This article is a section from a report “Investing in Nigeria” and shall be viewed in the context of the title. Please view the report for more information on the subject as well as references for this article.
There is a lot of interest in Sub-Saharan Africa private equity opportunities. The interest is across all sectors but one of the main sectors is the FMCG market. With 70 million Nigerians who might have $1 a day in disposable income, the FMCG sector is perceived as a good sector for constant cash flow and for great profits.
Private Equity is perceived as the solution to bridge the gap for pre-IPO stage companies. The success of NSE’s goal of 1,000 listed companies is linked to the successful development of the PE sector in Nigeria.
The Nigerian PE landscape is challenging, yet it’s also an enormous opportunity, as David Rubenstein, a billionaire co-CEO of a US based PE firm The Carlyle Group puts it – “The greatest explosion in private equity, if it is going to occur anywhere around the world in the next couple of years, is going to be in Africa, particularly sub-Saharan Africa, where the penetration rate is about one-twelfth or so of what it is in the United States.”
There is a lot of supply of capital and demand for good deals, in 2015 alone $4bn has been raised in PE funds for Sub-Saharan Africa. For the next 5 years, there remains a great opportunity for small and mid-sized investments into companies that require $5m-$100m per transaction.
Deals and private equity is happening in Africa, the challenge is finding these deals. Even big funds have to do small deals. There have been instances where a $3bn fund invested as little as $10m in companies.
Many of the South Africa private equity firms are now reaching out to other parts of SSA. This provides more exit options for the Nigerian focused PE firms. Generally, exits are done by selling to another PE fund or by an IPO. IPO as an exit is rare however, so the increased interest in SSA PE is great for the PE landscape, as there are more exit opportunities.
Challenges in the private equity landscape
While capital is very demanded in Nigeria and there is a lot of capital available for deals, there is a lack of good deals available. The main reason for this is people’s attitudes to ownership, companies prefer to borrow than give up equity. In 2015, many businesses still have ownership of 100% for the founders. Many entrepreneurs rather have the whole business than a small piece of a huge pie. There is also a level of emotional ties to the business – many companies are family run and owned.
There are of course businesses that are looking for private equity, especially considering the high interest rate they would pay if they borrowed. The interest rates are not sustainable, they are usually short term, two digit interest rate loans. The companies that are willing to give up the equity usually look for just an investment, not partners. This remains one of the main challenges for PE funds in finding deals – they want to help build the company they’re investing in, rather than simply invest.
Private equity funds are very risk considerate, there are huge number of businesses that need funds but only few get them. The main criteria is proper corporate governance, great auditors and transparency. A company must have a very clear sense of what will be done with the funds raised – PE firms are looking to bridge a gap with their knowledge and capital, not simply invest in a perspective company.
A PE fund is looking to grow with the entrepreneur, to co-operate with him. There is a desire to agree on the businesses strategic direction and fit it with the resources available, instead of simply putting executives in the business to run it. If a fund doesn’t have a co-operation with the owners and a partnership mentality, it will find it very challenging to bring anything other than capital to the business – employees will return to their old ways as soon as the PE executives leaves.
A private equity company induces a lot of discipline around corporate governance, brings expertise in the sector and networks. Private equity companies are accounted by their own investors for these things. This brings to the other challenge a fund faces – it must have the local networks and the expertise. That’s the biggest entry barrier for a fund to operate in Nigeria. Some funds partner with local partners just to bring the local expertise and connections to the table in their deals.
Some of the talent to run the businesses is returning from abroad, but they usually give up after around 18 months due to the unstructured business nature. This is especially witnessed in the medicine field, where nurses return home from the UK or other developed nation, just to find unstructured hospitals run on electricity generators. Many of the Nigerian doctors and nurses want to come home, but they request institutions with high institutional practices and standards.
Once a PE fund finds a great deal, it’s not uncommon for the given company to be run by educated entrepreneurs that have structured it to attract private equity. This results in little bargaining power for the PE fund and it ends up with a minority stake. There is also the issue on agreeing on a valuation, this is one of the biggest deal killers.
There is a major difference between a minority and a majority stake holder in Nigeria. A PE fund with the majority stake will find it needs to have a team on the ground in Nigeria to constantly monitor the transactions and the company, otherwise the majority stake will be majority only formally.
Exit options for a PE fund is improving but are still limited. There is a lack of domestic fund participation – everyone is after the fixed income assets. Pension funds are allowed to invest 5% of their capital in PE, but they rarely do.
There is a need for a positive cycle, companies being bought and sold, a sense of momentum. Lower interest rates would have a positive impact on this, as the domestic investors would invest in PE funds. There are however plenty of funds available for Sub-Saharan Africa, the challenge remains in the business landscape. There is a gap between the ideas the core shareholders value in a business versus what private equity investors would value a business on.
Future of Nigeria’s private equity sector
A lot of the challenges PE sees is being successfully tackled. Many entrepreneurs are becoming better educated and understand the benefits of working with a PE firm – you give up some equity but also receive enormous support in terms of operations and management. The other option is the bank that will charge a company two digit interest rate.
Equity is preferred and in many cases is the only option for the big multi-nationals, but the majority of Nigerian businesses are smaller than that. Some companies have been doing the same thing for 30 years and bringing in profits, yet still run their company out of the bedroom. There is plenty of room for growth for these companies, but they simply won’t attract any private equity. This is creating the gap between the funds available and the companies that receive them. There are, however quite many elements in place that make equity more favourable over debt, so the outlook of the entrepreneurs is on equity over debt.
It’s perceived that once the Nigerian business landscape becomes more structured, it will be easier to attract employees, the ones returning from abroad and foreigners.
Many of the long term investors that understand Nigeria are not tempted by the fixed income assets, they are using the recent economic slowdown to get in on many discounted deals.
There are numerous challenges for private equity funds in Nigeria, yet the gap that they bridge is highly profitable. Due to the specific requirements for investments, PE deals are quite safe and profitable, especially if they have the chance to exit through the capital markets.
The PE funds are run by people that know Africa in and out, know the operations and have Africa wide networks, bringing great deals as well as exit opportunities to other funds.