Private equity investors chase fast-growing businesses to hedge FX, inflation risk

Investors managing private equity funds in Nigeria are caught up in a gruelling hunt for businesses whose growth can trump inflation and serve as a hedge against foreign exchange volatility.

Finding such a business to invest in has become tougher in an economy that has suffered two recessions in the last six years and is contending with the fastest price growth in 17 years.

There’s also the pain of an acute dollar shortage that has made imports more expensive for several businesses that now source dollars at the black market at a near 70 percent premium to the official rate.

Spiralling energy costs in a country that has the world’s largest energy access deficit – with 43 percent of the population without access to grid energy, according to the World Bank, has also pushed up the cost of operations and squeezed company profits.

For private equity investors, most of whom manage dollar-denominated funds, finding a business that can deliver growth above inflation and serve as a hedge against foreign exchange risks is like finding a needle in a haystack.

In the past, Nigeria’s sprawling oil sector offered a steady pipeline of such businesses. There were big-ticket deals, and the businesses earned dollars, which meant investors didn’t have to bother too much about currency devaluation.

Declining investments in Nigeria’s oil sector has made such deals few and far between. Foreign investment into Nigeria’s oil and gas sector slumped 82 percent to a new low of $1.93 million in the second quarter of 2022, according to data from the National Bureau of Statistics.

“As long as we have currency issues, we need companies that can deliver robust growth that compensates for devaluation of the naira,” Gozie Chigbue, director, private equity funds at British International Investment, said at a conference organised by the Private Equity and Venture Capital Association, Nigeria (PEVCA).

Nigeria’s foreign exchange risks are well documented and hardly new. In 2016, several investors were sent parking due to dollar shortages that saw the naira lose more than a third of its value after the dust settled.

This time is unique however. Oil revenues have tanked despite high oil prices, with Nigeria missing out on the gains other oil peers are enjoying because it is exporting below capacity due to oil theft and declining investment.

Read also: Nigeria’s equities return fails to beat inflation

The impact has been telling on the naira, which has fallen to the lowest ever in the parallel market, trading at N740 per USD on Tuesday, Oct. 11, around 70 percent weaker than the less accessible official rate of N434.78 per USD.

That has left the gap between both rates at the highest since 2016. The currency has lost more than 90 percent of its value in the last five years.

Weak economic growth also leaves little to cheer about. Although the country’s growth rate has crossed 3 percent this year after six straight years of economic growth lower than population growth, there are ominous signs of an economy still reeling from the impact of two recessions.

Unemployment rate is at a seven-year high of 33.3 percent and poverty levels have deepened, with an additional 7 million adjudged to have slipped into the poverty pit last year. Rising inflation has dampened consumer purchasing power and the Central Bank of Nigeria’s record hike in interest rate to 15.5 percent has pushed up borrowing costs.

“The macroeconomic environment forces you to think harder,” said Wole Onasanya, director at Coronation Capital, who also spoke at the PEVCA conference themed ‘Private Capital for National Development: The Road Ahead’.

“We need to start thinking more of businesses that can scale beyond Nigeria, even while bearing in mind that other African countries are also going through tough times,” Onasanya said.

Some investors are weighing investments in naira-denominated funds to hedge against the foreign exchange risk but also note the challenges involved.

“Naira-denominated funds will help, especially knowing we are in a cycle of FX scarcity,” Dare Otitoju, executive director at Stanbic IBTC Pensions, said.

“However, we know the challenges associated with running a purely naira-based fund but perhaps it would be good to consider a naira and dollar fund, given that the dollar fund breeds confidence,” he said.

Despite the challenges of investing in Nigeria, there is also a growing trend where companies are more open to accepting private capital and that gives some hope for the future, according to Danladi Verheijen, managing director of Verod Capital and chairman of PEVCA.

“The future is bright,” he said. “Private equity is one of the greatest engines for job creation and economic growth, and we are starting to see the impact of PE become more pronounced in Nigeria.”