Africa is widely perceived as poor and corrupt hardly a great investment opportunity. But appearances can be deceptive, says Merryn Somerset Webb
How do you make real money? Most investors answer this in much the same way Warren Buffett does. They say that if you put your money into brilliant companies, brilliant sectors and brilliant countries, then hang on, you'll end up rich. Global Thematic Investors (GTI) disagrees. When something is that good, most people know about it already and your purchasing price is going to reflect that, which will limit your returns even if things go as well as the market expects. And what if things don't go as well as the market expects? Then your investment is going straight to "Money Heaven".
Instead, say the analysts at GTI, the key to wealth is to make investments "where outcome exceeds consensus expectations". If the consensus is that something is a basketcase and it turns out instead to be merely mildly mad, or even a recovery candidate, "it's a sure-fire way to garner riches". The more widespread the pessimism about an asset class, the more the odds are stacked in favour of "the early and the brave".
This brings us neatly to Africa, about which it is hard to find anyone saying anything optimistic at all. In the developed world, the entire continent is considered to be little more than one big failed state. The papers this week alone have been full of Robert Mugabe's £30,000 birthday party, the plight of child soldiers in the Congo, the Aids crisis in South Africa and the way in which the war in Sudan is spilling over into Chad. On top of all this, we know the region's infrastructure is unsatisfactory, that its economies are blighted by widespread, extreme poverty and that its politics leave a lot to be desired. Africa is by almost all accounts a complete basketcase.
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But look a little closer and you will see that there is more than misery here. In fact, if you take India and China out of the equation, sub-Saharan Africa is actually growing faster than Asia which everyone thinks of as being
packed with investible emerging markets. And as Patrick Collinson points out in The Guardian, the number of African nations seeing a decline in growth has fallen from 17 in 2003 to just six in 2006. Overall, the region is forecast to keep growing by at least 5% a year. There will be huge variations between countries, but the general direction is encouraging: much of Africa may be a shambles, but progress is being made.
Chinese direct investment in Africa
A great deal of this growth can be attributed to the new love-in between China and Africa. Earlier this year, China's president Hu Jintao set off on an eight-nation tour through Africa, carrying with him the promise of $3bn in soft loans (all to come "without political conditions") and a doubling of Chinese aid by 2009. It was just another step in the methodical courting of Africa by China: in the last 12 months, China's top leaders have managed to visit a massive 48 African nations and last November 43 heads of African states visited Beijing. "We in China," said Hu in one of his many long speeches, "take great pride in our friendship with the African people".
No doubt. But it isn't just friendship China is after.
As we have often discussed in MoneyWeek in the past, China's path from developing country to super-power needs to be paved with commodities. China needs Zambian copper, Nigerian oil, Tanzanian timber and South African platinum if it wants to keep its stellar growth rates going. It also needs food it buys prawns and cashew nuts from Mozambique and oranges from South Africa, for example which is why president Hu and his colleagues are so often to be found donning their lightweight blue suits and heading West. The result? Last year, trade between China and Africa soared 40% to a record $55.5bn. Direct investment has reached a cumulative $6.5bn, and at the November Forum alone 16 contracts between Chinese firms and African governments were signed. A third of Chinese oil now comes from Africa and it has recently agreed a $1.4bn deal to open new oil fields in Angola.
Benefits of Chinese investment in Africa
The many grants and soft loans that have paved the way for these deals are also bringing benefits. The Chinese have paid for a road-building programme around Ethiopia, including the "China-Ethiopia Friendship Road", which rings the capital; they are financing the rebuilding of 100 schools and 30 hospitals in Liberia; they have cancelled $100m worth of loans to Cameroon; they have helped rebuild Angola's once-famous Benguela railway; and they have set up a road-building programme in Mozambique.
None of this comes without its problems, but right now it seems the net effect is positive. When Hu talks about Chinese investment bringing "mutual benefit and win-win progress", he is actually making a perfectly reasonable point. The arrival of the Chinese and their money has revitalised large parts of Africa and already huge areas of the continent have much better infrastructure than they did just a few years ago.
The key for Africa is to ensure it structures the deals it does with China so that they end up bringing some long-term benefits in particular, this means investing the money strategically to help diversify economies away from their total dependence on natural resources. Africa has some time to figure out how best to do this the commodities boom, and hence the seemingly unlimited supply of cash, should roll in for many years to come and if it can get it right, many think it will mark a long-term turning point for the region. Using commodity growth to drive non-commodity growth, says Julian Ozanne of Uganda-based New Forests, represents "the best chance Africa is ever going to get to kick-start its own development". China is, after all, the first "interested party of a significant size" to be willing to engage with Africa "without force of arms", says Kobus van der Wath in the African Analyst.
African growth is about more than commodities
There is also a case to be made that African growth is not just about commodities. Chris Derkson of Investec tells Collinson the revival was underway long before the commodities supercycle really took off and points out that Kenya, buoyed by tourism and agriculture, is one of Africa's fastest growers, despite having no commodities. And in Zambia, while copper exports are a boon, agricultural exports are also booming (in part thanks to the efforts of farmers chucked out of nextdoor Zimbabwe by Mugabe).
There are also already signs of a middle class emerging. In Nigeria, mobile-phone penetration is 8% and rising fast, while each user spends around $20 a month. According to analysts at Investec, events of the last ten years the debt forgiveness that is giving nations a "fresh start", the rise in successful democratic elections, the arrival of the commodity cash with which nations are paying off sovereign debt, and improving infrastructure have all created a "momentum" that could now keep going even without the input of the commodities cycle.
Still, good news as this all is, the macro-environment is not the only reason to think Africa is a fantastic investment, says a recent GTI newsletter. There is also the fact that "African companies are some of the most profitable and fastest growing in the world". Not convinced? Consider this: between 1995 and 2005 the stocks that make up the Blakeney index of African stocks showed compound annual growth of 22%. This might seem unlikely, but it does make sense, says GTI. The very factors most cite as reasons not to invest in Africa political uncertainty, corruption and so on have also created a group of winning firms. Payback time has to be "lightning fast" to protect an investment from greedy kleptocrats and cash flow has to be self-generated, given how dysfunctional the banking system can be. The firms often subsidiaries of the world's leading multinationals that have adapted to these circumstances have prospered and "mostly ended up monopolies or duopolies". However, the best news is that they are also often cheap in both absolute and relative terms. Often, p/es are half those of Western firms, despite higher growth rates, for example.
A final point to bear in mind is that it won't take much money to get African's exchanges moving. The total market cap of Ghana, Kenya, Mauritius, Zimbabwe and Uganda is not much more than $30m and much of that is illiquid owned as it is by multinationals that have no intention of selling. There are more companies coming Derkson points to an expected round of privatisations in Kenya and Tanzania but if much more foreign money turns up in Africa any time soon, or if the emerging middle class of Africa develops its own share-buying culture, we can expect to see markets move fast. This is already happening in Kenya, which has gone share-crazy in the last five years. The local index has risen nearly 800% in dollar terms, and when KenGen, the state's electricity firm, listed last year, the offer was three times oversubscribed and the shares quadrupled in the first day of trading. Nearly a million Kenyans now own shares.
Kenya isn't the only African market to have risen recently in 2006, markets in Botswana, Uganda, Tunisia, Nigeria and South Africa all rose well over 20% but its extraordinary outperformance may be a sign of things to come elsewhere. With China's investments being very well publicised and the World Cup hitting South Africa in 2010, Africa is likely to keep attracting attention. Overall, as far as GTI is concerned, Africa is "outstanding value" and offers "the thematic investor" one of the best opportunities there is to make "multi-year, multi-bagger profits, rather like tech in 1990, oil in 1999, commodities in 2001 or Japan in 2003".
One final reason to buy Africa: figures from Investec show that it is largely uncorrelated to other investment markets. So if you think trouble lies ahead for the booming markets in the rest of the world, you might like to start thinking of Africa in a new way: as something of a safe haven.
African investment: Where to put your money
Many of Africa's shares look so cheap it is tempting to suggest having a go at buying individual shares listed on some of the separate exchanges. They have low p/es, high return on equity, and higher-than-average profit growth driven by fast-growing demand for goods and services. Nigeria's biggest investment bank, IBTC, is on a p/e of six times and yields 9%; BAT Kenya (BAT), one of the region's main cigarette manufacturers, is on a p/e of 11 times and yields 8%; while Zambia's National Breweries (NATBREW) is on 12 times and 8%. However, not only will this be verging on the impossible (it's hard enough to find a UK broker that will let you buy individual shares in Japan, let alone Nigeria), but it also probably comes with more in the way of transaction costs and risk than most of us really need.
Unfortunately, the alternatives are limited. There is the Investec Africa Fund, whose managers are particularly keen on Tunisia, Nigeria and Egypt over the next two to three years. Roelof Horne, one of the managers (based in Africa), points out that the fund is not leveraged just to China or a resources boom, but "rather to the structural economic and political improvement that we are seeing in many countries across the African continent". I like this fund and the way it is managed (it has risen 60% since launch in November 2005) and I agree with its managers that "the opportunities in Africa have barely been tapped", but I'm afraid it isn't much good for most of us: the minimum investment is $1m.
Another possibility might be Botswana-based Imara African Opportunities Fund, launched in 2005 to allow international investors access to Africa's emerging stockmarkets (it has limited exposure to South Africa and heavy weightings in Kenya, Zambia, Eqypt, and Nigeria, with an average p/e across its portfolio of about nine times). See Imara for more on the fund, but note it comes with a similar problem to the Investec fund: the minimum investment is $100,000. Finally, commodity funds give big exposure to the African mining sector. JP Morgan's Natural Resources Fund is one possibility.
The alternative is to invest in firms that do business in Africa: 40% of soap, pharma and white goods firm PZ Cussons's (PZC) sales come from Africa and Anglo American does a tenth of its business there. I have tipped PZ in the past and still like the look of it. It isn't cheap any more on a p/e of over 20 times, but given its growth rate and exposure to Africa, it could be a long-term hold.
More speculative is Lonrho (LONR). This small Aim-listed firm (which recently changed its name from Lonrho Africa), with its annual revenues of a few million pounds, is all that remains of what was once the main vehicle for controversial tycoon Tiny Rowland's many corporate manoeuvres and one of the biggest and most diversified firms in the world. But not for long. Its new boss, David Lenigas, has plans. "We had revenues of $3m in February (2006) and we will have revenues of $300m by the end of 2007," he told the FT. He intends to to rebuild Lonrho into the diversified conglomerate it once was (minus the deals with corrupt dictators and the feud with Mohammed Fayed). He may well manage it.
When he joined in 2005, Lonrho was down to £20m in cash, a stake in a hotel in Mozambique and one employee. Since then, Lenigas has been making deals left, right and centre. He's got a controlling stake in Luba Freeport in Equatorial New Guinea, a 43% stake in South Africa-based Norse Air, a 49% stake in Kenyan discount airline Fly540 (you have to fly in Africa he says, "there aren't any bloody roads"), a 10% stake in uranium producer Brinkley Mining and a 17% holding in South Africa-based Nare Diamonds. He has also entered the African water sector via a holding in a Swiss firm and Lonrho intends to invest in natural resources and infrastructure, as well as branching out into luxury hotels and tourism. The shares have risen 25% in the last 12 months, but I think they are still worth buying.
Problems with African investment
Not everyone is happy with the way the Chinese have infiltrated Africa's economies. The first problem to Western eyes is that no Chinese lenders follow the so-called "Equator Principles". This is a voluntary code setting out social and environmental standards for financing projects in developing countries. They aren't always applied well, but they do act as a "barrier to projects that do more harm than good", says the FT. Another worry is the flood of imports now finding their way from China to Africa might local industry be swamped under cheap Chinese manufactured goods?
There is also concern that Chinese cash threatens the direction of development policy in Africa. The two main tenents of this are debt forgiveness and the linking of aid to better governance. But what use is forgiveness if China just lends Africa more money, setting off the cycle of dependence and failed repayments again? And why should corrupt regimes bother with reform if Chinese aid comes with no strings? Consider Zimbabwe. President Robert Mugabe's birthday party this week took place against the backdrop of a ruined economy. The price of bread is rising 100% a day; it takes a farmworker two months to earn enough to buy a bag of maize meal big enough to feed a family of six for a month. Unemployment is at 80% and many of those who aren't, including all junior doctors, are on strike. Mugabe should be holding elections next year. He is extending his tenure instead. China is "right to invest in Africa", says the FT, and its willingness to take risks means "it has a lot to offer", but giving to the likes of Mugabe isn't helping anyone: with Chinese aid on hand there's no need for him to reform.
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