Editor's note

by Michael Avery

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Dealmakers are possessed with a natural optimism bias. When times are good, there are deals to be had in pursuit of growth-enhancing expansion. When times are tough, well, then assets become available on the cheap, and growth can be achieved through consolidation.

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The African private equity market experienced a surge in investment over the past decade, with almost $45bn invested in Africa’s private equity sector in 2019 alone – a high watermark. This investment has been largely driven by a number of factors, including the continent’s large and rapidly growing population, its wide array of natural resources, and its high rate of return on investment.

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However, the outlook for African private equity is becoming increasingly uncertain as a result of changing global economic conditions. The World Economic Outlook (WEO) from the International Monetary Fund (IMF) predicts that the global economic growth rate will decline in the coming years, due to tightening monetary policy all over the world. This is likely to have a significant impact on the African private equity market, with investors becoming increasingly cautious and risk-averse, and of course, with the cost of capital raising hurdle rates for transactions that rely on leverage to juice returns.

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The outlook for private equity in South Africa is particularly uncertain. The South African economy has been especially hard hit by the global economic downturn, and the country’s currency, the rand, has depreciated significantly against the US dollar in recent months, thanks to the ongoing bumbling of the government in its handling of the electricity crisis. This is likely to have a significant impact on South Africa’s private equity sector, with investors likely to be more cautious and risk-averse, and will raise the hurdles to attract global funds into our general partners.

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The downward trend in interest rates has been a constant in the investment world for the past two decades, as global deflation has generally outweighed the risk of rising prices, leading central bankers around the world to keep the monetary spigots open, and driving real interest rates to historic lows. This has led to a steady uptick in asset prices and the creation of massive wealth around the world. This has now come to an abrupt end.

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As rising rates undercut the value of assets today, generating returns in this environment can be significantly harder for private equity investors, who have benefited mightily from the run-up in multiples over the past two decades. This poses a dual threat to private equity as dealmakers risk the opposite if valuations flatten out, and inflationary cost pressures and margin pressure pose a real threat to just about any portfolio company.

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While the South African private equity sector has come under pressure in the midst of global economic turmoil, the venture capital and start-up sector has remained resilient. Africa is the only market where venture capital is still growing, despite the macroeconomic downturn. New funding is coming into the market, with the likes of global giants Sequoia Capital, Andreessen Horowitz and Tiger Global all entering the market for the first time in the last 18 months. But the global economic outlook is influencing South African start-up valuations and deals being made. Valuations are more difficult to achieve, and investors are becoming more selective in their pre-investment vetting. Start-ups are also advised to undertake some belt-tightening to weather the economic uncertainty ahead.

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2023 promises to be another bumpy ride.