DEVELOPMENT FRAMEWORK - JSE MAGAZINE

DEVELOPMENT FRAMEWORK

A serious amount of investment is needed for Africa to make up its infrastructure needs

DEVELOPMENT FRAMEWORK

Everyone wants a piece of Africa. After all, it’s the last major growth market. And it’s not small. For one, Africa’s population – which already stands at 1.1 billion – is expected to grow considerably by 2020. Furthermore, it is estimated that with current growth rates, the region’s economy is likely to double in under 20 years.

This makes the area a highly attractive investment destination – EY’s 2014 Africa Attractiveness survey puts Africa second only to North America. And while favourable demographics mean that companies are clamouring to address increasingly attractive consumer markets, the real money is being spent on infrastructure.

According to a World Bank report titled Africa’s Infrastructure: A Time for Transformation, the ‘cost of addressing Africa’s infrastructure needs is around $93 billion a year, about one-third of which is for maintenance – more than twice the Commission for Africa’s (2005) estimate’. This equates to ‘about 15% of the region’s GDP’.

However, even the $93 billion number itself is old – the report was released five years ago.

So that’s the required amount but how much is currently being spent? The same report arrives at a figure of $45 billion a year (in 2008 terms), ‘when budget and off-budget spending (including state-owned enterprises and extra-budgetary funds) and external financiers are taken into account’. This, it says, is higher than previously thought.

The split of where this money comes from is interesting: some ‘$30 billion of annual spending is financed by the African taxpayer’, $9.4 billion is from the private sector and the balance is from development assistance and other financiers. Most prominent in the latter grouping is China, through its various agencies. The other BRICS countries, as well as the African Development Bank, are also large funders.

That said, the private-sector contribution is somewhat distorted by its dominance in the ICT space, with 80% of capital expenditure per year being funded privately. However, nearly half of the $45 billion being spent annually is used for operations and mainte-nance, not capital expenditure.

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The spending split is weighted heavily towards the power and transport sectors – ICT as well as water supply and sanitation are in the high single-digit billions while barely $1 billion a year is being invested in irrigation.

That’s spending. In terms of investment, however, the continent is simply desperate for power.

The World Bank estimates that ‘40% of the total spending needs are associated with power, reflecting Africa’s particularly large deficits’. To put this into perspective, sub-Saharan Africa (49 countries, with close on 1 billion people) generates roughly the same amount of electricity as Spain (45 million people).

RisCura Fundamentals associate Heleen Goussard says: ‘The need for electrification is immediate and has a significant influence on an economy’s ability to take advantage of investment opportunities as the economy diversifies.’

She cites the example of Kenya’s cost of electricity – currently about $0.20 per kWh versus SA’s at $0.07, even after recent price increases.

‘This does not allow for development of major manufacturing industries or mineral beneficiation industries, as these have a high input cost of electricity. Kenya’s current programme of development hopes to halve the cost of electricity, allowing them to be competitive with SA imports after the cost of transport has been taken into account.’

Kenya’s President Uhuru Kenyatta promised in his campaign to increase generation capacity from 1 664 MW to 6 500 MW, says Goussard. ‘Although he might eventually fall short of this target, the current pipeline of projects look set to double the generation capacity of the country by 2017. Some of the projects in development or that have been completed are a coal-fired power plant developed by Centum Investment Company [960 MW], a geothermal power plant [280 MW] and the 300 MW Lake Turkana wind power project, which recently reached financial close.’

In Nigeria, the electricity problem is far larger – it has around 4 000 MW of installed capacity compared to SA’s 44 000 MW, which has a population a quarter of the size of Nigeria’s.

A lot, if not the majority, of this investment in the power sector is being privately funded or has private participation in a public project.

Private equity funds are aware of this opportunity. The Emerging Markets Private Equity Association estimates that $4 billion was raised in 2014 by private equity funds targeting African investments, a substantial increase on the year before.

‘Unlike performances in other regions, infrastructure assets in Africa still offer private equity-style returns and, moreover, enable private equity to invest in scale on a continent where there are limited investment opportunities of sufficient size,’ says South African Venture Capital and Private Equity Association CEO Erika van der Merwe in a press release.

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‘The nature of private equity funds make this a viable investment vehicle for long-term infrastructure assets’

HELEEN GOUSSARD, ASSOCIATE, RISCURA FUNDAMENTALS

‘The bulk of current investment activity is within the power sector and especially in renewable energy. There is a notable uptick in activity in the renewable space throughout Africa. The shortage of energy infrastructure and the move by policymakers and regulators towards alternative energy sources have created interesting prospects for private equity. These tend to be smaller projects compared with large, traditional power projects that are complex to fund and manage.’

In a presentation last year, Raoul Gamsu, CEO of JSE-listed Consolidated Infrastructure Group, said there is an ‘abundance of funding entering the continent chasing deals’.

He would know. With its Angolan oil-services company AES as well as Conco, its power and renewable energy business, 56% of CIG’s profits come from outside of SA’s borders.

However, all this funding triggers the ‘overpricing of assets based on speculation.’ Gamsu emphasised that one needs to ‘understand the operational and strategic “intrinsics” before investing. Macro isn’t good enough’.

It’s here that private equity funds have been sharpest. By definition, they’re excellent at finding and putting together deals that have the best potential returns.

Private equity remains one of the few ways for investors to access this space. ‘There is currently very limited opportunity to gain access to infrastructure investment in Africa by means of listed equity or even bonds,’ says Goussard.

‘This means that investors who want to access these assets must look toward the private equity and credit market. The longer-term nature of private equity funds, with a normal lifespan of about 10 years, make this a viable investment vehicle for long-term and less-liquid infrastructure assets.’

All this investment in infrastructure, particularly power, will unlock growth.

As the World Bank states in its report, the deterioration in the quantity and quality of power infrastructure between 1990 and 2005 effectively ‘retarded growth, shaving 11 basis points from per capita growth for Africa as a whole, and as much as 20 basis points for Southern Africa. The growth effects of further improving Africa’s infrastructure would be even greater. Simulations suggest that if all African countries were to catch up with Mauritius (the regional leader in infrastructure), per capita growth in the region could increase by 2.2 percentage points’.

That is big. Risks are obvious. Goussard says: ‘The main risk remains political, with infrastructure assets by their nature requiring interaction with government – either as buyer, regulator or co-financier.

‘Another risk is currency risk. Often loans are denominated in hard currency, while income is received in local currency, exposing entities to currency fluctuations.’

However, none of these risks are scaring capital away. Yes, they may be higher than elsewhere, but the rewards more than match that.

By Hilton Tarrant
Image: Mr.Xerty © www.nomastaprod.com