Articles from Cass Knowledge

Into Africa: the lion begins to roar

It has taken 50 years for the wind of change to blow through the continent, but former colonies, rich in commodities, are finally inching towards stable government and proving a draw for enlightened foreign investors, writes Nick Mathiason.

It was little wonder that, at the height of the leverage boom in 2006 when private equity rampaged through corporate Europe and America, a relatively small investment in Kenya escaped attention. The London-based private equity firm Aureos Capital injected $5 million (£3.2 million) into the Athi River Steel plant in Movoko, 30 kilometres (18 miles) east of Nairobi. But this deal, unlike most private equity acquisitions signed at that time, paid off. Since 2006 Athi has declared a 77 per cent rise in turnover from $9 million to $16 million and has expanded into new product areas. Its plant site has grown from five acres to 30 acres and Athi now employs 800 people in an area desperate for jobs. Kenya used to import 50 per cent of its steel. If Athi could undercut foreign firms, guarantee quality and ensure distribution of its products - a huge problem in much of Africa - it would thrive.

Unalloyed success
It has. It is an unalloyed success, exporting hot and cold-rolled steel to neighbouring East African nations and expanding organically and through acquisition. The story of Aureos - a joint venture founded in 2001 by the emerging markets specialists CDC Group and Norfund - is emblematic of a change in investor sentiment towards Africa. In 2009 Aureos raised $150 million to invest in African companies selling into local markets. "That's a large sum of money in a market where raising capital is tough," said Sev Vettivetpillai, the Chief Executive. "Today a large chunk of growth is in emerging markets and we have proved you can invest responsibly in these markets and achieve attractive returns while paying attention to building sustainable businesses." The story is being replicated across Africa. What was once a no-go continent for investors is seen today as a new frontier for growth. A consensus is emerging that the African lion is on the move. A recent McKinsey Africa report stated that the continent's GDP in 2008 was $1.6 trillion - equivalent to Brazil and Russia - but is projected to grow to what it calls "a $2.6 trillion business opportunity" by 2020. McKinsey predicts African consumer spending will grow from $860 billion to $1.4 trillion in nine years.

Technological revolution
Kate Phylaktis, Professor of International Finance and Director of the Emerging Markets Group at Cass Business School, said: "The potential of many African countries with plentiful resources has now been recognised and a number of fund managers are turning to Africa to take advantage of potential future economic growth, which will be reflected in high returns and possible international diversification benefits since African markets do not co-move with world markets." Analysts say the mobile phone is transforming African economic prospects. Since 2000 there have been 316 million new mobile subscribers. Cash transfers are increasingly made on phones. Unlikely as it may seem, Africa is at the vanguard of a technological revolution in financial services. Rapid urbanisation, while creating huge social problems, also fuels demand for new services and construction. As international attention focuses on how to feed a world population projected to increase by almost 50 per cent over the next 40 years to nine billion, Africa is beginning to be seen as a food security solution. The continent has 60 per cent of the world's cultivable land. This explains the rush of investors and sovereign wealth funds beating a path to Africa. The trend polarises opinion between those who believe increased investor funds will boost yields, bring more skilled jobs and enable an African "green revolution" and those who characterise the new agenda as "land grabbing", perpetuating exploitative, colonial-style relations between Africa and outsiders.

Misguided investment
For so long Africa was the continent where dreams shattered. "The wind of change" described by the British Prime Minister Harold Macmillan in Cape Town in February 1960 ushered in the age of African national independence, ending more than two centuries of plunder and colonialism. However, the hope of independence was swiftly extinguished by internecine conflict, famine, corruption, greed, proxy wars conducted by the US and the Soviet Union, disease, swingeing debt and catastrophically misguided investment. After independence, a series of industrial schemes should have turned countries such as Ghana into emerging economies. Instead, many were ruined. The drive to substitute imports with indigenous industry was a laudable ambition but largely floundered. This meant investment cash diverted away from agriculture. The result was economic stagnation and starvation.

Only now are the pieces being put back together with relatively stable governments increasing agricultural spend. Today, thanks to a reduction in African conflict, relative macro-economic stability has allowed debt and inflation to reduce. The break-up of state monopolies and other business-friendly policies and rising commodity prices have created a construction, banking and consumer spending boom. It has propelled Africa's GDP to rise, on average, by 4.9 per cent a year since 2000. It means, as McKinsey put it, that "global businesses cannot afford to ignore the potential".The World Bank is similarly optimistic. It stated in November 2010 that the continent "could be on the brink of an economic take-off, much like China was 30 years ago and India 20 years ago".

Political stability
Africa has been here before. In the early 1970s, high oil prices led to a temporary improvement before economies crashed as inflation surged and commodity prices fell back. Could the same happen again? It is possible but unlikely, given the huge reserves of oil, gas, gold, chromium and platinum in Africa. Everything depends, though, on continued political stability, with recent events in Sudan and the Ivory Coast giving rise to concern, and the ability of resource-rich nations to use the cash generated by those resources to diversify. While governance is still an issue - it is all but impossible for a Zambian to see a doctor quickly without paying a bribe to jump the queue - illicit cash payments by foreign firms to politicians and officials to secure advantageous tax rates and licence agreements are reducing. These days, upfront payments, equity shares, knowledge transfer and tangible infrastructure benefits are increasingly common requirements of mining agreements. Tougher terms have not dissuaded foreign investment into Africa. In fact it has increased sevenfold since 2000 from $9 billion to $63 billion and better terms of trade are certainly a price the Chinese seem willing to pay. In fact, since 2005, Chinese infrastructure commitments in sub-Saharan Africa have exceeded the World Bank's. The financial crisis did hit Africa hard. Equity markets fell. Nigeria's stock market capitalisation, for instance, peaked at $100 billion in March 2007. By December 2008 that was down to $30 billion. African nations forced to import oil were hit hard by huge price spikes that followed in the immediate wake of the bank crash. Subsequent falls hit commodity-rich nations. Overall, African trade with developed nations fell by a third in the immediate aftermath of the crash. Cotton growers in West Africa fared particularly badly as recession-hit Chinese garment factories wound down. But Africa's banking sector largely escaped unscathed thanks to its undeveloped nature, which meant that it avoided exposure to complex financial instruments. South African banks, in particular, fared well during the financial crisis. Their resilience came from proactive measures taken well before the financial crisis broke, bank analysts suggest. These included enhanced training for executive and non-executive directors, sensible pay structures and a rigorous focus on risk management. Perhaps in this respect, South African banks are leading the world.

Lack of liquidity
There is, though, a huge journey. Bank debt is not freely available to small businesses. They are generally required to put up land as collateral before loans can be accessed. This is highly restrictive to small and medium-sized enterprises which are the engines of growth in developed economies. It also means the main way of accessing capital is via an equity placement. "A lack of liquidity in many of these markets means investors might not be able to sell their shares when they want to," argues Professor Phylaktis. "A lack of corporate governance does not protect shareholders. A study we conducted on the African equity markets of Côte d'Ivoire, Ghana, Nigeria, Morocco and Tunisia found investors expect a premium for the lack of liquidity. They expect to be compensated for the illiquidity of markets and the poor legal institutions.* "Investors in African markets should have a long-term horizon. Finally, there is still a lack of information about these markets." Impressive growth figures can mask reality on the ground. During the boom years, the least developed nations, most of which are in Africa, averaged growth rates of seven per cent per year. But dependence on commodities in the 49 least developed countries increased overall. And in more than half of them the manufacturing share of the country's "total value added" declined.

Free-trade zone
Africa is at a crossroads. Its large, youthful population, increasingly business-friendly governments, fertile lands and abundant natural resources gives it enormous economic potential. But it faces huge challenges - infrastructure, education, health and governance - that constrain development and growth. Some believe that Africa looks like China 30 years ago. But the key difference is that Africa is divided into 54 separate nations. The ability to adopt a coherent, continental development plan for growth akin to "capitalism with Chinese characteristics" is questionable, although steps are being taken. At a recent G20 leaders meeting in Seoul, plans were outlined to create an African free-trade zone to develop "south-south trade". The World Bank said in November 2010: "The untapped potential of mobilising domestic resources and the rise in private capital flows to Africa calls for a new approach: Africa as an investment proposition." After being called "a scar on the conscience of the world" by Tony Blair in 2001, that is perhaps an indication of significant progress.

*Legal Regime, Size and Liquidity Factors in Asset Pricing, Bruce Hearn, University of Leicester, Kate Phylaktis, Cass Business School and Jenifer Piesse, King's College London.

Nick Mathiason, formerly Business Correspondent at The Guardian, is a business development and media strategy consultant.