Africa – A Case for Investment

Neil Urmson

03-Jul-2012

With many developed economies having lost their lustre and China and India displaying some cracks in their growth stories, where else can investors look for the next opportunity? Perhaps the dark continent of Africa offers some light and reasons why returns could be higher than previously anticipated.

Changing perceptions

Imagine a continent with ravaging diseases, terrifying poverty, escalating corruption, never ending wars and downwardly progressing economies. A dark continent that appears inviting only to those in search of precious metals and hidden gems. Conversely, imagine a bustling landscape, rising levels of foreign investment, a marked increase in GDP year on year, a rising middle class, a clearly defined consumer and a continent that is transforming not just on the merit of its natural resources but sectors like technology and telecommunication. Both describe the same continent - Africa, a cluster of countries that has emerged from a stereotypical framework into a region that is described as next growth market.

The change the continent has witnessed over the last few decades has been remarkable. A gathering of 50 odd economies are making conscious efforts at instilling infrastructure and systems in place to encourage investors to take a second look at their economy. Governments are working hard to create a better, safer environment for businesses. There is a clear recognition of the potential that exists and the changes that need to be made in order to match up to the growth offered by some other nations.

Africa is not far behind. Although political battles have struck economies in the north, sub-Saharan Africa is considered the second fastest growing region after Asia. GDP forecast for 2012 is 5.8%*, while foreign direct investment has increased from $9 billion in 2000 to $88 billion 2008**. FDI from developing economies is known to be on a rising trend.

Why then, does it not sit comfortably next to the BRIC nations with regards to investor appetite?

What's holding it back?

Economists believe that if Africa wants to bridge the gap between emerging and developed nations, it must have a few critical components in place. It requires the establishment of sound, sustainable business institutions. Opening up the private sector is considered to be paramount. Countries need to invest heavily in developing infrastructure, building transport links and constructing solid strategies to encourage further investment. A development model rests on few key pillars of political stability, property rights, access to capital, investment in health and education.

Some believe that an environment to support entrepreneurs is required. Viability of small businesses is essential to the health of any economy as growing, entrepreneurial companies create a multiplier effect. There is clearly a greater need for transparency, accountability and lower levels of corruption.

Governments need to develop the right policies and incentives for capital to come in. It is important that African authorities allow ideas, capital and businesses to circulate and develop. But while some of these factors may be discouraging the risk averse investor, it is creating tremendous opportunity for those in search of under-priced assets.

Emerging markets supporting growth in Africa

The developing nations have been the first to recognize this fact. Africa is strengthening trade and investment links with countries like Turkey and oil rich Middle East. There is data to support the fact that foreign direct investment from the emerging economies is rising compared to investment from the more developed countries.

Having shared a similar political past, countries like China and India recognize the dangers of colonialism and foreign intervention. China with its hunger for natural resources has approached Africa and offered a commitment to invest in infrastructure. Some predict that this is the early stage of a long and fruitful relationship. India began its involvement at a later stage and has noticed a few non-resource related skills that can be transferred easily to an expansive continent with a growing population. Countries like Russia are also starting to show an interest in Africa. And without doubt, economies of the West have been involved historically, over a longer period of time with the hope of extracting a higher rate of return on their investment. Give the size of the continent; the variety of countries, cultures and assets, almost any country could take advantage of the continent's growth.

A strategy for the private investor – buyer beware

What strategy should a private investor employ to tap into Africa’s potential?

The decision to invest in Africa should be no different from any other investment decision. Can you earn a return which is above inflation and which compensates for the risks taken. The risks in this case are many. Corruption and fraud. Government and legislative frameworks. Excessive debt against illiquid, unmatched assets. Permanent market failure and incorrect data.

The probability of mispricing is far higher in a market like Africa than in developed markets and is likely to be a function of one of the following:

Distrust. Most minds doubt disclosure and governance on the African continent. In addition, investors are distrustful of many governments, having witnessed many failed reform efforts which have lacked continuity.
Liquidity. Outside of one or two major markets, liquidity is an issue. Assets can become mispriced as investors try to exit positions or as excess fund flows chase prices up in an attempt to get fully invested. Short-selling is not currently a reality, further distorting price discovery and liquidity.
Corruption and fraud. This is a major concern, especially so where shareholders’ rights are not firmly entrenched and where shareholder activism and a free press are not encouraged. Perceptions of fraud and corruption can just as easily cause mispricing.
Political instability. Governments can quickly change, followed by significant change to the way an economy is run. The difference between one government and its opposition can be far wider than in the developed world.
Lack of information. African markets and the listed and unlisted assets in these markets are often not well-researched. This is partly due to large institutions not putting resources on areas not on their clients’ radars. Lack of information technology, less stringent reporting requirements and poor physical infrastructure can also make it harder to access data.

Where is the opportunity?

With this in mind, is an investor likely to find companies trading below fair value in Africa?

We believe the answer is almost certainly yes. Having considered the risks, Africa presents many attractive opportunities. We believe an investment strategy should be characterised by the following:

Bottom-up, in-depth analysis of investment opportunities, allowing for some margin of safety
Greater diversity than normal, without compromising on quality
A long investment time horizon
Fund management with specialist African expertise, with a commitment to investing in Africa for the long term and the resources and practical know-how to execute

Clearly it would be foolish to assume that you can employ one single strategy for a cluster of 53 countries. Africa does not represent one single opportunity any more than Europe, the BRICs or any other emerging market. Therefore with 53 countries on offer, different economies, a continent with natural resources in abundance, developing markets and clear consumer demand, the case for labelling Africa as an emerging economy exists. For the brave investor, a pioneering entry into Africa could provide returns that outweigh the risks by a mile. The dark continent could soon offer gems of a different sort.

*Source: IMF
**Source: United Nations

The opinions and views expressed are for information purposes only and are subject to change without notice. They should not be viewed as independent research, recommendations or investment advice of any nature.

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