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Private equity in_the_shadow_of_giants_12_01_11

  1. 1. Private EquityIn the Shadow of Giants INNOVATIVE APPROACHES ALONG THE INVESTMENT VALUE CHAIN IN SUB-SAHARAN AFRICA
  2. 2. About the StudyThis paper draws primarily on 43 formal interviews and more infor-mal conversations with a wide range of stakeholders in the Africanprivate equity ecosystem including general partners (GPs) andlimited partners (LPs) (both prospective and currently engagedin the region), research companies, solicitors, fundraising agents,recruitment consultants, and development finance institutions (DFIs).We also consulted a range of press articles, internet sources, reportsand studies of the private equity sector, most of which are listed inthe endnotes.This opinion piece does not aim to be a fully quantified primaryresearch report classifying countries or players by future attractiveness orpast investment returns. Rather, we have sought to collate the opinions ofstakeholders in the industry to create an overview of the sector and facili-tate a better understanding of the challenges they face and the innovativeapproaches to the business model they have made.We have, however, included an appendix containing the list of firmsinterviewed with a brief classification to give readers a sense of theindustry landscape and an overview of the sectors and countries mostattractive to those firms.Private Equity in the Shadow of Giants is aimed primarily at new-to-Africaactors interested in sub-Saharan Africa rather than the larger scale,established classic leveraged buyout (LBO) market in South Africa andelsewhere around the globe, hence the title.Christoph Andrykowsky, Victoria Barbary and Olivia Toye conductedthis research through interviews from August to October 2011 usingMonitor Group’s and the South African Venture Capital Association’s(SAVCA’s) extensive network. © MONITOR COMPANY GROUP L.P 2011 , .
  3. 3. Table of ContentsExecutive Summary.................................................................... 1Introduction................................................................................. 6Africa’s Challenges...................................................................10 PERCEPTIONS........................................................................... 11 COST TO SERVE........................................................................ 12Private Equity’s Challenges.................................................... 14 FUNDRAISING.......................................................................... 15 DEAL FLOW ............................................................................ 20 TALENT................................................................................... 23Innovative Approaches Along thePrivate 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............................................................................ 41Where Does This Leave Us?.................................................. 44 ENDNOTES .............................................................................. 47Appendix.................................................................................. 49Acknowledgements................................................................. 52About the Authors.................................................................... 53© MONITOR COMPANY GROUP L.P 2011 , .
  4. 4. iii Executive Summary
  5. 5. PRIVATE EQUITY IN THE SHADOW OF GIANTS 1 Executive SummaryMONITOR HAS BEEN SERVING THE AFRICAN FINANCIALinvestor community for almost a decade and felt that given the recent real andperceived increased interest in the continent, the timing was appropriate to capture,aggregate and elevate the financial investment actors’ views and opinions on howto best benefit from this positive trend in sub-Saharan Africa, home to the globe’slast large-scale frontier markets.As numerous recent reports have attested, including our own, Africa from theBottom Up, Africa comprises 55 rapidly urbanising, true frontier markets that havemoved beyond pure commodity extraction to a real consumer-led growth play. Foryears, sub-Saharan Africa has had a terrible image abroad, with more attentionbeing paid to the bad news emanating from the continent – civil war, famine, pi-racy – than the good. But perceptions are now improving and catching up with therealities that many investors find on the ground: almost under the radar, establishedplayers, even outside the South African market, have made good and consistentreturns. However, the bubble-like interest, despite the hype, has not yet resulted ina commensurate inflow of capital.African markets are still challenging to operate in. The cost to serve, execute dealsand deploy capital is still high due to a fragmented, largely unsophisticated marketwith a huge infrastructure and talent backlogs, which impedes economies of scaleELDERS GATHER TO MAKE A DECISION IN CÔTE D’IVOIRE:In sub-Saharan Africa, the deal-making process is localised and oftenfamily orientated making deal flow challenging.© MONITOR COMPANY GROUP L.P 2011 , .
  6. 6. 2 PRIVATE EQUITY IN THE SHADOW OF GIANTS Executive Summary and ease of doing business. For private equity players, this manifests itself in three core activities: • Fundraising: Prior to the global financial crisis, private equity investment in sub-Saharan Africa was largely the preserve of development finance institutions. However, more true frontier investors are exploring the region, seeking alternative African investment exposure that outperforms the small public markets through innovative funding structures. This has improved the fundraising opportunities for those GPs with differentiated business models. Consequently, the bar has been raised by institutional investors and teams have to demonstrate more value creation through true operational improvement, rather than just market growth or financial engineering. • Deal flow: Across the region, competition for deals has increased with the number of financial investors and renewed interest from (African and global) trade buyers, foreseeably turning the region into a vendors’ market. However, with the exception of the giants – South Africa and Nigeria – deal flow is likely to remain in the small- to mid-cap range. In this space, GPs supply growth capital to founder-led firms that aim to expand regionally, require corporatisation and upgraded governance processes and management systems, as they are rarely “investment ready” by Western standards. This is exacerbated by the nascent character of the industry in much of the region. Consequently, there © MONITOR COMPANY GROUP L.P 2011 , .
  7. 7. PRIVATE EQUITY IN THE SHADOW OF GIANTS 3 Executive Summary is an underdeveloped deal intermediary and service provider ecosystem. Entrepreneurs rarely seek out private equity as a way of growing their business as they are often unaware of it, partly because there is an almost complete absence of a venture capital industry in the region, which would typically feed the deal pipeline from the bottom.• Talent: This remains one of the biggest challenges, both at GP and asset level. However, strides can be made by employing a complementary blend of skills of returning expats with best in class global training and local talent with local networks, experience and potential.To address these challenges private equity players have innovated along the privateequity value chain.• Fund Strategy: Players are increasingly specialising and focusing on niches, pointing at a much more sophisticated market than the assets under management and market penetration would suggest.• Fundraising: New sources of patient capital, beyond development finance institutions and traditional institutional investors, are entering the scene. Frontier investors, family offices and funds from other emerging markets are seeking alternative structures in the region to deploy capital.• Deal Sourcing: Just bringing in money is no longer good enough for a GP to secure a controlling (but not always a majority) stake. In return, vendors are seeking partners with networks and© MONITOR COMPANY GROUP L.P 2011 , .
  8. 8. 4 PRIVATE EQUITY IN THE SHADOW OF GIANTS Executive Summary capabilities to unlock value. Creating concepts or platforms for regionalisation is a theme that many players are using to create value in their portfolio companies. • Post-Deal Holding: Although many actors understand the need to be actively engaged with their assets after the cheque is written, few of them have cracked the post-deal value-add nut. The implementation of value-enhancing changes in founder-led firms is still one of the key challenges, for private equity investors in Africa, but dedicated full-time (non-deal) operations executives are still the exception. Consequently, teams rarely implement proper dashboards, balanced scorecards or other cross-portfolio, value-based monitoring and post-deal value driving tools. • Exits: There is a wide range of potential exits, but a strong preference to extract premiums from strategic sales to multinationals seeking African growth platforms. Some GPs are also beginning to implement sophisticated third-party exit grooming, signifying increasing market sophistication. • Cost Base: Execution and post-deal engagement costs in Africa are still relatively high. While many investors choose to locate in London and partner with African companies, this model is unlikely to attract funding in future. The need to find a cost-effective way of keeping “boots on the ground” through leveraging flexible operating models and local networks is becoming more vital than ever. © MONITOR COMPANY GROUP L.P 2011 , .
  9. 9. PRIVATE EQUITY IN THE SHADOW OF GIANTS 5 Executive SummaryOverall, our study uncovered an attractive industry in flux, with increased competi-tiveness, but sufficient uncharted territory to grow from its still small base. Manyquestions need to be answered about the sustainability of many of the innovativeapproaches that have been proposed, or whether they are too far ahead of thecurve in terms of investor and investee perceptions and expectations. It will beinteresting 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 positionthemselves as the preferred provider of capital. Financial skills are table stakes; be-yond that, GPs will require specialised commercial skills to extract value. However,few GPs include individuals with such experience on their payroll or embed thisexpertise in the philosophy of the GP franchise.In the end, private equity in sub-Saharan Africa is a people business, and whoeverinstitutes value-driving change the quickest by being closest to the assets is mostlikely to win.© MONITOR COMPANY GROUP L.P 2011 , .
  10. 10. Executive SummaryIntroduction
  11. 11. PRIVATE EQUITY IN THE SHADOW OF GIANTS 7 IntroductionTHE LAST TWO YEARS HAVE SEEN A LARGE NUMBER OFreports in which consulting firms and research houses are proclaiming “now’s thetime for Africa” (lead by Monitor’s Africa from the Bottom Up in 2009). This followsa wave of growth, development and increasing political stability, albeit from a verylow base, that has engulfed sub-Saharan Africa over the past decade. Since 2000, theregion’s GDP has increased at a compound annual growth rate of 5%. Although ithalved during the global financial crisis, this level was almost restored in 2010.Assuming no further significant downward spiral in the global economy, the regionis expected to grow by 4.8% this year (5.8% excluding South Africa) and exceed thisrate in 2012 and 2013 (with some sources quoting up to 10% in some sub-regions).1Much of this growth is driven by private investment as investors wake up to theincreased 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 andregions where there are specific opportunities: the discovery of oil in Ghana sawFDI inflows increased by 1.5 times, while the expansion of mobile telecoms in theDemocratic Republic of the Congo has seen FDI inflows increase four times to$2.9 billion.3It is often argued that Africa’s rapid growth has been driven by the continent’s rushto exploit the region’s abundant natural resources, such as oil, bauxite, preciousand “rare-earth” metals, diamonds, and 630 million hectares of cultivatable agricul-AFRICAN BUSHVELDThe untouched beauty and wildlife in large parts of Africa creates ampletourism and eco-tourism investment opportunities.© MONITOR COMPANY GROUP L.P 2011 , .
  12. 12. 8 PRIVATE EQUITY IN THE SHADOW OF GIANTS Introduction tural land. While commodities have attracted foreign attention, most notably from China, and account for around 40% of FDI, sub-Saharan Africa’s growth is not just being driven by primary goods. Natural resources directly accounted for only 24% of the continent’s GDP growth between 2000 and 2008.4 The vast majority of growth is derived from manufacturing and service industries including construction, retail, banking and telecoms, which have grown two to three times faster than those in OECD countries. This has been driven by urbanisation and the African consumer’s rising levels of discretionary income. Although sub- Saharan Africa remains the globe’s least urban region, its cities have grown at 3.3% annually over the past decade: by 2032, over half the African population will live in urban areas.5 With cities driving growth and development,6 Africans are becoming more affluent. The number of Africans with discretionary spending power, exclud- ing the wealthy elite, more than doubled from 151 million to 313 million between 1990 and 2010, and is now of comparable size to the same class in India or China.7 And yet, despite all the hype, private equity investment in sub-Saharan Africa remains at modest levels. One of our LP interlocutors commented that “the nature of our industry is that there is a lot of looking, but not a lot of dipping into one’s pocket. There has been an almost bubble-like interest in Africa, but it hasn’t been demonstrated by any huge uptick in investment.” This is underlined by Emerging Markets Private Equity Association (EMPEA) data, which shows that fundrais- ing for the region lags behind other emerging markets. In 2010, $1.5 billion was raised for private equity funds in sub-Saharan Africa (6% of the total for emerging markets); that year, China-focused funds raised $7.5 billion and Indian funds $3.3 billion. Despite the attention sub-Saharan Africa has received recently, in the first half of 2011 the region’s funds raised $1.1 billion, largely comprised of Helios Investment Partners’ $900 million fund, the largest pan-African fund to date. This is dwarfed by the $10.3 billion China-dedicated funds raised during the same period. © MONITOR COMPANY GROUP L.P 2011 , .
  13. 13. PRIVATE EQUITY IN THE SHADOW OF GIANTS 9 IntroductionPrivate equity penetration in sub-Saharan Africa is also amongst the lowest in theworld; in 2009 it was only 0.16% of GDP, before falling to 0.06% in 2010 (seeFigure 1).Figure 1: Emerging market private equity investment as percentage of GDP 2009 – 2010 , 1.2 1.13 2009 2010 1.0 0.90 0.8 PE Investment/GDP (%) 0.63 0.6 0.57 0.43 0.44 0.4 0.34 0.32 0.26 0.23 0.21 0.2 0.16 0.16 0.13 0.11 0.10 0.06 0.08 0.08 0.06 0.06 0.06 0.04 0.02 0.04 0.01 0.01 0.01 0.01 0.01 0.0 United United Israel India Brazil China Russia Poland SSA South Japan MENA Mexico South Turkey Kingdom States Korea Africa* Source: Emerging Markets Private Equity Association.Source: Emerging Markets Private Equity Association *Note: the South African figures are likely to include government and captive player data less likely to be included in the other country figures.*The South African figures are likely to include government and captive player data less likely to be included in the other country figuresThe relatively low penetration points at an early-stage market, with the exceptionof South Africa. Returns have, however, been consistent and above average; allof our GP interviewees expected returns of over 20% in markets outside SouthAfrica, with established players reporting in excess of this figure. Indeed, one ofour interlocutors told us “if you can’t make 20% in Africa, then you shouldn’t be inthe private equity business”. The longer-established players have consistently out-performed the local public markets and other emerging regions. As the perceptionwith reality is catching up, more new entrants are now seeking this alpha.© MONITOR COMPANY GROUP L.P 2011 , .
  14. 14. Africa’s Challenges
  15. 15. PRIVATE EQUITY IN THE SHADOW OF GIANTS 11 Africa’s ChallengesINVESTING IN SUB-SAHARAN AFRICA IS CHALLENGING.Despite the growth story, African opportunities are often harder to exploit thanthat in many other high-growth emerging markets like in Asia and Latin America.The challenges GPs face broadly fall into two categories: investor perceptions ofthe region and the high cost to serve.PerceptionsDespite the hype around sub-Saharan Africa as an investment destination, it has aterrible image abroad.8 Coverage of the region and of its prospects has been relent-lessly negative, even from acknowledged friends and advocates. The “CNN Effect”has meant that the stories that grab headlines around the world – the civil war inCôte d’Ivoire, Somali piracy, the HIV/AIDS plague across the subcontinent, andthe recent humanitarian crisis in East Africa – tend to crowd out good newsstories – the region’s growing political stability represented by transparent electionsin Ghana and the recent peaceful change of ruling party in Zambia. Much like themedia itself, investors tend to take more notice of the three minutes they see on thetelevision news rather than getting into the region and looking and understandingthe market dynamics from the ground up.Conversely, the opposite is also increasingly true. As Western markets grow onlysluggishly in the wake of the global financial crisis, and European governmentsstruggle to persuade the markets that they can repay their debts, many investorsare reassessing risk and looking to new markets to find alpha. Such reassessmentsmake sub-Saharan Africa’s many markets look increasingly attractive on a risk-POWER LINES IN NAMIBIA:A large infrastructure shortfall is a major cost to doing businessin Africa.© MONITOR COMPANY GROUP L.P 2011 , .
  16. 16. 12 PRIVATE EQUITY IN THE SHADOW OF GIANTS Africa’s Challenges return basis. However, this may lead to misperceptions about the relative size of the opportunity in some of the sub-Saharan African countries, and about the levels of risk. Cost to Serve Due to is physical size, geopolitical fragmentation and lacking infrastructure, sub- Saharan Africa is also a hugely expensive place to do business, both in terms of time and money. Largely, this is the result of the major infrastructure shortfall and the lack of supporting ecosystems (legal, financial, intermediaries, etc.) across the region. On just about every measure of infrastructure coverage, African coun- tries lag behind their peers in the developing world, with the differences being particularly large for paved roads, flight connections, phone/data main lines and power generation,9 which makes doing business challenging, both for “fly-in” and “boots on the ground” private equity business models. Another factor that adds to the cost of doing business is the diversity and atomised nature of the region. Sub-Saharan Africa comprises 49 of the continent’s 55 states, many of which have populations of fewer than 20 million and economies smaller than $10 billion. These countries are characterised by cultural heterogeneity from the Islamic cultures of the Sahel, through the French colonial legacy of West Africa to the commercial sophistication of South Africa. Such diversity creates a complex web of legal and business cultures, which are not easily navigated and can limit businesses ability to spread across the continent. This diversity is made more challenging to navigate because the investment eco- system is underdeveloped or absent. Particularly at the smaller end of the market, there are few value-adding intermediaries and other (legal, accounting, banking, consulting) service providers. The major effect of the lack of a professional eco- © MONITOR COMPANY GROUP L.P 2011 , .
  17. 17. PRIVATE EQUITY IN THE SHADOW OF GIANTS 13 Africa’s Challengessystem is the high cost of due diligence. This is a “huge expenditure” and creates ahigher risk and abort costs for investors, particularly at the small- and mid-cap level,for a number of reasons:• Outside South Africa, due diligence firms are not generally considered to be particularly high quality, and thus global accounting, strategy or risk-consulting firms were often engaged to satisfy both GP and LP requirements, at a higher cost than the local equivalent.• There is little reliable market and consumer data available in Africa, as there is a large informal or cash economy, and standard information about companies frequently isn’t available.• As in other emerging markets, smaller companies often have two or three sets of financial records, to which GPs needed full access before investing. Traditional legal, commercial and accounting due diligence is considered insufficient in Africa; GPs and LPs need local knowledge about the immediate network and political position of investees, for example.• Both UK and US foreign corrupt practice legislation now require compliance both going into the asset and in ongoing monitoring throughout the investment period.10Even when this had been navigated and locked down contractually, manyinterviewees spoke of the necessity of staying out of court. In many Africancountries the courts system can be mercurial, and while the legal contracts arenecessary, they are insufficient to ensure that an agreement is enforced even afteran expensive legal process.© MONITOR COMPANY GROUP L.P 2011 , .
  18. 18. Private Equity’s ChallengesPrivate Equity’s Challenges
  19. 19. PRIVATE EQUITY IN THE SHADOW OF GIANTS 15 Private Equity’s ChallengesPRIVATE EQUITY COMPETES SIMULTANEOUSLY IN THREEdistinct but dynamically linked markets: the markets for funds, deals and talent. Asuperior team and track record create a virtuous cycle that enables smarter execu-tion and value extraction from the deal flow and thus attracts funding more easily.In each of these markets, the sub-Saharan-African environment presents specificchallenges 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 thelenses through which we, and the other actors, perceive the applicable differencesin Africa.FundraisingSources of FundingOne of the distinctive features of private equity in sub-Saharan Africa is theheavy development finance institution (DFI) footprint both as LPs and directinvestors. DFIs have long been important investors in African private equity,catalysing commercial investors’ interests and moving the investment agendafrom aid to commercial capital, helping stimulate the local private sectorthrough for-profit investments. Preqin documents that there are 51 DFIsactively investing in Africa-focused funds, representing 9% of LPs investing inthe region,11 but our interlocutors suggested that this underplays their influ-ence, with several suggesting that DFIs provide well over half the value ofLP investment in sub-Saharan Africa.Finding the right talent is one of the greatest challenges forGPs operating in sub-Saharan Africa© MONITOR COMPANY GROUP L.P 2011 , .
  20. 20. 16 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges GPs working in sub-Saharan Africa also have access to impact investors, who actively promote the growth and expansion of enterprises that have a development impact, while returning at least nominal principal, and have provided hundreds of millions of dollars to private businesses in the region.12 Another increasingly im- portant source of new capital for GPs is the African diaspora, whose remittances play such an important role in capital flows to the region. New vehicles are being established that aggregate the economic power of African ex-pats to invest profit- ably on the subcontinent. Additionally, in South Africa, Namibia, and soon Botswana, changes to public pen- sion fund legislation have allowed local pension funds to quadruple their allocation to private equity to 10%, which brings their allocation in line with more experienced public pension funds in North America. The raising of the private equity allocation in these institutions, our interlocutors hoped, would increase their awareness of the asset class and open new pools of funds to be deployed in this sector. Many GPs are, however, beginning to look elsewhere for funding. Many of those we interviewed were approaching family offices and high-net-worth individuals, particularly in other emerging markets, as more adventurous, nimbler investors with fewer conditions attached to funding. Endowments and foundations, particularly those from the US, and sovereign wealth funds also favour the region as they seem to have more risk appetite than traditional institutional investors,13 such as pension funds, funds of funds and asset managers. For example, we have seen a sovereign wealth fund and a specialised family office investment team execute focused sector roll-up strategies in consumer packaged goods and fast-moving consumer goods across the continent. By contrast, only a few traditional investors have dived in to Africa, amid concerns about risk and the maturity of the market.14 © MONITOR COMPANY GROUP L.P 2011 , .
  21. 21. PRIVATE EQUITY IN THE SHADOW OF GIANTS 17 Private Equity’s ChallengesChallenges of FundraisingSince mid-2008, GPs raising funds for sub-Saharan Africa have faced many of thesame difficulties as their peers around the world. Both private and public institu-tional investors have become more risk averse and have invested less in privateequity.15 A number of interviewees also identified a “certain dissatisfaction withthe private equity model in general” and a requirement for more transparency andaccountability from the fund managers. Even DFIs and government developmentagencies, operating in cash-constrained environments, are more aware that theyneed 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 USthat, on a risk adjusted basis, they can make equivalent dollar returns by investingin Africa as against investing in the US or Europe or Asia” by genuinely improvingthe strategy and operations of investee companies.Consequently, investors have raised the bar in terms of strategic sophistica-tion requirements for GPs, to mitigate risk and maximise returns. Many LPs nowhave more stringent track record requirements than they did in 2007. To convinceinvestors that they are “good, not lucky”, fund managers must demonstrate expe-rience and consistency in portfolio returns. This can adversely position first-timefund managers, particularly those without African track records. That said, LPsdo scrutinise individual personnel, requiring a team with all the complementaryskills that good parenting of a portfolio company requires. DFIs and institutionalinvestors are also looking more closely at GPs’ strategies and business models andrequire “carefully articulated strategies that take account of the realities of marketsthat have been well researched”.© MONITOR COMPANY GROUP L.P 2011 , .
  22. 22. 18 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges All these trends affect fund managers equally in other markets, but in sub-Saharan Africa, this has been amplified by the macro stereotypes about political risk and corruption, and the nascent state of the industry outside of South Africa. The risks, many stakeholders in the region believe, are “overhyped”; while there are some examples of potentially harmful legislation, such as Black Economic Empower- ment in South Africa and Indigenisation in Zimbabwe, nearly all our respondents argued that risk isn’t necessarily that much higher in Africa than anywhere else and some have the track record to prove it: one of our interlocutors’ firms is stated to never have lost or written off an entire asset in Africa due to country risk since the firm’s inception in 1948.16 Fundraising is particularly challenging for South African GPs at present. DFIs are less willing to invest in South Africa, because it is now considered a mid-income country. Moreover, given the current political situation there is a greater risk premi- um placed on South Africa by investors in London and New York, yet the returns and GDP growth rate are lower. However, given South Africa’s dominance over the region’s GDP, its market depth and the comparative sophistication of its private equity industry, it is “difficult to deploy $200 million in Africa while ignoring South African investment opportunities entirely”. On balance, fundraising constraints in sub-Saharan Africa may be easing; globally, Preqin’s most recent LP survey found that investors are “not investing at the same pace as in the years before the downturn, [but] the number of investors looking to make commitments is steadily improving”. Moreover, Preqin’s survey suggests that LPs are looking for returns of 200 basis points over the market; as African equities have performed poorly this year (see Figure 2), several GPs we interviewed suggested that private equity was an attractive option to those seeking African exposure (and to harness African growth) but with substantially higher returns. © MONITOR COMPANY GROUP L.P 2011 , .
  23. 23. PRIVATE EQUITY IN THE SHADOW OF GIANTS 19 Private Equity’s ChallengesFigure 2: Performance of African stock markets January–August 2011 INDEX PRICE 1D Av. YTD USD YTD North Africa EGYPT EGX 30 4728.55 0.28% -33.79% -35.51% MOROCCO CFG 25 24018.47 0.16% -8.30% -5.17% TUNISIA TUNINDEX 4513.03 -0.91% -11.73% -9.25% West Africa BRVM COMPOSITE 143.11 -2.36% -10.05% -6.30% GHANA ALL SHARE 1128.26 -0.30% 12.93% 9.37% NIGERIA ALL SHARE 21298.07 -1.11% -14.02% -16.09% East Africa KENYA ALL SHARE 73.60 -0.59% -24.76% -35.41% TANZANIA ALL SHARE 1279.83 0.02% 9.96% 0.41% UGANDA ALL SHARE 964.90 -0.26% -18.78% -33.37% Southern Africa BOTSWANA DCI 7287.30 -0.06% 13.63% 8.10% MALAWI ALL SHARE 4905.96 0.56% -0.95% -9.30% MAURITIUS SEMDEX 1929.58 -0.89% -1.92% 7.55% NAMIBIA OVERALL 749.38 -1.68% -13.59% -20.33% SOUTH AFRICA ALL SHARE 29525.83 -1.21% -8.07% -15.24% ZAMBIA ALL SHARE 3799.56 0.26% 15.00% 11.02% ZIMBABWE INDUSTRIAL 160.58 -0.16% 6.15% 6.15% ZIMBABWE MINING 160.64 1.11% -19.84% -19.84% Global Markets MSCI EMERGING 988.05 -0.16% -14.19% -14.19% S&P 500 1165.24 -0.74% -7.35% -7.35% EUROSTOXX 50 2080.10 -1.29% -25.52% -22.17% NIKKEI 225 8590.57 -2.21% -16.02% -12.15%Source: FM Capital Partners© MONITOR COMPANY GROUP L.P 2011 , .
  24. 24. 20 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges Deal Flow Deal flow has changed. The easy days of post-Apartheid unbundling of conglomer- ates in South Africa are long gone. On the whole, so too are the leveraged buy-outs relying on financial engineering and letting underlying growth recoup the debt. The tide is no longer raising all ships, even in this part of the world. Good deals are harder to find and there is greater competition. Investments no longer just create value by themselves; more sophistication is required to source and identify value in them, thus investment theses often demand more attention and skills by the GP to turn into real returns. In 2008 deal flow slowed, almost “constipating” the industry, resulting from the financial crisis. Due to limited debt, exits to financial buyers in that period had slowed and deals delayed waiting for movements in multiples, as unrealistic expectations created mismatches between buyers and sellers. Another challenge peculiar to South Africa was that “the listed markets continued to tick over and the changes to the Companies’ Act have made it more difficult and complex to execute transactions and increased the cost of failure”. This is borne out in EMPEA’s data: in 2008, South Africa was responsible for 28 deals, valued at $2 billion; in 2010, the deal volume had decreased by two thirds (to only 10 closes), worth only $47 million. This trend started reversing in 2011, with transactions like Savcio, Tracker and Universal indicating a return of high-value deals to the market. Conversely, however, the other giant market of sub-Saharan Africa, Nigeria, seems to have been less affected. In 2010, it accounted for $188 million (30% of the total value) in only six deals. © MONITOR COMPANY GROUP L.P 2011 , .
  25. 25. PRIVATE EQUITY IN THE SHADOW OF GIANTS 21 Private Equity’s ChallengesAnother factor that stymies deal flow is that private equity is in its infancy inthe region, with the exception of South Africa; consequently, capital-seekingbusinessmen have had little exposure to the asset class, and are often unaware ofit. They do not, therefore, seek it out as a potential exit or as a natural sourceof growth capital. The GPs in the region thus have to promote, demystify andeducate vendors about private equity, which can be a lengthy process, termed byone GP “the education overhead”. This is exacerbated by the fact that there isan almost complete absence of a proper venture capital industry in the region,even in South Africa, which means that entrepreneurs are not familiar with therole of outside investors.GPs investing in mid-market and early-stage companies across the region seemedcontent that there was sufficient deal flow, but many of those looking at largercompanies were struggling to find assets to take large tranches of financing. Oneof 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 SouthAfrica. Consequently, particularly in Africa’s largest market, there is increasingcompetition as more international GPs enter sub-Saharan Africa. That said, thoseGPs playing in this space, but who took a more entrepreneurial approach, andbroader geographical focus to deal sourcing told us that they had seen “limitedcompetition, and our current pipeline reflects this fact”. But, in the conventionalprivate equity space, there are relatively few companies by comparison to China andIndia that can take large ticket sizes. Many businesses are still young, founder-runand have small capitalisations, as until recently, political instability has constrainedcompanies’ regional and cross-boarder growth. Several GPs who specialised in© MONITOR COMPANY GROUP L.P 2011 , .
  26. 26. 22 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges small deals noted that many funds that had started out in small sub-$5 million deals were “edging upwards to... $10 million, $25 million deals”, so “it’s more and more congested higher up the food chain you go”, a trend exacerbated by larger, international GPs looking to sub-Saharan markets. There is also new competition from investment banks and some highly astute trade players. Russian investment bank Renaissance Capital, which operates in six African markets, completed 27 transactions in 14 African countries from mid-2010 to mid- 2011.17 Local trade players also compete with private equity as they have industry relationships, access to customers and more trade expertise to pick and choose assets. What is more, South African corporations with already established sub- Saharan activities have become targets for multinationals eager to gain a foothold in the region. A case in point is Wal-Mart’s $2.3 billion bid for South African retailer Massmart, which has a growing presence in 14 markets across the region. The slowdown in capital deployment is supported by EMPEA data, which shows that for the first time since 2006 capital invested was lower than funds raised in 2010, and that it had hit a five-year low at only $631 million (see Figure 3)  –  a drop of over 50% on 2009. Moreover, the data provides evidence for deal flow drying up at the top end of the market. In 2008, 50 private equity deals were closed in sub- Saharan Africa, with a total reported value of $2.9 billion. In 2010, there were 48 (only two less), but in value they represented only 20% of the 2008 level, suggesting the average deal size shrunk down to a fifth. © MONITOR COMPANY GROUP L.P 2011 , .
  27. 27. PRIVATE EQUITY IN THE SHADOW OF GIANTS 23 Private Equity’s Challenges Figure 3: Sub-Saharan Africa Fundraising & Investment, 2006 – 2010 (US$B) $4 3.4 Funds Raised Capital Invested $3 2.9 2.1 2.2 2.0US$ Billions $2 1.5 1.3 1.4 1.0 $1 0.6 $0 2006 2007 2008 2009 2010Source: Emerging Markets Private Equity Association. Equity Association. Source: Emerging Markets PrivateAs such, with the exception of the giants  –  South Africa, where the public marketand private equity is much more developed, and Nigeria, given its growth dynam-ics and size  –  deal flow is likely to remain in the small- to mid-cap space. Thesedeals are not about financial engineering, as is the case in LBOs; rather GPs needto supply growth capital to founder-led assets that aim to expand regionally, requirecorporatisation, and improved governance processes and management systems asthey are rarely at first sight “investment ready” by western standards. As such, theyrequire intensive post-deal engagement to realise the value.TalentTalent, both at GP and portfolio company level, is the major constraint for privateequity in Africa, almost unanimously confirmed by all players interviewed. Recruit-ers confirmed that not all skills – Western education, financial acumen, managementexperience, African background and operational track record – can be found in one© MONITOR COMPANY GROUP L.P 2011 , .
  28. 28. 24 PRIVATE EQUITY IN THE SHADOW OF GIANTS Private Equity’s Challenges individual for each position. Rather, recruiters have to construct teams mixing team members with some of these attributes and then invest in developing local talent to achieve the required blend. One investor told us that they were struggling to find an African to head their Johannesburg office as suitable individuals were unwilling to leave lucrative jobs in international financial centres or managing large international private equity funds to manage a smaller fund on their home continent for a necessarily lower salary. This, he believed was partly due to the fact that the “true egalitarian private-sector boom in Africa is relatively new and... this is the first chance many people have had to make real personal wealth”. Despite this constraint, talent is to be found amongst the returning diaspora or “re-pats”, who some LPs felt were ideal for the business due to their combination of developed world experience and sensitivity to local nuances. But while the finan- cial crisis might have encouraged some re-pats home, “the infrastructure does not yet exist to entice the bulk of the African diaspora back”, thus repatriation has yet to reach the levels seen in Asia. Also the banking crisis driven re-pats need to be complemented by more operational focused “heavy-hitting” operationally experi- enced re-pats, paired up with strong local team members to support them. Several LPs we interviewed believed there to be “a severe shortage of good GPs in Africa”. This echoes the findings of the 2011 Coller Capital EMPEA LP survey, in which nearly half of respondents said that the limited number of established GPs was likely to be the single biggest factor to deter them from beginning to invest in sub-Saharan Africa over the next two years.18 As one potential LP told us, “we have one set of investment guidelines and investment criteria irrespective of geography. They mustn’t expect that just because a manager is in a higher-growth economy like © MONITOR COMPANY GROUP L.P 2011 , .
  29. 29. PRIVATE EQUITY IN THE SHADOW OF GIANTS 25 Private Equity’s ChallengesAfrica that we’re going to give them any benefit of the doubt that they’re going toperform as well as any other manager”. This explains the current quasi-absence oflarge 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 credibleplayers is sufficient to spread their bets.Several of our interviewees pointed out that “there is a huge difference betweenthose who can do private equity and those ex-investment bankers who think theycan”. The distinguishing factor tended to be those teams that understoodthat investing in the growth capital space requires a wide range of operational andchange management skills, beyond just financial structuring and deal execution.© MONITOR COMPANY GROUP L.P 2011 , .
  30. 30. Innovative Approaches along the Private Equity Value ChainInnovative Approaches Alongthe Private Equity Value Chain PHOTO BY PIETERJAN GROBLER
  31. 31. PRIVATE EQUITY IN THE SHADOW OF GIANTS 27 Innovative Approaches along the Private Equity Value Chain DURING OUR INTERVIEWS WE HAVE ENCOUNTERED SUCH a wide range of GPs that it would have done little justice to the innovations, diversity and richness of their business models to force these into a simple indus- try classification (see Appendix). Instead, we have looked to where the particular challenges of sub-Saharan Africa have led GPs to innovate along the private equity value chain, and to illustrate how these innovations have worked at each stage. Figure 4: African GPs’ Innovations throughout the value chain Investment Strategy Investment Execution 1. Fund Strategy 2. Fundraising 3. Deal Sourcing 4. Deal Execution 5. Post-Deal Holding 6. Exiting • Regional funds • Pledge funds • On-the-ground • Convertibles • Active, hands-on • Trade/Strategic • Sector-specific funds • Listed company networks • Preference shares engagement Sales • Value-add funds • Deal-by-deal • LP & partner • Tranche investments • Capacity building • IPO networks • Insert experts • Group sale • Developing • Partnership • Non-cumulative platforms • Proprietary deal dividends • Regional expansion • Secondary sale • Holding company flow • SMEs and mid-cap • Open fund • Liquidation • Technical assistance • Sell back to • Limited preference management or • Following South • Captive intermediary- founder African companies • Debt financing • Merchant bank generated deal flow north • Higher fees • Management & oversight fees7. Cost Base Recruiting and Human Resources Regional Office Infrastructure Travel Support services: legal services, due diligence, finance (accounting & reporting), IT etc. RENEWABLES ARE GAINING MOMENTUM: Private equity firms operating in sub-Saharan Africa are finding niches to exploit. One of the most popular among our interviewees was green energy. © MONITOR COMPANY GROUP L.P 2011 , .
  32. 32. 28 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain 1. Fund Strategy As fundraising conditions have tightened over the past three years, competition for funding has intensified. Consequently, new-to-market small, sub-Saharan African players are developing sophisticated, differentiated strategies. The most common of these amongst our interviewees were sector plays: financial services, health, agri- business, and renewable energy. We also observed focused geographical strategies, both regional and thematic (e.g. post-conflict economies) which has resulted in investments being spread over a wider range of countries. EMPEA data shows a marked uptick in investments in Kenya and sub-Saharan African Most of our GPs had markets outside of South Africa, Nigeria, Ghana and Uganda. strategies focused on These accounted for half the total value of private equity invest-harnessing the growth of ment on the subcontinent in 2010, and represents an increasethe African middle class. of almost three times on both 2008 and 2009. We also noted a number of strategies segmented by market sector, such as ven- ture capital and SME investments, and value-add approaches – for example using South African networks to link businesses in neighbouring countries to Africa’s big- gest market, and backing South African entrepreneurs founding companies north of the border. LPs believed this to be an encouraging trend as it showed that “more thought was going into” the GP business models and strategies. Most of our GPs were seeking to harness the growth of the “slow but steady moving machine” of the emerging middle class; therefore, one of the most popular strategies was that of developing consumer products or agribusiness companies by buying platforms to expand into neighbouring markets, organically or through roll-ups. One GP told us “we don’t take technical risk”, rather they seek to take proven models to new geographies, either with one portfolio com- pany, or by sharing the knowledge across their portfolio. This strategy primarily involved mid-cap companies, with GPs taking a controlling minority stake of © MONITOR COMPANY GROUP L.P 2011 , .
  33. 33. PRIVATE EQUITY IN THE SHADOW OF GIANTS 29 Innovative Approaches along the Private Equity Value Chainaround $20 million. These are likely to benefit from changes like the creationof the East African Customs Union, which makes international expansion easierand 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 makingthis model work was either finding an underdeveloped sector, such as healthcare,or finding a company that had a particularly innovative business model that couldleapfrog existing technologies or products in the market.All these contrast with the classic model of the long-established, multiplevintage, larger-scale South African players who think about their capital allocationnorth of their borders more in the sense of backing their South African portfoliocompanies in their quest to double their non-South African revenue lines, ratherthan seeking standalone assets in remote markets.Regardless of the approach, many of our interviewees believed that while oppor-tunism had worked in the past, in the current climate it was more important to stay“consistently on-strategy”, and only buy assets where they had a detailed under-standing of the economic and political environment in which they were investing sothat they could efficiently unlock the sources of value over the investment period.2. FundraisingOne of our interlocutors told us that it is “increasingly difficult to justify run-ning a fund model unless you get to scale” and given the current challenges offundraising he thought it would be very difficult to raise another fund. Indeed,it appears that for many of our interviewees, the traditional closed-fund model© MONITOR COMPANY GROUP L.P 2011 , .
  34. 34. 30 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain was distinctly under threat. This, it was argued, was “a natural evolution for the business” and the development of alternative structures was an “important mile- stone for the industry”. We saw a number of alternative investment structures that actors had developed, either through necessity, or through intent: • Listed investment company using public market funding • Privately held holding company or conglomerate (on-balance-sheet lender) • Deal-by-deal fundraising or flexible capital model • Pledge funds • Open fund with no close • Captive funds with a dominant investor • Merchant or investment bank or principle investment arm • Wealth managers • Impact investors There were a number of reasons why actors had innovated around the funding model. Partly this was a result of the liquidity-constrained environment. With LPs reluctant to tie up their capital and expose themselves to the high perceived risks of Africa, having a model that provided investors with “liquidity and a real price point”, was advantageous because it reduced the risk, but still gave private equity exposure. Another benefit that actors saw in these structures was that they gave © MONITOR COMPANY GROUP L.P 2011 , .
  35. 35. PRIVATE EQUITY IN THE SHADOW OF GIANTS 31 Innovative Approaches along the Private Equity Value Chaininvestors “exposure to growing markets that they would otherwise be unable toaccess”, thus providing them with added diversification benefits.There is a clear preference for attracting more patientcapital, hence the emergence of more transparent, open Sub-Saharan Africanfunding models that were more flexible about ticket GPs are innovating aroundsize, stake size, sectors and holding period. As one the fund model tointerlocutor argued “the dirty secret of private equity attract a wider range ofis the seven-year lifespan. You have to sell a perfectly investors, reduce risk andgood asset at a predetermined point – from an investor provide liquidity.standpoint that’s crazy”. As a reflection of the dynamicnature of the African market, players viewed flexibility as particularly important:they needed to be nimble, quickly taking advantage of the opportunities that theyfound. They also wanted flexibility on holding period. Those actors investing ininfrastructure and property would hold for the longest period, but otherwise therewas a disparity across all other variables, with some players seeking to exit a com-pany within three years, even an early-stage one, and others feeling that to maximisethe value they needed to hold it for longer.19 Indeed, they wanted to be able to sellthe 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 fundmodel often asked to increase management fees. This is obviously unpopularwith LPs, particularly DFIs, as one told us “if a GP can’t survive on two andtwenty, it shows he doesn’t know the landscape well enough”. That said, someDFIs are willing to pay higher fees if the fund was below $50 million, if theyare engaging with SMEs, or in post-conflict countries, which they understandhad a greater economic impact and are more resource intensive. That said, all theLPs we spoke to were concerned that higher fees might represent a flaw in thesustainability of the GP’s underlying financial model.© MONITOR COMPANY GROUP L.P 2011 , .
  36. 36. 32 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain An alternative route is to charge investees a “management and oversight fee” baked into the shareholder agreement, which enables GPs to engage intensively with their portfolio companies without burdening the investors with the additional cost. The principle behind such a fee is that the companies should pay for the value-add that the GPs bring. However, as both the GPs that follow this model pointed out, it only really works if you can make a cast-iron case up-front for that value-add to the management of the investee company. Smaller, founder-led companies are gener- ally less open to this. 3. Deal Sourcing As in other markets, private equity is “very much a people’s business in Africa”, it is “very difficult to address without feet on the ground or partners that you’re truly aligned with and truly trust”. Our interlocutors thus emphasised the need to spend considerable time in creating and developing “soft relationships” learning the local cultural context and getting to know local entrepreneurs. This network is vital as “the deals get put together and you get invited; you don’t propose the deal if you’re a private equity player. Often the deals get done at a political or industry leadership level”. Those GPs considered to be successful by their peers were thus those that “really know their way around” their chosen region. This allows GPs to get to know the “potential investee companies, the market gossip and where the company sits within the business ecosystem”. It also enables firms to identify any potentially problematic (or advantageous) political affiliations that the entrepreneur might have. Good relationships with vendors also prevent GPs from being persuaded to “overpay for growth”, which can improve the investment’s performance as “if you overpay, it’s difficult to generate the kind of returns investors are looking for”. © MONITOR COMPANY GROUP L.P 2011 , .
  37. 37. PRIVATE EQUITY IN THE SHADOW OF GIANTS 33 Innovative Approaches along the Private Equity Value ChainThe importance of networks was underlined by the position of South Africanmanagers who were seeking to expand north of the border. Most understand theneed to tap the growth and have a tranche of their fund carved out for ex-SouthAfrica investments, but many struggle to source deals  – “how deals get done inthose countries is a mystery” due to the “complexity of the relationships” –  andevaluate risk. South African managers understood that expanding into the rest ofsub-Saharan Africa “requires our senior people to be committed and go to someof these places”, and that this required “spending money and putting offices andinfrastructure in place”. Rather than make this commitment, many South AfricanGPs seek to gain this exposure indirectly by encouraging their portfolio companiesto expand regionally. This, as one interviewee pointed out, is “self-serving, but it’salso valid”. However, “it underestimates inter-country differences, and in that sortof play, management is an issue”.Proprietary Deal FlowSeveral established players noted that competition for deals has increased notice-ably in recent years with one telling us “we have faced more competition on dealsin the last six months than in the last six years combined”. In this environment,the ability of a GP to secure propriety deal flow was considered by many stake-holders to be a litmus test of quality. Our interviewees believed that creating dealsand “build[ing] your reputation so people come to you” improved performance byreducing initial asset prices, and demonstrated your skill at finding a good invest-ment in unusual spaces. There was a certain amount of scorn for managers thathad bought assets that had “been around the block”, or had “wait[ed] for theopportunity to come their way when shareholder activity unlocks an asset” ratherthan going out and creating opportunities. There was also disdain for GPs thatrelied on intermediated deal flow. Most of our interviewees believe that these dealsare the preserve of global players (Actis, Bain Capital, Carlyle) or established large© MONITOR COMPANY GROUP L.P 2011 , .
  38. 38. 34 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain local firms with larger funds because “you need to be the highest bidder”, and most GPs, particularly those with smaller funds, are unable to pay over the odds. GPs’ views of investment opportunities are coloured by how they are plugged into the ecosystem. The most marked example of this comes in the form of attitudes towards the Asian family businesses of East Africa. Those GPs who understand these businesses and have good contacts there see them as an opportunity to create deal flow by building relationships and working with them to develop new busi- nesses. Others see them as competitors because they are “shrewd on-the-ground operators and they are well-connected with strong relationships with government... particularly in resources”. 4. Deal Execution Like private equity practitioners across the world, our GPs rarely take a plain- vanilla equity stake in their investee companies. They seek to protect their down- side by using convertible notes, preference shares, or investing in tranches, particularly in smaller companies. They may also have non-cumulative dividends, some form of liquidation preference in-line with other preferred stockholders, and standard conversion and dilution provisions. Bank financing in Africa is expensive; for example Barclays in Kenya currently offers business loans at 14.9% over a five-year period20 – double the equiva- lent in the UK – so some GPs investing in SMEs or early-stage companies also look to provide investees with some form of debt financing. This sometimes takes the form of a shareholder loan for start-ups, mezzanine financing, particularly in manufacturing industries that have an expanding customer base, and sometimes long-term debt “comparable to a bank”. © MONITOR COMPANY GROUP L.P 2011 , .
  39. 39. PRIVATE EQUITY IN THE SHADOW OF GIANTS 35 Innovative Approaches along the Private Equity Value Chain5. Post-Deal HoldingThe vast majority of GPs we interviewed emphasised the need to be very hands-onwith their portfolio companies; few of the GPs we interviewed had more than twoinvestments per partner, and all took the customary seats on the board. This wasalso reflected in the composition of GPs’ teams; several noted that they requireda mix of skills that ranged from accounting, legal, and financial to operationalknowledge in engineering and logistics. This would either be present within thepartnership, or they would call in the right skill sets asthe investee business changed, through networks of ex- Capacity building withinexecutives or consultants. portfolio companies is a vital part of turning aBut outside the venture/early-stage space, GPs prefer company around.not to get too close to the running of portfolio compa-nies themselves, instead helping the existing management to corporatise and growthe business. Nearly all the GPs we spoke to stressed that when making theirinvestment decision they back good management ; for one GP “it’s the only thingwe do”. However, in some particularly challenging post-conflict economies or atthe venture capital level, some GPs had taken on managing director roles; one evenhad to undertake the stock-take for an early-stage logistics business.On the whole, however, GPs look to help the existing management to improve andgrow the business. The emphasis here is very much on capacity building withinportfolio companies, particularly in smaller or family-owned businesses where mostof the skill and energy resides in the founder. GPs discovered that in many casesthe “talent is there, but there is not enough”. This often manifests itself in a big gapbetween the talent of the entrepreneur (or C-level executives) and the middle man-agers, who do not lack in “raw talent or integrity” but have less experience. They“usually require a little bit of deliberate study and understanding” because it’s themiddle managers that are going to implement the changes that need to take placewhen turning a company around and looking to become more commercial.© MONITOR COMPANY GROUP L.P 2011 , .
  40. 40. 36 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value ChainHELIOS INVESTMENT PARTNERS: BEST-IN-CLASS EXAMPLE OF DEDICATED POST-DEALVALUE-ADD CAPABILITIES IN SUB-SAHARAN AFRICA One player in sub-Saharan Africa, Helios all the way to the middle management Investment Partners, has adopted the layer, often “peeling off ” into the asset, philosophy of integrating commercial manning a project management office skills into the GP from their first vintage, (PMO) that actively implements the in- despite being technically “sub-scale” at vestment thesis and growth initiatives. the time, with economics perceived to be too small to carry this capability. The Ultimately, however, they are still part team has a clear division of labour of the GP with similar incentives to the between deal execution and post-deal GP’s deal executives. This is the critical parenting. Although the post-deal or op- difference to the more prevalent model erating executives do form part of the of the portfolio company hiring retired deal selection and due-diligence process, CEOs as sector-experienced operat- their primary role kicks in once the GP ing executives only into the respective “holds the keys to the business”. specific portfolio companies. Aligning post-deal executives’ incentives with Operating executives are located on the the GP encourages the sharing of best ground, close to the assets they nurture practice across assets, which can and they intervene far deeper than the improve asset performance throughout board. As in the more sophisticated the portfolio and thus increase post-deal private equity markets in Europe and executives’ compensation. Moreover, it North America, they have a different enables these practices to be passed to background, education and experience the GP franchise and thus transfer the than fund managers, mostly being drawn learning to the next deal or vintage. from the top-tier strategy firms or with operational improvement experience, as This model also facilitates innovation opposed to investment banking or ac- across the portfolio. Executives counting. They end up part of the asset’s employed by the portfolio company tend management team, coaching and advising to adhere to the principles and busi- © MONITOR COMPANY GROUP L.P 2011 , .
  41. 41. PRIVATE EQUITY IN THE SHADOW OF GIANTS 37 Innovative Approaches along the Private Equity Value Chainness models that have worked for them (in terms of carry points and incentives)in their past careers, which offer for the new operating executive. Thisgood downside protection for the invariably puts them on the back foot.assets. But more progressive players They will have to work hard to justifysupplement this with analytics, change their presence and the cost they create,management and multi-sector experi- in addition to being forced to hire ad-enced ex-consultants from the top tier ditional leverage to “move the needle”strategy houses, to ensure that some in the portfolio. Further, they have toof the more innovative and cutting sell themselves to the existing portfolioedge approaches to value creation CEOs, who will naturally feel threatenedget implemented. This is what global by more “share-holder interference” thatinstitutional investors are now increas- they hadn’t signed up for.ingly looking for and insisting on. One closing comment on the topic ofThe Helios model works as it does not controlling stakes: there is a percep-create a “second-class citizen” dynamic tion that the GP needs control to affectbetween deal executives and operating value driving change. Often GPs con-executives: they are part of the same fuse effective board control (or majorityteam and in the same boat when it shareholding) with the ability to affectcomes to shared economics and incen- change. By way of a global example:tives. However, if GPs try and add this one of the single biggest post-deal orprinciple half way through a vintage portfolio teams is part of a Special Situ-or the GP’s history, it can cause con- ations Fund (owned by a bank) that onlysiderable internal friction. Generally by ever takes minority positions, but is stillthen, the GP has been blessed by past highly effective at instituting value driv-successes that did not rely on such ca- ing changes quickly through influencingpability, and the team’s economics have and credibly convincing, rather thanbeen spent amongst the existing deal controlling the management teams.partners that than need to make “space” © MONITOR COMPANY GROUP L.P 2011 , .
  42. 42. 38 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain Some GPs did, however, bring in heavy-hitting outside expertise, with relevant experience. For example, one GP that invested in a bank in Equatorial Guinea, brought in an executive that had run a major international bank’s operations in Afghanistan. Others sought to source expertise from within Africa – particularly South Africa and Zimbabwe – and bring it to other African markets. Indeed, one of our interlocutors felt that the flexibility and willingness to move to other countries was one of the great strengths of the African talent pool. Sometimes, however, this was challenging. The ecosystem of executive search is undeveloped in Africa and expensive; GPs thus had to source individuals through their own networks: as one interlocutor told us “you can’t suggest hiring a CFO and then not have someone in mind”. Moreover, it could be difficult to persuade the management that additional people or skills are needed to help grow the business, particularly in founder-led firms. GPs operating in both the mid-market and larger spaces, sought to help their portfolio companies expand their operations regionally. This might be by simply leveraging their own network of public and private sector international contacts to help the investee enter new markets. In other cases, GPs used synergies between the companies in their portfolio to either share best practice or serve as clients. In financial services, providing technical assistance and growth capital to expand into neighbouring countries often proved enough to grow the acquired banks quickly. On balance, however, we found the post-deal efforts of African GPs more aspira- tional than real compared to their developed-market or even Indian counterparts. Few players have adopted a genuine separation of labour between the hunting and farming of value, or have real, dedicated (non-deal) operating partners with the right mix of operational, change management and analytical skills to institute early value driving changes into the acquired targets. Starting with cross-portfolio © MONITOR COMPANY GROUP L.P 2011 , .
  43. 43. PRIVATE EQUITY IN THE SHADOW OF GIANTS 39 Innovative Approaches along the Private Equity Value Chaindashboards and monitoring  –  measuring market externalities as much as financialperformance data  –  to cross-portfolio learning initiatives between executives, andmore innovative portfolio-wide commercial initiatives than just improved workingcapital management and the obvious low-hanging fruit in the supply chain. Veryfew of the GPs use a value-based management approach where growth initiativesand board proposals are constantly evaluated against the initial valuation modelsbuilt during the deal due diligence.21  Part of the reason is the skill mix of the ex-ecutives founding the GPs. In Africa often they have more of an accounting andbanking background where in India one finds more ex-CEOs being part of startingthe private equity franchises.Moreover, sub-Saharan African players have not made as much effective use oflong-term consulting arrangements for that purpose. The KKR-Capstone modelof retaining consulting capacity and “best-in-class thinking on tap” for both port-folio work and deal execution, has not been followed in the region. Players stillfavour the classic fee-based expert, which not only incurs scoping, selection andcontracting costs and delays, but also impedes the institutionalisation of knowl-edge across the engagements, and certainly does not align long-term incentivesbetween all three parties (GP/investor, portfolio company and consultant). In par-ticular, when it comes to seeing through the implementation of slightly longer-termchange programmes, the use of consultants experienced in private equity can leadto earlier value extraction.That said, credit must be given to those GPs that are trying, starting with eitherpart-time operational partners (half deal hunter, half value farmer) on the pay-roll, or other hybrid models. We found that the effective parenting of founder-ledentrepreneurial assets in Africa, given their scale, stage of development, degreeof corporatisation and openness to use external help, is probably (after fundrais-ing) the most difficult and least developed activity in the private equity valuechain in Africa.© MONITOR COMPANY GROUP L.P 2011 , .
  44. 44. 40 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain 6. Exits As the private equity market outside South Africa is very new, there have been rela- tively few exits, but as one of our interlocutors noted, “exits are hard to achieve in Africa”. GPs thus have to be “very creative” due to a lack of liquid public markets, no secondary market and a lack of bank financing for M&A. However, several GPs believed it to be advantageous to have the exit strategy planned early as ultimately this is the most important part of the investment: GPs need successful realisations to build up a track record and thus obtain follow-on funding. There was a wide range of opinions on potential exit strategies, with trade or stra- tegic sales being at the top of many lists, particularly for companies that created industry platforms where some GPs saw them as a target for multinationals to buy their way into new markets. The most divergent opinions came on using IPOs. For GPs investing at the top end of the market, a listing was the obvious exit, either on a local or foreign exchange. But views were divided for those investing in mid- and small-cap companies. One South African GP told us: “I’m not a fan of IPOs [as an exit], it doesn’t suit the African private equity model... it’s not a market for small caps, and is an unattract- ive exist mechanism”. Another working with start-ups and early-stage companies in post-conflict markets disagreed: “we are quite keen on looking at local listings for some of our companies... African stockmarkets have had a very good run and they’re looking to some extent overpriced. There’s a lot of money looking to get into Africa at the moment and there are very few IPOs... there is an opportunity for us to target that over the next few years”. In the small-cap universe, another potential exit strategy was aggregating parts of their portfolio and selling some of the businesses as a group, or listing to “generate © MONITOR COMPANY GROUP L.P 2011 , .
  45. 45. PRIVATE EQUITY IN THE SHADOW OF GIANTS 41 Innovative Approaches along the Private Equity Value Chainan incremental exit”. This strategy gave those GPs access to markets and investorsthat would usually be beyond their reach, and gave a diversification benefit to po-tential buyers.More recently we have seen a higher degree of sophistication by the larger SouthAfrican players when it comes to value extraction on exit. These players haveengaged external parties in a vendor due diligence fashion up to a year ahead ofenvisaged exits to reassess the asset and its remaining runway for value creation.These “exit grooming” or “corporate readiness assessments” more than pay fortheir own cost, as they allow for informed pre-exit choices. In other words, theyidentify those pockets of value to be extracted, by when, and which parts of thefuture value creation can be credibly marketed and “sold” to the new owner.7. Cost BasePractising private equity in sub-Saharan Africa is expensive: deal sourcing, diligence,communications, and being on the ground is challenging and time consuming. Fre-quently, GPs struggle to cover costs on standard 2% management fees, particularlyfor funds under $100 million: “bigger is beautiful because it helps make ends meet.”GPs have thus developed several approaches to fund operations.Flexible Operating InfrastructureEveryone we spoke to agreed on the necessity of having an extensive local networkand knowledge of the business environment. But many GPs did not think thatthis necessitated a permanent in-country presence. Several of the GPs we spoke towere based in London; as a global financial hub it gives access to a wide range ofpotential deals, investors and staff. Moreover, several GPs commented that it wasactually easier to travel to parts of Africa from London than within the region, and© MONITOR COMPANY GROUP L.P 2011 , .
  46. 46. 42 PRIVATE EQUITY IN THE SHADOW OF GIANTS Innovative Approaches along the Private Equity Value Chain this made interacting with investee companies easier. For many, a base in London mitigated talent constraints as they could recruit internationally and reduce costs on expatriate living allowances that are often needed to attract people to live in-country. However, those GPs are quick to explain that this is not a “fly-in”, “suit- case investor” model as they still dedicate considerable time to engaging their assets, even without a permanent in-country presence. Where GPs felt they needed an on-the-ground presence, they sought to minimise costs. To provide a low-cost permanent presence, one GP embedded staff in their assets, using the portfolio company’s office space and back-office services. In a reverse model, one venture capitalist brought his investee companies to him, incubator-style, so they were all within a ten minute drive of each other. Partnering Another model prevailing with “new-to-Africa” London-based players was by partnering or coinvesting with a local entity and operational expertise in the business of the investee company, rather than providing this themselves. Part- ners could be a local private equity firm, a high-net-worth individual or a financial institution, sometimes even a blue-chip trade or strategic player. Some GPs chose to partner with DFIs as “they have the expertise, the legal frame- work is less of a concern, and the political risk is mitigated as they have good relationships with the government”. Often these partners would also take equity in the investee to ensure that their interests were aligned. Some new-to-Africa GPs used this approach as a stepping stone into the region, allowing them to gain experience rather than immediately seeking controlling stakes from a distance in the more heavily competed geographies. © MONITOR COMPANY GROUP L.P 2011 , .
  47. 47. PRIVATE EQUITY IN THE SHADOW OF GIANTS 43 Innovative Approaches along the Private Equity Value ChainThis alternative was adopted either by international GPs with little in-country pres-ence or by those who were purely (passive) financial investors. Both understood theneed to have operational experience and to engage their investee companies, butadmitted that “we don’t have the local or expertise to get down in the weeds andactually run the company”. Instead, they engaged with the company through moni-toring. However, the scope for this model to succeed seems relatively limited, andwas only found amongst captives or government-funded investment initiatives; asone interviewee told us “why would investors be paying fees for this? Why wouldn’tyou just pay the local guys?”.© MONITOR COMPANY GROUP L.P 2011 , .
  48. 48. Where Does This Leave Us?Where Does This Leave Us? PHOTO BY MARK VANCE

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