Are there enough Equity deals in East Africa for the hunters?

Saturday January 18 2014

The traditional concept of private equity in the West is proving a hard sell in East Africa. Private equity firms will need to adjust their risk appetite for the region if they are to be a part of the African growth story.

Visit a bar at any of the leading hotels in Dar es Salaam, Kampala or Nairobi on a weekday evening and you are likely to bump into an investment banker or private equity rep in the country out to find the next best deal.

East Africa has become one of the leading destinations for deal hunters in the region, but are there enough deals?

The recent Africa investor awards to Emerging Capital Partners (ECP) for their majority acquisition of Nairobi Java House and Standard Chartered Private Equity’s $74 million minority investment in ETG Group show that big deals are possible.

This follows the announcement of the $55 million investment in UAP Group by Aureos, AfricInvest and Swedfund for a 40 per cent stake. The message here is that sizeable deals are available and happening.

Africa’s growing middle class is driving demand for goods and services and investors are looking at financial services, education, health, retail, infrastructure, consumer and industrial products as the sectors that will benefit most from growth. The challenge has been finding suitable targets to inject funding.

The growth in East African economies over the last 10 years has allowed companies to achieve strong organic growth, backed by banks willing to take more risk and extending favourable lending rates.


These booming businesses have become targets for private equity and corporate buyers seeking to be part of the current African wave. However, having achieved success with limited external influence, not all these companies are willing to sell to or invite strangers.

In fact, we are increasingly observing scenarios whereby targets have several offers on the table.

However, this ‘success’ has brought about its own problems through increased valuations, making investments more complicated, particularly for the private equity market.

With typical short to medium-term investment horizons, demand for clear exit mechanisms and IRRs ( internal rate of returns)  in excess of 20 per cent, the number of executable deals is beginning to shrink.

Investors have tried to turn this in their favour by introducing significant debt components as part of their investments, which will allow them to extract money earlier.

However, with the region still considered relatively risky for investment, alternative capital options tend to be expensive and short-term, with the terms offered making bank debt more attractive (sometimes even with the high prevailing rates).

Alternative capital options may only appeal to targets that have exhausted their traditional debt market options.

Sectors such as infrastructure that benefit from large capital allowances aimed at spurring growth in investment have the downside risk of making shareholder distributions difficult in years soon after significant capex investment as these are likely to attract compensating tax.

This looks and feels like capital gains tax in reverse. Additional debt in these cases may also lead to a breach in the thin capitalisation rules, depending upon the size of equity investment.

The traditional concept of private equity in the West is proving a hard sell in East Africa. Private equity firms will need to adjust their risk appetite for the region if they are to be a part of the African growth story.

Improving Private Equity

Longer investment horizons allowing for desired growth, returns and exit mechanisms are a likely right answer. Investors may also need to look at sectors that are not traditionally their forte.

Private equity will have to learn how to do business in Africa rather than teaching Africa how to do business.

Investors may therefore need to look at how to help family businesses plan for succession, prepare the way for successful listings as an exit route, and most importantly show that they can add value.

Strategies like these will set a track record improving private equity’s credibility. East Africa’s competitive culture will ensure that as soon as one sees another achieving a successful deal, the stakes will rise for all.

The writer is an Associate Director with PwC Kenya’s Transactions advisory practice.