Gateway to the Continent
South Africa remains attractive both as a market in itself and as a way to tap into growth elsewhere on the continent, says Ngalaah Chuphi of Ethos Private Equity.
Africa’s vast potential is hardly a secret. With a population of around one billion, set to double by 2050, economic growth rates that outshine the stagnant West, and myriad infrastructure projects underway to tap its vast reserves of natural resources, it should be no surprise that the investment world has turned its attention towards such a bountiful continent. Yet it’s not without its peril: a shortage of skills and persistent corruption in some countries make the area deserving of caution too.
Investors have become increasingly interested in the BRIC nations in recent years, but Ernst & Young’s latest Global VC and PE Country Attractiveness Index ranked South Africa above both Brazil and Russia in terms of its appeal. Not only is it the largest economy in sub-Saharan Africa, but it offers the skill base, robustness and security that many other African nations lack. Hence a company bought in South Africa can serve not only as a foothold in the continent’s largest economy, but also as an effective platform through which to access the continent’s wider potential.
This is the philosophy driving Ethos, one of the most experienced and successful private equity fund managers in South Africa. “This image of Africa as a centre of growth, and South Africa’s role as the way in, is being borne out by people speaking with their wallets,” says Ngalaah Chuphi, partner at Ethos. “They’re after capturing this growth.”
BENEFITING FROM THE BOOM
Ethos has experienced this investor appetite for South African businesses first-hand. Since its foundation in 1984, the group has invested in over 100 deals, and exited 89 of those with impressive returns. It recently put the seal on its Fund VI, which closed at $800 million.
There are several key factors that make South Africa such an appealing destination for private equity and venture capital. First, the helpful economic environment – from its friendly taxation policy to its investor protections and corporate governance. The latter is especially important. “Many nations outside South Africa have a governance issue which can make operating in Africa difficult,” says Chuphi. “But by buying a South African company, you lower the risk and strengthen your foundations. So we look for successful companies that have strong potential for growth. That company can then act as a way to exploit growth in the rest of Africa.”
South Africa also boasts a broader skills base and superior infrastructure than its neighbours, which again makes it a logical base from which to launch wider operations. Ethos has invested in several companies that follow that exact strategy: from Waco, a leader in scaffolding and modular building, to Brandcorp, Africa’s largest supplier of industrial tools. Both are well positioned to exploit the booming construction of roads and buildings that characterises countries like Ghana and Mozambique, as they seek to profit from the scramble for natural resources.
“We seek out those sectors that will drive the companies to superior growth,” says Chuphi. “Africa is still putting its infrastructure together – there’s all this demand for commodities but you need the infrastructure in order to get them out. We don’t invest directly in infrastructure but we do look for companies that will benefit from the infrastructure boom.”
But it’s not just about infrastructure. Ethos also sees huge potential in Africa’s consumers. Not only are Johannesburg’s retail areas buzzing, but with a vastly expanding middle class, already heavily urbanised, Africa is now experiencing growth in areas like retail, healthcare, education, and e-services around the financial services industry. Again, the method is to buy in South Africa, and to build the company to exploit its growth potential elsewhere. “Adding value is the bread and butter for us,” says Chuphi. “We buy good companies, make them great, and then sell them.”
A PLATFORM FOR GROWTH
As an active shareholder, Ethos invests in domestic businesses where it can have full or joint control. It has a mandate to invest up to 20 percent of the fund outside of South Africa, which is done via joint control with a trusted local partner. The onus in all deals is on finding companies that both demonstrate opportunities for growth and have a management team that is capable of capitalising on it.
From there, the focus shifts to optimising operations. Ethos meets the team to decide a plan for growth – whether that’s rolling out new stores in new areas, releasing new product lines or expanding into new geographies outside South Africa. It then provides the capital for them to do this, and finally finds them a natural home. That may be a domestic company wishing to expand its portfolio, a foreign group using it as a platform to achieve growth either within or outside of South Africa, or a listing on the Johannesburg Stock Exchange. “Usually our plan will take four or five years to play out, and then we look to exit,” says Chuphi.
Indeed, Chuphi cites ease of exit as another reason behind South Africa’s appeal to private equity. Its economy is suitably corporatised, with a capital market that is the sixteenth largest in the world. It also has a huge financial sector, which makes finding buyers relatively easy. No surprise, then, that 89 of Ethos’ 102 deals have closed for cash, with Chuphi citing great interest from, among others, Japanese investors. “Fifty percent of companies on the South African stock exchange are owned by foreign investors,” he says. “Multinationals want to use South Africa as a platform for growth, so they’re looking for great South African companies. And they’re buying these companies from Ethos. We typically have multiple interested parties when we contemplate an exit.”
With $800 million now accumulated for Fund VI, Fund V is at the point of maturation, and despite delays as a result of the global financial crisis (which, says Chuphi, has extended the holding period for many deals by 15 months) Ethos is starting to think about exits. “Obviously we will be assessing things to determine when is best to exit to get the best value for our investors. But we are lining things up and are ready to push the button over the next two or three years.”
Of course, while South Africa remains attractive, it isn’t insulated from what’s happening in the rest of the world. Its sophisticated economy is tied inextricably to events in the US and particularly in Europe, its largest trading partner for manufactured goods. So what happens there will affect its fortunes. Its reliance on commodities makes it vulnerable to fluctuations in prices there, too. And its M&A market is following the same pattern as M&A globally – the pace is currently slower than in the last couple of years, with sellers often maintaining an unrealistically high expectation of how much they should stand to make.
The key point, however, is that big deals are still being done. And with South Africa in prime position to act as a gateway to a vast continent of untapped opportunity, activity shows no sign of abating any time soon. “While South Africa’s growth forecast is moderate [the IMF predict it to slow from 2.8 to 2 percent this year], the superior opportunity presented by the rest of the continent balances risk and returns,” says Chuphi. “Yes, it’s slowing; but it’s still growth.” And growth, as Ethos knows, will always create opportunity.
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