Attracting Private Sector Investment in Intermediary Municipalities: A Case Study from the Kenyan Coast

Introduction

Kenya is rapidly urbanising, with its intermediary municipalities growing the fastest; for example, Malindi, on Kenya’s North Coast, experienced 45% population growth between 2009-2019.1 These intermediary municipalities have struggled to expand their infrastructure, service delivery, and create the jobs necessary to support this rapidly growing population.

For this reason, the Sustainable Urban Economic Development (SUED) Programme, funded by the UK government, was established to support twelve2 fast-growing intermediary municipalities across Kenya to attract investment for critical climate-smart value chain and infrastructure projects. After launching it in 2018, SUED supported the selected municipalities to develop sustainable urban economic plans3 to guide their economic growth, starting with the first set of municipalities, Isiolo, Kitui, and Malindi, followed by the remaining nine. In this article, we will examine what the experience of Malindi can teach future practitioners about how to successfully attract private investment into intermediary municipalities.

Context

From the urban economic planning process in Malindi, a long list of potential value chain and infrastructure projects emerged.4 The SUED team then worked with representatives of the county and municipality to narrow down to three high-potential projects to take forward to investment attraction, as an immediate step towards mobilising funding and attracting investments. In Malindi, the selected projects focused on fruit processing, the blue economy, and commercialisation of sewage sludge from a proposed faecal sludge treatment plant. The fruit processing project emerged as a front runner to attract private capital, as Malindi is well positioned for fruit farming and agro-processing because of its favourable climatic conditions, wide transport network, and substantial workforce.

The SUED team reviewed the fruit processing landscape in Malindi during the pre-feasibility stage to identify opportunities to strengthen and diversify the sector. SUED discovered that local operators working in Malindi and the surrounding regions have good working relationships with farmers in the municipality and distinct operational knowledge of the fruit processing value chain in Malindi. Operators would also be able to leverage the abundant supply of mangoes, pineapples, and passion fruits harvested in Malindi and its environs to increase the income of farmers and create more local jobs. This provided an opportunity for potential investment in existing processors to effectively strengthen and diversify their supply chain and enable impact.

Planned Approach

Initially, the investment attraction process as defined and agreed by SUED and stakeholders involved a progression from urban economic planning to pre-feasibility studies, then immediately moving to a single due diligence stage (see Figure 1). This due diligence was intended to review a single operator, selected from among the range of potential operations identified as capable through the pre-feasibility studies. This process assumed that a high-potential operator within the municipality would be easily identifiable. Based on this assumption, the programme intended to support that operator with raising capital, including

1 Kenya National Bureau of Statistics. Retrieved from: https://www.citypopulation.de/en/kenya/cities/.

2 Kitui, Malindi, Isiolo, Kathwana, Iten, Kisii, Eldoret, Kerugoya, Mandera, Lamu, Bungoma and Wote

3 The UEP is a plan that promotes economic growth and supports urban development in a sustainable and inclusive way through prioritised integrated projects

4 The urban economic plans can be accessed here: https://www.suedkenya.org/urban-economic-plans transaction structuring with potential support from the SUED Seed Fund, a grant facility to fill defined gaps in high-impact projects and leverage additional private capital. As the SUED investment attraction firm proceeded with this intended process, a number of lessons were learned about how to adjust this typical investment attraction process to the realities of working in intermediary municipalities.

Lesson 1: Cast a wide net for potential private sector partners

Additional projectstaken forwardby municipalityas capacityallows topursuefull UEPvision

As part of the investment attraction process, the programme learned that a broader number of potential operators, including regional players, may need to be considered, given the limited pool of businesses within higher-risk intermediary municipalities. The SUED team ultimately held conversations with more than 40 potential operators, investors, and industry experts, in order to identify one player to invest in Malindi’s fruit processing value chain. The initial consultations focused on local players, the most significant of which were a Malindi-based farmer-owned cooperative which operates a juice processing facility and a development finance institution (DFI)-owned processor which produced banana puree and mango concentrate for the export market. The SUED team conducted detailed due diligence reports on these two operators immediately following the pre-feasibility stage. Based on the due diligence insights and stakeholder feedback, the projects presented significant management, financial, and reputational risks for further engagement, hence a decision was made not to pursue them further.

After this experience, SUED focused on ‘widening the funnel’ by engaging regional players and more than 20 potential financiers willing to back operators as well as key sector experts and potential operational partners. From this wider set of conversations, one operator, Milly Fruit Processors Limited (“Milly Fruits”), emerged with the necessary experience and capital as well as interest to undertake a new project in Malindi. Milly Fruits operates a facility in Mtwapa, approximately 100 kilometres south of Malindi, which processes mangoes and other tropical fruits into pulp for the export market as well as producing bottled juice under the Picana brand for the local retail market. Milly Fruits had identified a plan to diversify into drying mangoes which would require a new production line and SUED was able to build their interest in locating this new facility in Malindi municipality, rather than their current base of Mtwapa, with support from the SUED Seed Fund. Milly Fruits was attracted by the opportunity to broaden their sourcing of raw fruits in and around Malindi as a central point on Kenya’s North Coast, with logistical synergies with a large-scale farm owned by the company as well as access to the port of Mombasa with a good road network.

Lesson 2: Perform a lighter-touch due diligence on several players before going deeper with the finalist

Initially, the investment attraction plan involved steps which are common across many other investment processes but proved unsuitable for the challenging environments in which SUED is focused. In these intermediary municipalities, there are few operators which have the scale, formality, and compliance protocols required for a donor-funded projects, and therefore, it was not efficient to perform a detailed formal due diligence early in the engagement with potential operators. After this initial experience, the programme developed a better-suited process by dividing the single stage due diligence resources into two stages - first conducting a “lighter touch” diligence on several players, then going deeper on the selected operator/investor (see Table 1). This two-stage process allowed SUED to ‘co-create’ plans with suitable operators, several of whom were entering new, higher-risk markets, including Milly Fruits in Malindi.

The revised two-stage due diligence approach has since been used on new opportunities pursued by SUED and has cascaded through to the other investment attraction firms, so all SUED municipalities could benefit from these initial learnings. In the case of a subsequent project to support the Malindi Water and Sewerage Company (MAWASCO) to contain and transport faecal sludge to be recycled into industrial briquettes, the due diligence process will take place after the project is clearly defined and external funders are identified. This change has streamlined the process by enabling the due diligence to be tailored to the particular funders’ requirements.

Table 1: Summary of the 2-stage due diligence process

Stage Process & key outcomes

Pre-Due Diligence

• Receive indicative buy-in from the key stakeholders for project approach, including a letter of interest (LOI) from the key implementor/operator

• Finalise an initial list of potential external investors for the project

• Based on the investors identified, finalise key components required for each due diligence process, which are likely to differ based on individual project needs

Due Diligence

Post-Due Diligence and Completion of External Investment

• Perform a detailed assessment of the operator and approach focused on key financial, legal, regulatory, and reputational risks and expectations tailored to the needs of the pre-identified likely investors and donors The specific content is expected to differ based on individual project needs

• Manage the investment attraction process through the completion of external investment

• In some cases, additional market building or partnerships work along the value chain will be required to address the risks highlighted in due diligence; this may be completed by the funder or other interested parties

• Public procurement or other public sector activities may be needed to ensure legal compliance and a facilitatory enabling environment

Lesson 3: Help the operator structure the opportunity and identify financing alternatives

In the case of Malindi, the project structuring interaction started with helping the operator think through the strategic advantages of the project, the proposed scale, how to measure impact, and the overall financing approach, to determine the suitability for the SUED Seed Fund. For Milly Fruits, they saw that the SUED Seed Fund presented an opportunity to accelerate the process of setting up a fruit drying facility by relocating to Malindi, rather than looking for resources to set up the facility within their current plant in Mtwapa; the also recognized the logistical synergies of operating in Malindi, given proximity to a largescale farm owned by the company and the good road network with access to the Mombasa port.

Thereafter, a significant component of project structuring was the evaluation of financing alternatives to meet the SUED Seed Fund’s co-funding and leverage ratio requirements. For private sector operators like Milly Fruits, it was relatively easier to structure the co-financing due to the operator’s individual contribution in the project. To meet the Seed Fund contribution threshold of approximately 25% of the total project cost, the SUED team evaluated potential options including cash contributions and debt. Due to Milly Fruits’ prior experience in acquiring commercial debt in the local market, Milly Fruits was amendable to raising debt from their existing bankers and financiers, which bridged the gap between the Seed Fund contribution and Milly Fruits' cash contribution. Upon further evaluation of the project during the Seed Fund application process, SUED was able to consider additional funding from impact investors to scale the project in a second phase of the project roll-out plan, which improved the leverage ratio significantly.

Conversely, structuring public infrastructure projects such as the commercialisation of sewage sludge in partnership with MAWASCO has been more complex due to the nature of the project, which aims to improve the sanitation value chain in Malindi by ensuring a sustainable supply of waste to be recycled into briquettes. As a public entity, MAWASCO has limited access to public finance, so the SUED team is helping MAWASCO to confirm the interest of several development and social enterprise partners to cofinance the project. As the application documents are developed, the partners funding commitments will need to be validated to ensure there is strong project ownership and accountability from the operator as well as the partners.

Conclusion

The initial investment attraction experience of the first municipalities participating in the SUED programme offers a suggested approach for future municipal investment attraction. For a streamlined approach, the following process is recommended:

1. Start with wider funnel of potential operators: Recognising that intermediary municipalities are more challenging environments, start with a wide range of potential operators, including regional players, if necessary.

2. Rapid high-level operator assessment: Rather than diving into an intensive due diligence process right away, conduct a high-level screening of potential risks, based on conversations with the prospective operator and other local stakeholders and industry experts.

3. Project structuring and identification of high-potential funders: Support the operator to structure an investor-ready project and identify likely funders, such that the final project structuring and due diligence can be tailored to their requirements.

4. Detailed due diligence: Conduct a tailored due diligence depending on the needs of the prospective investor and/or donor; this may include a review of financial, legal, regulatory, and reputational risks.

5. Financial close: Support the operator to close the investment, including, in some cases, conducting additional market building and partnerships formation along the value chain to address the risks highlighted through due diligence.