Why KKR’s decision to leave Africa shouldn’t matter
Africa is significantly underrepresented in international capital markets. Although the region possesses 16% of the world’s population, it holds less than 1% of private capital. The dearth of capital in Africa is a product of history and development challenges, but it also stems from investors’ failure to realize that what works in traditional New York private equity markets is not necessarily going to work in emerging investment hubs like Nairobi. Large private equity funds like Blackstone and KKR focused on financial engineering to boost profitability without necessarily creating growth are unlikely to find success in African markets, where flexible growth-focused capital is essential to creating future unicorns.
Private equity must fit the size of the companies in order to be right-sized capital.
After less than four years, KKR & Co. LP, one of the world’s largest private equity players, officially exited Africa in late November 2017. Following the announcement, company spokesman Ludo Bammens said, “To invest our funds we need deal-flow of a certain size. It was especially the deal-size that wasn’t coming through. There was enough deal-flow at a smaller level.”
That’s outdated thinking. What’s small and large is all relative to the market size.
PE firms typically invest hundreds of millions of dollars to improve a company’s performance and expect to sell their stakes within five years for a higher price. This Western, big buyout model is inappropriate for African markets in which the pool of blockbuster, billion-dollar companies is limited: there are currently only 400 companies in Africa with annual revenues of over $1 billion. By contrast, there are nearly 11,000 African companies with revenues of $10 million to $100 million and tens of millions below that threshold.
Clearly, the largest opportunities in Africa lie in small, fast-growing companies that have the capacity to grow quickly by leveraging outside capital and technical expertise. Zoona, Zambia’s leading mobile money operator, for example, has an estimated annual revenue of $13.2 million after just 7 years of operation and has experienced 20% year-on-year growth. Similarly, M-Kopa, founded in 2011, reached $15 million in revenue by 2014 and continues to double in revenue annually.
While African companies like Zoona and M-Kopa have demonstrated profitability in a short period of time, they are largely overlooked by traditional PE: global PE players are focused on trying to replicate successful business models from their own countries. Carlyle, for example, remains narrowly focused on investments in financial services and energy rather than branching out to dynamic sectors like technology that are poised for massive growth across Africa. KKR’s exit after just one deal in an export-oriented flower farm in Ethiopia shows just how dry powder compounds as marketable companies turn into missed opportunities.
Understanding the Local Context
While investors flock to cities like San Francisco and New York for proximity to investment opportunities and to be close to centers of innovation, Africa-focused funds tend to focus on buzzing entrepreneurial hubs like Lagos, Nairobi, or Johannesburg. All these cities may be emerging centers of innovation , but a biased focus on a handful of markets means that investors miss out on unique and profitable endeavors in fast-growing, less commodity-intensive economies. Ghana and Ethiopia, for example, are home to the world’s fastest growing economies.
To invest successfully in Africa it is essential to understand the local challenges faced by the average consumer while simultaneously having a firm understanding of what is being developed and scaled in traditional centers of innovation. Success lies at the intersection between emerging consumer needs and traditional centers of innovation; however, a cut and paste of solutions from one market to another is doomed to hit a brick wall.
Too Many Fish in the Same Pond
Without adequate understanding of local opportunities and a preference for replicating Western business models, it’s unsurprising that so many funds chase the same deals. According to EY, 47% of exits to PE and financial buyers in Africa were to other multinational PE houses or financial buyers in Africa.
The trend is increasing: the last 17 private equity exits of 2017 were to other PE houses versus a mere 7 exits to PE houses and financial buyers the prior year. In July, the Abraaj Group bought Java House, East Africa’s leading coffee chain, from private equity rival Emerging Capital Partners and Kevin Ashley, the Nairobi-based company’s executive chairman, for an undisclosed amount.
As these firms continue to search for elusive unicorns, they create unnecessary deal competition when they could be exploring the millions of high-growth businesses primed for scale and profitability.
For fast-growing African companies, spreadsheets only tell part of the story. But to discover their worth and unlock true value, investors can’t transplant strategies designed for Western markets to an emerging market context.
Instead, new models and ways of thinking are required. The same innovative thinking that brought Kenya to the forefront of the global mobile money industry should be applied to traditional finance, unlocking capital for the opportunities in Africa.
To make private equity work for Africa, investors must abide by three rules:
1) Tackle the market opportunity (millions of high growth companies) with right-sized capital,
2) Understand the market you are targeting with the right model. 2/20 10-year funds will not work if it takes 7 years to develop a infrastructure project. There is a role to play for local capital, PE, VC, DFIs and pension funds but we must first acknowledge that one size fits all will not work; and
3) Actively manage your investments irrespective of whether they are majority or minority positions.