Revamping Kenyan Private Equity Markets for Economic Growth

By Gatuyu Justice

In recent years, Kenya has witnessed significant growth of Private Equity (PE) markets. PE funds have become the new kings of corporate deal making. East Africa Venture Capital Association, PE industry lobby, estimates PE funds deals in East Africa for year 2016 to be over $152 million ranging in array of sectors.

HELIOS-HANDOVER-EDITED.jpg
Treasury CS Rotich handing over Telkom Kenya to PE Fund Helios Partners after successful buyout. Photo credit, Capital FM 

The Kenyan market has been attractive to the global PE funds due to reported high returns by PE firms in the country.

Equally, a policy of low-interest rates by United States Federal Reserve has led to investors re-channeling their savings to emerging markets, ensuring PE firms have mountains of dry powder to invest.

PE investment is not a new invention. It dates back from 1901, when J.P. Morgan, through PE, acquired Carnegie Steel Company. In Kenya, PE industry can be traced in 1967 when ICDC Investment Company (now Centum Investment PLC) was established.

But PE activities globally boomed in 1980s, a period which saw PE firms’ reputation nosedive, as they become notorious for corporate raids, hostile takeovers, asset stripping of targets, layoffs, and out-sized profits to investors.

They majorly acquired targets through leveraged buyouts strategy, being use of debt, and this was viewed as way of milking targets for short-term gains. Trade unionists in Europe went on warpath with PE firms, describing them as “locusts and barbarians at the Gate.” Warren Buffet, a reputed investor, accused them of ‘turning business into merchandise.’

PE firms have risen from rabble to reclaim legitimacy. Bain & Company, a consulting firm, reports exits from PE buyouts by 2014 were exceeding $450 billion, indicating the PE huge potential.

The trick to PE Firms success is their strategy. The intensity of pre-investment due diligence they conduct on targets ensures they make decision with perfect information. They then pump in money through various gradations of equity capital or debt. They bring in expertise and transactional dexterity in operations, nurture expansion and cut costs. They route incompetent managers whom shareholders may have been unable or reluctant to rout.

These actions increase the value of their target. After a specified period, 5 years mostly, they exit the investment to explore other ventures, and in their wake profit from capital gains.

Umeme limited, energy firm cross listed at the Nairobi Securities Exchange and Equity Bank are good case studies of benefits of PE investment. The Economist reports when Actis, a PE firm, acquired Umeme in 2005, it restructured the company by making minor changes such as replacing old insulators, reducing electricity theft and dismantling illegal connections, small changes which reduced losses by half and turned Umeme profitable.

Similarly, in December 2007, Helios Partners, a PE firm, acquired 24.99% interest in Equity Bank. This was a grease to the elbow Equity bank, boosting the bank standing amidst the then going concern doubts over its ‘unconventional’ banking model.

Fortunately, in encouraging PE activities, Kenya has made laudable steps. Rotich, National Treasury CS, recently allowed pension funds to invest up to 10% of their funds in private equity and venture capital. This was a good move that will drive portions of pension funds into private equity sector.

Equally, the Companies Act enacted in 2015 revamped corporate law, permitting issues such shares re-purchase programs and financial assistance by company to acquire its own shares, opening up exit options for PE firms.

Still, more reforms are needed.

The leading PE funds operating in Kenya are foreign, indicating lack of awareness on mechanics of PE among the local investors. At the NSE, only local investment firms listed at main market segment are Centum and TransCentury. More awareness needs to be created.

Second, tax laws needs to offer incentives. Currently, only registered venture capital funds have benefit of having gains and dividends paid to their members being exempt from income tax. Perhaps, incentive of lower capital gains tax rate should be granted to PE firms on exit.

PE activity in Kenya has majorly been directed towards large enterprises, with small and medium-sized enterprises given a wide berth. This has created a Macmillan gap, where small enterprises experience difficulties in raising long dated capital even when they offer sound collateral. PE firms should be encouraged to bridge this gap.

Fourth, as PE industry grow, accountability and transparency of the sector need to be enhanced. A PE transparency code, such as the Walker Guidelines in England, need to be enacted.

Fifth, Capital markets laws need to be reformed to promote PE activity by allowing innovative fundraising methods such as crowdfunding to take root. (Read more The Suffocation of the Capital Markets Authority)

Lastly, PE funds have been exiting from their investment majorly through trade sale. Little preference have been given for initial public offering due to illiquidity capital markets and winding bureaucracy of the process. Effort needs to be made to encourage PE firms exit through public offerings. These reforms will help the march of the PE firms and enhance their scope.

The author is a lawyer

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