African private equity exits through capital markets: A Saudi lesson

Exits through capital markets is one of the most attractive sell-out mechanisms in the global PE industry for all parties involved. For divesting PE investors, historically it has been a consistent exit route in line with secondary sales to other GPs and trade sales; in the US, about 14% of PE exits during the 1970-2007 period took place through initial public offerings-IPOs[1] [2] and globally about 16% of PE exits during the 2000-09 period also happened through IPOs[3].  It has been argued that IPOs are an optimal way to maximize exit value (with some research pointing out that PE exit returns are consistently higher than through other exit routes[4], which may explain why top quartile funds tend to use IPOs/private placements more frequently than low quartile funds[5]).  For buyers, it offers a fairly liquid investment that already has a track record and is been offered with full disclosure.  For policy makers, it helps to strengthen capital markets, with all its related socio-economic advantages.

While few need to be convinced about the virtues of PE capital market exits in developed economies, in many emerging markets there is still a case to be made especially among policy makers and regulators.   In Sub-Saharan Africa, the main factual obstacle is of course the low level of market capitalization as compared to the developed world: the OECD market capitalization average is 108% of GDP against 10% in Nigeria and 24% in Kenya[6], with the high market capitalization of the Johannesburg Stock Exchange been a notable exception. The result is a very low usage of primary issues as an effective capital market tool for PE exits: of 219 PE exits in Africa during the 2007-13 period, only 4% took place through IPOs and this participation dropped to 1% of all 83 PE exits during the more recent 2014-15 time framework[7].  As a matter of fact, IPOs represent a very limited equity market mechanism in Sub-Saharan Africa (except South Africa), with only 24 issues during the 2000-14 period[8].  Interestingly, the IPO route has actively been explored by African corporate issuers focused on raising foreign capital: during 2008-June 2015 $21.7bn were raised by Sub-Saharan African issuers through IPOs on international stock exchanges, with the London Stock Exchange (LSE) raising $13.4bn or 62% of total value for 80+ companies and the UK Alternative Investment Market (AIM) raising $4.6bn on behalf of 67 companies (AIM listings include issuers from DR Congo, Guinea, Liberia, Niger, Tanzania & Sierra Leone)[9].

The Saudi Experience

In 2003 the Saudi government launched the CMA as securities market regulator and set up a very innovative mechanism promoting IPOs.  By 2009, and despite a significant market correction in 2006, the Saudi stock market had expanded significantly to a market capitalization of 74% of GDP, having supported $19.5bn of primary/secondary offerings through 52 issues with active participation of both institutional and retail investors (the latter showing a cumulative peak of 58mm subscribers in 2008[10]) and the number of listed companies almost doubling from 70 to 134[11].

This significant capital market growth was of course underpinned by the strong oil price fundamentals (and the consequent massive injection of liquidity), with oil increasing from $30 per bbl in 2003 to $145 per bbl at its peak in 2008.  But beyond these favourable winds, Saudi Arabia was able to use pragmatism and institutional cooperation to create a highly attractive regulatory framework for domestic equity players.  The key was the realization of the need to put in place not only a top regulatory foundation that recognized international best practices (in areas such as transparency, corporate governance and tackling financial crime) but also reaching wider social and economic objectives including investor education, wealth transfer to the Saudi population (as ultimate beneficiaries of the country’s oil related wealth), investor protection, strengthening of the local financial services sector and expansion of the local institutional investor base.  The main features of the Saudi IPO scheme were as follows:

• A disclosure process involving detailed issuer information aimed at achieving a minimum level of investor education.
• An IPO requiring at least 30% of shares to be offered. This percentage was well chosen, as it allowed having an important critical mass of offered shares without substantial dilution or excessive supply.
• A mandatory underwriting requirement for equity issues imposed on the bank syndicate, to ensure risk sharing between financial intermediaries and investors.
• A securities offering system actively promoting retail participation. Broad retail participation was achieved through individual allocation limits on number of shares.
• A retail securities distribution process implemented through retail branches, teller machines (ATM), internet and phone banking with local banks acting as receiving agents.
• Institutional investor participation that started with allocations to equity mutual funds and subsequently expanded to other authorized entities (such as insurance companies).
• A pro-active supervision role played by the regulator during the entire process.

Naturally a process of this nature creates controversy and, in the case of Saudi Arabia, several features were questioned, namely:

• The pro-active role played by the regulator;
• A certain conservative bias on IPO pricing that exacerbated demand and created massive over-subscription on certain issues;
• The delayed return of funds in excess of allocated amounts, generating huge profits for receiving agents on the ‘float’.

But the shortcomings of the Saudi system have to be put in the context of a new process that had to rely on conservatism to avoid market failures that could have destroyed investor confidence. In fact investor confidence was quite high (at least until 2008 at the midst of the global financial crisis) and a strong alliance of stakeholders in support of the system endured.

Given the high potential for PE market expansion in Sub-Saharan Africa, the lessons from Saudi Arabia can be learned and used as a potential template to upgrade the securities offering framework, particularly in Nigeria and Kenya.

Of course a well functioning equity capital market requires as pre-conditions sound macro-economic policies, a strong institutional and legal setting and a well functioning financial infrastructure[12].  Several initiatives have been launched to address these important issues; in Nigeria, for instance, the Nigeria-UK Capital Markets Project (sponsored by the Nigerian Capital Markets Solicitors Association and the Law Society of England & Wales) has made important recommendations on market integrity, regulatory infrastructure, market incentives/barriers and market development[13].  While these initiatives are critical, an effort to actively expand the market requires further focused work, including significant liberalization of both institutional and retail investor participation.
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[1]Journal of Economic Perspectives,  Leveraged Buyouts and Private Equity, Steven N. Kaplan & Per Stromberg, 2008

[2] Harvard Business School, What Do Private Equity Firms (Say They) Do?, Paul Gompers, Steven N. Kaplan & Vladimir Mukharlyamov, April 2015

[3] Dealogic, Global private equity divestments, 2000-2009

[4] EFM Symposium: Entrepreneurial Finance and Venture Capital Markets, Exit, Performance, and Late Stage VC: the case of UK MBOs, Ranko Jelic & Mike Wright, Montreal, April 2010

[5] Preqin, Exits in Private Equity, Special Report, April 2011

[6] World Bank, World Development Indicators, 2016

[7] African Private Equity and Venture Capital Association (AVCA), The African Private Equity Landscape: Fundraising, Deals, Exits & Job Creation, June 2016

[8] PricewaterhouseCoopers, IPO Watch Africa 2014, January 2015

[9] Overseas Development Institute (ODI), Sub-Saharan Africa and international equity, Working paper, September 2015

[10] Capital Market Authority, Annual Report, 2009

[11] Capital Market Authority, ibid.

[12] International Monetary Fund (IMF), The Development of Local Capital Markets: Rationale and Challenges, Working Paper, Luc Laeven, December 2014

[13] Nigerian Capital Markets Solicitors Association & Law Society of England & Wales, The Nigeria-UK Capital Markets Project Report, March 2015