The recent credit rating downgrades by S&P Global and Fitch will affect mergers and acquisitions (M&A) activity in SA.
The economy’s health and M&A activity are intrinsically linked and regional economic difficulties present challenges for deals. Most significant is the effect on investor confidence, especially the attitudes adopted in bank lending and capital markets. After Brazil was similarly downgraded, the country saw a sharp rise in the cost of capital, especially private funding and risk-based investment.
Divestment also increased, especially from funds that required adequate investment grading, such as pension funds.
However, the rand has shown to be far more resilient than most had expected. After a period of sell-offs and volatility, there is hope for a normalisation of the economic environment and a rally of business to restore investor confidence. This may create big opportunities for acquisitions and a shift in deal financing and buying patterns to take advantage of the volatility.
In the short term, there are expectations that M&A activity will be created by investors withdrawing from the South African market due to the downgrades, voluntarily or as a result of complying with regulatory or policy requirements.
According to Baker McKenzie’s first-quarter 2017 Cross-Border M&A index, there were 14 outbound cross-border transactions worth $704m and 29 inbound cross-border deals totalling $6.2bn in the first three months of 2017 in Africa.
The deal values have dropped in comparison to the last quarter of 2016, in which there were 11 outbound cross-border deals in Africa, worth $4.6bn, and 22 inbound M&A transactions, worth $11.4bn.
SA plays a major role as an investment hub for Africa, particularly in southern Africa, but it shares this role with other strong African economies including Nigeria. SA and Nigeria are facing currency woes and the trickle-down effects of the Chinese slowdown.
The downgrades in SA’s credit status are expected to negatively affect the perception of the country as an entry point into the continent and as a destination for medium-to-low risk developing market investment. As almost half the continent’s M&A activity flows through SA, the downgrades will no doubt have a negative knock-on effect in the rest of Africa as well, unless SA’s standing as a stable economy can be maintained.
Africa also has its own primary drivers including a ballooning consumer market and rapid increase in middle-class households in certain economies. An increase in the development of African telecommunications industries and the opportunities for business created by this, as well as by a rapidly developing financial services sector, are also key drivers of investment activity.
Mining, as always, plays a crucial role as a driver for African M&A and the changing winds for global commodities will continue to influence African deal flow. Private equity exits will probably drive the sell-side of M&A activity for the foreseeable future.
According to the index, the global drivers for M&A activity are disruption and technological innovation, after-sales services, core competencies, divestments and defence spending. As these factors affect the world’s largest economies — especially the Americas, Europe and China — they will no doubt affect M&A activity in Africa as well, which is largely influenced through the trajectory of foreign investors.
The index shows that North America contributed the bulk of inbound investment into Africa, with investments valued at $4.1bn.
North American investment in Africa has traditionally been directed towards the export and establishment of global brands to satisfy the demand of a growing consumer market, as well as in the energy, oil and gas, healthcare and pharmaceutical sectors. Due to the opportunities the African economy presents in these sectors, this trend is likely to continue. Whether US President Donald Trump’s policies will directly influence this is difficult to predict.
The interest displayed by bidders targeting African investment should and could be higher than the $6.1bn for the first quarter of 2017. There are many untapped opportunities for attracting foreign direct investment, which the government has acknowledged.
In the 2017 budget speech by former finance minister Pravin Gordhan, it was indicated that the relaxation of several foreign exchange controls and tax penalties may be implemented to allow for SA to be more agile with inflows and outflows of capital, while protecting its currency reserves.
Africa could substantively increase its attractiveness as an investment destination in the Middle East and the EU. According to the report, bidders in the Middle East invested only $7m in Africa in the first quarter of 2017 and investors from the EU spent $481m in that period.
It seems that despite political and regulatory uncertainty, Africa remains rich with M&A investment possibilities
The report shows African outbound investment is mostly targeted at EU countries, with $625m flowing from Africa to the EU in the first quarter. SA and Africa generally suffer the consequences of currencies with weaker buying power for outbound investment. However, due to historic ties, synergies in certain sectors and a certain sense of familiarity, Europe has been favoured by local businesses looking to go global.
If anything, Brexit may have a positive effect on the trade relationship between Britain and SA as Britain may become more focused on finding trade relationships outside Europe.
The index shows that the consumer sector was most active by value globally (142 deals worth $113.3bn) while the technology sector was most active by volume (182 deals worth $14.9bn).
This is true for Africa as well, where the growing telecommunications infrastructure and access to internet services are broadening access to technology. Telecoms, technology and energy corporates are increasingly targeting Africa.
Growth in local demand for innovative technological services and solutions have also seen global technology companies such as Uber thrive in some African countries.
Due to the growing financial services sector, domestic banks have made significant investments in technology. Consumer growth is at an all-time high, with an increase in demand for foreign brands and products. This has lead to increased retail and shopping centre development in the property sector, which is backing the increase in the consumer market.
It seems that despite political and regulatory uncertainty, Africa remains rich with M&A investment possibilities. Consequently, many jurisdictions on the continent have been introducing investment-friendly legislation and regulations to attract foreign interest.
• Van der Merwe is co-managing partner at Baker McKenzie Johannesburg
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