Dr. Femi Giwa is a Healthcare Investments and Analysis expert. He is currently a Vice President in the Healthcare Investment Banking Group at Wall Street giant, Goldman Sachs, and is based in the global headquarters in New York. He started his Wall Street career in the Mergers and Acquisitions (M&A) Group of Bank of America Merrill Lynch, also in New York.
In this research work, which was initially published May-2020 on the research webpage of the Center for Private Equity and Venture Capital of the Tuck School of Business at Dartmouth, Dr. Giwa analyzed direct investments in 1,984 African companies in 47 countries from 2000 to 2019, providing an important perspective on pre-COVID private capital activities in Africa. The study further elucidated potential drivers of returns and opportunities for global investment vehicles seeking an African strategy as part of a broader diversification agenda.
INTRODUCTION
The private equity (PE) industry has its humble beginnings buried in early 20th century investment offices of wealthy American families (Lerner, Ledbetter, Speen, Leamon, & Allen, 2016). Today, PE is the catchall for firms that fund development projects in high-growth ventures, supply growth capital to firms with proven business models, and or fund the buyout of firms or managements (de Beer & Nhleko, 2008). For the purposes of this paper, I defined PE as an asset class of shares in listed and or unlisted stocks for the funding of growth or buyout opportunities.
This paper contributes to the literature on PE in emerging markets, a continent-wide mapping of PE firms in Africa. I have manually collected a database of 467 PE firms executing 1,984 deals on the continent. An understanding of the structural organization of the African PE market and how it has shifted in the past two decades may, in addition to other benefits, help to answer the question: is PE activity in Africa ephemeral and likely to never take root or is it a consequence of economic fundamentals organic to the continent?
Despite its promise, PE in Africa remains infantile when compared to PE in other markets, including the emerging geography. Doing business in Africa has been fraught with challenges, namely business environment, enterprise quality and quantity, weak capital market structures and related exit deficiencies, and dearth of talent (Babarinde, 2012). Similarly, the development of this paper has been largely limited by scarce data and inconsistency of available data.
MATERIALS and METHODS
2.1 Criteria for considering PE firms and deals for this study
The analysis focused only on private players; while there are several government interventions in Africa, the possible political undertones of such investments require exclusion of such observations from this analysis.
I used the proprietary dataset of PitchBook. The resulting data was triangulated using publicly available information from websites of PE firms and of portfolio companies.
I considered observations between January 1, 2000, and December 31, 2019. Similarly, I observed deals executed by these firms during the period. No restrictions by PE headquarters (HQ), fund size, region or sector focus, year of founding, investment tickets were applied. I maintained a search diary both in PitchBook and by hand to document keywords, databases, and search results. Firms not active in Africa were excluded. In addition, deals that were not executed in Africa during the defined period were excluded.
2.2 Data extraction: PE firms; deals; changes to portfolio companies; and structural impact of portfolio companies; comparative sources of financing
Data collection was be done by hand. The resulting Pitchbook data panels were screened line-by-line (firm-by-firm, deal-by-deal) for eligibility: Description notes, Financing Status Notes, and firm websites were thoroughly examined.
I extracted data on characteristics of the firms, each portfolio company and deal. Due to paucity of data, I was unable to collect data on outcomes of the investment in terms of returns to the PE company; similarly, I was unable to collect data on entry and exit changes in workforce, sales and top management. This data would have enabled me to determine whether PE leads to job creation, increased turnover, and changes in management practices.
Finally, I analyzed the extent to which PE is a complement or substitute to other sources of capital on the continent. Specifically: initial public offerings (IPO); all equity issuances to public sources (Equity Issuances); bonds that are either publicly issued or publicly guaranteed (PPG Bonds); commercial bank debt that is public or publicly guaranteed (PPG Commercial Bank Debt); other private debt and bank credits covered by a guarantee of an export credit agency (PPG Private Credit Debt); and private non-guaranteed bonds (PNG Private Non-Guaranteed Bonds).
2.3 Data analysis
The data on PE firms, deals, changes to portfolio companies, and structural impact of portfolio companies have been summarised in tables. The descriptive analysis was completed in Excel while the correlation and regression analysis were conducted in STATA.
Annual changes in various types of capital sources were expressed as log changes and correlated at country level. Using simple multivariate regressions, I regressed annual changes in each funding flow variable on gross domestic product, GDP, and population growth, including year dummy variables – standard errors in each regression were adjusted for year clustering. The regression was conducted in two streams: first, I specified only year fixed-effects to adjust for cross-country differences; second, I specified both year and country fixed-effects to more examine within-country changes in sources of funding to African enterprises.
I repeated same analysis using a financial crisis indicator variable for the years 2007 through 2010. This variable was regressed on change in GDP and population growth including only year fixed-effects and both year and country fixed-effects. Due to “insufficient observations” in PPG Commercial Bank Debt, the corresponding columns are blank (Tables 6-9).
RESULTS
I identified 467 PE firms and 1,984 deals (Table 1). These were investors executing deals in Africa between January 1, 2000, and December 31, 2019. The proportion of PE firms with African HQ was 38% with more than half of those being South African PE firms – South African firms represent about 20% of the total number of investors doing deals on the continent. The mean age of all investors was about 26 years; mean age of firms with African HQ was 20 years while mean age of South African PE firms was 23 years. I was able to extract data on year of founding for 91% of firms in my data sample (426/467).
I also tabulated characteristics of the portfolio companies to dimension the nature of the deals executed on the continent (Table 2). Even though most PE firms report “geographical focus” intentions and PitchBook equally reports this data, I decided to analyse the actual deal decisions of the firms. There are 1,974 observations (10 missing data items) included in this analysis and 40% of these deals occurred in Southern Africa with about 39% occurring in the nation of South Africa alone. As a contrast, Nigeria, with 3.3x the South African population and a larger GDP than South Africa’s, only attracted 8% of deals during same period. The Services and consumer/retail sectors attracted about 46% of deals executed while Financial Services attracted about 17% of deals executed during the period. The mean overall investment ticket was $115.4 million through such vehicles as development capital (PEF) and balance sheet (LBOs) at about 53% and 46%, respectively. The investment sizes, as observed through time, do not reveal any interesting pattern.
The sample includes AUM data for 249 PE firms (Table 3). While the mean AUM for Africa and South Africa are $366 million and $439 million respectively, the corresponding median AUM are $148 million and $211 million, respectively. Except for the 1 Australian fir in the sample, AUM for African PE firms lag AUM for non-African PE firms by many orders of magnitude.
In this study, I also explored the extent to which PE is either a compliment to or a substitute for other sources of capital available to African enterprises (Table 4). PE is a weak substitute for PPG Bonds, PPG Private Creditor Debt, and PNG Bonds. In addition, it has a weak complementarity with IPOs, Equity Issuances, and PPG Commercial Bank Debt. While the complementary relationship between PE and PPG Commercial Bank Debt is weak, it is an expected observation because of the additive role of debt in PE transactions. It is, however, unclear how PE complements IPO and other equity issuances on the continent – perhaps this is developmental in outlook. The negative correlations, though weak, are indicative of the substitutive effect of PE in the absence of traditional funding sources.
Furthermore, I examined whether the seven financial flows were related to changes in GDP and population. The years reviewed were 2000 to 2018 – as at the time of data collection in February 2020, complete 2019 data for both population and GDP were unavailable. The simple multivariate regression reflects a weak relationship between both GDP growth and population growth. For example, the result suggests that a one standard deviation in population growth will likely result in 7.45% increase in PE flows while a one standard deviation increase in GDP growth will likely result in a 0.08% increase in PE flows. I must caution that these results do not implicate causality but rather an indication of an association (Table 5).
In the follow-on regression with year fixed effects, I adjust for cross-country differences (Table 6). In this instance, I was able to observe a statistically significant relationship between GDP growth and PE investments. The result suggests that a one standard deviation in GDP growth will likely result in 98% increase in PE flows while a one standard deviation increase in population growth will likely result in a 23% increase in PE flows.
I repeated the above regressions employing a financial crisis indicator variable in STATA for the years 2007 to 2010. The result of the year fixed-effects model suggests that a standard deviation increase in population growth would likely result in a 19% increase in PE flows.
Due to data limitations, I could not explore the economic benefits of PE investments in Africa. In addition, I could not conduct the public market equivalent (PME) analysis – IRR data on PE exits in Africa were scant. It is therefore unclear what direction the above relationships would assume if the data set analysed was as large as would be expected in other climes with more developed capital market structures.
DISCUSSION
I mapped the universe of PE deals executed in Africa to improve understanding of the PE market on the continent – specifically, to elucidate the nature of the firms, type of deals completed, economic benefits, and the relationship between PE and other funding sources – and I found that the formation of private capital implicates investor optimism about the continent’s promise of economic transformation. My analysis suggests a changing investor profile in the African PE landscape, an upward trend in private capital inflows, and growth in capital commitments to consumer-based and productivity sectors. My analysis further confirms some of the prevailing truths about private capital formation in Africa: the continent still offers limited opportunities for PE investments; South Africa remains a dominant leader in Africa PE; the same time-honored factors still drive country coverage.
The “face” of PE on the continent appears to be changing. In their unpublished work, Phillips and Triki (Phillips & Triki, 2013) observed that 66% of PE investors active on the continent are African firms with a preponderance of firms with South African origin. The authors examined data from 1994 through 2012. My results take a departure from their finding. The face of PE firms in Africa is increasingly becoming global: in my dataset, African PE firms represent 38% of total private investors compared to 66% observed by the authors in 2013. Since the completion of their work, Africa has seen an inflow of PE firms from Europe (from 13% to 29%), North America (from 13% to 24%), and Asia (from 1% to 4%). Australian PE firms have also made inroads into the continent. There are a few plausible explanations. According to the AVCA, Africa offers global PE firms portfolio diversification in an increasingly volatile and uncertain global economy. Investors are willing to bet on the medium-to-long term growth potential of the continent while holding the view that any local uncertainties would only have short-term ramifications (Lerner, Ledbetter, Speen, Leamon, & Allen, 2016) (Delevingne, 2015). The destination of private capital also bears out this theory. During the period under review, more deals were executed in the Services (B2B), Consumer Retail (B2C), and Technology sectors than in other sectors. This supports the classic expectation of investors: as emerging markets mature, they are likely to transition from extractive economies into service-based economies, characterised by a burgeoning middle class, decent disposable income levels, and robust productivity (Lerner, Ledbetter, Speen, Leamon, & Allen, 2016).
The shifting nature of PE firms in Africa has another important implication. The industry was heralded in the 1990s by supply of capital from development institutions such as the World Bank’s International Finance Corporation (Babarinde, 2012). However, with many global PE firms setting up local teams in Africa, development institutions have seen a reduction in their roles as limited partners (LPs). Most global PE firms source capital from institutional investors, such as pension funds, and this has implications for the size of investments raised, which are typically much larger than development institutions can underwrite. This is likely antithetical to the theory that suggests the observed uptick in Africa fundraise may be a bubble (Dupoux, Becker, Hammoud, & El Fihri, 2016).
Local realities may also be driving the observed shift. As of 2015, only four African countries – Egypt, Morocco, Nigeria, and South Africa – had stock exchanges capitalized at $50 billion or more, limiting access to capital for local enterprises. This scarcity of alternative financing (despite potential for growth) may be responsible for the changing face of private capital (Dupoux, Becker, Hammoud, & El Fihri, 2016) – a case of local demand outstripping local supply. This position is further corroborated by the uptick in total capital raised relative to fund count since 2010.
While there have been shifts and changes, “eternal truths” persist. For instance, South Africa is not going anywhere. It is the HQ for 20% of all firms in the dataset and 54% of firms with an African HQ compared to “over 50% of African investors” in 2012 (Phillips & Triki, 2013). Furthermore, 38% of deals executed on the continent during the review period were completed in South Africa. A possible explanation is the cost of doing business on the continent. Due to political risks, red tape, immature legal systems, infrastructure deficits, dearth of talent etc., the cost of doing business in Africa is unusually high. This has the effect of “pushing” capital to relatively developed African markets where it is less costly to “do business” (Babarinde, 2012). In the Doing Business Rankings of the past decade, South Africa consistently ranked higher than Nigeria, Egypt, and other African nations of similar GDP size (The World Bank, 2019). The mean age of South African PE firms (23 years relative to 20 years for all of Africa) also offers a window of insight. This suggests South African PE firms have had more time to mature and, as a result, drive and contribute to the development of a local environment for private investments. This has the potential to build “PE discipline” in South African target companies further bolstering the probability that more than one in three (38%) deals done in Africa would be done with a professionally managed South African enterprise.
The drivers of country coverage also appear unchanged. There are significant similarities between this analysis and that conducted by Phillips and Triki. The results are consistent with the expectation that political stability and depth of governance frameworks rank highly for PE firms. It is worth noting that Kenya ranked almost equally with Nigeria in the current analysis (153 deals vs. 159 deals) despite its GDP being less than a fifth of Nigeria’s – Kenya was ranked 61 in the 2019 Doing Business Ranking while Nigeria was ranked 146 (The World Bank, 2019). More importantly, Kenya’s GDP per capita is three quarter Nigeria’s. Clearly, private capital has an unmistakable preference for the environment of business and disposable income of consumers over the number of consumers.
GDP growth appears to be more correlated to PE flows than it is to other sources of financing on the continent; population growth also appears to be more correlated to PE flows than it is to other sources of financing on the continent with the exception of IPO and Equity Issuances. This result is in keeping with Africa’s market realities, including a less developed capital market framework.
Finally, I observe that Africa’s PE industry is still in its nascent stages. PE firms have refused to change their “multisector” strategy – over 70% of PE firms have a deliberate multisector focus. This lends credence to prevailing evidence that individual African industries are likely not large enough to command robust deal flows (Phillips & Triki, 2013).
CONCLUSION
My analysis demonstrates significant changes in the African private capital market, including becoming a critical component of global diversified portfolios and lending support to the thesis that the “Africa Rising” narrative is not dead, that the need for private capital in Africa will endure. It also confirms that PE in Africa, though infantile, could serve as a substitute source of capital given the paucity of traditional sources of finance on the continent.
PE firms investing on the continent will likely see decent returns if they adopt a multisector investment strategy and a geographical focus that prioritizes business environment and demand sophistication over sheer market size.
There is an opportunity for a future study to examine the economic benefits of PE firms in Africa and further elucidate the firm-level effects of PE. It may be more practical for such study to be planned prospectively given noted challenges with data.
See (https://cpevc.tuck.dartmouth.edu/uploads/centers/files/Femi_Giwa_PE_in_Africa_paper_2020.pdf) for tables, reference list and full methods section.
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