What does risk look like in the New Africa with its impressive headlines on growth, investment, and the emerging middle class?
The truth is that risk in Africa today is murkier than ever: lessened by reforms, muddled by continued misperceptions and shifting reputations. What does this mean for private equity (PE) investors – buyer beware? Yes and no. You just have to know where to look, and who to ask, according to Deloitte's latest East African Private Equity Confidence Survey.
Many of the elements that characterise African Private Equity portfolios are also their principal risk factors. Investors must plan for longer term engagements: projects in Africa can take triple the time of other markets to get off the ground from inception to income flow. Most deals are growth investments that require hands-on engagement. And the prominence of development finance in African PE means that investors must further contend with impact mandates and consider what acceptable risk looks like for any Development Finance Institution (DFI) partners.
Operational risks are the number one concern for most PE investors in Africa. General Partners (GPs) want to work with strong companies and good management teams, but those can be difficult to find in what is still a relatively immature corporate environment. The lack of larger deals and resulting focus on SME investing lessens the amount of track record information that investors have to work with. Many smaller deals are also minority stakes, and in those cases it is especially important to understand the people you are doing business with. Reputational risk looms large, and can become particularly critical for sensitive DFIs who answer to tax payers in their home markets. Investors need to assess the type and extent of corruption risks they face. In principle, corrupt staff members can be replaced. But if corruption is intrinsically linked to the company, it will be hard to work around.
Political risk today is much more nuanced than exploding headlines, and often linked to corrupt local politicians who like to disagree with the ‘nature of the investment’. Citizens are also legitimately becoming more vocal, helped by stronger media and, importantly, by their ability to expose wrongdoings on social media. However, even for the best behaved investors who tick all the right ESG (environmental, social, governance) boxes, risks remain: In a corrupt environment, it is still easy for vested interests to mobilise the local population against investors, and feed a distorted media campaign. This is a particular challenge for any investment involving land rights, whether in extractive industries or in large-scale commercial agriculture: land is a notoriously emotive and mismanaged asset.
Regulatory risk in Africa varies widely across sectors and countries – as do corresponding political risks. The risk of corruption and the risk of government interference in a deal will increase commensurate with both the strategic status of the sector in the country and also with the size of the sector. For strategic sectors such as oil and gas, mining, infrastructure, land-related agribusiness or financial services, investors face increased risk of political interference, hidden ultimate beneficial owners, corruption and legislative change. Larger, expanding, multi-jurisdictional sectors like retail and fast-moving consumer goods offer a happy medium, with more opportunities and less vulnerability.
Due diligence: Most PE firms do initial due diligence in house. The model, in any emerging market, is very relationship driven and even more so in Africa, where all investors will need to build up capacity on the ground quickly to keep up, whether through local offices, on-the-ground teams, fly-ins or local partners. There is a historical impression that you need to identify a Mr. Whatever-the-Country is that you’re working in who can open doors for you, but that is changing. More PE funds do the ground work themselves these days.
Risk insurance: Once in bed, political risk insurance as offered by MIGA and ATI or guarantee schemes can hedge further risks, but PE funds have not traditionally gone this route. Cost is a disincentive for GPs and LPs alike – just a few percent per annum can cut into your returns. And for private investors, most of whom still avoid real frontiers like CAR, insurance is not enough to make them comfortable with the risk. At that level, you’re either in or you’re out. Many investors in Africa hedge using mezzanine structures, pure debt or convertible loans.
Veterans and newcomers: Overall, seasoned investors that have been in Africa for years – Aureos (now Abraaj), ACA in Nigeria, or ECP to name a few – are better equipped to manage these risks. They are more accustomed to long-term investments, more familiar with local regulations, have more support built up in house, and more deeply rooted networks. They may have also already made mistakes that taught them crucial lessons. But there are so many opportunities across Africa that even PE outfits new to the market can find their way around it as long as they invest time and resources identifying the right deals for their investment profile and finding partners they can trust.
This article is extracted from Deloitte's latest issue of the 'East African Private Equity Confidence Survey'.
See the full report here
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