time, with economics perceived to be too small to carry this capability. The team has a clear division of labour between deal execution and post-deal parenting. Although the post-deal or operating executives do form part of the deal selection and due-diligence process, their primary role kicks in once the GP holds the keys to the business. Operating executives are located on the ground, close to the assets they nurture and they intervene far deeper than the board. As in the more sophisticated private equity markets in Europe and North America, they have a different background, education and experience than fund managers, mostly being drawn from the top-tier strategy firms or with operational improvement experience, as opposed to investment banking or accounting. They end up part of the assets management team, coaching and advising
all the way to the middle management layer, often peeling off into the asset, manning a project management office (PMO) that actively implements the investment thesis and growth initiatives. Ultimately, however, they are still part of the GP with similar incentives to the GPs deal executives. This is the critical difference to the more prevalent model of the portfolio company hiring retired CEOs as sector-experienced operating executives only into the respective specific portfolio companies. Aligning post-deal executives incentives with the GP encourages the sharing of best practice across assets, which can improve asset performance throughout the portfolio and thus increase post-deal executives compensation. Moreover, it enables these practices to be passed to the GP franchise and thus transfer the learning to the next deal or vintage. This model also facilitates innovation across the portfolio. Executives employed by the portfolio company tend to adhere to the principles and busi-
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ness models that have worked for them in their past careers, which offer good downside protection for the assets. But more progressive players supplement this with analytics, change management and multi-sector experienced ex-consultants from the top tier strategy houses, to ensure that some of the more innovative and cutting edge approaches to value creation get implemented. This is what global institutional investors are now increasingly looking for and insisting on. The Helios model works as it does not create a second-class citizen dynamic between deal executives and operating executives: they are part of the same team and in the same boat when it comes to shared economics and incentives. However, if GPs try and add this principle half way through a vintage or the GPs history, it can cause considerable internal friction. Generally by then, the GP has been blessed by past successes that did not rely on such capability, and the teams economics have been spent amongst the existing deal partners that than need to make space
(in terms of carry points and incentives) for the new operating executive. This invariably puts them on the back foot. They will have to work hard to justify their presence and the cost they create, in addition to being forced to hire additional leverage to move the needle in the portfolio. Further, they have to sell themselves to the existing portfolio CEOs, who will naturally feel threatened by more share-holder interference that they hadnt signed up for. One closing comment on the topic of controlling stakes: there is a perception that the GP needs control to affect value driving change. Often GPs confuse effective board control (or majority shareholding) with the ability to affect change. By way of a global example: one of the single biggest post-deal or portfolio teams is part of a Special Situations Fund (owned by a bank) that only ever takes minority positions, but is still highly effective at instituting value driving changes quickly through influencing and credibly convincing, rather than controlling the management teams.
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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 banks 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 cant 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 aspirational 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
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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 executives 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 portfolio 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 knowledge across the engagements, and certainly does not align long-term incentives between all three parties (GP/investor, portfolio company and consultant). In particular, 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 payroll, 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 fundraising) the most difficult and least developed activity in the private equity value chain in Africa.
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6. Exits As the private equity market outside South Africa is very new, there have been relatively 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 strategic 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: Im not a fan of IPOs [as an exit], it doesnt suit the African private equity model... its not a market for small caps, and is an unattractive 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 theyre looking to some extent overpriced. Theres 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
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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 potential 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. Frequently, 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
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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, suitcase 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 companys 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. Partners 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 framework 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.
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This alternative was adopted either by international GPs with little in-country presence 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 dont have the local or expertise to get down in the weeds and actually run the company. Instead, they engaged with the company through monitoring. 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 wouldnt you just pay the local guys?.
Where Does This Leave Us?
PHOTO BY MARK VANCE
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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 Helioss investment in Shells 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.
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Finally, GPs seem to feel that the private equity fund structure is insufficient to meet the speed and complexity of financial innovation and evolving asset requirements in sub-Saharan Africa. They were thus seeking out new avenues of funding than previous fund vintages. DFIs still account for 60-75% of all LP investment in sub-Saharan Africa, but those we spoke to were cautious about investing in financing structures other than the GP/LP fund, because that was how their strategic asset allocation was set up. Several GPs we spoke to, whilst acknowledging the important role DFIs had played in the development of the industry, were frustrated by the apparently leisurely pace of DFI decision making, and sought to leapfrog up the LP ladder. However, private institutional investors were wary of first-time fundraisers because they were looking for international institutional quality GPs with a strong track record. While there were those LPs who didnt want to miss the boat or be late to the party, more cautious investors thought this was a dangerous dynamic. Their view is that given the potential of sub-Saharan Africa, the window of opportunity is not going to close and currently they wanted to let the cowboys be cowboys and wait until the market was more mature. Overall, our study uncovered a very attractive industry in flux, with increased competitiveness, but sufficient uncharted territory to grow from its still very 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, beyond that GPs will require more sophisticated skills to extract value. Few GPs keep those on payroll and as part of their philosophy of embedding it in the value of the GP franchise. In the end, it is a people business, and whoever institutes value driving change the quickest by being closest to the assets is most likely to win.
Endnotes
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Endnotes
1 2 3 World Bank, Africas Pulse: An analysis of issues shaping Africas economic future, volume 4, September 2011, https://blogs. worldbank.org/africacan/files/africacan/wb_africaspulse_sept2011_web2.pdf (accessed 23 September 2011). Some interviewees that are long-established in the region would argue that good returns have always been around but less talked about in Africa. United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2011: Non-equity Modes of International Production and Development, http://www.unctad.org/en/docs/wir2011_en.pdf (accessed 4 October 2011); UNCTAD, World Investment Report 2010: Investing in a Low Carbon Economy, http://www.unctad.org/en/docs/wir2010_ en.pdf (accessed 4 October 2011). Additionally, resources contributed indirectly to growth through government spending approximately 8% of GDP growth in the same period. Charles Roxburgh et. al., Lions on the Move: The Progress and Potential of African Economies, (McKinsey Global Institute, June 2010). UN HABITAT, The State of African Cities 2008: A Framework for Addressing Urban Challenges in Africa, (Nairobi: UN HABITAT, 2008). Monitor Group, Africa from the Bottom Up: Cities, Economic Growth and Prosperity in sub-Saharan Africa, (Monitor Group, Cambridge MA: 2009). This figure includes the middle class, which accounts for 13.4% of the population, but more importantly, the floating class (just above the Bottom of the Pyramid) with per capita daily consumption levels of between $2 and $4, who account for over 20% of the population, up from 11.6% in 1980. Mthuli Ncube, Charles Leyeka Lufumpa, Dsir Vencatachellum, The Middle of the Pyramid: Dynamics of the Middle Class in Africa, African Development Bank Market Brief, 20 April 2011; Vijay Mahajan, Africa Rising: How 900 Million African Consumers Offer More Than You Think, (Pearson Education, 2009). Monitor, Africa from the Bottom Up, p.19. Vivien Foster and Cecilia Briceo-Garmendia (eds.), Africas Infrastructure: A Time for Transformation, Overview, (World Bank, Washington D.C.: 2010), http://siteresources.worldbank.org/INTAFRICA/Resources/aicd_overview_english_no-embargo.pdf (accessed 15 August 2011).
5 6 7
8 9
10 This is one of the drivers of demand for specialised intelligence firms, such as Monitor Quest, that offer bespoke services to manage both propensity and opportunity to default in key individuals, increasing the cost to operate for GPs. We are in a new era of F.C.P.A. enforcement, Lanny A. Breuer, the US assistant attorney general for the criminal division, said last year, and we are here to stay. Peter J. Henning, A Warning as Wall Street Moves into Emerging Markets, New York Times, 28 September 2011, http://dealbook.nytimes.com/2011/09/28/a-warning-as-wall-streetmoves-into-emerging-markets/?pagemode=print (accessed 3 October 2011). 11 This is for Africa as a whole; south of the Sahara, it is likely to be a greater proportion. Bogusia Glowacz, Development Finance Institutions investing in African private equity, Preqin.com, 29 March 2011, http://www.preqin.com/ blog/101/3607/african-private-equity-dfi (accessed 4 October 2011). 12 See Michael Kubzansky, Ansulie Cooper and Victoria Barbary, Promise and Progress: Market-based solutions to poverty in Africa, (Monitor Group, Boston MA: 2011), esp. pp. 182-193. 13 Nick Kochan, The Final Frontier: Africa for Brave Investors, Euromoney, September 2011, p 326. 14 Strongly borne out in our interviews, but also corroborated by Coller Capital, Emerging Markets Private Equity Association, Emerging Markets Private Equity Survey 2011, p. 10. 15 The Preqin Quarterly, Q2 2009. 16 Simon Harford, Partner and Co-head, Africa, Actis, South African Venture Capital Association Conference Cape Town, February 2011. 17 Dominic ONeill, Investment banks eye the last frontier: Africa, Euromoney, May 2011.
48

Endnotes
18 Coller Capital, Emerging Markets Private Equity Association, Emerging Markets Private Equity Survey 2011, p.9. It is worth noting that this has dropped from 60% in the 2010 survey, suggesting that LPs are more aware of established GPs in the region than they were 12 months ago, and that more established GPs are seeking to tackle the market. Another point suggesting that LPs are better educated about the African environment than they were in 2010 is that those citing political risk as a deterrent to investment fell from 58% to 39%. 19 Recent research by INSEAD and PwC suggests that this is an approach favoured by LPs from the Middle East when they invest in sub-Saharan Africa. Their MENA LP survey found that they favoured investments with a short lifeline. Pascale Balze, Stephen Mezias and Yousef Bazian, The Next Five Years: MENA PE, September 2011, p.24 http:// campuses.insead.edu/abu_dhabi/research/documents/INSEAD-MENA-PE-Report-2011.pdf (accessed 4 October 2011). 20 Barclays Kenya Website http://www.barclays.com/africa/kenya/consumer/ (accessed 10 October 2011). 21 See also the authors work for the South African Venture Capital Associations Foundation Programme lecture at the Gordon Institute for Business Sciences.
Appendix
49
Appendix
African Private Equity landscape
Broadly speaking or without going into a scientific segmentation exercise (by size, region, theme or strategy, funding structure, etc.), and with no claim of completeness, we perceived seven categories of players: Global players with a presence on the continent: e.g. Actis, Aureos Capital, Bain Capital (which has made one investment in South Africa), Carlyle (which is starting out), Standard Chartered and few more rumoured to be investigating opportunities; Global players transacting from abroad, without an on-the-ground presence, but partnering with local actors or DFIs: e.g. HSBC Principal Investments, Cordiant Capital; Niche players transacting from abroad, without a permanent presence but partnering with locals: e.g. Silk Invest; Niche players with a (more or less) permanent local presence: e.g. ManoCap, Maris Capital, TLG Capital; Pan-African players headquartered abroad, but with bases on the continent: e.g. ECP, Kingdom Zephyr, Development Partners International, Helios Investment Partners; Regional or local players, solely based on the ground: e.g. African Capital Alliance, Catalyst Principal Investments, Salt Capital; South African players: e.g. Ethos Private Equity, Metier, Marlow Capital.
50

Appendix
Favoured Countries and Growth Stories
In this study we did not attempt to quantify and rank the hot countries and sectors by returns or attractiveness. Qualitatively however, we identified a number of trends for investment decisions:
GROWTH STORIES
Our interviews uncovered three growth stories that both private equity fund managers and their investors were chasing. Consumer-led growth: Increasing consumer demand as disposable income in sub-Saharan Africa increases and the middle class grows; Commodity-led growth: Classic energy and mineral extraction plays, and more recently, food security driven agri-food processing; Infrastructure backlog: This is present in both physical infrastructure (roads, ports, energy, telecoms, water and sanitation), as well as financial services, education, and healthcare facilities. The most favoured theme among our interlocutors appeared to be fastmoving consumer goods or consumer packaged goods roll-ups to create sizable regional players, which can then be sold to multi-national companies. Many private equity investors felt that both commodities and infrastructure required specialist knowledge and a range of skills within the team that they often could not provide.
Appendix
51
FAVOURED COUNTRIES
Drawing a conclusion on country selection beyond South Africa is harder. Our interviewees saw opportunities all over the sub-Saharan African region: East Africa: Kenya, Uganda, Tanzania and Ethiopia were all seen as attractive markets, particularly for those players in the small- to mid-cap space, who wanted to expand regionally. The customs union, the new telecoms infrastructure in Kenya, and good education standards created opportunities for many GPs. West Africa: Ghana was particularly favoured, even for many over Nigeria, as an easier place to do business and had a stable and less complex political and cultural environment. However, those GPs that knew the Nigerian landscape were extracting considerable value from Africas most populous country. Post-conflict countries: South Sudan, Liberia, and Sierra Leone were all attractive countries to GPs playing in the venture and early-stage spaces. The low base from which many companies in these countries start provided these funds with high growth opportunities and the potential of selling assets to strategic buyers looking to expand regionally.
52

Acknowledgements
Acknowledgements
The authors would like to thank all the senior executives who were interviewed for the project, without whom this report would have been impossible. Further we thank both the South African Venture Capital Association (SAVCA) and Unquote for their contributions. We would also like to thank Mark Fuller, the former Chairman of Monitor Group, for his support in making resources available to us to undertake our research.
General Partners / Investors Actis Aureos Capital African Capital Alliance African Development Corporation Catalyst Principal Investments Cordiant Capital Development Partners International Ethos Private Equity Helios Investment Partners Horizon Equity Partners HSBC Principal Investments Kingdom Zephyr Africa Management ManoCap Maris Capital Marlow Capital Metier Old Mutual Private Equity Omidyar Network RIT Capital Partners plc Salt Capital Sanlam Private Equity Silk Invest Sphere Holdings Surya Capital TLG Capital Trium Investments (Trivest) Limited Partners Capital Dynamics Citadel Wealth Management Coller Capital Hermes GPE Homestrings Pantheon Partners Group Development Finance Institutions African Development Bank Development Bank of Southern Africa International Finance Corporation Proparco Solicitors OMelveny Myers Norton Rose Research Organisations Malachite Jason Mosely Executive Search Egon Zehnder Fundraising Agents Asante Capital Trade Bodies South African Venture Capital Association
About the Authors
53
About the Authors

Christoph Andrykowsky
Christoph is a Partner at Monitor and is primarily driving Monitor Capitals efforts into Africa for both fee for service and upside /equity-sharing / co-invest arrangements. His work covers the full value chain of private equity from fund strategy design for a semi-captive private equity player, advisory on private equity deals, de-listings, strategic due diligences /sector studies, 100 day plans, post deal value extraction, corporate readiness assessments and exit grooming across a wide variety of sectors and businesses. He also manages Monitors relationship with Surya Capital in Africa. Prior to working at Monitor he spent six years in industry, managing business and export development projects for an international engineering group of companies covering Africa, Europe and Asia. Christoph completed a three year master degree in international business administration at E.A.P. European School of Management in Paris, Oxford and Berlin, now: ESCP-EAP and holds a BSc in industrial engineering, economics and business administration; Hamburg University, Germany. He is a French and German national with permanent residence in South Africa. He is also a commercial pilot.
Victoria Barbary
Until October 2011, Victoria was the Senior Analyst in the Office of the Chairman at Monitor Group, where she headed the London research team. Her work has covered a wide range of emerging-market issues including inclusive business and impact investing in India and sub-Saharan Africa, economic development in the Middle East and sub-Saharan Africa, as well as risk management and private equity investment strategies in emerging markets. Victoria is a leading expert on the activities and structure of sovereign wealth funds, and has written extensively on the topic, and regularly comments for the print and broadcast media. Victoria is the founder and managing director of Dhana Advisory, a specialist advisory and research firm concentrating on capital flows in emerging markets, with a focus on Africa and the Middle East. Victoria has a PhD in History from the University of Cambridge, UK, and Bachelors and Masters degrees in Modern History and Politics from the University of Durham.
The Design Studio at Monitor is a graphic design firm based in Cambridge, Massachusetts with a speciality in information design. Since 1998, the designers have worked closely with clients to understand their message and content in order to provide smart and creative visual solutions. Please visit www.thestudio.monitor.com for more information and project samples.
FOR MORE INFORMATION PLEASE CONTACT: Christoph Andrykowsky Christoph_Andrykowsky@Monitor.com tel +27-11-712-7517
www.monitor.com

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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

MONITOR COMPANY GROUP L.P 2011 , .

Private Equitys Challenges ................................................... 14

Innovative Approaches Along the Private Equity Value Chain .................................................... 26

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

Appendix ................................................................................. 49 Acknowledgements ................................................................ 52 About the Authors ................................................................... 53

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

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PRIVATE EQUITY IN THE SHADOW OF GIANTS

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PRIVATE EQUITY IN THE SHADOW OF GIANTS

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Source: Emerging Markets Private Equity Association

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PRIVATE EQUITY IN THE SHADOW OF GIANTS

MONITOR COMPANY GROUP L.P 2011 , .

Private Equitys Challenges

Private Equitys Challenges

PRIVATE EQUITY IN THE SHADOW OF GIANTS

Private Equitys Challenges

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

MONITOR COMPANY GROUP L.P 2011 , .

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Private Equitys Challenges

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

Private Equitys Challenges

Figure 2: Performance of African stock markets JanuaryAugust 2011

INDEX North Africa

988.05 1165.24 2080.10 8590.57

-0.16% -0.74% -1.29% -2.21%

-14.19% -7.35% -25.52% -16.02%

-14.19% -7.35% -22.17% -12.15%

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

Private Equitys Challenges

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS

MONITOR COMPANY GROUP L.P 2011 , .

PRIVATE EQUITY IN THE SHADOW OF GIANTS