Equity funds should consider flexible investment strategies – report

19th September 2016 By: Megan van Wyngaardt - Creamer Media Contributing Editor Online

Africa remains one of the world’s growth opportunities for private equity (PE) investors, with the pool of investment targets growing, a report titled ‘Why Africa Remains Ripe for Private Equity’, reveals.

Nearly 11 000 African companies have revenue of $10-million to $100-million and assets of $20-million to $200-million – with the ranks growing fast. Further, despite recent setbacks, most economists expect that gross domestic product growth in Africa will rebound over the medium term, driven by a swelling middle class, rising foreign investment in infrastructure and a growing skilled labour force.

However, the report, published by Boston Consulting Group, highlights that, to generate the high returns that investors expect, funds should consider more flexible investment strategies and new types of corporate targets.

Since the early 1990s, the number of PE funds active in Africa has grown from about a dozen to more than 200, while funds under management have risen from some $1-billion to upwards of $30-billion. This rapid growth, combined with the recent downturn in Africa’s largest economies, has raised concerns among some analysts that a bubble is emerging.

Yet, most PE funds and principal investors tend to invest only in minority stakes, with the goal of better managing their risks by leveraging robust local partners.

Also, they overwhelmingly focus on a limited pool of investment targets: profitable companies with yearly revenue of more than $100-million and proven records.

“Alternative investment approaches are particularly important if funds are to meet the rising expectations of their investors,” the reports states, adding that development finance institutions are increasingly being joined by global institutional investors that are far more focused on high returns.

As prices for stakes in large African companies rise, it will become more difficult for PE funds to deliver high returns, it notes.

“To fully capture the opportunities in Africa and earn high returns, PE funds must adapt to the rapidly evolving market and consider more flexible investment strategies,” said BCG associate director and report coauthor Marc Becker.

The report recommends that PE investors consider other investment approaches, such as majority stakes, strategic partnerships and evergreen funds, rather than only funds with timing constraints for divestiture.

It also suggests that funds look at a wider range of targets, such as Africa’s growing pool of dynamic smaller companies with significant growth potential.

“Too many PE investors are pursuing the same kind of target with the same kind of deal structure. But look beyond the narrow cohort of Africa’s corporate elite and you’ll see that the continent is awash with real opportunities.

“Some of the most promising targets in Africa are companies that are still off the radar of most funds,” coauthor and BCG senior partner Patrick Dupoux pointed out.

However, as most of Africa’s financial markets are still underdeveloped, PE firms will need to invest in a strong local presence. Access to information is also limited and, given the shortage of investment banks and other middlemen that typically screen opportunities and bring them to investors, funds often must be able to originate their own deals and perform their own due diligence.

Many PE firms also need experienced people who can help create value in their holdings by providing management expertise and strategic guidance.

Pursuing new investment strategies in Africa will be challenging and building local capabilities will add to costs. But funds that do so can develop powerful competitive advantages.

“Organisations that can navigate Africa’s complex investment environment and add value to companies are likely to gain an inside track on the best deals in what promises to be, over the long term, the world’s greatest growth market for PE,” Dupoux said.