There is no doubt that Africa still presents a great investment opportunity for investors keen on regional deals.  To respond to this demand, a wide array of investors have set up shop in Kenya with funds chasing after deals.  Majority of these funds have gone the conventional route, setting up a Private Equity Fund or a Venture Capital outfit.  Others have taken the easier approach of just lending money to commercial banks for on-lending.  The latter has its limitations in the returns they can net. 

There is a new wave of capital flocking into the market that includes family offices, debt funds and recently, holding companies (HoldCos) that do not necessarily have any particular form or entry strategy. These holding companies have taken the approach of ‘take every deal as it comes’ until they find direction. 

There’s a problem though. Majority of the deal seekers are not looking into real opportunities in the market. This is because most of them have used abstract or classroom approaches in screening deals and ignored the unique factors that make Africa specifically attractive.  As it may, these factors are often viewed as risks by many but the degree of risk in itself presents an opportunity. In addition, there is also the limitation in how most of these companies define SMEs. Whereas an SME in the West or elsewhere can be a company grossing in excess of USD. 2million per month, this could be an amount that most small companies in the region will only make in a full year operation cycle. The former is in most cases a listed entity or large enterprises that could raise funds publicly.

Early this year, I attended a special invite-only business roundtable organized by one of the European nations’ state fund.  The roundtable, among other objectives sought to explore entry strategies into the East African region for funding clean energy projects and enhancing access to energy for many East African households.  Among the groups invited were private equity funds that have a bias on cleantech as well as NGOs that in their small ways are in the clean energy playing field, state actors and energy generating and supply firms.  There were also commercial banks that have in the recent past financed clean energy initiatives. 

Of key interest were sentiments shared by a Principal of one of the largest (according to mainstream media) private equity funds.  According to the Principal, the fund had since entry into the local market screened over 100 deals each looking for over USD. 5 million which is their minimum threshold.  Unfortunately, none of these deals had met their investment criteria, not even at a bare minimum. As a result, it has resulted to an almost nil return on investor’s funds during the two years they have had a local presence.

The numbers are not as dismal in the rest of the industry. Most funds, whether debt, private equity to holding companies have closed very few deals in the region due to a number of reasons.

I have spoken to most of these funds in a bid to raise funds for companies mainly in Kenya and Uganda.  To me, the key challenge with these funds has been the lack of understanding of local dynamics.Majority of the funds have copy-pasted policies that worked perfectly back at home and ignored local market dynamics and disparities in the economic and operating environment.  A right-fit in Europe, US or Asian markets is obviously not a good-fit in the East African market and Africa. Take this case in point: in 2010, data shows that on average, the average size of deals closed in Africa was USD. 14.2million compared to China where single deals averaged USD. 40.3 million, against USD. 67.4 million for Brazil and USD. 26.4 million for India.  This is according to a research conducted by Ernst & Young. Secondly, these funds have restrictive policies, target a segment that is already funded by banks and therefore do not create a niche for themselves thus the length in closing a single deal.

Some funds argue that the only way to avoid managing a huge register of funded companies is to be selective on deals they take on and sticking to large amounts per single deal.  Others hold that Africa is a difficult market to understand and that SMEs are difficult to work with. Both are true to a large extent. However, I have seen a few partner with local institutions with strengths in screening deals and had it work perfectly. Others still argue that there is barely no clear exit route as the capital markets are rather small and underdeveloped and the elections at times coincide with the fund cycle creating an outright political risk. This has led to the lag between fundraising and finding deals that are worth closing; a scenario that could in effect frustrate Africa-centric investors.  Although there is little data on exits, AltAssets gives an average of around 82 percent on one of the funds on the local funding space.
 
This is not to say that there have been no successes in the local playing field. Some funds like Transcentury and Centum, though both took the listing route have posted excellent performance over a number of years and eventually had an exit in the local securities market. These companies have managed to scout for local deals in all sectors, weathered various macro-risks and still returned a handsome return to their investors’ year on year.  According to AltAssets, Ciel Group for example netted-off 82 percent return on their exit from Kibo Fund.  It is noteworthy that these two have taken the form of holding Companies instead of the Private Equity Fund route.

Demand for funds in the East African region is extremely huge in all sectors from agri, infrastructure, real estate, ICT to renewable energy. A few have worked, but most of them are not working at all. In the upside though, there is so much that still remains unexploited. There are too many SMEs that require funding but cannot get it from banks. The presumed saviors, the specialized funds, are not matching up to this niche market. 

These funds need to realize that the SME landscape is different than any other market and it is very dynamic as well.  There is no denying that they have to partner with local companies that understand the market much better. That way, they can tap into deals that are in tune with local investment dynamics. Many will say, a lot of the tried strategies don’t seem to work. Well, the ‘invest-as-you-go approach seems to be working out fine. It explains the success of the only two already listed funds in the country. 
 
By Michael Musau
Emerging Africa Capital
Michael@emergingafricacapital.com