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African M&A transactions commanding higher premiums
High expectations around growth prospects for Africa
As valuation practitioners in Southern Africa we are often offered anecdotal evidence of developed market trade players offering to acquire African companies at high earnings multiples. These multiples are particularly high when compared to those at which developed market companies are acquired.
Do African M&A transactions command a premium on developed market earnings multiples?
As valuation practitioners in Southern Africa we are often offered anecdotal evidence of developed market trade players offering to acquire African companies at high earnings multiples. These multiples are particularly high when compared to those at which developed market companies are acquired and the multiples at which developed market listed shares trade.
Vendors of African investments cite the limited growth opportunities offered by developed markets as the primary driver of these high African transaction multiples. It has been documented that companies have more cash on their balance sheets than ever before. With a real GDP growth outlook of 4.8% for Africa for 2013 and developed markets, Europe in particular, struggling to emerge from recession, Africa appears to offer an opportunity to deliver the growth required by shareholders.
However, African companies face challenges and uncertainty brought about by political instability in certain jurisdictions, infrastructural limitations, low GDP levels per capita, low levels of income in the majority of the population and skills shortages. These challenges should justify a discount to earnings multiples relative to those observed in developed markets. This discount can be estimated based on sovereign risk ratings and appropriate default spreads.
Can we observe a trend of higher earnings multiples for African transactions?
To investigate, we researched the enterprise value to earnings before interest, tax, depreciation and amortisation (EBITDA) multiples, where available, at which African companies were acquired by developed market bidders and compared them with those at which companies in similar sectors were acquired in the United States from 2006 to the present day.
From our research we found EBITDA multiples in the Consumer Markets sector averaged 12.2 for African transactions compared to 11.2 in the US, representing a 9% premium for African acquisitions. In the Telecommunications sector, African companies were acquired at multiples with an average of 11.2, 6% higher than the average of 10.5 for US transactions.
African transactions in other sectors had sample sizes too small to provide useful comparisons. Accordingly, the relatively small number of observable data points limits the extrapolation of our findings across sectors. However, our findings do point to a net premium for African companies in the Consumer Markets and Telecommunications sectors after considering a discount for the country risk referred to above.
What gives rise to this premium?
The variance in earnings multiples between African transactions and US transactions is dependent on the expectations of the bidder around future growth in cash flows relative to the return the bidder requires as compensation for its perception of the risk profile of the company’s future cash flows.
The premium we have found in the Consumer Markets and Telecommunications sectors may be attributable to a decline in the risk of investing in Africa as perceived by developed market bidders or the returns which they require as compensation for a similar level of perceived risk. However, African countries’ sovereign risk ratings and the implied default spreads indicate that investors continue to require a return premium for African investments, implying a discount when compared to developed market earnings multiples.
The primary reason for the premium on acquisition multiples, therefore, appears to be the investors’ high expectations around growth prospects for African companies in the Consumer Markets and Telecommunications sectors. These growth expectations are so significant that the value implications outstrip those of the relatively higher risk of investing in Africa.
In contrast, recent research by investment banks and others indicates that, on average, publicly traded stocks in emerging markets continue to be priced by the market at a discount relative to traded stocks in developed markets. This may reveal an important reason for the premium observed in African transaction multiples when compared to the relative discount observed in prices of African traded stocks, which represent the market price of a small minority interest. Acquirers of significant influence and controlling stakes in African Consumer Markets and Telecommunications companies may perceive significant opportunities for value-accretive synergies and improvements in operational efficiencies which are partially or fully included in the acquisition price. For example, a Consumer Markets company may be able to utilise an existing African distribution network to develop an African market for its own products, which represents value in addition to the inherent value of the target company on a stand-alone basis.
Literature on the subject also indicates that the premium on African transactions tends to be more evident in acquisitions of relatively larger African-domiciled companies. Our experience in transaction advisory supports this observation. The reasons for this include the often dominant market position of such companies, which makes them uniquely placed to take up trans-African opportunities, as well as the discount often applied for the additional risks associated with a smaller business.
Is the picture different in other developing markets?
Performing a similar comparison of acquisitions in India to those in the US over the same period, we observed that the median EBITDA multiples in the Consumer Markets and Telecommunications sectors were 49% and 60% higher than the median multiples in the same sectors in the US, respectively.
The same analysis for transactions in South America compared to the US revealed a 20% premium on average EBITDA multiples in the Consumer Markets sector, however a discount of 24% was observed when comparing average multiples in the Telecommunications sector.
Our analysis is summarised in the table available for download.
India’s sovereign risk is lower than the average sovereign risk for Africa and South America. Combined with its relatively high growth prospects and large population driving increased demand for the aforementioned sectors’ products and services, this may offer a reason for the significantly higher transaction multiples when compared to the US. This also points to potential for African transaction multiples to increase over time as country and continent risk reduces.