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GATEWAY TO GROWTH

PUBLISHED: September 2010 - The PEI Africa Handbook 2010

Ethos Private Equity, the 26-year old firm that has staked a claim as one of South Africa’s major players, has come to view the country as a gateway into other sub-Saharan African countries

The growth of middle class throughout sub-Saharan Africa has presented private equity firms with a vast and compelling opportunity for investment. But to access the budding middle classes in countries such as Kenya and Nigeria, businesses including some private equity firms have set up bases in South Africa which has become the gateway to the sub-Saharan regions, says Ethos Private Equity.

Ethos has been operating in the country for 26 years and is one of many firms looking to tap into the growth of a consumer class in sub-Saharan countries.

The firm was set up in 1984 and was originally established as part of the First National Bank, and then First Rand Group.  In 1998, the firm spun off from its parents to become independent. Since its formation, Ethos has raised five private equity funds, including the $750 million Ethos Fund V in 2006.

 Chuphi: 'democracy drives growth'

Platform 

The firm has followed as part of its strategy setting up platform investment in South Africa, and looking to expand them in other countries in sub-Saharan Africa.

For example, Ethos owned tyre manufacturer  Dunlop in South Africa.

The private equity firm initially invested in the Johannesburg-listed company in 1998 and took the company private in 2002. The business also had operations in Zimbabwe, Zambia and Nigeria.

A foreign trade buyer bought Dunlop from Ethos for an undisclosed amount in 2006.  The foreign buyer had targeted several different countries to make an acquisition, but chose South Africa because of the size of the economy relative to other sub-Saharan Africa countries, its growing middle class and the infrastructure rollout by the South African government, according to prior media reports.

South Africa’s “sophisticated” financial system, world class infrastructure and corporate governance helps make it a place investors want to come to set up shop, according to Ngalaah Chuphi, a partner with Ethos.  Also the country has trade agreement with other sub-Saharan countries that help ease companies’ expansion into territories north of its borders, he says.

Emerging middle class

Part of the success of Ethos’ Dunlop investment was the acceleration of automobile ownership in South Africa and throughout sub-Saharan Africa as the middle class expanded.  

The emergence of the black consumer in South Africa is one of Ethos’ overarching themes for investments in the country.  Since 1994, Chupi says, the government in South Africa has worked to democratise and facilitate integration of the black population into the economic mainstream.

Because of these policies, a middle class has been emerging, which can afford to spend on purchases such as homes, automobiles and appliances, Chupi says.

As an example, Chuphi says. “We saw the level of electrification after 1994 would increase dramatically.  The government began providing electricity to rural homes, and urban centres where black people lived, and with that, we knew most homes would need a stove and a refrigerator.  We invested in a company that built those products.”

The expanding middle class is symptomatic of wider improving macro-economic management and democratic stability, which is a significant factor in terms of the region‘s overall economic development.  

“A lot of people may tell you demand for resources is the only factor driving the growth in sub-Saharan Africa.  However, better macro-economic management and growing political democracy is also a key driver of the growth,” Chuphi says.  

Nigeria is another example of better macro-economic management and a growing democracy which is driving its growth and creating a middle class. “Since 1999, Nigeria has maintained democracy.  The economy is growing on average above 5 percent a year, which is creating an emerging consumer class.  South African companies are taking advantage of this and setting up operations in Nigeria,” he says.

Infrastructure Rollout

Another theme Ethos sees is the rollout of infrastructure.  The firm doesn’t invest in the actual infrastructure projects, but in the business that supply into the infrastructure projects.

“In South Africa, infrastructure upgrade includes expansion of the rail, road networks, expanding ports and building new power stations.  We look to take advantage, where possible, of companies that will benefit from this expansion,” Chuphi says.

In addition, South Africa is rich in natural resources such as platinum, coal, iron ore and gold.  Increasing the demand for these resources from India and China is causing South Africa‘s mining companies to expand capacity and put in a new infrastructure around their projects, which is creating opportunities, Chuphi says.

South Africa in the downturn 

As is the case with other emerging markets, South Africa was less impacted by the financial downturn of the past few years. In addition, while the economy was impacted, South African banks were largely unaffected by financial crisis and were able to continue lending throughout the crisis.  Furthermore government took stimulatory measures that helped the country pull out of the downturn relatively quickly by maintaining its infrastructure rollout programme.

“You could still find credit to fund growth even during the crisis,” Chuphi says.  “South Africa came out of the crisis relatively quickly.”

When it comes to new deals, it became difficult to price deals during the crisis due to lack of visibility on corporate earnings and private equity players stood back  and took a ‘wait and see’ approach ,” Chuphi says.

One thing the downturn did do was force some international firms to retract back to their home countries, where they had challenges to address.  “During the hey days, we started to see some large international firms coming into our markets. But since the crisis, the large international private equity players have retracted. However, this may change in time,”Chuphi says.

Into the Future

Since its formation, Ethos has invested in 99 companies, 85 of which have been realised.  Ethos is currently raising its sixth private equity fund, targeting $750 million.  The fund size is appropriate for our investment strategy, Chuphi says.

“We will maintain our strategy. We operate at the larger end of the deal market, where we’ve created competence,” he says.  “There’s a sufficient deal flow at that end and where the competition is less intense.  Competition is more intense the mid-and lower end of market.”

We see deal environment in South Africa starting to open, with banks ready to finance transactions and visibility on corporate earnings beginning to emerge, Chuphi says.