DealMakers - Q2 2023 (released August 2023)
How investing in generational impact can address SA’s socio-economic challenges
by Abdu-Rahman Abrahams
South Africa is facing significant socio-economic challenges, and the country needs to prioritise economic transformation, job creation and access to information to remedy these challenges. To accomplish this, South Africa needs increasingly to look at alternative investment mechanisms, now more than ever.
The socio-economic challenges facing South Africa remain stark. Data from Stats SA indicates that South Africa’s youth continues to struggle with the burden of unemployment, with more than 60% of those aged 15 to 24 currently unemployed, as well as more than 40% of those aged 25 to 34 years.
In the last two decades, global and local economic shocks have put the South African economy on the back foot. The 2008/2009 global financial crisis caused our first recession in 20 years, and ever since, economic growth has been meagre to moderate at best.
Despite South Africa’s emergence from the 2021 recession that arose from the COVID-19 crisis, South Africa continues to lag behind in its economic growth. The major challenges we face are the energy crisis, rising inflation, rising interest rates, and a weakening domestic exchange rate.
In this context, fortunately, investors are no longer only concerned about the profit motive, but also about the impact that their investments can make in addressing the socio-economic challenges that continue to affect the youth. This realisation has resulted in investors’ commitment to impact investing, which focuses on generating measurable, beneficial social or environmental effects, such as job creation, as well as a financial return.
Taking the idea further is the need for generational impact investing, which focuses on long-term, sustainable changes that will benefit future generations. Generational impact investing takes a longer view, focusing on investments such as infrastructure and technology, with a focus on transformation and job creation that will have a lasting, positive impact over multiple generations.
Investment vehicles proving their impact and ability to address challenges such as economic transformation, youth job creation and access to information, for example, are alternative investments, such as hybrid equity or hybrid capital.
Taking note of the lessons learned
Twenty years of successful investing proves that the hybrid equity or hybrid capital funding model works, and shows that B-BBEE can be done effectively and profitably for all stakeholders. These achievements are critical to creating sustained impact.
Many of our investments are B-BBEE transactions where black industrialists or woman groupings have been funded to buy equity in established businesses. We have also supported black-owned enterprises to grow through acquisitions or capital, to grow the existing business to a much bigger scale.
Here are some of the key lessons that we have learned over the past two decades, which can be applied, going forward, to investments for generational impact.
Lesson 1 – Mitigating Risk
With volatility and risk always present in markets, it is vital that downside protection is applied to the investment strategy to protect investors from capital loss. To reduce risk, we have developed the expertise and capacity to select investments with excellent cash flow predictability in very defensive industries. Among the preferred sectors are infrastructure, telecommunications, food processing, and financial services, as well as others which have proven resilient in the face of volatile economic cycles.
Hybrid Equity has sourced, structured, invested, managed, and exited transactions across multiple sectors and capital structures, through various economic cycles.
Lesson 2 – Having a Robust Business Selection Process
Having an integrated environmental, social, and governance (ESG) unit that is embedded in the team and part of the decision-making process, our due diligence process goes much further than just financial diligence, lending itself to a far more robust due diligence and selection process. Among our various criteria, a key requirement is that the businesses we choose must have been operating successfully for several years; have an experienced management team in place, with a good performance record; have a high demand for products that are good for the environment; and be sustainable in the communities in which they operate.
An example is the R150m investment into Enable Capital, a short-term funder that uses innovative technology as a distribution platform. It provides short-term funding solutions to small subcontractors who operate in the fibre internet industry and have contracts with fibre companies like Vumatel or Metrofibre.
In considering Enable Capital, Hybrid Equity identified that it had a sound business model and that its team had adopted a hands-on approach, as well as having deeply entrenched relationships with its client base.
These contractors often needed help accessing funding from traditional sources to facilitate their execution of capital- and labour-intensive infrastructure projects for their clients. However, through this investment, Enable has funded many small, black subcontractors to ensure that they have the necessary cash flow to run and grow their businesses. Many of these are young entrepreneurs.
Lesson 3 – Adding Value
As an indirect shareholder or key funder to strategic shareholders, we play an indirect advisory role to the company’s management on how to grow the business which, unlike traditional loan funding, assists in driving a return on investment. Our advice provides insights into other industries on capital structure and lending, bolt-on investments, and how to manage their treasury. We also contribute to elements such as governance and human resources strategy, and formalise ESG data collection, analysis and continuous monitoring, helping to make companies better.
An example of this success is the deal concluded in 2021 to fund the empowerment partner in the telecoms group, MetroFibre Networks. This deal expanded MetroFibre’s empowerment credentials and assisted in its R3bn capital expansion plan, allowing it to roll out fibre internet infrastructure to more parts of the country. This increased access to more affordable broadband services for more South African households.
Lesson 4 – Focusing on Investment Impact
Once the investment is secured, the focus is on its impact. Shareholders that we’ve funded sit on the boards of these companies, driving transformation in that business, on the ground. We can, therefore, track the status of gender equality, job creation, demographics of staff, governance and social responsibility in these businesses that we have invested in over set timeframes.
The Enable Capital transaction, for example, has fast-tracked the delivery of tangible fibre internet access to low-income households. It also resulted in job creation across the board and, helped to build sustainable businesses and economic transformation.
Enterprises that make an impact are those that combine their passion with good ideas that empower the nation through technological advancement, job creation, infrastructure, critical goods and services, and social and environmental benefits. The South African, international and local investment community would do well to pay close attention to similar lessons in order to leave a legacy for future generations.
Abrahams is co-Head | Hybrid Equity, a division of Old Mutual Alternative Investments.