Merlin Linehan, Trade Consultant at Frontier Market Strategy, explores the investment landscape of Nigeria, Africa’s biggest economy.
Nigeria has developed as a major investment destination in recent year. Its economy has enjoyed sustained growth and dependence on oil has steadily declined. And despite the decline in oil prices, falling national revenues and ongoing insurgency, international investors’ interest remain fixed on Africa’s biggest economy. And opportunities are springing up across a multitude of sometimes surprising business sectors. Leading emerging markets investor Mark Mobius is bullish on the country as are other observers – all of which should whet the appetite for all things Nigerian.
I was lucky enough to chat with Barakat Balmelli the director of leading West African focused investment firm Sana Elias who gave me the inside track on investing in Nigeria. In this article I cover:
What are the most promising sectors?
The best strategy for investing in the country
What risks does an investor face and how to mitigate against them
And as ever I like to pay special attention to the “China factor”; while the country is not yet the biggest external influence on Nigeria, it could soon be.
The Rise of a West African Dynamo
Sana Elias is one of a number of ventures which have emerged in recent years fusing expertise from international banks along with local knowledge to create a new breed of African focused investment firms which are raising capital and advising others on how best to enter the market. While some big names like Carlyle are now investing heavily in the continent many global banks have avoided Sub-Saharan Africa – leaving the field open for new players.
At the time of writing, Nigeria is facing a period of economic uncertainty and major cuts in government revenues caused by the dramatic drop in global oil prices and the subsequent fall in value of the Naira. All of which might make this feel like a terrible time to consider investing, but it is always worth remembering the maxim to buy when everyone else is selling, which is certainly the case at present. While these risks have to be taken into consideration, it is the Nigerian government that is heavily dependent on oil revenue; the rest of economy is more diverse and has seen recent growth driven by sectors like telecommunications, entertainment and agriculture.
My own feeling is that it is an exciting, formative time to be investing in Nigeria. The country has enjoyed sustained growth and optimism is in the air, but there will be headwinds and scares like collapses in the oil price and US interest rate hikes. At junctures like this, there will be the temptation to flee, but those who hold their nerve and stay the course will benefit in the long term.
Private Investing verse Stock Markets
There is a substantial if illiquid stock exchange in Lagos, but Barakat’s preferred angle was investing privately, in particular taking stakes directly into local companies with strong track records. Nigeria’s bustling entrepreneurial outlook make it a sweet spot for high growth companies, which are often the prime targets for private equity firms. Of course private versus stock market investing is an on-going business debate.
In Nigeria’s case it is preferable to look for fast growing private businesses in select sectors which have a mixture of strong management and impressive financials. Often this will mean a blend of international and local talent along with a healthy cash flow and balance sheet. But how do you source these opportunities? Well you need to be talking to local companies or discussing options with an investment firm like Sana Elias who have access to numerous ventures in need of capital. As with any investment it is handy to have co-investors to spread your risk exposure, organizations like Homestrings are a good place to meet investors who have placed funds in Africa or are thinking of doing it.
But a word of warning, do not expect to turn up with funds and expect a high return for no risk on your part, there are always problems, but also ways to mitigate against loss which is covered below. If you are still interested, the next step is thinking about which sectors have the most potential in this market.
The first area that until recently was perhaps worth avoiding is the power sector. Power or lack of it has been a major bottleneck in the Nigerian economy for a long time. Quite simply an energy rich country has faced shocking electricity shortages for decades and it goes without saying that absence of regular power makes businesses and households suffer. This problem has been partly offset by generator usage, but remains an expensive and polluting option. Now the time is ripe to back investment in power plants, these projects are capital heavy, but the payoff is expected to be well worth the effort in the long run. The country is rich with energy, it just needs the means to utilize it correctly.
Investing in the oil industry is a massive subject worth an article or book on its own, but it is generally a closed shop unless you are multinational oil firm or bank. However there is a related sector worth considering, which is auxiliary services – investing in companies that supply the needs of the oil companies, food, materials, equipment, specialized services. Identifying and filling a niche can be highly lucrative when you consider the clients are some of the largest, most powerful companies in the world such as Shell, Exxon etc. There is a major opportunity to supply these corporations’ needs locally, rather than having to bring in supplies and equipment from Europe and North America.
The Rise of the Nigerian Consumer?
Fast moving consumer goods FMCG is a sector which has become almost mythical in its potential; strategists look at African middle class + population growth + growing demand = massive revenue for all the items you would find in a typical supermarket. I remember talking about this to a Unilever executive five years ago, who said that he rarely spoke about the African market, simply because they were making so much profit there they didn’t want others muscling in.
While the African middle classes may not match up to the income levels seen in Europe, the amount of discretionary spending available to consumers in the Nigeria and other countries is rising and converging with two other trends; urbanization and a youthful population, all of which has the ingredients of a consumer boom. This is well covered in the ground breaking McKinsey report: Lions on the Move.
Sensible Finance, Insurance and Mortgages
The financial sector is another to consider looking at, perhaps not the big four banks (who are now performing well following restructuring after near collapse a few years ago), but instead the often overlooked non-bank financial institutions, insurance companies and mortgage firms. Nigeria’s middle class is demanding better housing, which is being built, but the availability to finance them is yet to catch up and should enjoy strong growth in years to come. Mortgages along with the pent up demand for financial security that insurance affords will see these two products rapidly develop in the next few years.
Above I have focused on sectors which have the most unrealized potential, beyond these there are still plenty of opportunities in established and take off sectors such as telecommunications, hospitality, agriculture, logistics and real estate.
The Dawn of a New Era or a Powder Keg? Risks and Mitigants
As we have seen Nigeria has potentially lucrative sectors, but what are the biggest risks and how can you mitigate against them?
Firstly there is a massive difference between the coverage in the press and the reality on the ground, but there is no avoiding the subject: Nigeria is renowned for corruption, the Boko Haram threat and political instability; this along with government dependence on oil for revenue and the difficulties of doing business. Corruption, bureaucracy and general business headaches all add up to a tarnished business reputation.
While these are all real risks, they have to be put into context to get a rounded picture of the country. It is important to remember the vast majority of the country is peaceful and business continues as normal. In regard to Boko Haram and political violence, certain states in the North – Borno, Adamawa and Yobe – are certainly worth avoiding. But in the South (the richer part of the country) this communal violence is unlikely to affect you.
Falling Oil Price, Falling Naira
Assuming that the price of oil remains low government revenues and exports will suffer and the Naira will fall in value. This will undoubtedly cut government expenditure and services with negative economic impact, shaving off some growth. In the longer term cutting dependence on oil can only be a good thing for the economy, perhaps providing impetus to the industrial sector and forcing the government away from its addiction to “black gold”, which as so many have pointed out causes multiple economic problems for emerging economies. The falling Naira is a headache for those wanting to exit Nigeria, but for those looking to put money into the country or encourage non-oil exports it is a real boon.
Nigeria remains a frontier market and it will continue to face economic shocks in the future, but these predicaments always present opportunities to the cool headed investor. With cheaper Naira and a government forced to further restructure the economy, this could be the ideal time to invest in Nigeria.
The Cost of Doing Business
Like many emerging economies Nigeria faces serious reputational issues around corruption, red tape and mismanagement. One of the biggest fears faced by outside investors (and locals) is that as soon as they start investing or doing business they will have to pay huge bribes; basic infrastructure such as electricity will not operate and the government will make your life hell through crazy and expensive regulations, so instead of making the business grow you will be sorting out basic problems. These fears are well founded and obviously the stress of doing business in frontier markets is not for everyone. But what can you do to mitigate?
Hands off approach, if you have enough financial firepower, you can get experienced hires to do the hard on the ground work, while you act as a silent, distant or hands off partner, just providing funds and minimal supervision. This is great until things go wrong and you have missing key issues and developments only to realize too late your investment has been squandered or the firm’s strategy has failed. Realistically you will have to put in time and effort to monitor your investments, but there are plenty who will take your money and put it to work while you take a back seat.
If you want to be involved on a day to day basis, taking on a strong local partner is an absolute must. If you put the effort to build relations and trust a Nigerian businessman or woman or someone with considerable in country experience, you can lean on their know how to guide you through the inevitable problems you will face.
The China Factor
China has become a major trading and now investment partner with Nigeria, first attracted by the oil supplies. But with Nigeria’s developing market and consumers needing low cost products, the country like so many others quickly became a market for Chinese goods. This relationship is set to develop further as Nigeria is forced to pivot away from the USA as that country is no longer reliant on energy imports. Abuja will instead look increasingly to Asian markets to make up the shortfall. Nigeria is a major investment destination for Chinese firms, which are willing and able to put money into railways, infrastructure and many other projects across Africa.
Chinese firms have been active in developing the Lekki Free Trade zone – an interesting new development in Lagos which promises to replicate the success of places like the Shenzhen free trade zone which helped to kick start China’s development. Chinese businessmen have also flocked to Nigeria (like the rest of Africa), to set up shops, small businesses and other ventures as well as working on the big Chinese sponsored infrastructure projects.
There is no question that Nigeria faces major economic challenges, which have been compounded by the recent fall in oil price. But having discussed and analyzed the market in depth, I’m firmly bullish on what is surely Africa’s most innovative and exciting country: for anyone interested in frontier and emerging markets, it merits serious consideration.