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Opinion & Analysis

Country a magnet for deal hunters

Visit any of Nairobi’s leading hotels on a weekday evening and you are likely to bump into an investment banker or private equity representative in the country eager to find the next big deal.

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

The recent Africa Investor award to Emerging Capital Partners for ‘Deal of the Year’ was for their majority acquisition of Nairobi Java House. The deal raised Kenya’s profile, showing that big deals are possible.

This follows announcements earlier this year of Standard Chartered Private Equity’s $74 million minority investment in ETG Group and the $55 million investment in UAP Group by Aureos, AfricInvest and Swedfund for a 40 per cent stake.

The message is clear that sizeable deals are available and happening.

A growing middle class drives demand for goods and services and investors are looking at financial services, education, health, retail, infrastructure, consumer and industrial products as the sectors benefiting the most from growth.

The challenge has been finding suitable targets to inject funding.

The strength of Kenya’s economy over the last ten years has allowed companies to achieve strong organic growth, backed by banks willing to take more risks and extending favourable lending rates.

Booming businesses have become attractive to private equity and corporate buyers seeking to be part of the current African wave.

However, having achieved success with limited external influence, not all of 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.

Success and competition bring about their own challenges like increased valuations which make investments more complicated, particularly for the private equity market.

With typical short to medium-term investment horizons, demand for clear exit mechanisms and internal rates of return 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), which may only appeal to targets that have exhausted their traditional debt market options.

Sectors such as infrastructure that benefit from large capital allowances that are aimed at spurring growth in investment have the downside of making shareholder distributions in years soon after significant capex investment difficult as these are likely to attract compensating tax, which essentially looks and feels like capital gains tax in reverse.

The traditional concept of private equity in the West is proving a hard sell in this region. Increasingly, private equity will need to adjust their risk appetite for the region if they are to be a part of the African story.

Longer investment horizons allowing for desired growth, returns and exit mechanisms are likely to be the answer. Investment in sectors that are not traditionally their forte may also need to be explored.

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

These investors may therefore need to look at how to help family businesses plan for succession, help prepare the way for successful listings as an exit route and most importantly show that they can add value. They can set a track record that will improve their credibility.

Mr Otolo is the Advisory Transactions Manager at PwC Kenya

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