Private Equity | |
Private Equity | |
2204 VIEWS | |
![]() |
Wednesday, July
08, 2020 / 08:00AM / Proshare Research / Header Image Content: Auren
Economic uncertainty has
become a key consideration amongst financial analysts and the global financial
community as the COVID-19 pandemic is linked to a slow-burning economic
meltdown that continues to adversely affect asset values, equity pricing and
private debt raise in new and unusual ways. Corporate Finance experts are
becoming increasingly troubled by the consequences of COVID-19 on emerging corporate
valuations, debt costs and expected financial yields. For example,
Coronation Capital's Managing Partner, Mr. John Opubor, recently noted that
uncertainty has created unique difficulties and opportunities in asset
valuation.
Indeed, according to Opubor,
the global COVID-19 pandemic has in some shape forced companies to reassess
their operations, offerings, valuations, and expectations for the future. He
notes that lofty growth plans on the back of previous high growth targets have
since been revised downwards in line with the current realities and the
underlying revenue expectations of businesses.
A growing number of
businesses in 2020 have had to come to terms with increased revenue
uncertainty, wider supply chain disruptions and a rise in the domestic cost of
debt despite increases in COVID-19 induced financial market liquidity.
Coming To
Terms with The New Normal
The post-COVID-19 'new
normal' will mean different things to different people and corporations as individuals and businesses come to terms with the current
reality. Organizations are increasingly being compelled
to reset their business responses to downward-looking
demand projections (meaning lower operating cash flows), rising cost of
logistics and difficulties in obtaining imported inputs. However, the 'new normal' will differ across countries and continents.
The pre-existing realities of each country and the fiscal head rooms of each
government will determine what the new shape of economic and corporate management would look like in months ahead. While in North America, Europe and Asia, citizens would vote
for greater digital interaction in Nigeria this would be difficult given the
challenges of acquiring computer hardware, the cost of internet access and the
intensely communal nature of Nigerian lifestyles.
The cost of acquisition
of laptops and desktop computers, internet modems and other
communication facilitators such as a generator to power the business and
personal hardware would make remote work and business interaction difficult in
a society where 85% of businesses are located in the informal sector of the
economy.
Another problem with
the concept of the new normal as applies to Nigeria is that there are
deep-rooted cultural mores that place a premium on interacting on a
person-to-person basis; the village square is more than just a place to
congregate, it is a place for dispute resolution, communal planning and an
incubator for folklores and the passing of ancient wisdom across generations. No
digital programme or contraption could substitute for the folksy mystic of the
village. Social distancing is a notion simply alien to the realities of rural
Nigeria.
Furthermore, social distancing in environments that
are heavily dependent on daily -subsistence earnings is impossible. The hustle
and bustle of commercial trading cycles from Lagos to Kano and from Port
Harcourt to Abuja make urban cities the hotbeds of social interaction as they
fasten deep commercial and financial bonds that tie everybody together. The
large retail markets of Lagos, Kano, Port Harcourt, Aba, Onitsha, Kaduna and
Jos repel efforts at keeping safe distances. The reality of the market, like a
cyclone, overwhelms the expediency of health rules no matter how well-intentioned.
Economist have noted that
for the Nigerian government to take full benefit of the digital age it
must gradually reduce the size of the informal sector and increase the breadth
of the formal sector as it ramps up electricity generation and distribution,
improves transport infrastructure and supports a significant reduction in the
cost of access to the internet. Internet data costs need to fall as micro,
small and medium-sized businesses (MSMEs) become more active in the emerging
formal sector which will experience consumer spending shifts.
The New Shape of Retail
The retail sector will likely migrate slowly from a
physical consumer interface to more digitally-inspired consumer interaction. Business-to-Business
(B2B) and Business-to-Consumer (B2C) transactions will ride on
the shoulders of increased internet data penetration and a fall in the cost of
data which could arise as a result of a major reduction in the right-of-way
(R0W) costs of laying digital cables across states, the Ekiti State government
recently reduced the cost from N4,500.00 per metre to N145.00 per metre. If
reductions of this magnitude occur across all states, data costs could come
down and improve data access by micro and small-scale businesses.
With increased digital penetration and consumer
sensitivity, the retail market will likely see faster expansion in spending,
greater product and service choices and superior user experience and
interaction.
Lower consumer sensitivity, especially in Nigeria's
large informal sector, and low or non-existent digital involvement would keep
the economy running along the same old rail track and would perhaps bring the
country to a point of repeating the same worn responses to future pandemics
with little lessons learned and nothing gained in terms of socioeconomic
repositioning.
The realities of the COVID-19 pandemic indicate that
societies that will grow stronger from the pandemic experience are those that
migrate from non-digital existences with low consumer sensitivity to those with
higher digital engagements with increased consumer participation in influencing
product or service design, quality and delivery.
The medical and pharmaceutical sectors will need to
raise their delivery standards as equipment, research and development and
personnel training will all have to be ramped up over a very short time. Indeed, medical laboratory technicians will have to be vastly
improved with more professionals schooled in the science of lab technology as
vengeful viruses remain an ever-present potential global threat. Healthcare
insurance will, therefore, also have to be leveraged to achieve wider coverage
and more efficient pricing. Life insurance would equally need to be made easier
to buy and faster to process as more micro and small-scale
entrepreneurs are brought into a micro-insurance coverage scheme. Medical
science and its various supply chain interfaces will need to grow into a state
of unending preparedness.
The traditional concept of the market place may take
time to transition to a new normal, but Nigeria's young national demography
(over 60% of the Nigerian population is between the ages of 1 and 35) with
growing digital capabilities will result in a gradual reduction in the
importance of physical retail platforms. Digital market places will slowly
become the go-to platforms for fast-moving consumer goods (FMCGs) and other
more durable purchases. How fast the transition occurs depends on the pace of
digital infrastructural growth and development.
Is this the age of
commercial drones? The concept may not take quickly but over the
next half-decade logistics would be more about technology than brawn as human
intervention in the E-commerce distribution (or 'fulfilment') value chain would
be more about programming than lifting, driving and counting. The outcomes of the post-COVID-19 economy would reshape the realities of
a variety of businesses going forward (see
illustration 1 below).
Illustration 1: The
Deadly Economics of a Virus
The Global
Shape of Things To Come
The world is set to be
less rather than more integrated. The disruptions in global supply chains as a
result of the ongoing health pandemic has made nations more inclined to reduce
dependence on foreign supply sources and more focused internally on domestic
substitutes. The meaning is a less globally-linked supply network for
manufacturing and commerce and a major change in global terms of trade and
capital flows. Large manufacturing countries like China and the United States
of America would see large growth in domestic manufacturing and commerce as
domestic production of manufacturing inputs replace imports, especially in the
areas of pharmaceuticals and healthcare products, food production, chemicals
and agro-allied industries. Smaller economies will still be dependent on these
larger economies but at an incrementally slower rate as import-substitution
strategies in these smaller economies tend to reduce imports but only
marginally.
The changing global trade
dynamic introduces weaknesses and opportunities. For a country like Nigeria
with heavy import dependence for both finished and intermediate products, the
declining revenue from its major export products Oil and Gas may mean a weaker
ability to satisfy domestic demand for inputs but it would also suggest
interesting opportunities for domestic replacement of old foreign-facing supply
chain channels. The gradual depreciation of the naira in foreign exchange
markets may increase input costs and make domestic production more expensive in
the short-term but as manufacturers create domestic replacement chains the
domestic costs will begin to fall and inward-looking strategies to keep
production lines working will create huge medium-term payoffs. Nestle Nigeria
has proved the point in its strategy of sourcing most of the inputs for its
baby formula business from sorghum, maize and barley grown domestically. The
strategy which took off in the early 2000s has shielded the company from the adverse
impact of rising foreign exchange rates and international supply chain
disruptions. The company may still have to face challenges with machinery parts
for servicing and maintenance but with time this may create opportunities for
fabrication factories in places like Onitsha and Nnewi in the eastern part of
the country to step up capacity and quality. It would also create opportunities
for farm crop expansion in places like Kebbi, Benue, Plateau, Delta, Edo, Ondo,
Osun and Ogun states.
In the emerging local
Nigerian realities, the post-COVID-19 industry gainers would include:
The losers of the post-COVID-19 economy would include the following:
Internationally the
consequences of COVID-19 would see similar losers and gainers across industrial
sectors (see illustration 2 below)
Illustration 2: Sectors
Gainers and Losers
Debt or Equity? The Financing Problem
As COVID-19 restrains equity investors from committing more funds to businesses, a growing number of large corporations are opting for debt market solutions such as fixed-interest commercial papers (CPs), Dangote Cement has raised N100bn in five-year notes (from an N300bn Issuance Programme) while Mixta in the real estate business has raised just under N10bn in medium-term notes between 2017 and 2018 on the FMDQ (see tables 1 and 2 below). The resort to the debt market shows a growing appetite for corporate debt as new equity issues have proven difficult. Even Nigeria's most successful microfinance bank, Lift Above Poverty Organisation (LAPO) microfinance bank has only listed its debt on the Nigerian Stock Exchange (NSE) in June 2020.
Table 1 Dangote Cement Plc - N300.00bn Bond Issuance Programme
Source: FMDQ, Proshare Research
Table 2 Mixta Real Estate Plc - N30.00bn Medium Term Note
Programme
Source: FMDQ, Proshare Research
Debt increasingly appears to be the financing route of preference as
COVID-19 makes equity even more difficult to raise as cash flow uncertainties
and difficulties in establishing the proper valuation for companies and their
equities have spooked prospective investors in the equities market. But as the
equities issuance thins down, debt finance has proved resurgent, attractive and
accessible. The rise in the medium to the long-term corporate debt market, in
Nigeria for example, maybe an indication of the new direction of corporate
finance, especially in the emerging markets of Africa.
A Rebalancing Act
A major lesson from global economic crises is that it should never be
put to waste. The COVID-19 economic challenge may be taken as an opportunity to
rebalance the domestic Nigerian economy and raise opportunities in the non-oil
and gas sectors. The fact that oil and gas contribute less than 10% of gross
domestic product (GDP) shows that most of Nigeria's economic output comes from
a variety of sectors of which agriculture is a major part. The improvement in
the agricultural sector could expand and deepen supply chains and increase
domestic employment as jobless rates decline.
To improve local supply chains the machinery and pharmaceutical sectors
may need to improve their output and depend more heavily on local raw inputs.
The machinery sector could provide locally made equipment and spares, while
research and development in local pharma may improve overall healthcare
resilience and protect the local health value chain. Nigeria should be capable
of manufacturing personal protective equipment (PPE) for frontline health
officials while also providing local drug solutions for the various health
challenges that will inevitably persist after the COVID-19 curve has been
globally flattened. The need to raise finance to bolster the local Nigerian
healthcare sector is strategically non-negotiable and private debt and equity
raise in this sector is a major imperative of local corporate financiers
thinking forward.
Where Private Capital Pays
With the world likely to be awash with financial liquidity as
governments globally adopt new fiscal and monetary initiatives to drive growth
or stem recession, private investors would be looking for superior returns that
do not come with outsized risks.
Emerging markets with their typical gaps in social and economic
infrastructure may retain their attractiveness. Nigeria, barring corruption
challenges could be at the top of the investor's pecking order as a few sectors
look strongly attractive with the right policy framework in place and a free
market price discovery process allowed to work.
Some examples of sectoral opportunities include, but are not limited to
the following:
The Nigerian market presents massive investment opportunities in a
post-COVID-19 reality with older industries redefining their purpose and newer
businesses setting up to lead in emerging consumer demand. The proposition for
both longer-term debt and equity to thrive in this so-called 'new normal' underscores the need for financial professionals to design instruments that
build new uncertainties into corporate cash flows and provide more robust
frameworks for determining corporate valuations.
As part of the emerging financing reality, mergers and acquisitions
(M&As) within traditional and newer economic sectors will bring about
stronger entities and more creative solutions to business sustainability.
Kemi Owonubi, the
Corporate Finance head of RMB Nigeria in a recent post on Thisday
said that there would still be opportunities for sizeable M&A deals in
non-discretionary sectors, as demand will be relatively resilient across
critical sectors such as healthcare, grocery and food retail, other consumer
staples, telecommunications and logistics; while companies in the discretionary
sectors, who entered the crisis with high leverage levels, may present bargains
for investors, with restructurings occurring where the business is a good fit
to the existing strategy.
According to her, M&As
will remain active. Though typically deal heavy sectors may slow down, the
activity will continue to be driven by value opportunities and consolidations
(the banking sector in Nigeria seems to hold out opportunities and FMCGs may
also present plausible options). There may also be consolidation opportunities,
fueled by a need to survive, and a general realignment of property prices in
the real estate sector, as properties investment are realized for more optimal
use of cash.
Closing out deals
A key difficulty from a deal-making perspective is the disruptions caused by COVID-19 to transactions in progress, the
lack of predictability of operating cash flows and income streams builds
additional layers of risk into previously stable business models thereby making
corporate valuations very much a hit-or-miss gamble. The increased difficulty
in predicting incomes and cash flows in a time of a global health pandemic is
compounded by the uncertainty related to the weighted average cost of capital
(WACC). The required yields in a period of volatile capital costing have left
finance professionals in a quandary as rising domestic and global liquidity has
not necessarily translated to lower financing costs in countries such as
Nigeria. But what has become evident is that people, connections, collaboration
and deliberately reinforced confidence are key factors in deal-making processes
going forward.
Cornelia Anderson, Head,
M&A and Capital Raising, Product Strategy, Refinitiv says that deal
makers with access to high-quality data have a distinct advantage, considering
that the demand for information rises exponentially when there is uncertainty
in the market. Financing will not be an after-thought, though covenants will
become tightened while warranties and earnouts will become popular.
As far as Daniel,
Christopher and Hareem of the CSIS Project on Prosperity and Development are
concerned, "developing countries would benefit from mobilizing local pools
of capital as well as from increased foreign direct investment (FDI), remittances,
and investments from pension funds. Financial tools and approaches such as
guarantees, green and infrastructure bonds, and advanced purchase agreements
can be used to encourage participation from untapped private sources."
The Opportunities This Time
Coronation Capital's Opubor has argued that amid the COVID-19 challenge
a new light has shone on businesses and their models for financial and
operational sustainability. Opubor says, "the opportunities for growth and investment in
Nigeria and the need to focus on improving internal capabilities, understanding
fundamental analysis to take advantage of market opportunities when perceived
has become critical at present".
As a part of its
Education, Development & Impact Series, leading Private Equity Firm,
Coronation Capital is organizing an online master class on July 20 - 21 and 27
- 28, 2020 with Aswath Damodaran, a renowned Professor of Finance at New York
University's ("NYU") Stern School of Business.
Related
Reports (PDF)
1. Download the Full PDF Report - Coronanomics and the Nigerian Economy,
June 06, 2020
2. Executive Summary PDF - Proshare, June 06, 2020
Related
News
1. Coronanomics
(28) - Nigerian Equity and Fixed Income Markets
2. Coronanomics
(27) - Impact of Government Policy and Restrictions on Households
3. Coronanomics
(26) - CBN's Vexing Trilemma
4. Coronanomics
(25) - A Regulator's Burden - CBN's Tale of Heterodoxy
5. Coronanomics
(24) - Sectorial Analysis of Nigeria's Oil Sector
6. Coronanomics
(23) - Sectorial Analysis of Nigeria's Trade Sector
7. Coronanomics
(22) - Sectorial Analysis of Nigeria's Transportation and Storage Sector
8. Coronanomics
(21) - Sectorial Analysis of Nigeria's Manufacturing Sector
9. Coronanomics (20) - Sectorial Analysis
of Nigeria's Finance and Insurance Sector
10. Coronanomics
(19) - Sectorial Analysis of Nigeria's Agricultural Sector
11. Coronanomics
(18) - Selected Sub-Nationals: The Different Faces of Trouble and Redemption
12. Coronanomics
(17) - Sub-Nationals: Digging Deep, Wide and Hard
13. Coronanomics
(16) - Deconstructing Nigeria's Trade
14. Coronanomics
(15) - Nigeria's National Income - Understanding The Black Box
15. Coronanomics
(14) - Nigeria's Debt Profile - Swimming in Deep Waters
16. Coronanomics
(13) - Nigeria: The Budget, The People and Poverty
17. Coronanomics
(12) - The Nigerian Economy in Relief
18. Coronanomics
(11) - Fighting A Virus - Africa's Equity Market
19. Coronanomics
(10) - Impact on the Travel and Tourism Sector
20. Coronanomics (9)
- China, US-Africa Bilateral Trade Data - Changing Partners
21. Coronanomics (8)
- African Economies - An Emerging Market Fight Back
22. Coronanomics (7)
- Global Policy Responses Against the Negative Impact of COVID-19
23. Coronanomics (6)
- Global Stock Market - Top 3 Decliners Dipped By 0ver 26% YTD
24. Coronanomics (5)
- Global Oil Market - Spinning Around A Vortex
25. Coronanomics (4)
- Chinese Economy and The Rest of the World
26. Coronanomics (3)
- The Global Economy Spinning on a Wishing Wheel
27. Coronanomics (2)
- Easing Out of a Crisis
28. Coronanomics (1)
- Understanding the Realities of an Impending Recession
Related News on Private Equity
1.
Brickstone Sponsors The Resilient Africa Week 2020, A
Session Organized by The Africa Catalyst
2.
Transforming Isolation, Testing and Caring of COVID-19
Patients Through Private Capital
3.
IOSCO Report Provides New Data on Global Hedge Fund
Industry
4.
Lekki Port Receives $221m China Harbour's Equity Infusion
5.
COVID-19: Ventures Platform and Lagos State Government
Partner in Fight Against
6.
Venture Capital Firms Will Play Key Roles In Africa's
Economic Growth - Dr. Ola Brown
7.
Venture Capital Can Work Despite Economic Slowdowns - Dr.
Ola Brown
8.
Branch International raises $170M Series C Financing, led
by Foundation Capital and Visa
9.
Nairobi Hosts Africa Private Equity Conference with Investors
Managing Over US$1.5trn in Assets
10. Network Intl, Middle East and Africa Pyt Processor Plans
London Floatation - Private Capital Update
11.
An Overview of AI for Wealth Management - What's Possible
Today?
12. Why Private Investment Works And Government Investment
Does Not
13. Investec Aviation's New Fund To Target Up To $2bn Of
Aircraft Acquisitions