North Africa has been wracked by political turmoil since early 2011, but private equity firms are looking beyond the problems and continuing to find opportunities in the region
By Anna Lyudvig
Following the Arab Spring and continued political instability, several North African countries are facing difficult economic situations in the short term, with growth rates especially diminished in the countries that experienced regime change. However, private equity (PE) investors buying into the region, who need to take at least a medium-term economic view and focus on the fundamentals of a business, are still finding grounds for optimism.
Proponents argue that the case for the region is clear. North Africa accounts for around one third of the continent’s total GDP and is home to over 17% of its population. Moreover, the region has long-held trade and investment connections with Europe and the Middle East, and as the world’s developed economies are emerging from the global financial crisis, North Africa’s governments are poised to capitalize on these relationships to the benefit of their economies.
“You have a strong underlying macroeconomic environment, supporting the investment, whether it is attractive demographics or high per capita income,” according to Ahmed Badreldin, senior partner and head of MENA for the Abraaj Group, a leading investor in growth markets, which manages $ 7.5bn in assets.
Over the last decade, strong growth, an expanding middle class, and a global trend that is seeing more investors seeking growth from a broader and more varied range of markets is driving an increased international investor interest in the region, says Nayel Georges Vidal, director, Tunis at Emerging Capital Partners (ECP), a pan-African private equity firm that has raised over $2bn for investment across the African continent, including North Africa.
“An emerging market fund of funds would once not have looked at Africa to invest; now they are thinking that 10-15% of their capital should be there. Investors continue to show strong interest in Morocco and Algeria,” says Vidal. “While they are cautious on Egypt and Libya in the short term, there is potential for good growth after political stabilization.”
Vikas Papriwal, UAE head, SWF and PE practice at KPMG, agrees, saying that once the effects of the Arab Spring fade, one can expect to see investment returning. “If you look at the more macro trends, there is around $145bn of dry powder in the system globally, which needs to be invested soon. In Africa, there is a massive need for capital and the region has high growth potential; in North Africa, we are seeing funds being raised in various sectors including infrastructure and telecoms,” he says.
The Abraaj Group believes that the story of investing in North Africa still holds. In July, it completed its first exit in Tunisia, making a “significant return” despite the political backdrop.
“If you look at empirical evidence, you will find that the companies we have invested in or have looked at in the past are still growing at 15-20% every year despite the Arab Spring,” says Badreldin.
Abraaj is currently raising capital for its second mid-market fund for North Africa, investing in Egypt, Tunisia, Algeria and Morocco, focusing on mid-market strategy with a target size of around $15-30m. The group has local offices in the above countries, which is very important to source these transactions. “You cannot do North Africa using a suitcase banker approach,” stresses Badreldin.
Given the negative investment sentiment towards Egypt, it may come as a surprise that CedarBridge Partners, a $65m private equity firm with a mandate covering geographically the whole Mena region, has a particular focus on the country. The company invests in small and medium enterprises mainly in healthcare, education and retail, and has one current active investment in CIRA, one of the largest educational groups in Egypt.
“We have been investing or looking for opportunities despite the political turbulence. Our schooling business has been growing year-on-year, and it is rewarding,” says Imad Ghandour, managing director at CedarBridge Partners.
Ghandour says that while investment sentiment has been up and down over the past 2.5 years, it is now a case of “wait and see” until things have settled down politically.
“Our general view of Egypt is that it is a stable market despite political turbulence and it is a big market, which you cannot ignore. We have been investing in Egypt over the past five years from various funds and it has been generally rewarding. At the micro level the businesses continue to do well even if the macro picture does not look that rosy,” he says.
The two other countries the firm is considering are Tunisia and Morocco, while Algeria and Libya cannot yet be considered for regulatory or political reasons, according to Ghandour.
PE firms are currently concentrating their attention on sectors which are defensive and have growth potential, whether they are export focus or consumer-driven. Infrastructure, hospitality, financial services and agriculture are a few common investment themes.
ECP, which looks at deals in the region of $40m to $120m, invests in companies that operate in business environments characterized by limited competition or in sectors where Africa has either a comparative advantage or an unmet need.
“This strategy maintains diversification within ECP’s investment portfolio and provides our investors with greater, risk-adjusted returns that are generally uncorrelated to the US and other global markets,” says Vidal.
In North Africa, ECP Fund I (which is fully exited) invested in and helped grow four major infrastructure companies, whereas ECP’s Fund II (that closed at $523m in December 2005), is currently in the post-commitment phase. It has two portfolio companies based in North Africa: Générale Assurance, one of Algeria’s largest private insurance companies and Société d’Articles Hygiéniques (SAH), Tunisia’s leading producer of absorbent hygiene products.
Meanwhile, country-specific funds also play a role, such as the Moroccan Infrastructure Fund (MIF), which was established in December 2006 with MAD800m ($95.67m) of commitments to capitalize on the demands for infrastructure needed during Morocco’s growth spurt. The fund is a joint venture between ECP and Attijari Invest, the private equity arm of Attijariwafa Bank, Morocco’s largest bank. MIF targeted numerous sectors including telecoms, transportation, energy, power and water, and ports.
According to Vidal, MIF holds minority positions through equity investments that typically range in size from MAD50m to MAD150m ($6m-$18m). “MIF recently exited its entire position in Osead Maroc Mining, the full exit representing 8.4x MIF’s initial funded investment and an internal rate of return of 94%,” he says.
More rewarding than the GCC?
In the context of the wider MENA region, the North African private equity industry is in a nascent state, but many experts believe it is more fertile ground for such investment than the GCC, in terms of market access and revenue potential.
“I think North Africa is one of the most promising sub-regions where capital is well appreciated and rewarded as opposed to the Gulf region where there is an abundance of capital,” says Ghandour. “You can find good deals, not as many as you would like, but better than what you will probably find in Saudi Arabia.”
Badreldin agrees. “In North Africa you can invest in companies with attractive valuations and get higher returns. In the GCC you can get the same company and pay 30-40% more in terms of the valuation.”
For pan-emerging market players such as Abraaj, the competitive field in North Africa is relatively clear, he adds.
“There is not too much competition in private equity, because the market is very young and there is enough opportunity for everybody,” continues Badreldin.
For KPMG’s Papriwal, from a private equity point of view it is very hard to find a lot of businesses of scale to invest into, while the other big issue is exit, because the local markets are fairly illiquid or small.
“I think because there are not that many fund managers on the ground, which have credible track record, it is also hard to do fund-of-fund type investment. I think you need to be on the ground clearly to meet management and companies,” he says.
Despite the deepening of the African PE industry, there are still significant barriers to entry, agrees ECP’s Vidal. “As a GP, you need to demonstrate significant investment experience. In particular, it is important that you have experienced multiple investment cycles and know how to execute across turbulent markets. This is critical for developing exit strategies and ultimately achieving above-market returns,” he stresses.
However, for experienced investors, challenges can also present opportunities, he says, adding that Africa has a perceived risk that is higher than its actual risk, resulting in limited competition and attractive valuations for investors.
One challenge to the reputation of private equity investment in North Africa lies in overcoming investors’ misconceptions of the effect of political instability in the region. The risk/return reward trade-off for investment can be significant if correctly managed by experienced professionals.
“During politically volatile times, private equity investors can benefit from providing essential long-term growth equity to entrepreneurs or leading businesses while temporary liquidity constraints are impacting their ability to access other sources of financing. In fact a number of prohibitive investment regulations have been lifted by the new governments in the region, allowing for easier access by foreign investors,” says Vidal.
One way in which ECP mitigates political risk is by investing in companies with pan-African operations. During times of conflict, the asset manager reports regularly to its LPs, and maintains support of its investee companies.
Vidal points out that the effects of political uprisings can be short-lived, citing the case of the firm’s investment in Tunisian SAH. While operations closed for two weeks in January 2011, business picked back up quickly and domestic sales, which were down by 40% in January 2011, had recovered in March and surpassed their 2010 level by April. Since then, SAH pursued with strong double digit growth in revenues and achieved more than 30% growth in revenues in 2012 compared to 2011. Since the Fund’s investment in 2008, the company has more than doubled its revenues and EBITDA.
For players like CedarBridge Partners and the Abraaj Group, political risk is not that high on the agenda. Ghandour points to country-specific risks such as the currency depreciation in Egypt, whereas for Abraaj’s Badreldin, the key challenge is around security. “We can always price in the political risk, but it is very hard to price in the security risk. The elections or impeachment of President, you can always price it in, because the technocrats are largely the same and you know which way the ball will fall.”
“The problem is when the country enters a security situation - what is happening now in Cairo. This results in curfew, which impacts businesses, people’s ability to get to work, so you can have a negative spiral effect,” he concludes.