Exits in Africa hit a record high of 82, with 48% of them being strategic sales, but quickly plunged to 43 in 2023 as Africa continues to battle brutal economic headwinds. Clifford Chance’s private equity partner Nicholas Hughes sits down with senior associate Mayowa Kalesanwo and associate Christopher Ndegwa to discuss maximizing exit values. Clifford Chance has consistently won the Overall Legal Advisor of the Year in the Private Equity Africa Awards.
How does Africa’s recent exit numbers reflect what you are seeing in your deals?
While 2022 saw a record-high number of exits, this statistic is deceptively buoyant. This is partly due to the backlog of exit processes that were either postponed or did not begin at all in the previous 18 to 24 months due to the coronavirus disease 2019 (COVID-19) pandemic. In comparison, there had been far fewer exits in 2023, which is probably more reflective of the state of the current global and African mergers and acquisitions (M&A) market, which has been impacted by the global macroeconomic climate.
Notwithstanding this, there have been some standout transactions in some of the more resilient sectors, such as renewable energy. An example of this is the sale of Lekela Power by Actis and Mainstream which is one of the largest renewable energy deals in Africa, and where Clifford Chance represented the sellers. There is also the exit of Tessara, a South Africa-based agriculture inputs manufacturing business by the Carlyle Group, and AfricInvest divesting Promamect, a leading medical devices business in Morocco.
Which are some of the macro headwinds affecting Africa’s exits?
The global economy had remained stagnant throughout 2023. Major African economies such as Nigeria, Ghana, and Egypt had experienced significant inflation rates over 2023. Although inflationary pressures are expected to start easing, it will take some time before they return to normalised levels. Another key macroeconomic factor has been the significant currency depreciation against the US dollar.
The Nigerian Naira lost over 50% of its value against the US dollar in 2023, and other African economies such as Ghana and Egypt had also experienced significant devaluation. Aside from the direct impact on the returns achieved by US dollar-denominated funds, currency depreciation has made it particularly difficult for foreign investors on the continent to secure access to international currencies for repatriating funds.
How are these macro headwinds affecting deal valuations?
We are generally seeing a more buyer-friendly market, with buyers adopting a ‘wait and see’ approach, where possible. For sellers, many are holding onto their assets in a bid to weather the volatility. In many market deals, we are seeing tensions around valuation and risk allocation. Exceptional cases arise when the exit is driven by the need to restructure a business or a closed-end fund nearing the end of its term.
On the other hand, the ‘wait and see’ approach is a concern for sellers because businesses may not be growing as quickly as expected, leading to a decrease in valuations. Consequently, the ‘wait and see’, approach being adopted by buyers puts a downward pressure on the price that buyers are willing to pay. On their part, buyers are becoming more focused on the strength of the businesses and do not want to overpay. For assets with steady or contracted cash flows, or in sectors where businesses are better hedged against inflation, we see less valuation tensions.
Are you seeing changes in due diligence and deal terms?
Given buyers’ heightened perception of risk, they are dedicating more time to due diligence. As a result, sale processes are becoming more protracted and less competitive. Consequently, we have seen many buyers end up in a stronger position during negotiations. With an enhanced focus on risk allocation, products such as warranty and indemnity (W&I) insurance, which can alleviate the need for the buyer or seller to take on a particular risk, have become more relevant.
These types of insurance are being considered in most of Africa’s large M&A deals as awareness of the mutual benefits of the product for buyers and sellers increases. This has led to an increase in the number of warranty and indemnity insurance providers offering coverage for significant M&A deals in Africa and becoming more at ease with diverse markets.
Although we are witnessing longer sale processes, we have not seen a fundamental change in deal terms. The fact that more processes are proceeding on a bilateral basis gives buyers greater leverage. Some are pushing for increased protections, such as material adverse change clauses, which outline conditions that might conceivably give the buyer the right to walk away from a deal. However, well-advised sellers are continuing to secure reasonable exit terms. We are, nevertheless, seeing some bespoke terms being introduced to bridge valuation gaps in transactions.
How are players bridging valuation gaps?
Assuming a seller is not willing to simply agree to a lower price, a common focus will be on whether the parties can sign up to a purchase price mechanism that provides sufficient certainty and protection to the buyer. This is particularly relevant due to the extended period between signing and completion in many of Africa’s M&A and private equity deals. Some buyers advocate for a later valuation date, aiming to safeguard themselves through a completion accounts mechanism. This allows any adverse effects on the business during that period to be captured in the price. However, this marks a departure from the more common practice of most transactions being agreed upon with a fixed price or locked box mechanism.
Where a seller is unwilling to move to a full completion accounts process, which will be the case for private equity sellers, a hybrid structure can be used. In this structure, the purchase price is set by reference to locked box accounts, with some true-up elements being tested at completion. These adjustments can be structured in two ways, firstly as a dollar-for-dollar adjustment in both directions against an expected level, or as floor values where an adjustment only takes place if the minimum expected level is not achieved.
What are the other options for extracting value during the exit process?
Buyers seeking enhanced protection after completion often look for provisions that allow for deferred consideration, retention of a portion of the purchase price, or an earn-out structure. Alternatively, a buyer may seek to restructure the transaction to acquire a smaller stake, require a vendor loan, or invest at a different level in the capital structure, for example, through convertible preferred securities.
Faced with these types of terms some sellers are also considering non-traditional M&A solutions to realise value in their portfolios. This could include structuring some form of continuation vehicle in which certain assets continue to be managed by the GP fund manager with new investors being brought in. A financing solution may also allow an interim realisation with the final exit delayed until market conditions are more favourable.
