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Analysis > Analysis and Strategy

Understanding the rules of engagement and the ideal deal conditions in Africa

Rob Bergman, Principal in Corporate Finance, Bravura
Dec. 3, 2020, 11:10 p.m.
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Despite the projected 3% contraction in Africa’s GDP in 2020 (IMF) followed by modest recovery next year, there remain unmatched investment returns on the continent. However, many investors continue to struggle with finding the “ideal deal” despite the significant foreign direct investment into Africa over the past few years, which saw inflows to the continent rising to $46bn in 2018 followed by an 11% increase in 2019 (UNCTAD’s World Investment Report 2019).

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Despite the projected 3% contraction in Africa’s GDP in 2020 (IMF) followed by modest recovery next year, there remain unmatched investment returns on the continent. However, many investors continue to struggle with finding the “ideal deal” despite the significant foreign direct investment into Africa over the past few years, which saw inflows to the continent rising to $46bn in 2018 followed by an 11% increase in 2019 (UNCTAD’s World Investment Report 2019).

Sourcing African investment opportunities requires two key considerations: a willingness to adopt a different approach when seeking out investment, and the awareness of the complexities and complications that invariably emerge in African deals. Don’t expect similar “rules of engagement” to those in developed markets. In order to tease out investment opportunities, Africa requires a unique approach.

In Africa, there is an abundance of family-run businesses (which carry with them great prestige). Selling the business or part thereof is not regarded as a signal of success in most African communities, which makes it challenging for a family-run business to sell a majority share, even should they wish to do so. Successful deals could start with taking a minority position with an agreed route to corporate structuring and the removal of the family shareholding over time.

Depending on the jurisdiction, accessing debt funding can prove difficult. Mezzanine funding is concentrated to a few funds specifically mandated for the purpose. While not impossible, finding mezzanine funding requires careful investigation.

Given the limitations of in-country funding instruments, transactions in Africa will often include parties from different jurisdictions, taking several months from signing to closure in order to meet inter-conditional legal and tax requirements and obtain regulatory approvals. Strong personal skills and relationships are critical to ensure all the parties remain committed around the negotiating table.

Investors in Africa are invariably investing in companies that sell products and earn revenue in local currencies. It is seldom that the local African business will source all products and costs locally. This infers that a large portion of the cost of production could potentially consist of imports with a hard currency cost component.

Macro-economic factors such as inflation become an exponential investment risk as the local currency will depreciate. It would be critical for the investor with an international return requirement to select an asset that is able to grow by meeting inflation (to stay stable in the USD currency) plus the required equity returns.

Some of the best assets in Africa will be those that are foreign currency generating products that are exported into jurisdictions such as the United States and the European Union. Investorswishing to hedge their investment should look for an existing export component to the business with a clear line of sight to an interesting export story where the company’s value could be further developed. Investments in businesses that have their revenue pricing dollar linked are known to perform very well.

Avoid complex structures and investments where persons not immediately recognisable as shareholders or directors seem to have a say in the business. This can relate to family members, a silent investor or governmental influence. Also look out for the company being used for family expenses, which might be difficult to part with post-transaction. One usually would not pick this up in a desktop due diligence – an understanding of the local market and direct socio-economic environment of the company is required.

Intercompany revenue or expense is a difficult parameter to understand, especially where the product development or distribution channels are structured as different companies, requiring an understanding of the impact of buying a business out of a larger group.

With any business it is easier to be creative with accounting records than with actual cash. As an investor, aim to match the actual cash flows with the accounts. A lack of cash generation or a recent increase in debts are a tell-tale sign of further due diligence requirements into the presented financial accounts.

For investors serious about the long-term gains in Africa, considerable importance should be placed on knowing the environment and partnering with the right advisors or in-country stakeholders.

 

Bravura is a South African investment banking firm now in its 21st year, specialising in corporate finance and structured solutions services. Bravura Holdings has a primary listing on the Stock Exchange of Mauritius and a secondary listing on the NSX.

www.bravura.net

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