Creative capitalisation: Private equity has become attractive as an alternative to more traditional funding methods

Among many industry players, private equity (PE) has rapidly developed as an alternate source of funding for Nigeria’s corporations. Initially dominated by development finance institutions (DFIs), the sector is attracting a growing number of private funds both foreign and, increasingly, domestic, thanks to the rapid growth of pension assets. While channels for divesting remain somewhat constrained, recovery in the equities market will add the option of public listing.

While still a relatively new concept in Africa’s most populous country, PE has captured the attention of foreign funds, eager for returns in the face of lacklustre global growth. The original source of such longer-term financing came from DFIs like the World Bank’s International Finance Corporation (IFC), the UK’s Commonwealth Development Corporation (CDC), the US’s Overseas Private Investment Company, Norway’s Norfund and Germany’s DEG. But private PE funds took notice when the IFC’s best-performing funds became those for Africa – particularly Nigeria.

PE funding started offshore as part of global pan-African funds’ allocations to Nigeria. While several deals had been financed through pan-Africa funds beforehand, the profile of PE was significantly raised as banks like Oceanic and Intercontinental sought to raise funds for growth, starting in 2007, and to deal with the fall-out from the 2008 crisis subsequently.

GROWING FAST: Total PE investments in Africa have grown from $151m in 2002 to $3bn in 2011, according to the Emerging Markets Private Equity Association (EMPEA), with South Africa and Nigeria accounting for the majority. The dominant forms of PE have been management buy-outs and restructuring through the financing of greenfield or expansion investments. Nigeria’s share of the continent’s PE is 10%, says the association, lagging far behind its economic weight. According to the central bank, there are now 10 domestic PE firms and 16 international ones looking to invest in Nigeria – fewer than Egypt’s 30, Kenya’s 40 or South Africa’s 80, but still very encouraging.

PLAYERS TO MARKET: The IFC led the way in the first PE deals early in the millennium, and significantly scaled up its investments over the course of the Nigerian banking crisis. More locally, South Africa’s PE firm Ethos and its largest insurance company Old Mutual also made a move by purchasing a $130m stake in Oceanic Bank in October 2007, and a number of banks followed suit. Ethos’ investment commitments in Nigeria rose to $926m in fiscal year 2011, 34% higher than the previous year’s $690m, focused on financial institutions like First City Monument Bank (FCMB) and Diamond Bank, as well as microfinance.

Originally the CDC’s PE arm, but then spun off as an independent fund manager, Actis is an emerging-market focused firm with some $1.5bn invested in Africa. Leading several top deals, including Nigeria’s largest shopping mall (The Palms) operator Persianas and the industrial and property group UACN, the group has a proven record of successful exits. An early investor in the telecoms sector, Actis sold its stake in Starcomms in 2008 through an initial public offering (IPO). The fund’s current investments include $151m in Vlisco Group, a well-established West African fashion fabric producer, as well as Diamond Bank, in which it invested $134m. It also completed a second commercial property, a $100m project in which it holds a 60% stake, in 2012 when the Ikeja City mall opened.

The firm has earmarked $500m for property projects in sub-Saharan Africa and particularly Nigeria. “We believe that Nigeria and Ghana alone have the potential for at least 20 or more similar scale malls,” Michael Chu’di Ejekam, real estate director at Actis, told local press at the mall’s opening.

Aureos Capital is another key player. The PE firm was originally spun off by the CDC and Norfund in a management buy-out in 2008 and then sold to the UAE’s Abraaj Capital in February 2012. A sign of looming consolidation in the PE industry globally, the sale demonstrates the appeal of Africa-focused funds. With some $1.3bn under management, Aureos’ investments in Nigeria have included Portland Paints, Deli Foods, chemicals company Nycil, Custodian & Allied Insurance, Computer Warehouse and oil services firm AOS/Orwell.

Emerging Capital Partners (ECP) has also focused moved towards pan-Africa funds. Raising some $613m for its third pan-Africa fund in 2010, ECP now has $1.8bn under management. Its most substantial investments in Nigeria have included fertiliser company Notore Chemical Industries, Starcomms and Intercontinental Bank. The firm says it invested over $1bn in total on the continent in 2010 and hopes to grow its Nigeria book in particular.

NEW FOCUS: Beyond these global funds, a number of PE fund managers focusing closely on Nigeria and West Africa have emerged as strong contenders. Nigerian banks like First Bank and Standard Chartered Nigeria have established PE subsidiaries, although banks’ enthusiasm has largely waned in the face of tightening credit and mitigated successes. The largest of the independent PE firms is African Capital Alliance (ACA), which has launched three funds since its inception in 1997, raising $750m, and invested in over 30 companies. The fund manager has built up a portfolio of diverse active investments, including Cornerstone Insurance, MTN Nigeria, Capsea Marine, Linetrale Gas, Linkserve and Swift Networks. The fund staged an early success when it divested itself from Associated Bus Company through an IPO in December 2006. Its largest deal came in 2011 when it led a consortium of investors in the $750m recapitalisation of Union Bank. The firm is also gearing towards real estate, forming a N5bn ($32m) joint venture with Guarantee Trust Assur to develop the Assur Plaza office complex on Victoria Island, due for completion in August 2012. Meanwhile its first 100-room hotel project with South Africa’s Protea brand is set to open in 2012.

Helios Investment Partners was established by two Nigerians in 2004 and has launched two increasingly successful funds. The CDC was the single biggest backer of Helios’ first $350m fund, investing $50m. A key early success was Helios Towers Nigeria, a telecoms infrastructure operator with a regional footprint, in which Helios invested $100m and attracted a further $275m from private foreign investors and the IFC. While it struggled to reach its $200m first close for its second pan-Africa fund in January 2010, it raised a record-breaking $900m in the second close in June 2011. The latter funding round attracted the highest level of interest with over $1bn in demand. In February 2011 Helios partnered with Vitol, a Dutch energy-trading firm, to acquire Shell’s downstream oil distribution and retail operations in 14 African countries for $1bn. Another PE fund focused on West and Central Africa, Travant Capital, established by two Nigerians in 2007, closed its first fund with $107m committed capital, $77m of which came from investors in the region (the largest such commitment) and the remainder from CDC. The first investment was in Dorman Long, an oil services firm, in 2008.

The first of the world’s largest PE firms to enter the Nigerian market, the US’s Carlyle Group (with some $88bn under management worldwide) established an office in Nigeria in 2010. While other big PE firms have used South Africa as a base for investments, the arrival of big names like Abraaj and Carlyle reveal that the high hopes of the global PE industry for Nigeria’s growth story, attracting high-profile investors like Saudi Arabia’s Prince Al Waleed Bin Talal with his African PE firm Kingdom Zephyr Africa Management.

DOMESTIC SOURCES: Smaller indigenous PE firms have emerged in the past few years, although have yet to execute a deal. Nigeria’s TBF Group has teamed up with Oman’s GEP (BVI) to form an equity fund to develop new communities in the mid-range affordable and luxury segments of the market.

Vine Capital, a Nigerian fund, reached advanced stages in leading a group of foreign PE funds and DFIs to acquire a stake in Afribank in 2011, but the deal collapsed on concerns about the fund’s ability to raise sufficient capital. Nigerian brokerage ARM Capital has constituted a PE fund with a target size of $150m, focusing on Nigeria and West Africa.

As the number of PE funds focused on Africa has grown, along with the pipeline of deals in Nigeria, key changes in domestic investment regulations have opened the doors to a local source of funding many pan-Africa funds now seek to harness. The first of these have been pension assets, which since the system’s reform in 2004 has spurred a rapid accumulation of assets under management of pension fund administrators (PFAs), reaching some $16bn by mid-2012. Revisions to the Pension Act in December 2010 allowed PFAs to invest in PE for the first time, capping investments at 5% of assets. The Securities and Exchange Commission (SEC) licensed the first domestic PE fund when it registered ACA’s Nigerian unit in 2011, amending its rules slightly. The requirement for 10 years experience in the Nigerian PE industry was extended to financial services generally, while the requirement that fund managers hold 5% of the fund was dropped to 1%, as in countries like South Africa.

“The SEC hadn’t regulated PE before because all of the funds were based offshore and would create partnerships and the like,” Olubunmi Adeoye, the vice-president for PE at Capital Alliance Nigeria (CAN), told OBG. “But now you must be registered with the SEC in order to access onshore funds such as those held by the PFAs.” Local PE fund managers expect further reforms to PFA ceilings in coming years to match South Africa’s limit of 10% on PE.

Another key source of longer-term capital will likely be a sovereign wealth fund (SWF), due to be established in the coming year (see Economy chapter). The SWF bill passed by the National Assembly provides for investment in PE and venture capital, although exact ceilings have yet to be set.

DEAL PIPELINE: Nigeria’s investment needs are significant, with shorter-term bank credit accounting for only a fraction of the amount and maturity of financing required. While a clear focus has emerged on the property sector, a variety of new opportunities are being scrutinised by the growing number of PE players on the market.

In the oil and gas sector, for example, significant opportunities arise from Shell’s divestment from its onshore production assets, valued at some $2bn. ACA bought a stake in First Hydrocarbon Nigeria in 2010, following the oil independent’s investment in OML 26 block alongside Shell. Meanwhile ACA also holds a stake in Vertex Energy, a Nigerian independent, alongside First Bank, Leadway Insurance and the African Finance Corporation (AFC). Moreover, Vertex acquired Shell’s OML 40 block during 2011.

Beyond the energy sector, investors see significant potential in the government’s agricultural policy. While the sector’s most important challenge has been market access, opportunities are arising in the development of supply chains for modern grocers. As stores like Shoprite continue to develop, some of their key suppliers like Zambeef Products Nigeria (a joint venture with Shoprite) and Fortuna Eggs are looking to expand their local scale. South African PE firm PSG’s agricultural arm Chayton Africa unveiled plans in June 2012 to commit $46.7m to Nigeria, Ghana and Côte d’Ivoire in the near future.

Entertainment is another key sector being targeted, in light of Nigeria’s substantial film and media industry. In early 2012 US-based PE firm Tiger Global Management invested $8m in Nigerian online movie and music distribution company Iroko Partners. Established in 2010, Iroko is the largest distributor of Nigerian entertainment worldwide and is the biggest partner of YouTube in Africa, reporting some $1m in advertising revenue in 2011.

EXIT STRATEGY: While PE investment is flowing in, a lingering concern lies in the options for divestment over the five-year timespan. “Exit is one of the biggest questions we ask ourselves at the time we enter into a deal,” John Van Wyk, co-head for Africa at Actis, told a conference in April 2012.

While the stock exchange has been used as a channel in the past, the lacklustre performance of equities since 2008 has dampened the exchange’s appeal. Successful listings included that of ABC Transport by ACA in 2006 and Starcomms in 2008, though no new listing has taken place since then.

The more popular option has been trade sales to strategic investors and management buy-outs, as in the case of Actis’s investment in Persianas. “We try and invest in businesses that will have strategic appeal to a trade buyer,” said Van Wyk. A number of funds have yet to prove their exit credentials.

HIGH EXPECTATIONS: While Helios has achieved a partial exit from its investment in FCMB by selling a 40% stake in January 2008, the deadline for actualised returns is drawing nearer. Its first 10-year, $305m fund is due to expire in 2016, although it could be extended for a further two years. Investors’ eagerness for profit is also affecting expected returns. “Interestingly, because interest rates are high this actually raises expectations on the part of investors who are looking for returns of up to 30%,” Adeoye told OBG.

While the equities market may yet bounce back in 2012, strategic sales and management buy-outs will continue to dominate exit strategies. Yet with such high interest rates domestically, the scope for management buy-outs is limited to smaller deals. But as an increasing number of Western corporates seek higher returns by growing their emerging-market operations (for example, Heineken’s purchase of a majority stake in Nigerian Breweries and Consolidated Breweries) there is not likely to be any shortage of interest for such trade sales, for particular deals.

Global PE funds clearly see the potential for lucrative returns from Nigeria’s growth story, though significant constraints remain. Beyond the challenges of deal making and due diligence on the Nigerian market, the opportunities for divestment remain limited. With the planned deepening of the capital markets and increasing interest by multinationals for market access through acquisition however, many of the existing PE investors in Nigeria are likely to be vindicated.