Opinion: In Africa, Local Firms Gain More Than Investors When Private Equity Gets On The Train

Written by Dana Sanchez

Sep 24, 2015

The time it takes to send a container by rail on the Rift Valley Railways has fallen by more than half and, for the first time in decades, the trains are running on time.

Now, as much as 10 percent of the traffic out of Mombasa is carried by rail—double the share of a few years ago—and new wagons and locomotives may double that share again.

The improvement is almost entirely due to the influence of private equity on a railway that, when built in British colonial times, seemed such an outlandish venture that it was dubbed the “lunatic line.” Qalaa Holdings, an Egyptian investment firm, has invested almost $200 million in improving the railway since it first took a stake in 2010.

More than money, Qalaa has brought skills and technology. When it arrived it found a “dead fleet” of locomotives rusting in the sidings for lack of spare parts. Almost half have been repaired. New machines now carry out maintenance on the tracks at a rate of 1 kilometer an hour, where previously it was done by hand at a pace of 40 meters an hour.

“Without proper processes and maintenance, capital spending is just money down the drain,” says Karim Sadek, Qalaa’s managing director.

Other private-equity firms are drawing similar lessons. “You have to be really hands-on with every one of your companies,” says Suleiman Kiggundu of CDC, a development arm of the British government that uses private-equity techniques. With luck, this will mean that the large amounts of private-equity money now going into Africa—seen as the last great frontier market—are not wasted. Last year such investments reached $8.1 billion, close to the pre-crisis peak and well up on the low of $1.5 billion in 2009.

This great migration of capital comes as African economies are slowing after a decade of good growth. Lower commodity prices are dampening expansion in places such as Nigeria and Angola. Poor financial management is hurting others, such as Ghana, Kenya and South Africa. But the slowdown may affect African businesses less than ones that private-equity firms have invested in elsewhere in the world.

In many countries, a typical deal would involve a buyout fund loading its newly acquired business with debt, to multiply its returns. In Africa, most buyouts are done with little or no debt because domestic-currency borrowing rates are so high—perhaps 15-to-24 percent in the region’s larger economies. (Foreign-currency rates are much lower, but are a risky bet for businesses that do not earn revenues in dollars or euros to pay back their loans).

So, instead of boosting African businesses’ returns through debt, private-equity firms have to increase revenue and improve efficiency.

Yet even if they adapt to local conditions, buyout firms still find that Africa is no path to easy riches. In the 10 years to September 2014, South African private-equity firms, for instance, delivered returns that, although seemingly juicy at 18.5 percent a year (in local currency), were less than their investors would have earned simply by betting on stock markets.

Data on other firms and other countries are sparse, but industry insiders reckon that African deals had annual returns of only about 11 percent for the decade to 2012. Fewer than half of buyout funds did better than the median fund investing in listed stocks. The worst-performing investments were those struck during the previous peak, a warning to those firms now itching to spend unused capital.

In the rich world, private equity is often accused of enriching investors at the expense of the firms they buy. In Africa, the reverse seems to hold.