Home to a vast swath of emerging and frontier markets, Africa is often touted as the promised land of impact investments. However, the reality is more sobering. Although there is a lot of room to help the continent catch up with the rest of the world, institutional hurdles remain and many investors that were once enthusiastic have now left the continent.
Africa, it would seem, is not a playground for the unexperienced, the unprepared or the wide-eyed investor. Nevertheless, for those asset managers ready to do their due diligence, find reliable partners, align incentives and structure their transactions thoughtfully, Africa can fulfil its promise.
The TLG Capital Way
Discussing their approach to investments in Africa, Zain Latif, Principal, CEO and Founder of TLG Capital and Isaac Marshall, Investor at TLG Capital, are keen to emphasise three key characteristics to their approach: TLG is looking to do business, not change the politics or culture; scalable business models are key, and; well-structured transaction can help address the liquidity problems that limit investors’ ability to exit positions and achieve above market returns on the continent.
“We’re not a political or moralistic investor. We are not looking to go into a country to change the way things work. TLG Capital is in the business of considering which credit investment opportunities are available in a specific country as it is. We ask ‘What are the problems?’ and ‘How can we help?’ in a way that is robust and commercial, tailored to conditions on the ground. To do that, we need to find local stakeholders with whom we can partner,” Latif says.
“When we look for business opportunities, scalability is an important factor that ensures our investee companies are able to generate the returns we are looking for. While manufacturing remains an interesting sector to us, it is often difficult for African manufacturers to compete with those in China and India, where domestic markets allow economies of scale and ease of expansion. African markets, by contrast, are fragmented and regulations differ among jurisdictions. Therefore, a key focus is also to fund technology and advanced services companies (health, education, telecoms),” Latif argues.
“To compete globally, African companies will often need government support in the form of lower taxes or preferential treatment. However, this is not a sustainable approach. Governments come and go, and policies change. When we were starting out, we invested in a local telecom company motivated by a policy whereby only national players were being attributed telecom licenses. Sadly, shortly thereafter, a subsequent government allowed foreign operators to purchase licenses too, which undermined our investment and although a positive exit was achieved, it took longer than originally envisioned,” Marshall says.
Further, scale is sometimes not enough. The absence of references to Ethiopia across all conversations about foreign investment in Africa is deafening considering it is the second most populous country on the continent. This absence is a result of policy. “Ethiopia is still a victim of its socialist past, which still casts a long shadow on national policy. The country imposes rigid exchange rate controls that make lending in foreign currency and getting money out of the country a very big problem. Otherwise people would be pouring into Ethiopia. It’s a fantastic country,” Latif notes.
Finally, Latif and Marshall both highlight the difficulty of achieving exits in African markets, “The secondary market is a linchpin for the primary market to develop. In Africa the big problem is exits. Because no one does refinancing and no one buys in the secondary market, there’s no liquidity in the system and so no one can exit. The only people that end up entering primary markets are the people who don’t care about exiting. The entire system of primary investments is therefore primarily constrained to high impact capital that understands that exits are difficult and is able to still invest given more flexible, impact oriented mandates,” Marshall says.
“This is a real problem and explains why of the 1000 enthusiastic funds investing in Africa in 2010, less than 200 remain. The hidden truth is that a lot of impact investors in Africa cannot exit their positions. There’s no liquidity in the market. There is an exceedingly limited IPO market while national pensions tend to invest in governments bonds rather than the real economy. This means there is a limited number of local investors to support and invest in companies for the long term, unlike in Europe, most of Asia and America,” Latif adds.
TLG’s Approach Today
TLG has successfully structured investments into private companies across Africa for over a decade, backing over 35 companies, and achieving 22 exits to date (all with IRRs between 6 and 37%). Keeping in mind the African market risks and factors as outlined above, TLG Capital believes that the best way for it to scale investing into Small and Medium Sized Enterprises (SMEs) across the continent is to partner with strong local financial institutions. Small and Medium Sized Enterprises (SMEs) should be the engines of economic growth. Yet they currently lack the necessary financing to grow. Local banks are at hand help but have limited loan terms, can lack hard currency liquidity, and often times put in place loan structures that squeeze rather than support companies, particularly in times of economic shock (Covid, the Ukraine War etc).
“Working with banks to support SMEs they already have relationships with is an innovative strategy,” Latif says. “Africa is not attractive on a relative value basis at the moment. No one is looking to help performing companies across the continent, much less stressed ones, which may have less than ideal loan terms or may have been hard-hit due to recent global volatility. This means that there are a lot of good businesses with sound business models that are burdened with loan structures that don’t fit them,” Marshall explains.
Figure 1: Kenya
TLG has identified over US$ 6.6 billion in SMEs who experience stress because their bank loans are not properly matched to the cashflows of the company from a survey of Tier 1 banks across Nigeria, Ghana, Kenya and Tanzania, equivalent to an average of 14% of the total gross loans in these markets.
The Need for Structuring Expertise
According to Latif, TLG Capital’s outstanding advantage stems not from its ability to find good investments, but rather from its ability to structure them well. “We excel at finding good deals, but so do other investors. We are not the only asset manager with a good network of contacts that helps us find attractive investment opportunities. We stand out for our ability to structure deals well. That is our expertise. We’ve been invested in companies where others have made a loss but we made a positive return. This is due to the nuances of how we structured our investment,” Latif says.
“Our structuring skillset is what allows us to specialize in debt in Africa. When macroeconomic trends can shift rapidly, otherwise healthy companies can be wiped out by that change in the environment. Our skillset is in approaching transactions in a way that is robust to potential negative headwinds and protects investors downside,” Latif adds.
The Importance of a Suitable Structure
The investment case is perhaps best understood with an example. “An advanced surgery and specialist medical centre recently lost a key corporate client just as principal payments were due on their bank loan. It’s a good business and everyone can recognize that there is extremely high demand for specialist medical services, but it’s struggling at the moment and without a lifeline it could disappear,” Marshall explains.
“However, as loans tend to be short tenor in Africa, debt service requirements are often quite significant in any given year. So the medical centre faces risks on meeting upcoming debt service requirements. However, they would be able to repay that with a longer tenor loan, with a maturity of five to seven years instead of the one to two years loan they get from their bank, even on their current profile,” Marshall adds.
“This is a scenario where TLG Capital may look to step in. We would provide a loan with a longer tenor and a coupon rate that is low enough to allow the company to have some breathing room. Our loans in scenarios like this are often secured by a bank guarantee or insurance product, ensuring our principal and minimum amount of interest is protected. In addition, TLG ensures alignment via receiving equity upsides in the company should it perform in line with expectations.
“A bank provides off-the-shelf loans. It does not have the mandate to do this this sort of bespoke transaction. From what we have seen, often banks in the region are constrained and therefore may struggle to customise loans to match the cashflow needs of the company,” Marshall continues.
A Win-Win-Win Transaction
“Our intervention helps the SME, but it is also a way to partner with local banks and businesses to provide them with better financing and give them the breathing room to fix their operations and come back. Partnering with us allows the bank to get liquidity, give the loan a structure that fits the company’s needs and retain the client whose account remains with the bank.
Partnering with local banks in this manner also overcomes some of the principal-agent problems faced by distant investors. “When your creditor is a lender in a faraway developed country, there are a range of hurdles that would need to be overcome to chase back the borrowers. This structure preserves the relationship between the SME and the local bank which is on the ground and has a close relationship with this borrower, making it that much more reliable. The bank also holds the borrower’s collateral on behalf of TLG and issues a guarantee to TLG on the back of this,” Latif says.
“From a practical perspective, we also don’t have to go through any registration hurdles. There is no transfer of property. The principal asset which was used to secure the original loan stays with the bank because they are giving us a guarantee. They don’t have to worry about this loan for seven years and they know that TLG will own the process, as we are incentivised to do so due to equity upsides embedded in our transaction,” Latif adds.
“The great thing for us is that once we agree with the bank and the borrower, the whole process closing becomes just about documentation. The borrower signs the document, the bank issues us with a guarantee and the money is sent to the borrower. Our ability to reach and to serve a much larger set of SMEs across the continent is delivered by working closely with banks who have existing relationships with excellent companies across the continent that could benefit from loan terms that better suit their business,” Latif explains.
To date, TLG has reached over 50 banks across 12 countries. “To return to our initial argument, the core of this model is that it is also scalable. Most western banks operating in Africa will claim to have offices in South Africa or in Nigeria, but not many are in Botswana or in Tanzania. Their coverage is limited. On the other hand, by partnering with local banks, we can reach deeper into the continent and deploy it across our network at scale,” Marshall argues.
“We look forward to our continued journey, backing sustainable businesses across the continent, that to date have not received financing structures suitable to their needs.” Marshall concludes.