Over the past decade, demand for commodities, increased political stability, improving legal and regulatory environments, sustained economic growth and deepening financial liquidity have all been positive trends that stimulate economic growth and attract investors to Africa and its population of one billion people. African Foreign Direct Investment (FDI) rose by 17 percent to $62 billion in 2008, compared to a global decline in FDI of 20 percent, according to www.AfricanEconomicOutlook.org. The first half of 2009 has, of course, seen a net outflow of foreign capital from all emerging markets, including Africa, with some of that capital now returning.
African FDI is invested into infrastructure businesses and projects. In West Africa, the growth of the oil and gas and mining industries is creating demand for new power generation and transport infrastructure. In North Africa, there is demand for gas-fired power plants and export-led infrastructure such as ports. In Central, East and Southern Africa, the mining industry needs power and transport infrastructure, and growing populations are demanding more and better electricity, water, transport and telecoms services.
Each country is different
Each country within Sub-Saharan Africa (SSA) has its own regulatory regime, macro-economic dynamics, political priorities and cultural heritage. In an attempt to avoid SSA generalities, this article will focus on three SSA countries: one from the South (South Africa), the East (Kenya) and the West (Nigeria).
Consistent themes in each of these countries include a limited volume and quality of existing stock of infrastructure assets. The Infrastructure Density Index (IDI – an index of paved roads, rail network, airports and telephone lines’ density) shows how SSA measures up against other regions.
The index calibrates the supply/demand gap that is witnessed in daily commuter traffic jams in Lagos, average rail speeds of 20km/h in Kenya, intermittent land and mobile phone connections in Nigeria and regular power load-shedding in Uganda and South Africa. In the power sector, capacity per person in SSA is one third that of South Asia (they were equal in 1980). SSA consumption is 500 kWh per capita per annum versus 1,200 kWh pa average in all emerging markets.
Underinvestment into infrastructure is a universal problem but the SSA region is worse than most. Drivers of this underinvestment include inefficient delivery of new greenfield projects due to a lack of political will, a shortage of public finances and relatively few private sector investors with appetite for SSA countries.
The SSA countries all have growing populations. This growth is widening the supply/demand gap and worsening the existing situation. The pressure on governments to address this under-investment is now compelling. There are growing indications that the political and economic environment is improving in many of Africa’s important economies. In particular, regulatory frameworks are developing that enable the private sector to play an enlarged role in bridging the continent’s infrastructure supply/demand gap.
Private sector finance is increasingly viewed as the saviour of this lack of investment. New regulations have come into force in countries including Nigeria, Kenya and Tanzania that have created opportunities for private investors to participate in the privatisation and construction of infrastructure assets.
Risk/reward varies by country, sector and project and every
investor assesses it differently
Private sector equity finance is attracted to infrastructure opportunities where the risk/reward balance is favourable to the investor. Drivers behind this balance include the regulatory environment, financial liquidity and the ability to deliver projects on time and in budget.
The regulatory environment provides a framework for the risk to the project’s revenues, costs and long-term stability. Monopolistic infrastructure industries accept a level of regulation and seek a regulator that is independent of politics and understands that the private sector requires a fair return. Each country in SSA has a very different regulatory environment but in recent years there has been significant progress in regulation in countries such as Nigeria, Kenya and Uganda. Private sector reform led by multilaterals including the World Bank has helped governments to improve the environment for the private sector.
Each country has a different risk/return profile that is best proxied by the yield on a US$-denominated government bond. Very few SSA countries have US$-denominated government bonds or credit ratings and so it is difficult to compare and contrast the cost of capital in each country. The capital asset pricing model (CAPM) is often used in association with country risk classifications to compute guideline equity returns. The project and company-specific risks then need to be added to or subtracted from the country cost of capital, which is not an exact science. Actis analysis for leveraged power generation assets shows how projects in different emerging markets and SSA countries have different levels of capital costs, with Botswana the lowest and Kenya and Nigeria high above South Africa. SSA capital cost is often higher than in other emerging markets. Each project has unique structures and features that impact on the levered equity cost of capital.
Impact of the slowdown
2008-09 saw a significant slowdown in FDI globally and Africa was also impacted. In June 2009, the World Bank said that “despite the financial and economic crisis, new private activity in infrastructure continues to take place […] but at a slower pace”. It also observed that the cost of financing has risen and that greenfield projects that have survived were able to raise financing due to the relatively high quality of the sponsors and the participation of bilateral and multilateral agencies.
SSA is a focus market for the multilateral community, led by the World Bank and the African Development Bank. Their importance to the markets has grown with the introduction of new facilities to mitigate the withdrawal by commercial lenders. 2008 full year lending commitments from the WB and AfDB showed consistent growth and are a significant increase on 2007.
Historic deal volume in Africa relatively low
Delivering projects on time and on budget is a challenge for the infrastructure industry globally. Africa seems to have gained a reputation for its share of white elephants such as the Inga Falls hydro scheme in the Democratic Republic of Congo, where the potential is evident but the delivery of the project by the private or public sector fails continually because of its huge size and the scheme’s challenging location.
The private sector has not recently delivered an operating hydro power plant in Africa but there are encouraging signs for the future with the financial close of Bujagali dam in Uganda and the development of hydro projects in Cameroon and Zambia. Political stability, top-down leadership and consistent policies towards the private sector funding of infrastructure are key. In North Africa, Egypt is setting a strong example with its public private partnership (PPP) programme and in SSA the Ugandan government has shown true commitment in the unbundling and privatisation of its power sector.
Equity financing of Africa’s infrastructure, as measured by the World Bank’s Private Participation in Infrastructure (PPI) database, is increasing. Total private sector deal values in Africa remain low relative to other emerging markets and the demand and need. The increase in private investment from 1997 to 2007 and rapid growth from 2004 to 2007 is the result of the improvements to the risk:reward ratio for investors. 2008 data is not yet available although Actis tracks the market and there were several private sector deals completed during 2008 but very few so far in 2009.
Opportunities for private investment
Actis maintains a database of over 500 live infrastructure, mining and oil & gas projects in Africa with a total value of over $400 billion. The infrastructure projects represent over $200 billion of the total and are dominated by power and transport with the majority of the projects by number and value in Nigeria and South Africa.
The 80 power and 50 transport opportunities that Actis is currently tracking in Africa are in sectors and countries that welcome private sector equity and the project partners and stakeholders are committed.
The power sector has been open to private investment since the early 1990s. The legal and commercial structure of an independent power producer (IPP) is well-established and the technical and structuring knowledge can be replicated in different markets. Ports have always had clear commercial economic models where terminals are offered as concessions and the user pays for the facility. Service and user fees on public roads are now becoming more acceptable and usual.
West Africa’s growth is driven by Nigeria and Angola’s profitable oil industry, growing trade and the government’s policy of leveraging private sector finance to solve the power and transport shortages. Nigeria’s government is restructuring the power sector to encourage IPPs and private distribution concessions. Progress in power sector reform has been slow but is expected to accelerate. To date, it has granted concessions on 21 ports and is now focusing on a PPP programme for the road sector in Nigeria.
East Africa’s transport infrastructure is a priority with the Nairobi roads concession and Mombasa-to-Kampala cross-border rail concession. Mombasa and Dar-es-Salaam ports are also set for expansion to accommodate the growth in commodity exports and consumer goods imports for the growing economies.
South Africa’s primary focus is on solving its power shortfall. Eskom has been mandated to source over 4000 MW of baseload capacity from the private sector: this process is progressing slowly. There are also other IPP projects in Southern African countries that will sell electricity to South Africa.
Progress is being made and projects are happening – whatever the papers say
Media headlines often reflect civil unrest, conflicts and strikes, and industry headlines describe frustration and investment hurdles. Despite this, there is increased interest in African infrastructure opportunities from investors experienced in and new to African countries. Development finance institutions (DFIs) such as WB, AfDB, FMO and DEG continue to play a lead role in advising and financing challenging projects. Established investment organisations such as Actis, Emerging Capital Partners and the Aga Khan’s IPS have been joined by new African organisations such as the Pan-Africa Infrastructure Development Fund (PAIDF). African and international banks are broadening their products to include equity for infrastructure projects, contractors are prepared to commit more equity and state-sponsored entities from countries including Russia and China are taking on significant infrastructure projects.
New projects and deals announced during 2008 and 2009 with private equity investment include the financial close of Bujagali hydro in Uganda ($700 million), refinancing of the NI/N4 road in South Africa ($500 million), the Enfidha airport concession in Tunisia ($600 million), commissioning of the Seacom undersea cable in East Africa ($600 million), financial closes of Rabai IPP in Kenya ($150 million) and Lagos Ibadan ($700 million) and Lekki toll road ($420 million) in Nigeria. The infrastructure PPP programmes covering the electricity, transport and water sectors in Egypt and Nigeria continue to progress, albeit slowly.
The African risk/return balance is favourable to the investor
The supply of both capital and development expertise in Africa remains limited compared to other markets, despite the increasing need for infrastructure services and the improving investment environment.
This creates an opportunity for investors who understand and can manage the risks to make superior risk-adjusted economic returns. Investors that are prepared to take on the increased risk of developing new assets will create the most value. Africa’s rapid economic and population growth is increasing the size of the prize and the renewed private sector interest in its infrastructure projects is not surprising.
Infrastructure assets have long lives and hold periods. It is impossible to forecast every turn in a country and sector’s fortunes over a 20-or-30-year period. Time will tell whether the private sector transactions currently being structured and negotiated are pricing the risk correctly, but the indications are that Africa’s risk continues to be over-rated and experienced investors are able to lock in superior risk-adjusted returns.