1. MACRO ECONOMIC ACTIVITY IN AFRICA CONTEXTUALISED JUNE–DECEMBER 2017
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1.1. Recent developments
This essay analyses various global and Africa specific macro events and their likely impact on the African continent’s evolution over the next couple of decades with a particular focus on Sango core countries. Sango Capital is a long-term investor with a focus on African countries. As such, we believe that long-term secular changes will continue to drive both the macro economic and political evolution of various countries. We review these secular trends in this essay. Sango maintains both a strong top-down as well as bottom-up investment selection strategy. Ultimately though, we believe market-leading companies with good management teams tend to perform well and weather macro-economic head-winds better than companies that are not well run.
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1.2. Effects of Fed tapering
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In June 2017, the Federal Reserve approved its second-rate hike of 2017 and provided more detail on how it planned to unwind its US $4.5 trillion balance sheet. The effect of these actions is expected to be a reduction in global liquidity. The build-up of global liquidity has helped finance certain countries with current account deficits and has fuelled stock market rallies across the world. Within an African context, we expect the most exposed countries to be those whose equity market activity and size is a substantial part of economic activity as well as those countries with substantial current account deficits that are not financed by more permanent capital such as foreign direct investment (FDI). From a capital markets perspective, transmission of global risk depends upon the size of the public debt and equity markets relative to the economy as well as the volume of activity of those markets (turnover). The chart below shows 2015 total turnover and stock market capitalizations as a percentage of GDP for Sango focus countries which have a stock market and other geographies. As shown in the chart below, South Africa is the only focus country whose stock market size and activity is substantial enough to expose investors to the risk of global contagion.
From a debt perspective, South Africa’s publicly traded debt capital markets are estimated at approximately 18.7% of GDP while Nigeria’s market is estimated at approximately 20% of GDP. The latter market is also relatively illiquid, which limits the transmission effects of global macro liquidity events. Considering the balance of payments as a transmission mechanism for global liquidity, the next graph shows the proportion of various Sango target countries’ current account balances (as a % GDP) that are not financed by FDI or bilateral aid flows. Assuming that the bulk of any remaining deficits are financed by debt and/or equity portfolio inflows, the countries with the largest shortfalls as depicted below are most sensitive to tightening of global liquidity and reversal of flows to developed markets as their markets recover. The most exposed countries are South Africa, Nigeria, Mozambique, Angola and Kenya. The Fund’s exposure to Mozambique, Angola and Kenya is de minimus, however, the Fund is likely to be sensitive to Fed tapering given its meaningful exposure to South Africa and Nigeria.
To contextualize the risk of FED tapering, we looked at past periods of US FED tapering between 2013 and 2014. The release of FOMC minutes on May 22, 2013 together with then Chairman Bernanke’s speech before the Joint Economic Committee of the U.S. Congress triggered a global reassessment of expectations around the timing and path of adjustment in U.S. monetary policy. This revision in expectations was accompanied with a broad-based sell-off of EMs’ assets. In our analysis, we focused on currency depreciation and declining equity prices, whose transmission effect is immediate, direct and relatively easy to discern. Between May 2013 and December 2013, the South Africa rand depreciated by 9%, and the Nigerian Naira barely moved given that it was a managed float at the time. Equity markets in both countries appreciated during that period.
As shown above, the only Sango core focus country that may be sensitive to more acute global geopolitical risk (especially as it relates to exports and remittances) is Cote d’Ivoire. The only exposure to Cote d’Ivoire is the Fund’s US$7.5 million in ABI which is headquartered in Cote d’Ivoire but has operations throughout Franco-phone West Africa.
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1.4. Key trends for Africa’s long-term future growth
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Whereas the details of global volatility and risk are important day to day and quarter to quarter, the multi-year themes and strategic shifts driving long-term growth in Africa are ultimately likely to play a greater role in economic, country and sector performance over our private equity time horizon. In spite of Africa’s more recent volatility we believe that long-term returns will be driven by supply-demand gaps and tail-winds that tend to be thematic in nature. As we have discussed in the past, we believe that Africa’s long-term growth will be driven by 4 investible themes i.e. (a) the rising consumer driven by demographics, rising technology use, higher labour productivity (b) a natural resources - food theme driven by urbanization; (c) an infrastructure services theme driven by the region’s response to the historic infrastructure gap in the form of massive long-term spending on the sector; and (d) an energy theme - driven by the long-term supply/demand gaps in energy. These themes form the base for sustained and steady growth while the abundance of natural resources and the commodity cycle provides the cyclical ups and downs relative to that base growth rate. A recent report from the McKinsey Global Institute (MGI)1 reiterated some of these trends with updated analysis. We thought it timely to revisit trends in a little more detail in the next section.
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1 Lions on the move II
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1.4.1. Young population with a growing labour force
Africa's young population with a growing labour force will continue to be a highly valuable asset in an ageing world. Africa still has a young population with a median age of 18 compared with the world average of 30. Africa’s population is expected to grow at a compound annualized growth rate (“CAGR”) of 2.3% between 2015 and 2050 while the world population is expected to grow at a CAGR of 0.8% over the same period. It is also worth mentioning that this projected growth means that as the global ageing population (60yrs+) grows by 1.2 billion, Africa’s most productive population cohort (25-59) is expected to grow by 540million (CAGR of 2.9% from 2015 to 2050). Africa’s workforce remains the second largest in the world today and is expected to be the largest in 15 years, essentially the next 2 private equity fund life cycles. The chart below puts that projected population and labour force growth into perspective.
This combined growth in population and labour force productivity is expected to translate into rising consumption. McKinsey Global Institute projects Africa’s consumers will spend $2 trillion over the next 9 years alone. This trend is driving rising demand across a number of consumer-facing companies in our portfolios and consumer focused funds in our active investment pipeline.
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1.4.2. Increasing urbanisation
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Africa has the fastest urbanization rate in the world and much of the economic benefit lies ahead. Over the next decade, an additional 187 million Africans are expected to live in cities, according to the United Nations. By 2030, over 50% of Africa’s population is expected to live in urban areas and this figure is expected to increase to 60% by 2050.
This urban expansion is contributing to rapid growth in household and business consumption. Household consumption grew at a 4.2% compound annual rate between 2010 and 2015 –faster than the continent’s GDP growth rate –to reach $1.3 trillion in 2015. A substantial percentage of this consumption is food related. We will continue to look for opportunities in the food value chain.
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1.4.3. Rapidly accelerating technological change
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African economies remain well positioned to benefit from rapidly accelerating technological change that can unlock growth and leapfrog the limitations and costs of physical infrastructure in important areas of economic life. Mobile and internet penetration, for example, have increased at a CAGR of 30.5% and 29.8% respectively between 2000 to 2014 according to the World Bank. Mobile telephony has already had an outsized effect in Africa as it connected people who previously had little or no access to telecommunications. Studies by the McKinsey Global Institute found that the internet contributed more than 10% of total GDP growth over the past five years in China, India, and Brazil and its impact is accelerating. Various benefits of the internet have been documented over time. These include increased efficiencies in the delivery of public services, increased efficiencies in and accelerated growth of business operations, as well as higher consumer spending power as online sales (which tend
to be cheaper than offline sale) effectively increase each consumer’s purchasing power.
Against, that historic perspective, given the fact that current FED tapering seems to be been more clearly communicated to enable orderly market expectations, we would expect a more muted market response to the ongoing FED tapering. That said, Sango’s investment strategy expects that currency depreciation will occur. Our underwriting for both fund and direct transactions anticipates that depreciation will occur over the life of the relevant investment without a recovery in the currency. In order for us to invest, we have to maintain our conviction despite that depreciation. Additionally, we diversify the portfolio across countries and regions to mitigate such FX effects. Moreover, given the fact that our strategy is focused on private not public markets, we are able to average into select country positions as capital is drawn down to buy assets priced at cheaper currency levels. In addition, the managers we back are hands on in managing around such risks in real time. Furthermore, most of our companies are market leaders in their sectors. Consequently, we would expect that our portfolios will weather periods of even more aggressive currency depreciation. To put this in context, Sango’s combined Fund I and Fund II portfolio achieved average revenue growth of 57.6% in Nigeria in dollar terms in 2016 when the Nigerian Naira had devalued by 58%.
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1.3. Effects of global geopolitical risk
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As part of our risk management, we monitor how global geopolitical risk may be impacting capital flows into and out of Africa, the cost of capital and the volume of international trade. This process help us understand how geopolitical risk may ultimately affect acquisition prices and exit prices for private assets over time. The nationalist and protectionist tide sweeping across the U.S. and Europe is casting a shadow over trade between select African countries and either region. That uncertainty can lead to volatility in balance of payments, capital flows and bilateral aid flows.
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Movements in any or all three can ultimately affect the foreign exchange markets or the attractiveness of certain export oriented sectors. Today, we believe that the low integration of most African economies in the global trading system imply weak transmission mechanisms of geopolitical risk to long-term financial market performance, borrowing costs or trade. To assess the strength of that transmission mechanism, the next chart shows the largest trade and financial exposures of African countries as a percentage of GDP to two of Africa’s major trading partners (United States and European Union).