Dealmaker

Understanding the rules of engagement for INVESTING IN AFRICA —a dealmaker’s considerations by Rob Bergman, a Corporate Finance principal at Bravura

With the South African economy showing limited growth, and likely to be close to recession this year due to Eskom’s power cuts, South African investors are increasingly looking north of the border for better investment opportunities and returns.

In Africa, there are fewer companies with established footprints and the potential is significant given its populous and fastgrowing markets. The adjunct to this is that the potential is only significant if investors know and understand the African environment or use advisors who are familiar and experienced in doing deals on the continent. The failure to do so can have a costly negative impact, as evidenced by several of South Africa’s largest multinationals having had to write down the bulk of their investments on the continent.

Merger and acquisition pitfalls - Africa is not Africa International investors are cognisant of the fact that regions such as Europe or Asia include different markets that require specific investment strategies. Yet Africa continues to be perceived as a homogenous population group. Reference to a population of one billion inhabitants somewhat recklessly conflates numerous different markets into one. The reality is that similar to Europe and Asia, the continent is characterised by countries with diverse populations that have different consumption preferences and spending patterns and there are clear distinctions between countries and regions from a cultural and social perspective.

Deal making needs time Deal making in Africa takes a long time. It can take a few years to source the right deal after having built relationships and established trust. Building up personal relationships requires meetings, dining, discussing and getting to know potential partners, as well as fully understanding the environment the company operates in. Additionally, it takes longer to build and create value. In all probability, the investor may have reached year seven or eight after the initial investment before the value is created. Following this, a structured exit would need to be generated which will again take a long period given that the new partner must feel comfortable with the deal and the remaining local partner. Therefore, investing in Africa is a long-term game, at least longer than the standard investment period most (financial) investors are used to.

A few dollars a day for Africa’s middle class Africa’s potential is linked to its emerging middle class which is the fastest growing in the world; according to the World Bank, it stands at 350 million (Africa’s overall population is one billion people).

Although consumer spending accounts for 50 to 60% of Africa’s economic growth, 85% of Africans live on less than $5.50 per day. This means that the choice of investment is critical and careful consideration must be taken of the product that will be brought to market and whether an existing global product will require adjustment to meet the requirements of the local consumers and their purchase power. In other words, don’t invest in a premium product that costs multiple dollars and expect the volumes that other countries are producing. Selling premium products and large packaging items are more difficult to yield strong results; a local market of 100 million people spending a few dollars a day on food or consumables (i.e. in small packaging) has greater potential.

For example, consumable products may require packaging limited to single-use portions and distribution channels might primarily consist of wholesale outlets and informal street vendors rather than retail shopping centres and corner stores. Only a thorough understanding of the particular characteristics of the target country’s consumer markets will deliver sustainable profits. Understanding extends to considering the product’s commercial

aspects and whether these should be adjusted to meet the local consumers’ buying constraints or habits.

Understanding distribution Struggles with logistics and distribution are common in Africa, partly as a result of poor infrastructure. Although the African Continental Free Trade Area (AfCTFA) agreement signed by 49 African Union nations to enable free cross-border trade on 90% of goods has been billed as a potential game-changer, Africa’s commercial challenges linked to distribution will likely remain. Market polarities as previously mentioned result in low instances of successful product replication in other African jurisdictions. Additionally, building local distribution channels to the endconsumer in a location without formal infrastructure takes a tremendous amount of effort. Successful local businesses in Africa know their markets and distribution channels. Once having successfully tapped into the market, expansion is achieved through the development of new products within the same country, using the same distribution method. Africa is not Africa as mentioned it doesn’t consist of one massive population and there are intricacies within each country. For companies looking to expand across African territories, this will mean beginning at ground level in each country, doing research, building contacts and developing distribution networks. One size will not fit all. Undoubtedly owning the distribution channels in Africa can bring competitive advantage, but many investors will not have the resources of time, effort and a high learning cost to build this up successfully. For those companies wishing to make an investment, and particularly when they don’t have an existing in-country presence, the best advice is to partner with businesses or investment advisors that do understand these markets and can tap into the local context.

The 360 o due diligence A 360-degree due diligence is critical in that it builds up a full image of the potential investment in order to ascertain whether it will be a good fit, whether the business is built around the owner and if so, what the likelihood is of the business running as before should the owner take a minority position or exit altogether. Talking to other people who are able to provide supplementary information about the potential acquisition and its perception in the market is highly useful. The main example of this dynamic is the promotor’s role in driving the business environment and relationships. Although the company looks good to an outside investor, little is usually known about how the interaction with the direct business environment will change post-transaction. There are ample examples of government policy or distributor and client relationship changes negatively impacting the company’s operating model immediately post-transaction due to the underestimated influence of the promotor on this business environment. This means performing one’s due diligence shouldn’t just focus on the target company but should also include an assessment of post-transaction business environment changes once the promotor is not in control anymore.

Finally, doing business in Africa is significantly relationshipbased and driven by strong political dynamics. Building a business requires access to the right people and often requires intensive interaction with the government as a stakeholder. This does not refer to bribery and corruption; it is the notion of being wellconnected in order to find opportunities or to be introduced to existing distribution channels and established service providers. Being able to bring an attractive deal to the table requires ample groundwork and will include positioning the product, building up the distribution channels and suppliers, and getting to grips with the market from clients to competitors.

Always invest with a local partner As a final conclusion to what makes a great investment in Africa: always invest with a local partner. The intricacies of doing business in Africa take great skill to manoeuvre and can only successfully be done by entrepreneurs who’ve been doing it for a long time in that country. Don’t try to go in alone, there are not a lot of success stories of such a route out there.

Conclusion

The reality is that many investors into Africa do not do their homework adequately which leads to loss-making acquisitions; a high cost to pay for their efforts. Yet for those who invest time and effort into understanding the market, taking into account those unique cultural, social, consumer and business environments that exist on the continent, and understand that it’s critical to partner with the right people, significant investment opportunities await.