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Section II – The Market for Impact Investments in Sub-Saharan Africa

Economic growth in Sub-Saharan Africa

The African growth story is one of particular importance and relevance for the next decades in global socio-economic development. Between 2000 and 2010, Africa’s average GDP growth rate was 5.4%, making it one of the fastest growing regions in the world.

The growth continued in the period 2010-15 but at lower rates (3.3% average) due to the global slowdown and its effect on commodity prices. In the last two years, average Sub-Saharan Africa growth numbers have come down even further. However, aggregate numbers paint a misleadingly negative picture. In fact, Sub-Saharan Africa is experiencing a multispeed growth scenario that holds significant promise for its future growth prospects. Large oil exporting countries like Nigeria and Angola that previously fuelled the aggregate numbers are now experiencing contraction or very low growth. Non-resource intensive countries such as Cote d’Ivoire, Senegal, Ethiopia and Kenya are still growing at 5.5% p.a. and are expected to grow at 6-8% in the next couple of years.5 And while the shrinking production in the resources sector is dragging the average GDP growth numbers down in commodity exporting countries, they are seeing their economies diversifying and their non-resources sectors growing faster. McKinsey projects that consumer and business spending across Africa will grow from $ 4 trillion in 2015 to $ 5.6 trillion in 2025.6 And this growth is going to translate into improvements in the quality of life. EY predicts that GDP per capita will double between 2015 and 2030, to USD 4683.7

There are several drivers of this growth:

5 IMF Regional Economic Outlook, Sub Sahara Africa, October 2016 6 McKinsey Global Institute, Lions On The Move II: Realizing The Potential Of Africa’s Economies, September 2016 7 EY, Africa 2030: Realizing the Possibilities

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1. Population growth: Africa has the youngest and fastest growing population of any continent. The working population is expected to rise to 1.1 billion by 2034, more than India or China. Thus far, the rate of job creation in Africa has outpaced the population growth. It is expected that this will remain the case, delivering a demographic dividend to Africa in the next few decades when the population levels in the rest of the world are stabilizing or shrinking.

2. Urbanization: by 2030, 50% of the African population will be living in cities and 65% by 2060. Urban per capita productivity is higher, and therefore urbanization is expected to boost the GDP per capita.

3. Rising middle class: with the increased numbers of aspiring middle class citizens, the faster growing African economies will find increased political stability which in turn creates a better investment and trade climate boosting economic growth. We have already begun to see through elections in Gambia, Tanzania, Ghana, Nigeria and social movements in Zimbabwe; the strength of a growing young middle class population in determining and engaging with its political landscape.

4. Innovation and technology: The mobile industry remains a key driver of economic growth and employment across the region. According to reports by the GSMA, in 2014, the broader mobile ecosystem generated 5.7% of GDP in Sub Saharan Africa, a contribution of just over $100 billion in economic value. Developments towards mobile broadband and the growth of new services will see this figure increase to 8.2% of GDP by 2020, reflecting how increased access to mobile

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services generates regional growth and development. The mobile revolution in Africa has enabled providers of basic products and services to reach underserved segments of the population, e.g. the rapid development of mobile money solutions. In turn, this is enabling a wide range of innovations that fill critical supply gaps in sectors such as health care, education and energy.

Overall, Africa is a dynamic continent that has shown resilience during the global slowdown. There are growth opportunities in many countries and various sectors and further developments and innovations happening across the continent. Risks can be managed by carefully spreading activities.

Access to financial services in Sub-Saharan Africa Access to financial services means access to savings, payments, insurance, loans and other relevant financial products and services. In Sub-Saharan Africa, 66% of adults, amounting to well over 350 million people, are unbanked, despite the growth in the number of banks, microfinance institutions and other service providers focused on providing access to financial services. Mobile money is driving the growth of financial inclusion in Sub Saharan Africa. 12 % of adults have a mobile money account, and 45% of them have only a mobile money account. However, much more still needs to be done. Despite the growth of financial inclusion, only 25% of the adults living in the poorest 40% of households have a mobile account or an account with a financial institution.

8 http://www.worldbank.org/en/programs/globalfindex/infographics/infographic-global-findex-2014-sub-saharan-africa

Daily, much of the population in Africa faces difficulties in managing irregular income streams, dealing with unforeseen events or starting a business. In addition, lack of financial intermediation is a severe strain on general economic development as, amongst others, World Bank research has all too often evidenced. Economic development is positively correlated with the Sustainable Development Goals and if poverty is to be eradicated, financial sector development is an important means to an end.

8 World Bank, Global Findex 2014

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Obstacles to Firms’ Operation and Growth, an International Comparison9

According to World Bank research in 201410, SMEs are the largest employers in many low-income countries, yet their viability can be threatened by a lack of access to such risk-management tools as savings, insurance and credit. Their growth is often stifled by restricted access to credit, equity and payments services. In an IFC-McKinsey study, the unmet credit needs of the SMEs in the formal sector in emerging markets are estimated between $900 billion and $1.1 trillion. As a result, job creation stays behind and too many economies remain dependent on expensive imports of basic goods and services. In addition, although investor interest in the continent is rapidly growing, the market is still heavily underserved by specialized investment funds or microfinance investment vehicles

Use of formal account and loan services across firm size groups in international comparison11

9 ACET, Access to Finance for SMEs, 2016 10 IFC, Access to Credit Among SMEs, 2014 11 Brookings, SMEs Finance in Africa, 2014

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Within the African continent, there is a substantial difference in access to financial services between the countries as is demonstrated by the graph below, which shows the level of access in a select number of countries (MIX and CGAP - 2011 Sub-Saharan Regional Snapshot).

African countries south of the Sahara are poised to enjoy a surge in growth in their banking systems in the coming decade due to high rates of economic growth, financial deepening to fulfil unmet needs for basic financial services and new technology, particularly mobile phone technology and its use of the convergence between financial services and telecommunication. The boom will vary markedly across the continent. According to a study by the Economist Intelligence Unit (“EIU”)12 countries with a relatively well-developed banking system like South Africa, Botswana and Namibia are expected to show growth rates of banking assets below the regional average. Growth will be strongest in currently poorly-served countries including Ghana, Uganda, Angola and Tanzania as well in other countries including Nigeria, Kenya, Ethiopia, Mozambique and Zambia. The projected financial deepening will result in more access for households and businesses to savings, loans and money transfers combined with more intensive usage. Hence, the growth of the banking deposits and asset expansion is projected at 1.5 times the rate of GDP growth. Sub-Saharan Africa is trailing the rest of the world in developing banking systems that are essential for stronger economic development and growth. This is driven by the size of the continent and the large rural areas with limited infrastructure that still need to be connected to the mainstream economy. Particularly the usage of mobile banking and innovative approaches to reaching new customers combined with the relative openness to new investors will allow Sub-Saharan Africa to catch up or even leapfrog. The recent growth of mobile banking — a form of “branchless banking” —has allowed millions of people who are otherwise excluded from the formal financial system to perform financial transactions relatively cheaply, securely, and reliably. Mobile money is reaching more than 411 million people globally. Moreover, it is available in 85% of countries where the vast majority of the population lacks access to

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a formal financial institution. This is an extraordinary achievement, demonstrating the power of mobile, underpinned by the critical role mobile network operators have played in building this industry.

The number of mobile money agent outlets grew by 45.8% in 2014, reaching a total of 2.3 million globally in December. This is particularly impressive if we consider the size of traditional financial institutions’ and remittance services’ networks (see Figure below). In three-quarters of the 89 markets where mobile money is available today, agent outlets outnumber bank branches. In 25 of those markets; there are more than ten times as many mobile money outlets as bank branches.13 Mobile money is bringing financial services to millions of previously unbanked and underbanked people around the world, making this industry a key enabler of financial inclusion. At the end of 2013, there were already more registered mobile money accounts than banks accounts in Cameroon, the Democratic Republic of the Congo, Gabon, Kenya, Madagascar, Tanzania, Uganda, Zambia and Zimbabwe. In 2014, Burundi, Guinea, Lesotho, Paraguay, Rwanda, the Republic of the Congo and Swaziland passed this threshold, bringing it to 16 countries. According to the World Bank, 62% of the world’s population has a bank account. In 2011 that figure was 51%. In three years, 700-million people became "banked" in some way, and the number of "unbanked" individuals dropped 20% to 2-billion adults. Much of this progress was attributed to mobile money. 14 Mobile banking has really taken off in Kenya, with M-PESA being the region’s clear leader (68% of adults report using mobile money). In addition, in countries like Tanzania, Nigeria, Uganda and Ivory Coast, new initiatives are rapidly growing and gaining market share.

13 PwC, Banking in Africa Matters, 2016 14 GSMA, State of Industry Report: Mobile Money, 2015

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Recent statistics indicate the rapid growth of mobile services across the continent as shown in the figure below.

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The uMunthu team has gained experience in this sector through its investments in Pagatech in Nigeria, Nomanini in South Africa, Musoni Systems in Kenya and EPS in India, the screening of several other deals (rejected and in pipeline) and through involvement with payment technology and fintech startups prior to joining the team. In most high growth-countries in Sub-Saharan Africa, bank deposits and assets are foreseen to rise at least threefold in the period to 2020 (EIU). High growth, further professionalization, stricter regulatory measures and limited own resources means that substantial amounts of risk capital will be flowing to the financial sector in the coming decade, a process in which uMunthu aims to play a role. Investment opportunities in this market segment: The banking sector in Sub-Saharan Africa is diverse with a few countries well ahead of others in terms of infrastructure and suitable business environment. The graph below from a report by Accenture demonstrates the market attractiveness for financial services (including factors such as per capita income) as well as the business environment for financial services (including availability of appropriate legislation, technology) for several countries15.

15 Accenture, Tipping Point Index, 2012

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For several countries, significant growth of assets of the financial sector is expected in the coming decade. This expected growth is amongst others a function of legislation, openness for foreign investment, current available infrastructure and actual coverage. Generally, it is expected that banking assets will grow in Sub-Saharan Africa, in a scenario with no further financial deepening, of approximately 180% in the period 2010 – 2020. In a scenario with further financial deepening and therefore providing access to financial services for the underserved and emerging consumers, assets and deposits of the financial sector in the period 2010 – 2020 could grow respectively around 250% and 270%. Given Africa’s current pace of change and future growth potential, most financial services analysts still underestimate the opportunities it presents. Research shows that banking in Sub-Saharan Africa has undergone dramatic changes over the past 20 years. Financial liberalisation and related reforms, upgrades in institutional and regulatory capacity, and more recently the expansion of cross-border banking activities, with the rapid development of pan African banking groups’ networks, have significantly changed the African banking and financial landscape16. The financial services markets in several countries across Africa are either already well-established, or nearing the “tipping point” of rapid growth. The firms that seize the emerging opportunities now will build a lasting competitive advantage in these promising markets. The Company has a strong focus on innovation and the use of technology. In the financial sector, the Company will invest in providers of digital financial services as well as ‘brick and mortar’ financial institutions that are technology enabled. The Company will also invest in providers of enabling technology services to the financial sector (e.g, core banking services).

Access to SME finance in Sub-Saharan Africa Small Enterprises, specifically Micro, Small and Medium Enterprise (MSMEs) (including the ones operating in inclusive business sectors) lack access to finance for growth (African Growth Initiative, Brookings 2014). Sub-Saharan Africa is one of the most difficult regions

16 EIB, Recent Trends in Banking in Sub-Saharan Africa, 2015

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in the world in which to access financing for SMEs with an estimated 1.5 to 2 million SMEs without access to financial services, representing 40% to 60% of the total number of SMEs. MSMEs in developing countries face an estimated financing gap of $2.1 to $2.6 trillion, which is equivalent to 30 to 36 percent of current outstanding MSME credit. There are 200 to 245 million formal and informal enterprises that do not have a loan or overdraft, but need one—also referred to as the unserved sector—or do have a loan but still find access to finance as a constraint—also referred to as the underserved sector. More than 90 percent of the unserved and underserved enterprises are formal micro enterprises or informal MSMEs. Access to Bank Loans and/or Lines of Credit by some Sub-Saharan Africa Countries Firms

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Africa’s credit gap exceeds $360bn, leaving over 20 million formal and informal SMEs without access to capital according to the World Bank. Yet SMEs also comprise the overwhelming majority of Africa’s economic fabric – around 90% in Cameroon17, for example. Please note that these graphs only refer to the credit gap and not access to a full range of services (including accounts, saving and payment facilities, insurances etc.).

Investment opportunities in this market segment: Emerging market MSMEs are a very attractive segment for investment. More specifically as can be seen in the diagram below by McKinsey, South Africa and Nigeria are categorized as “red hot” and “warm” markets respectively, indicating the current growth in financial penetration per annum in the MSME market. Red hot” countries have fast-growing, large and partly unserved MSME banking markets, such as China, India, Brazil and South Africa. “Warm” countries should see moderate growth in financial penetration of, say, 1.0–2.0 per cent per annum, yet they still represent an exciting opportunity for banks. These include Kenya, Nigeria and Ethiopia18.

17 IFC, Access To Credit Among Micro, Small, And Medium Enterprises, 2013 18 McKinsey& Company, Micro-,Small and Medium-Sized enterprises in Emerging Markets

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The African Development Bank (AfDB) estimates that 84% of investments in SMEs in Africa are financed through internal funds – where company profits are used as a source of investment – in comparison to an average of 70% in other developing countries. The research also indicates that the share of equity financing is less than two 2%, compared to an average of 11% and 8% respectively in other developing countries; bank loan funding is only 9%. This creates huge opportunities for investment entities that provide financing to MSMEs, where investments can offer the much-needed alternative source of funding while stimulating growth.

The African Agri and Food Opportunity

Agricultural development has a fundamental role in the fight against poverty. It is central to the livelihoods of the rural poor who, despite rapid urbanization, still account for most the world ‘s poor. In Africa, it provides two-thirds of employment and over one-third of Gross National Income. As the main income source for most of the poor, no other economic activity generates the same benefits for the poor. By providing affordable food and through import substitution (a/o local processing), it also ensures benefits to the poor beyond the countryside.

In Sub-Saharan Africa, agricultural yields are about 25% of the global average; fertilizer use per hectare is one-seventh of South Asia; and, only 4% of farmland is irrigated. In many places, smallholder farmers still have to rely on their own saved-up and low-yielding seeds. Driven by population growth, urbanization and economic development, there are abundant opportunities for growth across the agri and food space. Certain sectors are positioned to grow disproportionately, such as animal protein, especially fish and poultry. Many industries that Africa has good natural conditions for are not built yet. There is also large potential for investments in companies that offer infrastructure and services that make value chains more effective The social impact of investments in agri & food value chains are outsized: such investment can strengthen and grow companies that bring better inputs, better access to information and advice and more efficient value chains with stable market access to smallholder farmers. The growth of such companies is a necessary condition for improvement of smallholder farmer livelihoods.

The yield gap:

Cereal yields (metric tons per hectare)

Source: World Resources Institute

The yield gap in the field

Local variety vs. improved hybrid maize Photo: AGRA

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Access to other basic needs and services in Sub-Saharan Africa The main driver of growth in Sub-Saharan Africa over the next decade will be its rapidly growing consumer market. McKinsey19 estimates that Africa will have approximately 1.3bn consumers by 2030 and 60% of them will represent the low-income/BoP market. The market opportunity is concentrated within 10 of the 53 countries, namely, Algeria, Angola, Ghana, Egypt, Kenya, Morocco, Nigeria, Sudan, Tunisia and South Africa, representing 80% of Africa’s consumption. Globally, the World Resource Institute20 indicates that consumer markets are typically under-served by traditional business at the BoP. Sector markets for the 4 billion BoP consumers range widely in size. Some are relatively small, such as water ($20 billion) and information and communication technology, or ICT ($51 billion as measured, but probably twice that now because of rapid growth). Some are medium scale, such as health ($158 billion), transportation ($179 billion), housing ($332 billion), and energy ($433 billion). Similar inferences can, therefore, be made for the potential market in Sub-Saharan Africa. The IFC21 confers that business models that offer critical goods, services, and livelihood opportunities to those at the base of the economic pyramid are increasingly being explored as engines of business and development benefit. On the development side, many products and services – when appropriately designed, packaged, and delivered – can help purchasers meet basic human needs and improve their productivity. This is especially true in industry sectors such as food and beverage, financial services, information and communications technology, education, health care, and water and sanitation. Similarly, the opportunity to participate as suppliers, distributors, or retailers in commercial value chains can help increase local job and wealth creation, enhance skills and capacity, add purchasing power, and generally stimulate economic activity and development –contributing, in the process, to quality of life. On the business side, models targeting the base of the pyramid can unlock potentially vast new markets and help catalyze innovation, reduce costs, increase flexibility and the ability to specialize, meet legal requirements, and enhance social license to operate, thus contributing to overall competitiveness. In recent years, a new generation of passionate entrepreneurs has emerged who focus on scalable and innovative business models that target these most difficult-to-reach communities and the toughest social, environmental and developmental problems. Exciting inclusive business models are successfully serving low-income individuals as entrepreneurs and producers, employees and consumers. Disruptive innovations are breaking down barriers in sectors like finance, agriculture, energy, education, health care and housing. The success of these inclusive businesses and disruptive innovations in reaching the masses is an important driver of Africa’s projected high growth for the coming decade. SMEs are increasingly being recognized as productive drivers of economic growth in Sub-Saharan Africa. They constitute more than 95% of all companies in Sub-Saharan Africa. In Ghana for instance, it is estimated that SMEs account for 70% its GDP and 92% of its businesses. In South Africa, SMEs make up 91% of formalized businesses, contributing between 52% and 57% of GDP and providing approximately 61% of all employment. Whereas in Nigeria 70% of the manufacturing sector are SMEs.

19 The Rise of the African Consumer, Mckinsey and Company, 2012 20 The Next 4 Billion, World Resource Institute, 2012 21 Business Linkages: Enabling Access to Markets at the Base of the Pyramid, IFC, 2009

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It is therefore clear, that investment in these businesses, more especially those that provide basic needs and services at the BoP has the potential to have significant impact on the continent’s development. It is without a doubt that the market for products and services in this sector is huge and while there are many SMEs that have been able to provide these services profitably, the key to being success and the ability to build significant scale has been centered on the following factors: Ensuring availability of products and services – unlike in the developed world,

distribution channels in BoP markets can be fragmented or non-existent and the task of simply getting products to people can be a major hurdle to overcome;

Ensuring that products or services on offer are affordable - consumers have low disposable incomes, and products may also need to match the cash-flows of customers who frequently receive their income on a daily rather than weekly or monthly basis;

Ensuring acceptability for the product or service - there is a need to offer products and services that are adapted to the unique needs of both customers and distributor.

Dalberg22 estimates that there are approximately 192 private equity funds supporting SME investments in emerging markets with 60% focusing on Sub-Saharan Africa; however, these firms focus mainly on large and medium sized firms and do not commonly invest in MSMEs or in inclusive businesses that provide basic goods and services at the BoP. uMunthu will invest in inclusive SMEs in various sectors that provide and cater for basic needs and services specifically targeted at the BoP. These will include amongst others, inclusive businesses in the energy sector, agribusiness, mobility, education, healthcare and affordable housing. The Company has a strong focus on innovation and the use of technology. In the inclusive SME sectors the Company will invest in providers of digital services, in ‘brick and mortar’ businesses and in providers of enabling technologies. In this way, The Company provides its investors a balanced exposure to proven business models and innovations across different sectors in some of the largest and fastest growing markets in Africa.

Private equity markets and exit opportunities When it comes to the private equity (“PE”) markets, interest in Africa has never been higher and it continues to receive strong interest from investors. The next decade promises to be an exciting time for PE in the region23. The increase in Africa’s quality of life is leading to a shift in focus for Foreign Direct Investment, from extractive to consumer-facing industries. Also, Africa’s perceived attractiveness has risen dramatically over the last several years, according to EY24. While South Africa remains the region's largest PE market, opportunities beyond its borders did attract more interest in recent years. The value of investments in Sub-Saharan Africa reached 2.1 billion in 2014 according to the Emerging Markets Private Equity Association. The range of deals available to PE investors is also expanding into financial services, technology, telecommunications, agribusiness, consumer products and infrastructure. Several factors are driving the rapidly increasing PE interest in Africa— from the already established and growing market of South Africa, to the frontier markets such as Nigeria, Ghana and Kenya. PE firms are attracted to the regions with high growth rates and nascent shift from commodities and agrarian-based economies to consumer economies, driven by a growing middle class.

22 Report on Support to SMEs in Developing Countries Through Financial Intermediaries, Dalberg, 2012 23 EY, Private Equity Roundup for Africa 2015 24 EY, 2015 Africa Attractiveness Survey

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Despite increasing activity and limited competition for high-quality deals, PE has yet to achieve significant penetration into the economies of Sub-Saharan Africa, including South Africa (Ernst & Young). As a percentage of GDP, PE investment represents just 0.11% in Sub-Saharan Africa and 0.14% in South Africa. This compares with 0.74% in the UK and 0.67% in the US25. The low level of stock market capitalization (16.6% in Sub-Saharan Africa, ex South Africa, compared to 83.7% in high income countries in 2012) shows not only the potential for capital markets expansion, but is also a good indicator of the high level of SME economic activity26. For investors seeking to tap into growth opportunities in Africa’s consumer sector, PE provides much better exposure than listed equities. “Investors should consider whether the listed route will result in the required exposure to African growth prospects. If you compare the sector breakdown of GDP versus that of the stock markets, they look like two different

25 EY, Attractiveness Program Africa 2016 26 SuperReturn, SME Private Equity Fundraising: An African Experience, 2016

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countries.”27 This is illustrated for instance by Nigeria, at 170 million the continent’s most populous country. The consumer discretionary sector accounts for 20 per cent of GDP but less than 1 per cent of stock market capitalisation. An almost equally large imbalance occurs in Kenya, which is also among the continent’s four largest equity markets. These imbalances are even more pronounced in countries with smaller stock markets. Some of these deficiencies are starting to be addressed. In Nigeria, for example, those in formal employment now must join an approved pension scheme. These schemes, which can only invest domestically and typically have a 20-30 per cent exposure to equities, now have almost $20bn of assets and are attracting $2bn of inflows a year. Such developments also influence the opportunity to complete successful exits in these markets: several exits by PE investors in Africa to local pension funds have already occurred in the last few years. Private equity exits in Africa reached a nine-year high in 201528, even as firms held onto their investments longer due to economic uncertainty, according to data from EY and the African Private Equity and Venture Capital Association (AVCA). Private equity firms exited 44 companies in 2015, an increase from 39 in both 2014 and 2013. The findings revealed that there were 249 private equity exits in Africa between 2007 and 2014. 2014 was also a record year for exits on the continent with 40 exits announced by private equity firms. While South Africa continues to lead in exits, the last few years have seen an increase in activity in East Africa and Southern Africa highlighting a market showing increasing momentum for private equity exits. AVCA research shows that trade sales accounted for more than half (55 percent) of 2014’s exits and private equity firms were more active than ever before as buyers of other firms’ portfolio companies. Africa will see strategic sales like these will continue to prove a powerful source of exits to investors in the near term.

uMunthu sees a role for itself in the sector in the years ahead by finding and grooming several hidden jewels and guiding them to scale. The Company will invest across Sub-Saharan Africa with a focus on Nigeria, East and Southern Africa. These regions represent large markets for consumer goods and services and they are the largest Private Equity markets in Africa. Through its presence in these important markets, the Investment Advisor has built a substantial deal flow and pipeline. The focus markets combined provide a balanced mix of more developed markets with access to more mature investments and growth markets with high potential to create value and achieve scale.

27 Rory Ord, RisCura, FT June 2013 28 EY, How Private Equity Investors Create Value, 2016

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To achieve a wider geographic diversification, additional opportunities in other countries may be sought, subject to stringent conditions to manage country and portfolio management risks (see section V, geographic focus). To achieve growth, the investment team will look for investees that are aiming to grow through the introduction of (improved) technology, improved systems and procedures, management, governance or a combination of these elements. To maximize impact, the investment team will further strive to support a broadening of the supply of a wide range of products and services at affordable rates.