When looking at the prices being asked for PE assets in South Africa and Africa, and the landscape that influences those, we can see market fundamentals reflected.
Muted asset prices directly reflect South Africa’s poor growth outlook, an increased risk profile, and the lingering impact of the pandemic. While somewhat rebounded, the average EV/EBITDA multiple paid for a private equity asset is still among the lowest it has been since we started gathering data more than 10 years ago. However, the asset class has a proven track record of outperformance in periods of weak economic growth and market volatility. Combined with current low prices, this may indicate that funds currently deploying capital will return good performance relative to other asset classes.
When looking at the prices of African private equity assets excluding South Africa, it can be difficult to understand price movements purely from the cost of equities calculated using CAPM and growth forecasts. To correctly interpret this, you need to understand African capital markets and CAPM well. CAPM relies heavily on several underlying assumptions, which are stretched to breaking point when looking at African capital markets, especially the private equity market. The most relevant are assumptions such as frictionless trading between asset classes, which stands in stark contrast to illiquid capital markets, the fund commitment model, and restriction on the free movement of capital.
Despite erratic fundraising and mixed risk and growth outlooks, market trends in African private equity have remained constant. Despite PE prices dipping below those of listed companies, deal activity is growing significantly. In 2021, notwithstanding the dramatic drop in funding, and the change of risk and growth outlook, our data shows that deal activity had reached new highs (albeit at lower transaction values). Multiples pricing have remained stable, with only a slight decrease in prices observed. The pricing level is, however, well below that of the listed market. It has done, returning the relationship between listed and unlisted prices to more conventional levels.
It appears that the significant amount of committed capital has had a stabilising effect on pricing, which survived short-term changes in funding levels and risk profile. However, the committed capital model can only delay the efficiency of markets. Prolonged decreases in fundraising and risk outlook are filtering through to pricing. The sharp decrease experienced in fundraising is expected to gradually recover following the pandemic and the resultant economic slowdown. However, if these trends continue, prices may be less buoyant going forward.
Realising Africa’s potential for enormous growth and innovation, given its young population and vast natural resources, will require considerable investment into economic reform, education, healthcare and digital skills development. Africa is still an attractive investment destination, but requires enhanced economic reforms, good governance and a stable political landscape to continue attracting PE fundraising and entrepreneurs. Addressing these factors can play a pivotal role in the development of the continent.
The perception of risk and returns, compared to other investment opportunities, influences the PE market. We explore the theoretical cost of equity, which reflects the perceived risk of the different markets.