Investment potential: The private equity market is expanding, particularly in the property development segment

Private equity has rapidly developed as an alternate source of funding across Africa, and Nigeria, as a risky but often undervalued market, is no exception. Although development finance institutions have long dominated private equity projects on the continent, an increasing number of private funds, both foreign and domestic are active, attracted in part by the success seen by the development institutions. This burgeoning trend is especially noticeable in the real estate market, though options for recouping costs and selling off assets remain somewhat constrained.

TAKING ROOT: While still a relatively new concept in Africa’s most populous country, private equity 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 has been from development finance institutions like the World Bank’s International Finance Corporation (IFC), the UK’s Commonwealth Development Corporation (CDC) and the US’s Overseas Private Investment Company. However, private equity funds began to take notice when the IFC’s best-performing funds became those covering Africa, in particular Nigeria.

The IFC led the way in the first private equity deals early in 2000, but it significantly scaled up its investments during the 2007-09 Nigerian banking crisis. Its investment commitments reached $926m in fiscal 2011, up 34% on $690m the previous year, and were focused on financial institutions such as First City Monument Bank (FCMB) and Diamond Bank as well as several microfinance institutions. Spurred by the IFC’s success, a number of private equity firms began investing in the country later in 2000, the first of which was South African private equity firm Ethos and its largest insurance company, Old Mutual, which purchased a $130m stake in Oceanic Bank in October 2007. The IFC, however, still leads as the top equity investor in Nigeria’s financial sector.

ON THE UP: Total private equity investments in Africa grew from $151m in 2002 to $3bn in 2011, according to the Emerging Markets Private Equity Association, with South Africa accounting for the largest portion of this total. Nigeria, meanwhile, accounts for just 10% of total private equity on the continent.

According to the Central Bank of Nigeria, there are 10 domestic and private equity firms and 16 international ones actively looking to invest in Nigeria.

Although this is less than Egypt, which has 30 companies looking to invest, Kenya (40) and South Africa (80), it is still encouraging. Management buy-outs and restructuring through the financing of greenfield or expansion investments dominate the country’s private equity environment.

FINANCING BUILDING: While some private equity funds in Nigeria have plans to become specialists in specific sectors, so far all of the ones on the market have been generalists, financing deals in a variety of sectors, including banking, entertainment, telecoms, and oil and gas. Private equity activity has been particularly prominent in the real estate sector, where some of the larger property acquisitions and developments are being financed by private equity investments. While the environment remains challenging for deal making, a number of strong fund managers have emerged, which has increased the competition for new private equity companies wishing to enter the market.

Originally the CDC’s private equity arm, independent fund manager Actis, which focuses on emerging markets, has some $1.5bn invested in Africa.

Leading several top deals, including Nigeria’s third-largest shopping mall, the Palms, operator Persianas, industrial and property firm United Africa Company of Nigeria, the group has a proven record of successful exits. In 2012 it also completed a second commercial property – a $100m project in which it holds a 60% stake – when the Ikeja City mall opened. In addition, Actis has earmarked $500m for property projects in sub-Saharan Africa, particularly in Nigeria. “We believe that Nigeria and Ghana alone have the potential for at least 20 or more similar scale malls,” Michael Chudi Ejekam, the director of real estate at Actis, told local press at the opening.

Aureos Capital is another key player. The company was originally spun off by CDC and Norfund in a management buy-out in 2008 and then sold to Abraaj Capital in February 2012. A sign of looming consolidation in the private equity industry globally, the sale demonstrates the appeal of Africa-focused funds. With some $1.3bn under management, Aureos’s investments in West Africa include Regimanuel Grey, a Ghanaian property developer that has projects in Ghana and Sierra Leone.

STRONG COMPETITORS: Beyond these global funds, a number of fund managers concentrating closely on Nigeria and West Africa have emerged as strong market contenders. Nigerian banks like First Bank and Standard Chartered Nigeria have established private equity subsidiaries, although banks’ enthusiasm in the country has largely waned in the face of tightening credit and mitigated successes.

The largest of the independent private equity firms is African Capital Alliance (ACA), having launched three funds since its inception in 1997, raising $750m from investments in over 30 companies. The fund manager has built up a portfolio of diverse active investments, including Cornerstone Insurance, MTN Nigeria, Capsea Marine and Swift Networks. 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 Lagos’ 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, in Benin City.

A number of smaller indigenous private equity companies have emerged in the past few years, although they have yet to execute a deal. Nigeria-based TBF Group has teamed up with Oman’s GEP to form an equity fund to develop new communities in the mid-range affordable sub-sector as well as the luxury segment of the market.

EXIT STRATEGY: While private equity investment has been flowing into the country, a lingering concern is how to exit an investment quickly, which is often not an option in smaller African markets. “Exit is one of the biggest questions we ask ourselves at the time we enter into a deal,” John van Wyk, the co-head of Actis for Africa, said at the Reuters Africa Investment Summit in April 2012.

This can be especially challenging in property and infrastructure development, where investment horizons are far longer, with investors often needing to wait between 10 and 15 years before gains can be realised. Moreover, to attract private equity cash flows, these sectors not only need high returns, but these returns must also be predictable. This requires a consistent and stable regulatory environment. A more popular option has been trade sales to strategic investors and management buy-outs, as in the case of Actis’ investment in The Palms. “We try and invest in businesses that will have strategic appeal to a trade buyer,” said Van Wyk.

There are a number of private equity funds that have yet to prove their exit credentials. While Helios Investment Partners has achieved a partial exit from its investment in the FCMB by selling a 40% stake in January 2008, the deadline for actualised returns is drawing near. Its first 10-year $305m fund is due to expire in 2016, although the fund could be extended by a further two years. Helios is planning several exits over the next 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%,” Olubunmi Adeoye, the vice-president of Capital Alliance Nigeria, the local arm of ACA, told OBG.

GROWING INTEREST: While the equities market may bounce back in 2012 – enabling funds to list – sales and management buy-outs are expected to continue dominating exit strategies. Yet with such high interest rates domestically, the scope for management buy-outs is limited to smaller deals. However, as more and more Western corporates seek higher returns by growing their emerging-market operations (see Heineken’s purchase of a majority stake in Nigerian Breweries and Consolidated Breweries, for example), there is unlikely to be any shortage of interest in such trade sales.

Private equity funds clearly see the potential for lucrative returns from Nigeria’s growth story, particularly in the property and infrastructure segments, but 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 rising interest by multinationals for market access through acquisition however, many of the existing private equity investors in the country are likely to be vindicated by the market.