Managing Expectations in African Private Equity
July 24, 2017
The African oil and gas industry is increasingly turning to private equity for financing. What kind of investor is looking at African energy, and how can they best unlock value in the sector?
At last month’s Africa Oil & Power conference in Cape Town, an overwhelming theme was the role of private equity investment in the African oil and power sectors. Most questions were centered around the quality of private equity investor appetite for opportunities in African oil and gas against a background of the so-called “Africa Rising” narrative. The narrative assumes the continent, given its abundant potential, is on an upswing, potentially attracting significant investment dollars across many sectors, and is buoyed by its youthful population and increasingly solid institutional, regulatory and democratic frameworks. Unfortunately, this is an exaggerated expectation of some African leaders and their commitments to speedy political and economic reforms. And following the collapse in oil prices, slow growth in the US, Europe, and an economic slowdown in China and to some extent India, Africa’s rise began to look a little less stellar.
According to panelists on the Private Equity panel session, many opportunities do exist in the oil and gas sectors. However, investors with an African focus, particularly in oil and gas, will need to have a nuanced approach. Each country has its own regulations, and is at its own individual level of development of its petroleum resources. Most governments are inclined to promote an existing state monopoly or locally established producers. Investments in the oil and power sectors tend to be politically sensitive, capital intensive and labour intensive, making the barriers to entry very high. This gives existing companies a serious advantage over new entrants. The resultant minimal competition does, in fact, create opportunities for those private equity firms with deep pockets, open-ended investment structures and those who are comfortable with long term annuity income expectations.
To invest successfully, companies have to navigate between the portfolio investment expectations and the reality on the ground. In most Sub-Saharan African countries, oil companies that are in need of expansion or growth capital are primarily on-shore local producers, and are oftentimes owned by family-led business owners. There is a tendency for these businesses to have a very wary attitude towards private equity-type funding, and its various expectations — such as seats on the board, line of sight to monthly management accounts, etc. This is due primarily to insufficient exposure to capital market realities and the variety of available funding sources. Most of these companies have tended to rely on traditional bank financing. In situations where the opportunity to invest is clear, closing a transaction has required a lot of “hand-holding” throughout the negotiations.
Notwithstanding that there is a present surplus of oil production in the market keeping prices at $50 per barrel and less, the demand for oil and gas is not going away anytime soon. While alternative and renewable energy is growing, the world today still depends on oil and gas, and that is not slowing down.
Additionally, the issues African focused oil and gas investors face are not dissimilar from those of other investment categories. Clearly, on a risk adjusted basis the African oil and gas opportunities should make sense for the sort of investor who is comfortable with a particular risk profile with potentially high returns. These investors also should not have a ‘one size fits all’ style of de-risking strategy. To potentially unlock value, investors will have to closely shadow their investments through improving corporate strategy and governance.
There is increasingly a larger presence of Africa-originated funding in the African oil and power space, including private equity, in the form of African-owned family offices and development finance institutions like the African Development Bank and African Export-Import Bank. The involvement of development institutions can also encourage private equity firms to seriously consider investment opportunities, as their role oftentimes helps mitigate issues of sovereign risk guarantees.