When looking at the prices for private equity assets in South Africa and Africa and the landscape that influences it, we can see market fundamentals reflected.
Muted asset prices directly reflect South Africa’s poor growth outlook, an increased risk profile, and the impact of the pandemic. The average EV/EBITDA multiple paid for a private equity asset is currently the lowest it has been since we started gathering data more than ten years ago. However, the asset class has a proven track record of outperformance in 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 one looks at the prices of African private equity assets excluding South Africa, it can be difficult to understand price movements purely when looking at the cost of equities calculated using the capital asset pricing model (CAPM) and growth forecasts. To correctly interpret this, one needs to understand African capital markets and CAPM well. CAPM relies heavily on several underlying assumptions, which are stretched to the 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. Deal activity is growing significantly, and prices have stabilised since June 2017 at a level that currently exceeds that of listed companies. In 2020, despite the dramatic drop off of funding, and the change of risk and growth outlook, prices and deal activity have remained stable, with only a slight decrease in prices observed in the first six months of 2020.
It appears that the significant amount of committed capital has had a stabilising effect on pricing, which is likely to survive short-term changes in funding levels and risk profile. However, the committed capital model can only delay the efficiency of markets, and prolonged decreases in fundraising and risk outlook are likely to filter through to pricing eventually. The sharp decrease in the fundraising experienced because of the pandemic and resultant economic slowdown is expected to continue for at least 18 months. If these trends do continue, prices may prove to be less buoyant going forward.
Along with changes in the supply of capital and investable opportunities, another factor that influences the prices at which asset change hands is the perceived risk and rewards of a particular investment.