Thorts - Private equity: Value creation in an increasingly competitive African market

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Thorts - Private equity: Value creation in an increasingly competitive African market

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Published Date: 2017-07-06 | Source: DealMakers | Author: DealMakers

Thorts - Private equity: Value creation in an increasingly competitive African market

Andrei Vorobyov and Stephen York

The emergence of African private equity as a popular asset class has had much to do with Africa's compelling economic fundamentals. As private equity matures in Africa, a greater focus on alpha is required to deliver attractive returns, write Andrei Vorobyov and Stephen York.

Over the past decade, African private equity has emerged as an attractive asset class, underpinned by favourable fundamental trends. However, stronger competition for deals, recent macroeconomic headwinds and operational challenges in Africa are requiring private equity funds to put greater emphasis on value creation to continue delivering attractive returns. We examine some of the archetypal approaches to value creation used globally and examine how they are being deployed in Africa.

Since the turn of the millennium, Africa has become increasingly attractive for private equity investors. The emergence of African private equity as a popular asset class has had much to do with Africa's compelling economic fundamentals. Sub-Saharan Africa's real GDP has grown by an average annual rate of about 5% since 2000, according to the Economist Intelligence Unit. This rapid economic expansion has been supported by a growing population, greater market liberalisation and increased macroeconomic stability.

As a result, Africa has seen rapid growth in the number of private equity funds operating on the continent - from 12 funds in 1997 to more than 200 today, based on data from the African Private Equity and Venture Capital Association (AVCA). Predominantly local private equity funds that have operated in Africa for decades (such as Ethos in South Africa or African Capital Alliance in Nigeria) have grown their fund sizes, while regional funds (such as Actis, Helios and the Abraaj Group) have also expanded their African presence; Abraaj alone has made 14 investments in sub-Saharan Africa since 2012. Major global players have entered the market as well: In 2014, The Carlyle Group raised a nearly $700m dedicated fund, and KKR made a $200m investment in Ethiopian flower company, Afriflora.

Private equity investors in Africa, however, face some very real challenges, including greater competition for a limited number of attractive assets, renewed macroeconomic headwinds and distinct local operational challenges.

According to AVCA's Annual African Private Equity Data Tracker, private equity fund-raising in Africa grew at an annual rate of 15% from 2010 to 2015, while the number of typical target private equity companies (those with more than $100m in revenues) grew annually by just 2% during that same period. This has led to a large increase in competition, raising the valuations and multiples being paid for assets.

Recent years have also brought renewed macroeconomic challenges. The brisk decline in key commodity prices since 2014 hurt the many African countries still reliant on the export of natural resources. That was compounded by recent political uncertainty across Africa, including three of the largest African markets - South Africa, Nigeria and Kenya - resulting in the rapid depreciation of many African currencies.

Lastly, private equity funds are also facing some very real operational challenges in Africa. Many companies are still run by their original founders or their families, afraid to relinquish control to new investors. There is often limited depth to the management skills and capabilities. This is particularly true below the top management level. Opaque business practices prove challenging, with some businesses still reliant on informal practices such as providing "gifts" to obtain an import licence. And indigenisation trends are on the rise, with many African governments encouraging local economic empowerment by limiting the extent of foreign ownership.

Faced with these challenges, African private equity funds are increasingly looking to promote value creation in their portfolio companies in order to deliver compelling returns for investors.

Since the global financial crisis, private equity funds around the world have benefited from market beta - underlying economic growth, rising equity values and readily available low-cost debt - to help deliver attractive returns. With these passive forces now waning, private equity firms need to further develop the strategic and operational skills required to create alpha in their place through active value creation. Alpha is the measure of the active return on an investment relative to a suitable market index.

Based on Bain & Company's extensive global experience, we have outlined four archetypal approaches to creating value at portfolio companies:

  • The adviser-led model. Private equity firms that adopt an adviser-led approach typically take a less interventionist methodology to their portfolio companies. They will selectively lean in on particular investments to help shape the management team's goals and supply resources to help deliver on those goals. Adviser-led value creators typically assemble a network of external experts who can address specific needs.
  • The functional playbook model. Some activists take a more hands-on prescriptive approach to creating value in portfolio companies. Private equity funds that adopt the functional approach typically employ full-time experts who implement a dedicated playbook with initiatives that improve business processes, reduce costs or deliver other operational improvements.
  • The maestro model. This places considerable emphasis on early, high-level and continuous engagement with portfolio management, but is well suited for private equity funds that lack the resources or the desire to staff expensive in-house operating teams. Private equity funds that adopt the maestro approach typically designate a seasoned leader within the firm to coordinate a flexible team comprising deal team members and external resources to develop and implement value-creation plans.
  • The general-activist model. Some larger private equity funds build portfolio activism into their DNA. Their multidisciplinary operating teams bring a high level of engagement to each investment. These multidisciplinary portfolio groups work closely with the newly acquired companies to provide deep strategic analysis, support the development of value-creation blueprints and help management teams put them into operation.

Increasingly, leading African private equity firms are recognising it is only by generating alpha through active portfolio management that they can deliver attractive returns. In the African context, funds may use different value-creation models for different investments, with the chosen model depending on the extent of control that funds have over the portfolio company. Where funds have minority stakes, direct value addition is considerably harder, and softer skills such as influence become key.

Despite Africa's distinctive investment climate, Bain has observed these archetypal global approaches being applied by funds across the continent. We believe Africa is an attractive investment destination for private equity funds, but it is becoming increasingly clear that these funds cannot rely on market beta alone. Rather, they require a greater emphasis on portfolio value creation to generate alpha and attractive returns.

Bain believes that any properly structured approach to value creation should flow organically from a private equity fund's unique size, strategy and values, and depends on the fund's philosophy (its objectives for value creation), its engagement model (how and when it will intervene) and its organisation (what internal and external talent it needs). In general, a balance should be struck between developing dedicated expertise in-house and flexibly using trusted external resources with a track record of delivering results.
Finally, given the challenges inherent in investing in Africa, it is critical that private equity funds continually adapt and innovate their value-creation models to react to local market conditions, by examining where and how they can achieve the highest returns on their costly investment in portfolio management resources. 


Vorobyov, a partner in Bain & Company's Johannesburg office, leads the firm's Private Equity and Mergers & Acquisitions practices in sub-Saharan Africa.

York is a principal in the Johannesburg office of Bain & Company, with experience in many areas, including corporate strategy, private equity and performance improvement.
(This article first appeared in Catalyst,DealMakers' sister publication)



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