Enhancing Development While Reaping Enviable Returns: Assessing The Private Equity Landscape In Africa

Richard Laing

CEO, CDC Group plc

28 February 2010

2

CDC – who we are

CDC’s mission: to foster growth in sustainable businesses, helping to raise living standards in developing countries

• CDC, wholly owned by the UK Government, is the world’s oldest development finance institution. We have been investing in developing countries, including Africa, since 1948.

• Since 2004, CDC has operated as a fund of funds. We commit capital to emerging market focussed private equity funds, which invest in private sector businesses.

• Private sector businesses play a vital part in economic growth and development: they employ and train people, provide decent livelihoods, pay taxes, invest in research and development and build and operate infrastructure and services.

3

CDC – our portfolio

• Through our funds, we have invested in 71 countries in the emerging markets, and across all industry sectors.

• CDC has a strong focus on sub-Saharan Africa, Asia and Low Income Countries.

• CDC has invested with 71 fund managers, 143 funds and approx 1,000 private sector businesses.

• As at the end of 2009:

– Net assets: £2.5bn

– Total commitments of £2.9bn.

– Total returns of £207m in 2009

– Average annual returns of 16% over the past five years.

– 6% ahead of the MSCI benchmark on a three year rolling basis.

CDC portfolio value by region, 2009

CDC portfolio value by sector, 2009

4

Africa’s macroeconomic outlook: Continued growth & resilience to the crisis

2011 GDP growth forecast (% annual growth)

6.0%

5.1%

8.3%

8.5%

8.7%

4.8%

5.2%

2.3%

SSA excluding SA

Sub-Saharan Africa

MENA

China

India

Russia

Brazil

OECD

Source: EMPEA 2010

?

5

Africa’s macroeconomic outlook: Continued growth & resilience to the crisis

• SSA was able to combat the financial crisis thanks to improved macroeconomic fundamentals.

• A number of reforms implemented across the sub-continent over the past two decades have resulted in improved current account balances, a fall in external debt (also aided by international debt relief) and relatively low inflation. In fact, many of these indicators are better in sub-Saharan Africa than in more advanced economies.

2011 GDP growth forecast (% annual growth)

6.0%

5.1%

8.3%

8.5%

8.7%

4.8%

5.2%

2.3%

SSA excluding SA

Sub-Saharan Africa

MENA

China

India

Russia

Brazil

OECD

Source: EMPEA 2010

?

6

6.9%

17.5%

4.9%

5.7%

3.4%

7.7%

DRC

Ghana

Kenya

Nigeria

South Africa

Angola

Africa’s macroeconomic outlook: Continued growth & resilience to the crisis

• SSA was able to combat the financial crisis thanks to improved macroeconomic fundamentals.

• A number of reforms implemented across the sub-continent over the past two decades have resulted in improved current account balances, a fall in external debt (also aided by international debt relief) and relatively low inflation. In fact, many of these indicators are better in sub-Saharan Africa than in more advanced economies.

2011 GDP growth forecast (% annual growth)

6.0%

5.1%

8.3%

8.5%

8.7%

4.8%

5.2%

2.3%

SSA excluding SA

Sub-Saharan Africa

MENA

China

India

Russia

Brazil

OECD

Source: EMPEA 2010

?

7

Which countries in Africa?

NIGERIA

Population: 156.1m

GDP (2010): $206.7bn

SOUTH AFRICA

Population: 49.9m

GDP (2010): $351bn

Source: IMF, World Economic Outlook, Oct. 2010. GDP is in current prices

EGYPT

Population: 78.2m

GDP (2010): $210bn

LIBERIA

Population: 4.3m

GDP (2010): $1.0bn

BOTSWANA

Population: 1.8m

GDP (2010): $12.5bn

DRC

Population: 66.7m

GDP (2010): $12.6bn

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Does the politics matter?

• We are closely watching developments in Tunisia, Egypt, the rest of north Africa, Cote d’Ivoire and Sudan.

• With 18 elections in 2011 in Africa and increasing food prices, we can expect social demonstrations to gain momentum in the continent.

• We are watching particularly investments in the financial and the power sectors, where CDC’s exposure is concentrated.

• Governance risk related to close links and relationship between politic leaders and business owners.

• Local knowledge and experience is essential – to define investment strategies that protect investments from potential unrest and to take adequate measures to protect value of investments.

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Does the politics matter? CDC’s investment in Cote d’Ivoire

• In 1996, through its investment in CompagnieHévéicole de Cavally (Cavally), CDC acquired 2,000 hectares of rubber plantation located in the MoyenCavally region of western Côte d’Ivoire. At the time, CDC was still a direct investor. CDC’s investment has been managed by Actis since 2004.

• CDC’s investment enabled the Cavally to build a modern rubber processing factory, which is an important source of employment in a remote rural region, with its 1000+ employees.

• CDC was one of few foreign investors that remained active in Côte d’Ivoire following the coups d'état in 1999 and 2002, and the subsequent civil war.

• Despite the long periods of instability experienced in Côte d’Ivoire throughout CDC’s 11 year investment period, Compagnie Hévéicole de Cavally developed one of the most productive rubber plantations in West Africa producing a premium export product.

• The plantation was sold in 2007 to a well-established tropical plantation business. Returns were in the range of 3x and 12% IRR.

10

0

50

100

150

200

250

300

350

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

United States Western Europe Emerging Asia (ex-JANZ)

LatAm & Caribbean MENA Sub-Saharan Africa

• PE fundraising was severely hit by the crisis, both in developed and emerging markets. In the US it fell from a peak of $325.8bn in 2007 to $70bn in 2009.

• Fundraising in SSA is still very small compared to other markets. Even at the peak in 2007-8, fundraising in sub-Saharan Africa was less than 1% of that in the US.

Private Equity Fundraising: Africa vs. the rest of the world

Global PE fundraising 2001-2010 ($bn)

Source: EMPEA 2010. Europe data are full year preliminary estimates

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0

500

1,000

1,500

2,000

2,500

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Private Equity Fundraising in Sub-Saharan Africa

Sub-Saharan Africa PE fundraising 2001-2010 ($m)

Source: EMPEA 2010

• PE fundraising in sub-Saharan Africa fell from a high of $2,241m in 2008 to $964m in 2009.

• After the crisis, the recovery of fundraising momentum in sub-Saharan Africa was stronger than in many other emerging markets, including China, India and Russia, and comparable to robust performance seen in Latin America.

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Shortage of capital in Africa and PE investment

• Despite increase in fundraising and investment in the last decade, private equity investment in Africa remains at low levels. Outside South Africa, penetration rates are still very low.

• Institutional investors from Europe and the US are very cautious, and require higher rates of return, based on an overly high perceived risk. In fact the main perceived risk factors (political instability, weak legal systems, corruption, etc), are comparable to those of other emerging markets.

• Conclusion: there is huge capacity in the African market for higher volumes of PE investment.

0.00%

0.50%

1.00%

1.50%

UK US Brazil Russia India China South

Africa

Sub-

Saharan

Africa

MENA

2008

2009

2010

PE penetration rates (% of GDP)

Source: EMPEA

Sub-Saharan Africa

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What sectors in Africa? Infrastructure

3.4

18.221.9

93.3

0.9

11.616.2

7.6

45.3

9

40.8

9

0

50

100

ICT Irrigation Power Transport Water supply

and sanitation

Total

Spending requirement

Existing expenditure Funding gap of $48bn pa

Most severe in power and water supply and sanitation

• Sub-Saharan Africa lags behind other low income countries in all measures of basic infrastructure provision. The most severe deficits are in power generation, transport, telecoms (fixed lines).

• There is a huge funding gap for infrastructure, of which part is due to inefficiencies, lack of maintenance, distribution losses, overstaffing but also to inadequate allocation of resources.

• Efficiency improvements would save about $17.4bn pa.

After potential efficiency gains, the funding gap is $31bn a year, 75% in power

Africa infrastructure gap ($bn)

Source: AICD, 2008

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What sectors in Africa? Consumer and the growing middle class

• The commodity boom explains only part of Africa’s growth in the last decade. Internal consumption is increasing, driven by favourable demographic trends: a growing and young population, and urbanisation.

• Consumer facing sectors (consumer goods, telecom, and banking, among others) are already growing three times faster than those of OECD countries.

• Africa’s households spent a combined $860bn in 2008, more than those in India or Russia. This is projected to rise to $1.4trn over the next 10 years if GDP maintains its current growth rate.

2 1

149

35

29

31

36

1825

2000 2008

Compound annual growth rate, 2000-08

-0.2

1.5

-0.8

3.2

3.5

Discretionary income

Share of households by income bracket (% of households)

Source: McKinsey Global Institute, 2010

$2,000-5,000

<$2,000

<$2,000

$2,000-5,000

$5,000-10,000

$10,000-20,000

>$20,000

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What sectors in Africa? Financial services

• Africa’ banking assets totalled $1.2tn in 2008, the same size as India. Financial reforms have enabled growth in the sector, at a higher pace than GDP.

• New technology (e.g. mobile telecoms) is increasing formal financial inclusion.

• However, access to the banking sector remains low. Banking services are expensive and a majority of African adults rely on informal services. The growing middle class is driving demand for consumer financial services (banking, insurance, mortgage lending and asset management).

• Private sector credit is also low with the exception of the biggest economies.

0% 20% 40% 60% 80% 100%

Zambia

Tanzania

Kenya

Botswana

Namibia

South Africa

Formally included

Semi formally included

Informally included

Excluded

Financial inclusion (% of population)

Source: Finscope Africa, 2007

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Private equity investment in Africa: LPs perception

60.0%

58.0%

34.0%

29.0%

27.0%

Limited number of

established GPs

Political risk

Weak exit environments

Challenging regulatory/tax

Scale of opportunities to

invest is too small

Source: 2010 EMPEA/ Coller Capital EM PE Survey

Factors deterring LPs from beginning to invest in Africa

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Successful

investing in Africa

Pioneering mentality

Long term perspective

Best practice approach

Diversified portfolio Growth investing

Tolerance for risk

Local knowledge

Extensive research

Private equity investment in Africa – how we do it

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The link between financial and development performance

Result: Correlation between good ESG management systems and 15% higher IRR at CDC portfolio companies.

Explanation: Possibly generally better managed companies. ESG management is a subset of company management.

Next steps: Improved data over time and further analysis.

For fund managers: CDC ESG Toolkit provides guidance for fund managers on identifying and prioritizing ESG actions as part of their business plan for portfolio companies.

CDC encourages its fund managers to identify ESG risks and include ESG improvements in their business plan for potential investee companies. This is consistent with CDC’s Investment Code and CDC’s Toolkit on ESG which seek to implement ESG best practice over time.

CDC’s portfolio in 2010 demonstrated a correlation between companies’ financial performance and their ESG management. IFC’s Monitor newsletter made a similar observation in 2007.

“ Financial performance of IFC’s client companies is highly correlated with development outcome: over 97% of projects with satisfactory or better financial performance also have high development ratings, whereas only 5% of projects with unsatisfactory financial performance achieve high development ratings” IFC October 2007

-8

-4

0

4

8

Poor GoodModerate

-7.7%

5.6%

7.4%

(N=143)

IRR(%)

ESG management systems and portfolio company returns (mean IRR, %)

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Relevant to all stages of investment cycle:

Tool 1 Adding value through ESG improvements

Tool 2 ESG policies and guidelines

Tool 3 ESG considerations at each stage of the investment process

Tool 4 Questions to assess a fund manager’s ESG management systems

Relevant to specific parts of the investment process:

Tool 5 Rating ESG risks

Tool 6 ESG due diligence

Tool 7 Environmental and social impact assessments

Tool 8 Questions to assess a company’s ESG management systems

Tool 9 Investment paper and action plan for ESG improvements

Tool 10 Investment agreement

Tool 11 Investment monitoring

Tool 12 ESG reporting

Tool 13 Information for the public: annual reports and websites

Tool 14 ESG considerations for exits

CDC’s Toolkit on ESG for fund managers contains 14 Tools

CDC’s Toolkit provides tools aimed at integrating and achieving added value from ESG throughout a fund manager’s investment process. It can be downloaded from CDC’s website: www.cdcgroup.com

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Private equity investment in Africa – CDC’s portfolio performance

• The IRR of CDC’s total African portfolio between 31 Dec 2004 and 31 Dec 2009 was 25.2%.

• This compares with returns of:

• 14.1% from the Cambridge Associates Emerging Markets VC/PE Index

• 9.7% from the Cambridge Associates US PE Index

• As CDC only became a fund of funds in 2004, the majority of the realised returns come from the direct investments that CDC had made with its balance sheet prior to 2004

• Actis has been managing and exiting these investments on behalf of CDC

• Between 31 Dec 2004 and 31 Dec 2009 these “legacy” African assets had an IRR of 40.0%

• CDC has classed the riskiness of new PE fund investments (ex-ante) in three groups:

• Best of Breed I (lowest risk – i.e. best-in-class funds)

• Best of Breed II

• Frontier (highest risk – e.g. first-time teams,unproven strategies, new markets etc)

• As this chart shows, the risk/return relationship has held well.

(Caution: many funds are still in the early stagesof the “J-curve”)

2.5%

10.0%

16.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Best-of-Breed I Best-of-Breed II Frontier

Ne

t IR

R

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Conclusion

• Africa has buoyant underlying economic growth

• This presents huge potential for private sector investing, especially in infrastructure and consumer based sectors

• Africa presents significant opportunities for PE investment:

• Valuations remain low, and returns are high, compared to all-time low yields in developed markets

• There is little competing capital

• Exit opportunities are increasing, due to domestic institutional capital growth (pension funds, insurance companies, etc) and increased buy-out appetite from strategic buyers

• There is still opportunity for early mover advantage

• Development impact and financial return go hand-in-hand

but ………….

• There are not enough fund managers and deal flow is limited

• Avoid businesses too closely linked to governments

• Deep local knowledge is necessary

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