The hottest frontier Strategies for putting money to work in a fast-growing continent WHEN you are trying to keep

a retail outfit afloat amid hyperinflation, it helps to have a sideline. We had a business selling crocodile skins to Herms and Gucci for shoes and handbags, says John Koumides, chief executive of Innscor, a conglomerate based in Zimbabwes capital, Harare. The currency earned from this exotic export was a lifeline for the firms other arms, including its SPAR stores, when Zimbabwes shops were short of stock in 2008 as its currency collapsed. Innscor survived. It remains an unwieldy mix of businesses even though it has shed the crocodile-skin enterprise. But it is attracting attention from investors seeking to profit from the emergence of a new class of African consumers: its shares have risen by 50% in the past year. The firms mainstay, and the bit that excites the most interest, is fast food, with brands including Chicken Inn and Pizza Inn. Its outlets are now in a handful of other African countries, including Nigeria. Africas equity markets are hot, with investors attracted by the sub-Saharan regions GDP growth rate of more than 5% over the past three years. The main markets in Nigeria and Kenya have risen by more than 50% in the past year. Over the past decade Africa supplied six of the worlds ten economies with the fastest growth. By 2020 more than half of African households will have enough income to splurge some of it on non-essentials, according to McKinsey, a consultancy. Furthermore, more than half of Africas population is aged under 20. Within three decades it will have a larger working-age population than China. But Africa is short of savings and capital. That creates an opening for rich-world investors seeking a better return than is available at home. North Africa, tied to Mediterranean trade, is fairly well developed and is seen by some as a separate investment proposition. So is South Africa, the continents biggest economy, which has a slower growth rate than most of its neighbours and more mature consumer and financial industries. The real source of excitement is the frontier markets of sub-Saharan Africa. This is where the flavour is, says Thabo Ncalo, who manages an Africa Fund for Johannesburg-based Stanlib. Small investors looking for a taste might choose to buy a stake in a mutual fund or one of the exchange-traded funds that mechanically track an index of frontier-market stocks. Fund managers are mindful of the liquidity problems that forced the closure of New Stars Africa Fund in 2009 barely a year after it was launched. Of 200-odd shares listed on Nigerias stockmarket, the largest of the frontier markets in sub-Saharan Africa, perhaps two dozen are liquid enough to make mutual-fund managers feel truly comfortable. A handful of big consumer firms that have been in Nigeria for a long time, such as Unilever and Nestl, are listed locally and are liked by foreign investors. A local favourite is UAC, a food company with interests in paint and property, which has doubled in value in the past year. Its Gala sausage rolls are a popular snack and it is the local partner with Innscors fast-food outlets. Beer companies are another way to gain exposure to the African consumer. Nigerian Breweries makes Star Lager and Legend Extra, a stout for those who think Guinness lacks punch. East African Breweries, listed in Nairobi and half-owned by Diageo, has similar appeal. Its combined market in Kenya, Uganda and Tanzania is more than 120m people, not much smaller than the Nigerian market of 167m. Beyond Nigeria and Kenya is a big liquidity cliff, says Andrew Brudenell, who runs a frontier fund for HSBC. The next-largest exchange is Zimbabwes. Even quite large stocks can be hard to buy and sell on a given day. PZ Cussons Nigeria, an offshoot of the Manchester-based firm behind Imperial Leather soap, has an average daily turnover in its stock of $220,000, notes Mr Brudenell. But strip out the big blocks of shares that occasionally change hands and the stock churns $73,000 a day. One way around the shortage of liquid stocks is to buy companies that have most of their assets or earnings in Africa but are listed elsewhere. Some mining firms listed in London and Toronto have most of their assets in Africa. The trouble with such stocks is that they are a gamble on commodity prices and the skill of a team of geologists rather than a bet on a broader story about Africas improving economy. That is why some mutual funds prefer stocks such as MTN, a South African cellphone firm that makes a lot of its money in the rest of Africa. Shoprite, the largest grocery retailer in South Africa, is growing beyond its home base in South Africa and in a few years might similarly qualify for inclusion as a frontier investment. A

concern for would-be investors is that mutual funds stick only with liquid stockseven ones that look expensiveand miss out on small and local businesses, such as retail chains, that could turn into regional giants. The public-equity pipeline Some investors fret that the supply of fresh equity may fail to keep pace with the demand from richworld buyers. Family-owned businesses are often unwilling to cede control by selling shares. A privatisation drive in Rwanda, which took off with the sale of the countrys biggest bank and of a big stake in its main brewer, has lost momentum. Yet demand usually creates its own supply. You cant always put a lot of money to work very quickly, says Clifford Sacks, the chief executive of Renaissance Capital in Africa. But patient investors can benefit from liquidity events when a chunk of stock is suddenly on offer. Ecobank, a Togo-based bank, raised $250m last year from PIC, South Africas state-employee pension fund, to buy Oceanic Bank, a Nigerian lender. What is more, because liquid stocks are prized, a family business might be persuaded to sell a block of stock to attract a broader class of investors. In the process it will raise the value of its remaining equity. Price is always a consideration. The owner of a Nigerian consumer business would be rightly reluctant to list at 2009 prices. But if the rally in stocks continues, a spurt of initial public offerings (IPOs) should follow. New issues tend to occur in three stages. Banks are among the first enterprises to list. Next come telecoms firms, breweries and cement companies, which need a lot of capital spending to sustain their growth. Dangote Cement, a big Nigerian firm, has plans to list a chunk of its stock in London. Cement stocks are a way for small investors to get exposure to infrastructure projects, which are financed by private and development banks. A third tier of potential listings includes consumer businesses in Nigeria, property companies in Kenya and enterprises related to the recent oil-and-gas discoveries in east Africa. A few biggish IPOs in Africa would increase the universe of stocks. But many people think the real opportunity lies with private equity, which can stick with businesses while they grow. Barbarians welcome Private equity in Africa is different from its equivalent in America and Europe. A typical rich-world deal might involve a mature but torpid firm, which is acquired and loaded with debt to magnify the returns of the equity owners. In Africa the returns come from revenue growth and efficiency gains, not from financial engineering, says Runa Alam, head of Development Partners International, a private-equity firm that specialises in Africa. Expertise as well as capital is supplied. Single-country firms are often transformed into regional ones. Celtel, a mobile-phone company started by a British-Sudanese entrepreneur, Mo Ibrahim, is one such privateequity success story. Celtel was sold to Zain, a Middle Eastern cellular outfit (it is now owned by Bharti Airtel of India). Such trade sales are a source of regret for public investors starved of biggish stock to buy. As Africas stockmarkets deepen, and valuations rise, private-equity firms will increasingly look to the public markets to realise their investments. In November Actis, a British private-equity fund, reduced its stake in Umeme, an electricity-generation company bought from the Ugandan government in 2005. It did this through the first ever dual listing in Uganda and Kenya, where liquidity is greater. Investors in Africa are buying a big-picture story of progress towards a formal and regulated economy with stable politics, the rule of law, independent central banks and stricter accounting rules. That prospect is brighter than it was. Nobody can guarantee that future progress will be in a straight line. But given the troubles in large parts of the rich world, many will feel there is a lot more to gain than to lose.

The Economist, Apr 6th 2013

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