IS PRIVATE EQUITY KENYA’S ECONOMIC PANACEA?
With inflation at 19%, commercial lending rates well above 25%, a currency that at its lowest point had depreciated by 30% last year and a on the Nairobi Stock Exchange (NSE) of minus 23% in 2011 - the current state of Kenya’s economy leaves much to be desired. Although the exchange rate has since stabilized, the prognosis in the short-to-medium term does little to inspire confidence as uncertainty continues to grow from;
· an escalating war with Al Shabaab - a militant group that has stubbornly rebuffed invasions by the U.N., Ethiopian and Ugandan forces since 2006;
· imminent results from hearings at the Hague with the potential of resurfacing the animosity that divided our nation in 2008;
· Looming elections in a new constitutional regime that will significantly alter the country’s political landscape.
Despite Kenya’s economic malaise, the country’s aspirations through Vision 2030 remain a beacon of hope. However, recent policy decisions to hike interest rates in a bid to tame inflation have seriously undermined this ambition. The ensuing tightening in liquidity and credit markets is already significantly slowing down capital investment and consumption - critical ingredients for economic growth.
Last year’s drought, arguably the worst in half a century, exposed the weaknesses of our economy. Agriculture currently accounts for about 20% of our GDP and hydro power generation accounts for over 50% of our total power supply, both vital sectors of the economy that are heavily reliant on what are every increasingly unreliable and unpredictable rainfall patterns. This act of nature I believe is the root cause of current inflationary pressure. The bleak outlook for the health of our country’s exchange rate and current account balance largely stem from the subsequent economic impact on these two sectors. Kenya annually imports over 20% of its total food requirements and recent KPLC price hikes are further eroding the competitiveness of our struggling manufacturing sector with electricity prices now over three times that in China and twice that in Egypt.
With a population growing by over 1 million every year and with weather patterns unlikely to improve due to global warming, Kenya is faced with two potentially crippling issues; food security (human energy) and electrical power security (commercial energy). Both of which are fundamental economic drivers that are not receiving the deserved attention through recent monetary and fiscal policy interventions. Effectively upgrading our agricultural and power sectors in-line with Vision 2030 goals no doubt will require significant capital investment, in the order of trillions of shillings over the next two decades. Only 10% of arable land in Kenya is currently irrigated and we are yet to develop our vast geothermal resources estimated at 7,000 to 10,000 MW compared to our current power supply of approximately 1,400 MW.
The question that beckons is; “Where this capital will be sourced with a government that is cash strapped and operating at its debt ceiling, and the scarcity of now risk averse foreign capital in the wake of the sticky Euro debt crisis?” As often said; “charity begins at home”. A closer look at the country’s balance sheet indicates a vast reserve of private capital, currently underutilized and often chasing a limited number of ‘pricy’ opportunities. Casing points are:
· The Safaricom IPO in 2008 that was oversubscribed by 532%, raising over KES 220 billion over an offering period of under one month almost causing a systemic liquidity crisis in our banking sector in the process.
· A real-estate market producing over 30,000 units every year despite there being under 20,000 mortgages in existence today indicating a significant proportion of 100% equity financed purchases.
· Pension funds with total assets of KES 415 billion and a meager allocation of 0.6% (KES 2.5 billion) to Private Equity (PE) compared to the West where fund allocation to PE in the range of 15% to 20% is not unusual. In Kenya, close to 29% is allocated to quoted equities, which has left investors wreathing over the past 5 years with annualized returns averaging a poor 0% underperforming real estate by 14 % and inflation by 9% over the same period.
Having established the investment need, identified investors seeking long-term investment products with stable equity like returns but lower price volatility, and a source of private capital adequate to the fund equity portions of large agricultural and power projects - the emanating million dollar question is; “How can this capital be mobilized and deployed where it is needed most?”
There are four critical success factors required to achieve this need. First, the Government needs to create an enabling policy framework that will reduce investment risk and subsequently improve the attractiveness of Greenfield investment opportunities in these two sectors. In Agriculture, this could be done by providing sovereign off-taker agreements for agricultural produce creating a win-win situation for both suppliers and consumers. In the power sector, actualizing talks of providing sovereign guarantees to reduce dry well drilling risk in the geothermal sector is a key success factor for the development of this resource. I would argue that these ‘setup’ costs are small in comparison to the potentially catastrophic consequences of doing nothing or the Government bursting its borrowing limits to finance capital investment in these sectors.
Secondly, key regulatory bodies e.g. the Kenyan Retirement Benefits Authority that institute checks and balances on the allocation of capital amongst asset classes need to acknowledge that Kenya’s local PE industry has come of age and deserves a larger portfolio allocation. What was once an unfamiliar nascent industry now boasts a wealth of world class local talent and expertise evidenced by; the supernormal returns generated by investment companies such as Britak, TransCentury and Centum, and global recognition of some fund managers e.g. James Mworia, Centum’s CEO who was awarded the 2011 CNBC Africa Young African Business Leader of the Year.
Thirdly, PE managers need to work with technical partners to identify, develop and structure investment opportunities that meet the return expectations and risk profile of private investors, who are increasingly seeking wider diversification beyond quoted equities, fixed income and real estate. Finally, there is a need for continual engagement and education amongst the key stake holders identified on the PE business model and the benefits and opportunities realised by pooling funds in PE vehicles supported by well aligned full-time investment professionals. A conference such as the Super Return Africa PE Conference held in Nairobi in November 2011 is an example of an effective forum in doing so.
In closing, it would be difficult to argue that PE alone is Kenya’s economic panacea however; there is a strong case to suggest that PE has the catalytic potential to remedy some of Kenya’s economic woes and accelerate the country’s progression in realizing Vision 2030. Better still, all the tools required to unlock this potential are within our grasp today.