Local firms gain more than investors when private equity arrives
A LONG line of smoke-belching lorries clogs the highway for miles outside Mombasa, Kenya’s main port. They are waiting to collect shipping containers that they will haul across 1,200 grinding kilometres to Kampala, Uganda’s capital. Doing so is slow and costly. Yet for a quarter of a century this was the only viable way of shipping goods into east Africa’s interior. The moribund railway was even slower, and thoroughly unreliable: at best it would take 12 days to move a container by train.
Today a procession of brightly painted locomotives (pictured) belonging to Rift Valley Railways are taking an increasing share of the load. The time to send a container by rail has fallen by more than half and, for the first time in decades, the trains are running on time. Now, as much as 10% of the traffic out of Mombasa is carried by rail—double the share of a few years ago—and new wagons and locomotives may double that share again.
The improvement is almost entirely due to the influence of private equity on a railway that, when built in British colonial times, seemed such an outlandish venture that it was dubbed the “lunatic line”. Qalaa Holdings, an Egyptian investment firm, has invested almost $200m in improving the railway since it first took a stake in 2010.
More than money, Qalaa has brought skills and technology. When it arrived it found a “dead fleet” of locomotives rusting in the sidings for lack of spare parts. Almost half have been repaired. New machines now carry out maintenance on the tracks at a rate of 1km an hour, where previously it was done by hand at a pace of 40m an hour. Modern electronic control systems have helped trim spending on fuel by about a tenth.
“Without proper processes and maintenance, capital spending is just money down the drain,” says Karim Sadek, Qalaa’s managing director. Other private-equity firms are drawing similar lessons. “You have to be really hands-on with every one of your companies,” says Suleiman Kiggundu of CDC, a development arm of the British government that uses private-equity techniques. With luck, this will mean that the large amounts of private-equity money now going into Africa—seen as the last great frontier market—are not wasted. Last year such investments reached $8.1 billion, close to the pre-crisis peak and well up on the low of $1.5 billion in 2009.
This great migration of capital comes as African economies are slowing after a decade of good growth. Lower commodity prices are dampening expansion in places such as Nigeria and Angola. Poor financial management is hurting others, such as Ghana, Kenya and South Africa. But the slowdown may affect African businesses less than ones that private-equity firms have invested in elsewhere in the world.
In many countries, a typical deal would involve a buy-out fund loading its newly acquired business with debt, to multiply its returns. In Africa, most buy-outs are done with little or no debt because domestic-currency borrowing rates are so high—perhaps 15-24% in the region’s larger economies. (Foreign-currency rates are much lower, but are a risky bet for businesses that do not earn revenues in dollars or euros to pay back their loans).
So, instead of boosting African businesses’ returns through debt, private-equity firms have to increase revenue and improve efficiency. Consider the example of Umeme, which runs Uganda’s power-distribution grid. When Actis, a British investment firm, bought a stake, power losses consumed 40% of the electricity generated. By making some simple changes, such as replacing old insulators on its cables and reducing the theft of electricity by dismantling illegal connections, it has cut those losses in half.
Companies can also get help from private-equity investors in expanding into new markets, or replicating existing businesses in other countries. Agri-Vie, a South African firm, owns stakes in several agricultural and food-processing businesses, ranging from a flower grower in Kenya to an Ethiopian fruit-grower and juice-maker. “We find solid companies. The key challenge comes at the point of scaling up and moving beyond a single market or country,” says Herman Marais, its managing partner.
In other cases private-equity firms find themselves acting more like venture capitalists, or even startup founders. One of Nigeria’s most successful home-grown firms is Verod Capital Management, which earned about 15 times its investment on a new factory making drinks cans. It is now involved in several other startups, including a fish farm. It has bought Spinlet, a Finnish music-streaming company, and transplanted it to Nigeria.
Yet even if they adapt to local conditions, buy-out firms still find that Africa is no path to easy riches. In the ten years to September 2014, South African private-equity firms, for instance, delivered returns that, although seemingly juicy at 18.5% a year (in local currency), were less than their investors would have earned simply by betting on stockmarkets.
Data on other firms and other countries are sparse, but industry insiders reckon that African deals had annual returns of only about 11% for the decade to 2012. Fewer than half of buy-out funds did better than the median fund investing in listed stocks. The worst-performing investments were those struck during the previous peak, a warning to those firms now itching to spend unused capital. In the rich world private equity is often accused of enriching investors at the expense of the firms they buy. In Africa, the reverse seems to hold.