January 18, 2008 836 VIEWS

Macro-economic play on Africa’s largest emerging market - http://www.proshareng.com/blog/?attachment_id=344


The REPORT contains the following sections:
Political and Socio-Economic Update

Elections Aftermath: Stability and Continuity                16

Continued Economic Growth                                          19

Key Risks: Infrastructure, Security, Corruption               20


Nigerian Banking Sector

2007: After Reforms, Growth                                         22

The Opportunity is Real                                                 23

Size and Capital are becoming Key                                  25

Capital Markets have Helped                                          29

But there are Risks                                                          31


Post-Consolidation Scenario

New Rules: Size is Imperative                                          34

New Entrants: Top Dollar, Tough Market                      35

Grand Ambitions: Expansion and Diversification            36


Bank Profile: Fifteen Banks


Operating and Valuation Statistics

Macro-economic and General Statistics                        72

Financial Forecasts                                                       74

Public Market Operating Comps, Part I                        79

Public Market Operating Comps, Part II                       80

Public Market Valuation Comps                                    81

Chart List                                                                     82


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Independent assessment of Nigeria’s macro-economic performance continues to be favourable...


In December 2006, the International Monetary Fund (IMF) published its second review of Nigeria under a two year Policy Support Instrument (PSI). IMF endorsement had been a key part of achieving the US$31bn 2006 Paris Club debt restructuring agreement. The IMF made the following statements on Nigeria’s economic performance, following on positive commentary from its previous review:


“GDP growth and per capita income have doubled in the last five years compared with the previous two decades. Headline inflation declined to single digits in 2006 and the parallel and official exchange rates have converged, reflecting the unification of the foreign exchange markets.”


“…the authorities have maintained their commitment to the reform agenda; nevertheless, the ongoing conflict in the Niger Delta poses a policy challenge. Growth would benefit from significant infrastructure spending. This spending reflects the government’s efforts to address pressing infrastructure needs.”


 ...And much of the local and international financial community have become familiar with the compelling Nigeria story.


Following years of tortuous reforms, and stability ensuing from over eight uninterrupted years of democratic governance, Nigeria has begun to exhibit macroeconomic characteristics that are more in line with the worlds’ leading emerging market countries. Foreign portfolio investors have been quick to take advantage of opportunities in the market. Amid the global quest for higher yields in 2006-2007, Nigeria witnessed significant inflows into its sovereign debt and public/private equity

markets. Afrinvest Research estimates that, the banking sector (considered by many to be an investment proxy for the larger economy) has attracted over US$5.0bn in new foreign debt and equity investments, excluding direct equity portfolio investments on the Nigeria Stock Exchange (NSE). The Nigeria story is essentially one of a larger, yet faster growing version of “commodities rich” Africa. Just as importantly, significant room continues to exist for growth, with per capita GDP barely over the US$1,000 mark despite recent advancements (See Chart 1 and 2 - http://www.proshareng.com/blog/?attachment_id=344).


In many ways, Nigeria’s story mirrors a wider African renaissance.


Key elements of the Nigeria macro story (GDP growth, declining inflation, improved sovereign risk ratings and increased inward flow of Foreign Direct Investments) are very much in line with emerging trends in many countries within the sub-Saharan African region. A continuing global commodities boom has combined with significant amounts of international interest in (and demand for) emerging market opportunities, to spur a renaissance in many African markets. Many of these countries are now enjoying the longest, sustained period of uninterrupted economic growth in their post-colonial histories.


According to data from sovereign risk specialists Standard and Poor’s, Africa’s major markets (a sample including South Africa, Nigeria, Egypt, Morocco, Tunisia, Kenya, Senegal and Ghana) are each seeing 5-year average output growth rates in the 5% per annum region. Each is also seeing per capita GDP exceeding or approaching the US$1,000 mark, with South Africa (US$5,516) and the North African countries (averaging US$2,356) being well ahead of the rest of the continent. While these indications of prosperity appear more pronounced in these more developed African economies (South Africa and the Northern African countries) than in Nigeria, a closer analysis reveals that there is indeed a higher, underlying level of per capita wealth within the Nigerian economy.


The wealthiest 20% of Nigeria’s population accounts for 80% of national output; an estimated market of 28 million people with a per capita GDP of US$4,000 per annum.


There is evidence that a small proportion (estimated at 20%) of Nigeria’s 140 million people account for up to 80% of the nation’s wealth. With a 2006 year end GDP of US$140bn, our analysis indicates that while Nigeria may report a national per capita GDP of merely US$1,000, there is actually a select, underlying market of up to 28 million people in the country; boasting a per capita GDP of US$4,000 (very nearly comparable to South Africa, and well in excess of the North African average).


We believe that this select section of the population is responsible for much of the underlying consumer market demand that is beginning to come to light in Nigeria. Due to very high poverty rate, much of the analysis of the market opportunity has failed to take cognisance of this latent consumer group, itself a substantial market, and primary targets for immediate new business opportunities.


Democracy has come to stay in Nigeria...


The nation completed a historic political transition in May 2007, when President Umaru Musa Yar’Adua was sworn into office; albeit amid widespread domestic and international condemnation of the polls that brought him into power. Despite the controversy, the successful transition has raised hopes that the momentum of economic reforms of the outgoing government will be sustained. The previously unknown and reclusive new president now seeks to step out of the shadows of former President Obasanjo.


…and stability is spurring economic growth: a boom for banks.


A combination of robust economic growth, an ambitious government initiative to position Nigeria as a regional financial hub, and fierce competition among the surviving 25 players has underpinned the rapid growth of the Nigerian banking sector.


Total assets have grown by 39% over the last year, an indication of the strength of the underlying market. Banks continue to be successful in financing these assets from various domestic and international sources. Retail deposit generation has been a major imperative for the larger banks as they seek lower cost financing. Capital raising was a major theme of 2007, following on the rounds of mergers and acquisitions in 2005-2006. 2007 saw local and/or international capital market transactions by at least 15 banks, with over US$15bn in new capital expected to have been raised by the end of Q1 2008.


Industry regulation is strong and forward-looking...


The central bank has stepped up surveillance of the industry, unveiling an ambitious plan for an integrated transformation of the financial services landscape (the FSS 2020 plan). This integrated plan envisions a Nigeria that becomes one of the largest economies in the world by the year 2020, propelled to those heights in large part by its indigenous financial institutions.


...and so the next round of consolidation has begun.


A second round of consolidation has begun to gather momentum as the local players compete to remain among the critical top 10 (out of 24). The strategic priorities for the major banks include regional expansion, expanded retail banking, real estate finance, project and infrastructure finance, mortgage banking, expanded consumer lending, and corporate finance.


Economic growth remains robust; forecast at over 6% per annum for the next 3 years..


The Nigerian economy is experiencing its longest growth streak in over two decades. High oil prices, combined with effective fiscal and monetary guidance by the Central Bank of Nigeria (CBN) contributed to the 6% average annual GDP growth recorded by the country since 2006. Non-oil GDP growth continues to outpace oil related growth, as robust expansion in the agriculture, trading, building and construction, and services sectors compensate for the decline in the oil sector, where growth has largely been stifled by disruption in production by local militants.


The international investment community has continued to endorse the emergence of structural changes in the Nigerian economy on the back of a BB- sovereign rating, and investing billions of dollars in the debt and equity markets. In particular, the banking, infrastructure, industrials, consumer goods and insurance sectors have attracted significant interest from international institutional investors, including private equity and hedge funds from as far away as Europe, Asia, and the AmericasSeveral international banks have also upgraded their operations in Nigeria, seeking investment opportunities and offering corporate finance services as they aim to lead the search for new capital to finance the growth of the economy.


...translating to accelerated development of the local financial markets.


Nigeria’s financial markets have recorded significant positive developments over the last 12 months. Equity returns on the NSE ranked 3rd among emerging markets in 2006, behind Zimbabwe and China. A flurry of new issues and a bull market supported by excess local and international liquidity have led to a 74.9% appreciation in the benchmark NSE index during 2007. In the fixed income arena, Primary Dealer Market Makers (PDMMs) have been appointed to create a secondary market for trading in Nigeria sovereign bonds, leading to an active market with a 10-year yield curve. Yields on the Nigerian bonds have continued to decline, with successive issues achieving higher levels of over subscription from both local and international institutional investors. Newly licensed pension funds, large commercial banks and recapitalized insurance companies provide most of the local subscription to the bond markets.


Growth is broadly distributed across sectors, and primarily non-oil related.


Of crucial importance, much of the stability in new growth comes from non-oil related sectors. Agriculture, wholesale and retail trading, telecommunications and services have been the largest contributors to growth in output over the last five years. Crude oil related output on the other hand, has been unreliable: driven largely by factors such as global oil prices and domestic production output. In any event, the oil and gas sector continues to be an enclave, largely separated from the rest of the economy, with bridgeheads only resulting from federal government revenue inflows via petroleum taxes and royalties.


Domestic production output has declined significantly in recent years, due to violent protests, kidnappings, and other militant related production disruptions. Anglo-Dutch giant, Shell, Nigeria’s largest oil corporation, has been forced to shut down almost 50% of its production capacity in the on-shore Niger Delta region, with largely offshore based ExxonMobil recently assuming the top spot in Nigeria’s production rankings. Total national output has thus dropped by almost 0.5m barrels per day to about 2.2m barrels per day.


National foreign exchange revenues and reserves are up; with the naira holding up well against the U.S. dollar.


Regardless of recent developments in the oil and gas sector (Nigeria’s major source of foreign exchange income), the country’s currency has proven resilient against major international currencies, particularly the U.S. dollar. We have seen essentially a relatively stable naira/dollar regime over the last eight years, and a steady appreciation of the naira during the last three of those years (2004 to 2007). Over the same period, foreign reserves have soared, largely on the back of disciplined fiscal planning by a more accountable democratic government. Now at over US$50bn, with external debt almost wiped out, Nigeria has one of the lowest national debt and highest national reserves to GDP ratios among emerging market countries.


This recent appreciation in naira valuations (in part on account of the general slide in the value of the dollar across global markets) has supported inward flows of foreign investments into the local fixed income and equity markets. The impact of this has been quick to emerge: declining yields across sovereign bond maturities, a demand driven stock market, and new private equity inflows across sectors. While some of this demand can be attributed to the emergence of local institutional investors (pension funds) and an influx of domestic retail investors; these favourable conditions for foreign inflows has provided a further source of supporting liquidity to the local markets.


Nigeria’s newly capitalized commercial banks, are tapping into emerging opportunities.


Fresh from an enforced round of consolidation in 2005/2006, Nigeria’s lenders are rapidly growing into the macro opportunities in the market.


There are now 11 Nigerian banks in the ranks of the top 1000 in the world (according to The Banker magazine, measured by Tier 1 Capital), up from only 7 in 2006. Nigeria’s banks are achieving greater scale and profitability from lending to large corporates and institutions, as well as a fast growing consumer market. Total banking sector deposits have doubled during 2007, with credit to private sector growing at an annualized rate of 72% (to Q1 2007). By year end 2007, up to 7 Nigerian banks had more than US$1bn in capital; and more than 10 banks had a total market value in excess of US$2bn each. Credit to retail consumers is becoming increasingly available, with most banks reporting the fastest loan book growth rates in their consumer loan portfolios. Of crucial significance, growth has not occurred at the expense of credit quality, with total bad loans (Non-Performing Loans, NPL) as a share of total loans declining to an average of less than 8% for the entire industry (down from over 20% prior to commencement of sector consolidation).


Commercial realities appear to be driving a new round of capital raising.


Capital raising was the dominant theme for 2007. Nigeria’s banks, immediate beneficiaries of macro-economic growth are seeing various new opportunities for deploying capital to capture market share. However, specific market opportunities aside, some of the banks appear to be raising capital merely to stay abreast with the competition and to tap into auspicious equity market conditions. In 2007 alone, up to 15 of the 24 surviving banks in Nigeria made arrangements to raise new money, with average deal sizes within the US$250m to US$300m range, and a number of banks doing deals in the US$750m to US$1bn range. Capital raising is expected to continue well into Q1 2008. Afrinvest Research estimates that about US$15.1bn would have been raised in new debt/equity by a total of 19 banks by early 2008 (based on announced and completed deals since Q3 2006).


While M&A speculation continues to be rife.


Aggressive capital raising aside, 2007 was also a year of intense speculation and several failures as far as mergers and acquisitions are concerned. There have however been a number of successes, notably the landmark Standard Bank merger of its Nigeria operations into IBTC Chartered; and simultaneous Tender Offer to acquire shares leading to a 50.1% stake in the new entity. More recently, we have seen board level announcements of on-going discussions towards a merger between Sterling Bank and Ecobank. There is also news that one of the country’s largest banks may be successfully closing on a deal to acquire the last remaining privately owned bank.


Aside from the one successfully completed transaction therefore, 2007 has been notable for unconsummated deals. Among others, we saw intense public speculation regarding a potential First Bank-ETI combination; indiscreet moves by an aggressive mid-tier bank to acquire one of Nigeria’s oldest banks; as well as speculation regarding a tie-up between two banks, both of whom have since gone their separate ways to seek new capital from the equity market. We expect that 2008 will see a number of M&A deals that commenced in 2007 reaching closure. Following on those closures, we anticipate that talks will continue between the ownership and management of various banks during 2008 and profile in this report the nature of transactions that we think could feasibly occur, and their potential impact on industry structure.



Afrinvest banking universe

For the purposes of our analysis, we have relied on operating and valuation statistics for publicly traded banks in Nigeria. Our calculations are based on operating performance, current market valuation, and forecast financial performance for these banks. Our data is based on most recently published financial statements for the banks, and in some cases, Afrinvest estimates. Financial forecasts for the banks are based on management discussions and our view of the banks’ most recent performance and future outlook. Share price information is as at 5th December 2007.


Afrinvest Research segregates between top and middle-tier banks using three criteria: Shareholders Funds, Total Assets and After Tax Profits. The banks in our top-tier comparables universe are currently the largest by two or more of these criteria. The rest of the banks in the industry make up the middle-tier universe of comparables. At present, our top tier comparables universe includes: First Bank, GTBank, Intercontinental, Oceanic Bank, UBA, Union Bank, and Zenith Bank. Our middle-tier peer group includes: Access, Afribank, Diamond, Ecobank, FCMB, Fidelity Bank, IBTC (pre-merger), Bank PHB, Skye and Sterling Bank.


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This report has been issued and approved by Afrinvest West Africa Limited (“Afrinvest”). This report is based on information from various sources that we believe are reliable; however, no representation is made that it is accurate or complete. While reasonable care has been taken in preparing this document no responsibility or liability is accepted for errors or fact or for any opinion expressed herein. This document is for information purposes only. It does not constitute any offer or solicitation to any person to enter into any trading transaction. Any investment discussed may not be suitable for all investors. This report is provided solely for the information of clients of Afrinvest who are expected to make there own investment decisions. Afrinvest conducts designated investment business with market counter parties and intermediate customers and this document is directed only at such persons. Other persons should not rely on this document. Afrinvest accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is for private circulation only. This report may not reproduced distributed or published by any recipient for any purpose without prior express consent of Afrinvest. Investments can fluctuate in price and value and the investor might get back less than was originally invested. Past performance is not necessarily a guide to future performance. It may difficult for the investor to realize an investment. Afrinvest and/or a connected company may have a position in any of the instruments mentioned in this document. Afrinvest and/or a connected company may or may not have in the future a relationship with any of the entities mentioned in this document for which it has received or may receive in the future fees or other compensation. Afrinvest is a member of The Nigerian Stock Exchange and is regulated by the Securities and Exchange Commission to conduct investment business in Nigeria.

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