INTRODUCTION
“Investing in emerging markets doesn’t mean that you have lost
faith in the U.S. market. The U.S. market could go on from here to
even new highs, baffling the experts much as it has done for the
last several years. But diversification into emerging markets,
though it hasn’t proved out to be worthwhile for a long time, may
make a lot of sense now.” A quote from ‘where there’s Risk,
there’s Opportunity: Revisiting Emerging Markets’
by Max Isaacman
Since 1999 Nigeria has experienced a profound level of structural, political
and economic changes that have made it one of the emerging markets in
Africa as well as a vital contributor to the world economy. Nigeria has
evolved to the point where there are excellent investment opportunities in
multiple asset classes, including public equities, debt, and private equity.
The key themes creating this opportunities are well known, including the recapitalization of Financial institutions and Insurance Companies, the trend towards privatization of state-owned companies, the emergence of world class companies and an overhaul of legal regulations guiding Investments.
WHY INVEST IN NIGERIA?
The fundamental case for Nigeria’s high economic growth combined with
valuations that are near historic lows is due to the various economic reform
programmes the Government has embarked on. Gross Domestic Product
(GDP) growth of Nigeria is almost double that of developed markets (In 2006
GDP growth rate of Nigeria was 5.6 percent and GDP growth rate of England
was 2.8 percent source Economist Intelligence Unit), The inflation rate has also
falling to a single digit of 7.5 percent and economists forecast that this trend is
likely to continue for the foreseeable future.
The private equity markets are still at an early stage of development
compared to public equity and debt, but this asset class offers substantial
opportunities to invest in a broad range of smaller, rapidly growing
companies. Various foreign companies have commenced to harness this
gold mine. For instance no fewer than six Nigerian banks have raised fresh
funds from foreign institutional investors.
While Nigeria may have significant risks, a number of developments have
reduced risk in the markets. Improvements in corporate governance,
accounting, local securities regulations, and the investment infrastructure,
such as the Investment and Securities Tribunal, have all seen steady
improvements and significantly reduced the risk factor.2
To fully appreciate the viability of the Nigerian economy, some structural
changes that have occurred over the years shall be intrinsically considered:
Improving Corporate Governance:
Poor corporate governance is often cited as a reason to avoid making
investments in Nigeria. But many emerging markets governments are moving
to enhance their regulatory frameworks with an eye toward maintaining
interest from foreign investors. Many companies are also moving on their own
to adopt U.S.-style corporate governance standards.
The Securities and Exchange Commission, the Nigerian regulatory body
saddled with the responsibility of regulating the investment market in
conjunction with the Corporate Affairs Commission published a code of best
practice for Corporate Governance. While attitudes towards corporate
governance vary substantially from country to country, the risks can be
managed by active portfolio managers who carefully evaluate individual
companies. In the wake of Enron and WorldCom, it has become more
difficult to make the case that corporate governance risk in at least some
emerging markets is greater than similar risks in developed markets.
Improving Legal Structure:
The investment infrastructure in Nigeria is rapidly evolving in addition to is
becoming friendlier to foreign investors .Many countries realize they need to
strictly enforce their securities rules and regulations if they want to boost
investor confidence. In the past, paperwork burdens created enormous
obstacles for foreign investors, but many countries are working to relax
restrictions.
Nigeria is not left out of this metamorphosis, in 1999 the Investment and
Securities Decree (now Act) was passed into law. An intricate part of this new
legislation was the freedom of any foreigner to invest, transfer and sell stocks
in Nigeria unlike the restriction in Section 7 of the old law. Furthermore to
enhance speedier resolution of disputes that arise from investment
transactions, the Investment and Securities Tribunal was established.
Reduced Trading Costs:
Commissions in Nigeria have decreased dramatically over the last eight
years, much more dramatically than in the developed markets. In some
instances, in percentage terms, emerging markets commission rates will be
below those of developed European countries as well as the U.S. and
Canada. In 1995 the rates for executing trades in Eastern European countries
ranged between 1% and 2%. Today the standard is below .5%, a 50% to 75%
decrease. In Nigeria the Securities and Exchange Commission recently
revised the transaction cost of the primary market for equities from 6.92% to
4.32 % which is a 45 percent decrease.
Commission rates for developed and emerging markets around the world
seem to be converging. The explicit transaction costs are nominally higher in
emerging markets, but this cost factor is not as significant as it once was.
There is no reason why commission rates should not continue to decline. They
may eventually approach parity across multiple markets. Transaction costs
can be expected to continue trending downward for several reasons, the
improved data transparency in a growing number of markets; and an
increased emphasis on “index” names for emerging countries, which allow for
improved risk hedging.
Low Correlation:
Diversifying across countries and industries can reduce risk, yet increase
potential returns. Despite their reputation for volatility, investments in
emerging markets could actually lower portfolio risk assuming a low
correlation either to developed markets or to each other.
Historically, developed markets and emerging markets have not moved in
unison. Market leadership has changed year to year from one market to
another. For the five-year period ended August 25, 2003, the correlation
coefficient of the emerging markets (as measured by the MSCI Emerging
Markets Free Index) to the U.S. (as measured by the Standard & Poor’s 500
Stock Index) was 0.35. Emerging markets have also tended to have low
correlations to each other. While some regions may record poor or steady
performances, others can record robust performances.
For example, early this year some of the major stock markets in the world
experienced a fall in majority of its stock; the stock market in Nigeria was not
affected by this surge. This further reinforces the need for diversifying across
countries.
Where are the Opportunities?
Emerging markets constitute a small part of the current total global market
capitalization, but their rapid growth rates and steadily improving risk profiles
justify higher valuations over time. At the end of 2000, the total capitalization
of the world’s three major stock markets (the U.S., the U.K., and Japan) was
about $20.7 trillion. By comparison, emerging markets represented only a
small portion at $3.3 trillion, or 16%.
However, between 1991 and 2000, the market capitalization of Emerging
markets grew faster, at 716%, compared to developed markets, which grew
about 231%. Various Foreign companies have started to harness this potential
through equity funding in Nigeria as stated above.
Private equity is another type of FPI (Foreign Portfolio Investment) which
various companies are starting to harness in Nigeria. The advantage of
private equity is an injection of fresh funds into the business without the
burden of debt payment. Private equity mean funds from private investments4
collected in a pool of funds investments which is professionally managed by
an investment manager (private equity manager), in the unregistered
securities of private and public companies.
The major players in the private equity market are the investors (fund
providers), intermediaries (fund mangers) and the Issuers. We will briefly
examine the private equity market institutional structure in detail.
1. Investors ( Fund Providers)
These are typically the class of person(s) who provide funds for the
purpose of investing in private equity for strictly financial reasons,
specifically because they expect the risk-adjusted returns on private
equity to be higher than the risk-adjusted returns on other investments
and because of the potential benefits of diversification. This class
involves wealthy families and individuals, bank holding companies,
Insurance companies, investment banks, non-financial corporations, and
foreign investors.
2. Intermediaries (Fund Manager)
These are the mangers of the pool of funds. In Nigeria, these may be in
the form of a Company under CAMA or a Partnership under any of the
Partnership laws.
Under the partnership arrangement, institutional investors are the limited
partners and professional private equity managers, working as a team,
serve as the general partners. In most cases the general partners are
associated with a partnership Management firm, such as the venture
capital firms, or affiliates of a financial institution (an insurance company,
bank holding company, or investment bank); the affiliated firms
generally are structured and managed no differently than independent
partnership management firms.
Under the corporate structure, the fund manger would be incorporated
a s a company under CAMA, with the objective to conduct business as
a private equity investment company, venture capital, publicly traded
investment companies, and other companies.
The Fund Manager will be responsible for the Fund’s financial and
operating performance, as well as for the legal and other aspects of the
Fund’s formation. The Fund Manager will actively monitor and supervise
investment activities and review all documents related to investments.
The Fund Manager will enter into a Fund Management Agreement with
the Fund providing for a Fund Management Fee to the Fund Manager
for services performed. The Fund Manager will also oversee accounting
and financial reporting and ensure that the Fund and Sub-Funds are in
compliance with applicable laws as well as with the applicable statutes,
corporate documents, Fund Management Agreements, and other
related agreements. Investments will be structured generally in 5
anticipation of exits through management buybacks or sales of shares to
strategic investors within a short period of time of investment.
3. Issuers
Issuers generally are companies that cannot raise financing in the debt
market or the public equity market. Issuers of traditional venture capital
are young firms, most often that are developing innovative technologies
and idea and are projected to show very high growth rates in the future.
They may be early-stage companies, those still in the research and
development stage or the earliest stages of commercialization, or later stage companies, those that have several years of sales but are still trying to grow rapidly.
Some may be companies with stable, profitable businesses i.e. Low
technology Manufacturing, distribution, services, and retail industries
who want to finance expansion through new capital expenditures and
acquisitions and/or to finance changes in capital structure and in
ownership.
Public companies also issue private equity to help them through periods
of financial distress and to avoid the registration costs and public
disclosures associated with public offerings or in situation where they
want to go private, issue a combination of debt and private equity to
finance their management or leveraged buyout.
How do you get involved?
We shall briefly consider the regulatory frame work of starting Business as an
equity funding company in Nigeria. The prospective equity funding company
must first be incorporated pursuant to the Companies and Allied matters Act
(CAMA). The Company will be a Special Purpose Vehicle (SPV) through which
the investments will be made. It must be noted that the Memorandum and
Articles of the company must specifically state the kind of business it intends
to carry out.
After the company has become registered, if the company intends to deal in
securities of a public company akin to buying into a listed company, the
Investment Securities Act provides that the company must seek the approval
and register with the Securities and Exchange Commission the apex
investment regulatory body in Nigeria. It should also be noted that Section 17
of the Nigerian Investment and Promotion Commission Act (NIPC) allows a
non Nigerian to invest in any Nigerian enterprise; however such interests must
be registered with Commission.
The company must also register the securities it intends to invest in pursuant to
the Securities and Exchange Rules; this may either be a public offer or a
private placement. It should however be noted that only investments in
public companies require registration with SEC.
The company will also have to be aware of the various tax laws in Nigeria
including the Personal Income Tax, Companies Income Tax Act, Capital
Gains Tax Act and Stamp Duties Act to mention but a few. It should however
be noted that the Government in encouraging venture capitalist passed the
Venture Capital (Incentive) Act which provides Tax relief on personal
investments by venture capital company/projects where such investment is
not less than 25 % of capital required for venture project and the company
engages in:
I. Acceleration of industrialization by nurturing innovative ideas ,
projects and techniques to fruition:
II. Commercialization of research findings with high potential for far
reaching forward or backward linkages
III. Promotion of self reliance through the establishment of resource
based and strategic industries through the provision of risk
guarantee and insurance:
IV. Encouragement of indigenous processes and tech:
V. Promotion of the growth of small and medium scale enterprises
with emphasis on local raw material development and
utilization:
VI. Such objectives as specified by the FIRS(Federal Inland Revenue
Service)
Conclusion
Nigeria has become a significant option in the realm of global investment.
While investing in Nigeria involves significant risks, substantial progress has
been made on a number of fronts to reduce risk in those markets. Corporate
governance, accounting, and local securities regulations have all seen
steady improvements and the Government has shown a genuine desire to
nurture the growth of FPI through private equity investments.
For more details please contact:
Oluseun Sodunke on 234 1 738 8369, 234 1 791 07 02
Email: oluseun.sodunke@bloomfield-law.com
Kunle Obebe on 234 1 738 8369, 234 1 791 07 02
Email: kunleobebe@bloomfield-law.com
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