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:
Road infrastructure; the road construction sector can be funded on a build operate and transfer (BOT) or build own operate and transfer (BOOT) for operating terms of between 25 and 30 years. At a time COVID-19 places challenges on government's fiscal resources, allowing private capital to be mobilized to build world-class road networks seems sensible. The usual problem with these arrangements is the perennial refusal of the government to respect the sanctity of contracts. If governments at both national and subnational levels can step out of their way, then COVID-19-inspired liquidity could lead to the rapid growth of road infrastructure which would reduce road travel time, vehicle maintenance expenses and the cost of domestic logistics. The economic benefits would exceed the economic cost.
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)
9. Coronanomics (20) - Sectorial Analysis of Nigeria's Finance and Insurance Sector
Related News on Private Equity