Investing in Africa requires a certain level of business maturity and sophistication (see African investment part 1: Africa is an opportunity to get investment right, on this website) that goes well beyond pure financial erudition.
The primary reason is that investing in Africa means investing in communities rather than markets. For one thing, markets in Africa tend to be tiny, because of the vast geographical, cultural, and political differences that separate one country from another and, in some countries, such as Nigeria, one region within a country from another.
There are growing but limited links, by road, rail, air, telephony, or Internet among the various countries. So moving goods to and from their production areas is not easy. A trend is developing in which countries with a common interest establish an economic community by means of which they can share one another’s facilities and jointly build up some trading power. The Southern African Development Community (SADC) was formed in 1992 and the Common Market for Eastern and Southern Africa (COMESA) has evolved from its position as a replacement in 1994 of the Preferential Trade Area (PTA) to having significant regional market influence.
But, in general, creating large, influential markets remains difficult for African countries.
Like it or not, therefore, investing in Africa frequently comes down to investing in communities. And that means thinking about approaching the mechanism of investment from a different perspective, without sacrificing the financial fundamentals. In its way, investing in communities is more of an intellectual than a financial frontier for investors. It’s actually remarkably interesting work.
The crucial factor, of course, is that communities are not businesses. As a rule, they don’t have balance sheets or audited accounts. Mostly, though, they do have assets and capital – in the form of natural resources, ingenuity, and entrepreneurial spirit. Their needs are basic, as in food, shelter, schools, roads, clothing, and communication capabilities. So, they constitute a market in which demand far outstrips supply.
They don’t run like businesses, but they are conduits to business opportunities.
Platinum and poverty
A case in point is Musa Capital’s work with the 30 000-strong Bakubung Ba Ratheo community that lives in a small town close to Sun City, home of the annual Million Dollar Golf Classic set in the spectacular surroundings of a dormant volcano and casino resort.
The community has chosen to govern itself by its traditional conventions, under South Africa’s Traditional Leadership and Framework Act 41 of 2003, which allows for the country’s diverse population to maintain local traditions while still acknowledging national law. The Bakubung Ba Ratheo’s traditions include having a hereditary royal family, headed by a king (kgosi), being governed through a broadly representative traditional council (which encourages the participation of women at the council level), and the holding of communal land.
The Bakubung Ba Ratheo’s communal land just happens to sit on top of some substantial platinum deposits. Historically, however, the Bakubung Ba Ratheo, like other black South Africans, have been subjected to hundreds of years of political and economic oppression.
So, in spite of their access to platinum minerals, the Bakubung Ba Ratheo have lived in dire poverty.
In 2005, a South African junior mining company, Wesizwe, bought from the Bakubung Ba Ratheo their mineral rights in return for the promise of building a mine that would provide the Bakubung Ba Ratheo with some 3,000 jobs on their own doorstep. The Bakubung Ba Ratheo would also hold 117 million shares in Wesizwe, thereby participating directly in an ongoing wealth creation project.
The difficulty was that tangible proceeds from the deal would accrue to the community only once the mine was in production – and that could take anything up to 20 years.
However, the community was in dire need of money – for roads, houses, the means to pump potable water to homes, education facilities for its children, care facilities for its elderly, and employment opportunities for everyone. Twenty years was too long to wait.
How to have your cake and eat it
So, the community went looking for financial advisors. In a competitive selection process, Musa Capital won the mandate which was to:
1. permit the community to realise some immediate cash benefit from the asset it was holding in order for social and infrastructure programmes to be implemented;
2. accomplish this first objective while still allowing the community to participate as a shareholder in Wesizwe so that it could realise any potential upside of the shares;
3. diversify the community’s asset holdings away from a single investment;
4. and shield the community from the inevitable dilution that would occur to its shareholding during the capital raising that Wesizwe would have to do in order to fund its development efforts.
Musa put extremely sophisticated ‘global’ finance to work in a situation where most of the beneficiaries of our work had neither a computer nor access to one.
As the Bakubung’s shareholding constituted over one fifth of Wesizwe and the shares were, generally, illiquid, selling their shares in the market was not a viable option. It would have resulted in a significant depression of the stock price, thereby negatively affecting both other shareholders and the company’s ability to raise capital. Selling the shares in the market would also not accommodate any of the other aims.
Our recommendation to the community, approved by the Traditional Council and the Kgosi, was to create a structure that would permit the community to "swap" its shares in Wesizwe in exchange for cash and a shareholding percentage in a vehicle that would hold not only the Wesizwe shares transferred from the community but also additional Wesizwe shares that were acquired from other parties - thereby increasing the community’s influence. The original intent was to accomplish this through one transaction but, as things turned out, because of market realities and counter-party needs, the transaction was ultimately accomplished in two steps.
The two transactions resulted in a net effect of converting the community’s 117 million Wesizwe shares into a shareholding interest of approximately 60% in a company that held 143 million Wesizwe shares, along with a realisation of in excess of US$70 million in cash for the Bakubung, plus additional capital for later share subscription at Wesizwe. Some of the cash has been placed in a diversified portfolio of investments and used to fund the community’s economic development entity (BEDU), which is now in its third year of providing socio-economic benefit and infrastructure development to the community.
Had Musa not been successful in its solution for the community, as of April 2011, the original shareholding of the community would have been worth approximately US$35 million, and the community would have had no significant cash assets. Instead, the community now has a shareholding, cash, and investment portfolio that is worth approximately US$100 million.
Providing comfort for the institutions
Musa arranged the funding for one portion of the structure from an international investment bank, via a derivative product called an Equity Linked Note (ELN), which is, in essence, an advance of cash by one party (in this case, the investment bank) to another party (in this case a special purpose vehicle established for the transaction) in exchange for the right to participate in the "upside" of a certain quantum of equity shares (in this case 70 million Wesizwe shares).
In the second transaction, through an arrangement with a South African funding partner, a further structure was implemented that resulted in the transfer of the community’s then remaining 73.63 million shares for a cash consideration of US$42 million, a shareholding interest in the company that purchased the community’s remaining shares, as well as purchasing the special purpose vehicle.
The objective was to have a total of 143.63 million shares residing in this final company - in which the community has a beneficial ownership of approximately 60%.
Within a span of three years, the community became three times wealthier than it would have been without the transaction - and has infinitely more liquid capital as its disposal. Importantly, the community has also diversified its wealth base so that it won’t be fully reliant on the mine once its comes into production in five to seven years.
In addition to its liquid wealth, the community now has a substantial shareholding in a new platinum mine that will be run and backed by new Chinese majority shareholders that have a vested interest in bringing the mine into operation. The community wins, big time. And, the local, national, and regional economies win.
The point being that, if you’re prepared to innovate, it is entirely possible to invest in communities rather than businesses.