Private Equity through a sub-Sarahan African lens
By Bruce McGlogan, Head of Product: Private Equity & Real Estate (Africa/Europe)
The private equity industry has remained resilient over the past decade despite the global financial crisis and resulting regulatory changes. According to PwC, the private equity market size was approximately $3.8 trillion in 2015 and is expected to grow to nearly $7 trillion by 2020 due to increased investor appetite for alternatives products and growth in emerging markets.
At the start of 2016 there was $1.3 trillion of uninvested dry powder in global private equity funds. We have also seen the return of private equity exits over the past few years as a result of a more conducive economic environment with revised capital structures and returning corporate cash balances. Indeed in 2015 it was reported that private equity investors enjoyed a fifth consecutive year of distributions from funds outstripping capital calls.
It is fair to say that the mechanics of global private equity have returned.
Sub-Saharan African growth
International private equity has become the fastest growing source of investment in sub-Saharan Africa, with foreign investors largely from Europe, the US and the UK attracted by many of the fastest expanding economies in the world. Private equity commitments in sub-Saharan Africa are boosting foreign direct investment and infrastructure.
In South Africa specifically we continue to witness a steady uptick in investment into private equity funds with capitalisation of the industry standing at some R165 billion with PE returns over the last 10 years well ahead of comparative returns from listed equities.
What are the drivers?
Fiscal and regulatory changes in South Africa over the last five years are part of the reason for the success, including the government’s commitment to a broad-based investment manager exemption to ensure foreign investment funds are not inadvertently subject to worldwide taxation. This builds on an amendment introduced in 2011 in relation to trading gains.
The extension takes the 2011 exemption a step further by eliminating any potential liability that could arise on a fund on a worldwide basis by virtue of the fund being held to have its place of effective management in South Africa.
This was effectively the final hurdle for a broad-based investment manager exemption and should persuade fund managers not only to remain in South Africa but to relate their business to the jurisdiction. This was a pivotal change in the legislation and has been broadly well received.
Foreign investors prefer to invest through offshore rather than South African funds. This is mainly on account of the tax advantages afforded to offshore investors. The main challenges facing the set-up of offshore funds are i) to ensure that the structure does not become a South African tax resident; and 2) to ensure that the source of gains is not deemed to have occurred in South Africa.
Route to market
As South Africa and the rest of the African continent continue to attract global capital, investors are cognisant to secure investment in a secure and tax efficient manner. They are most likely to choose structuring routes through recognised and reputable International jurisdictions such as Luxembourg, Cayman and more recently Malta. Where funds are available to global and local investors, local structuring is predominately through Mauritius. That said, the South African Reserve Bank has introduced a number of exchange control relaxation measures that are directed at making South Africa the preferred jurisdiction from which to raise and manage private equity investments into Africa.
Amendments to Regulation 28 of the South African Pension Funds Act have gone some way to incentivising the pension funds industry to invest in private equity with an increase in funds allocation to the sector. As exposure to the industry has traditionally been held by individuals and foreign investors, this is a very positive move for the industry.
South African private equity funds are increasingly exploring investment opportunities into the rest of Africa and in particular sub-Saharan Africa. Many firms are looking to raise capital to invest in sub-Saharan Africa investment strategies and are actively looking to source opportunities.
The main rationale for this is that emerging markets have become very attractive to South African private equity funds, with potentially large growth potential in areas such as energy, infrastructure and mining. Further, investments in sub-Saharan Africa include low asset valuations, a commitment to economic reforms and a gradually improving legal framework; another advantage has been resilience amid the financial crisis and economic recession.
The challenges however for foreign investors remain. They are concerned with macro factors, human capital deficiencies and lack of sophistication amongst portfolio companies. Transparency and corporate governance are also marked as areas in need of more attention going forward.
Investments by private equity funds into companies hold great benefits beside the mere cash impact to develop business. Investments have a great impact in terms of job creation and skills development as they include the transfer of knowledge and not only the injection of capital. The rationale here is that private equity fund managers have an active role to play as they derive value from their investments. Indeed in South Africa the private equity sector is seen as a productive contributor to the development of the South African economy.
Although the capitalisation of the private equity market remains small when compared to global funds, the injection of capital is good for Africa in that it will provide much needed capital for small and medium sized businesses.
Another vital application of private equity in South Africa is facilitating the introduction of BEE investment. The industry’s impact on BEE is far reaching and has contributed immeasurably to the socio-economic process in the country.
In conclusion, sub-Saharan Africa remains very much in a growth phase with for investment into Africa’s private equity sector.