The ABC of Private Equity.
Richard Walker takes you past the often-bewildering initials to the heart of what PE is and why Africa is so attractive to fund managers.
Private equity investment is one of the fastest-growing areas of African finance. Private equity firms are queuing up to find attractive companies to buy into directly, and private equity investors have stumped up a record $2bn in investment commitments for African funds in the year up to September 2013 according to Prequin, a provider of data on 'alternative investments'. So what is private equity, and why is it proving so very popular among investors interested in Africa?
Private equity is an 'alternative investment' approach. It is usually grouped a long with hedge funds, venture capital, and specialist funds like infrastructure and real estate investment funds - all ways of aggregating capital and investing it in specialist areas of the economy. But unlike hedge funds or sector specialists, private equity does not usually invest in publicly traded shares or corporate debt.
Traditional investment approaches are based on public equity. Public equity means the shares that are traded on stock exchanges - exchanges which usually require businesses to publish detailed, audited accounts that make it relatively easy for investors to see what they are buying.
Private equity - or PE as it is usually known - is very different. Private equity investors take large stakes in companies that are usually not listed on stock exchanges, quite often familyowned businesses that are in need of finance, or technology, or management expertise.
Since the private equity stake is relatively large, it gives the PE investor the kind of influence over the way the business is run that public investors are unlikely to have. PE investors are more like owner-managers of the business, and they act like them, often dictating how the business should be run, and even who should be running it.
This kind of investment has been growing fast in Africa. Just look at the last three months' worth of inward deals and investment raising: Databank Agrifund which manages part of a large $243m fund controlled by PE manager Phatisa bought an undisclosed share of Nigerian bakery business Top Crust; Phatisa also bought a majority stake in Malawi-based agricultural engineering company FES; private equity manager XSML which focuses on ' f rontier markets' invested an undisclosed amount in DRC-based transport company Cotrama; the Abrj Group and Swedish Swedfund put $6.5m into private healthcare in Kenya; Convergence Partners, which concent rate s on African investments, raised $145m from PE investors including many international development finance institutions for its new African communications technology fund; Vantage Capital Group raised $215m for its South African renewable energy fund, while Metier raised $67m for another South African energy and waste management fund; Peninsula Group made a second round of investment in Ghana-based provider of mobile technology Rancard; and AfricInvest Group put $20m into Nigeria-based energy company Broron Oil & Gas.
That is just one quarter's worth of deals in sub-Saharan Africa. Note how many of the deals are for 'undisclosed amounts': unlike public equity trading where investors usually have to disclose investments if they rise above fairly small percentages of the total ownership of businesses, private equity investors are just that - private. Their deals are usually private transactions with private companies, shielded from the scrutiny of investment professionals or of the press.
Lifting the veil on PE
So let us lift the veil on this secretive industry. The private equity business is really rather simple, even if it does like to hide behind a bewildering array of initials. Firstly, private equity or 'PE' is not quite the same as venture capital, or 'VC', which usually means investment in start-up or very earlystage businesses.
Confusingly some investors use 'VC' to cover start-ups and also the investments in more mature working businesses - but gradually the idea that PE and VC are slightly different is catching on).
And there are more initials to deal with: the private equity world is divided between the LPs, or ' limited partners', and the GPs, or 'general partners'. Again, it is simple: the limited partners are the investors who provide the money that private equity funds invest. They are 'limited' in two ways - first, because they just provide the capital, not the management or strategic expertise that funds hope to put into the companies they buy - and second, because their investment is usually for a set amount of time.
That is not unusual in the traditional investment world, and many equity funds and hedge funds will expect at least some investors to lock in their money for a period of years, but in private equity it is standard practice. Private equity funds argue that they need the stability of long-term investment in order to get best value from the businesses they buy.
The 'general partners' or GPs are simply the managers of the private equity funds. They are 'general' because they will use the capital they get from LPs to invest in a range of companies, sometimes in very different sectors or very different countries - although usually there will be some common theme, even though that theme may be as broad and simple as investing in Africa.
But why Africa? Most of the big public stock markets in sub-Saharan Africa have done rather well over the last 12 months - so why would investors take the risk of locking up their money for years at a time, using private equity approaches that many would find rather opaque?
Private equity managers would argue that there are several good reasons. Stock markets in Africa are very small: the total capitalisation of the South African market which accounts for 60% of the entire region's markets is only around $320bn, and Nigeria - the next largest - is around $40bn. That compares to a total of $2.3 trillion in the London main market alone.
Small size means low trading volumes, the likelihood of volatility, difficulty in selling large holdings without damaging the share price, and not much choice of companies. Private equity gets around most of these problems, not least because Africa is very rich in small to medium-sized companies that are not publicly quoted. If you want to buy into them, you have to do it privately.
Perhaps more important, those unquoted African companies are often in transition, and in need of technology or management skills, as well as capital. That is what private equity tries to offer, pumping in advice as well as cash, in the hope that after a period of ownership the company will be worth more when the time comes to sell - the so-called 'exit'.
In fact, some private companies end up being passed around the private equity world, as one PE manager sells on to a second, or even to a third: these are known as secondary or tertiary exits.
The dark side
There is a dark side to all this, according to the critics of private equity. They say private equity is indeed private, but what goes on behind this screen is asset stripping and job cuts.
According to a recent study by Ernst & Young (E&Y) of 383 businesses owned by private equity, the record is actually of job growth, and assetbuilding.
According to the most recent annual survey of private equity investors in all emerging markets from the Emerging Markets Private Equity Association, Africa is now the preferred destination for emerging market private equity investment.
For the first time in the survey's nine-year history, LPs put Africa ahead of the other BRICS countries (that is, in this case, Brazil, Russia, India and China), with over half saying they plan to expand or make new commitments to the region.
Strikingly, only 36% of investors said they were concerned about political risk in sub-Saharan Africa, compared to 66% in the previous year's survey.
For African businesses the message is clear: like it or not, the private equity guys are heading your way. n
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|Date:||Feb 17, 2014|
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