Taking continent's stock

As Chinese companies survey their investment options in Africa, share buying gains favor

At the inaugural Africa investment summit in Hong Kong 18 months ago, fund managers in Hong Kong and the Chinese mainland were given a rundown on the blossoming opportunities in the continent.

One clear message came through: The activities of Chinese managers of retail and pension funds are restricted to certain markets, and they venture beyond these only when they are hard-pressed to find out-of-the-ordinary investments.

Even though Chinese investors have been relatively cool toward Africa's capital markets, they have outbid other foreign companies to buy major stakes in mining companies, in southern Africa in particular.

In May 2011, Jinchuan Group, a metals company in Gansu province, and the China-Africa Development Fund, bought 51 percent of Wesizwe Platinum, listed on the Johannesburg Stock Exchange, for $227 million.

It has also bought a majority stake in Munali nickel mine in Zambia and Metorex Ltd of Johannesburg, which owns mines in Zambia and the Democratic Republic of Congo.

Other Chinese metal producers have also extended their reach into Africa - Sinosteel Corp mining chrome ore in South Africa and Baiyun Nonferrous Metal Group Co Ltd mining gold in the same country.

The business model is suitable for entities seeking, among other things, to generate greater value through improved economies of scale, increased market share, cost efficiencies and savings on tax.

"However, for investors that have a liking for entry and exit without affecting the share price, direct investment gives them an opportunity to relocate money easily with the benefit of accessing better returns as and when they arise," says Elizabeth Ndung'u a research analyst at Dyer and Blair, a financial advisory and brokerage firm in Kenya.

Chinese fund managers have been content to rely on huge economic growth in the world's second-biggest economy to deliver them handsome returns. At the same time, African stocks seemed to be unappetizing because of their size and lack of liquidity. But volumes managed by Chinese managers are massive.

"If, for example, they wanted to spend $10 million on Delta Corporation, it would be very unlikely to happen in one trade as there are just not sellers of $10 million worth of Delta out there," says Murray Lynton-Edwards, the founder of Lynton-Edwards Securities, a stock brokerage in Harare.

Delta, one of the top companies on the Zimbabwe Stock Exchange, has interests in beverages and agro-industrial sectors.

African capital markets have done a poor job in marketing their wares to Chinese investors, he says, and that is not just because of language barriers.

The continent has 23 stock exchanges, up from 18 a decade ago. One of the new ones opened in Rwanda four years ago and listed four companies.

In December last year representatives of the Nigerian Stock Exchange were in Beijing trying to persuade asset managers to start looking favorably towards the bourse. The forum attracted about 100 participants, confirming the coming of age of African capital markets in tapping the Chinese market.

Johnson Nderi, manager of corporate finance and advisory at the Nairobi brokerage and financial advisory firm ABC Capital, says it is not the size of the bourses that matters but the size of an economy.

"In a big economy, shares of big companies are attractive, and this can be seen in Nigeria, the biggest economy in Africa."

In 2013, Nigeria's GDP grew 7.8 percent, and growth in sub-Saharan Africa has averaged 5 percent over the past decade. The World Bank says this is sustained by diversification into infrastructure investment, increased agricultural production and a buoyant service sector.

European and US investors play a key role in activities on African stock exchanges. In 2010 the Nairobi exchange was only moving shares worth an average of $4 million daily, and last year that shot up to $10 million, largely attributed to foreign investors, who account for 51.1 percent of market turnover.

Turnover on the Dar es Salaam stock exchange rose 50 percent last year compared with the year before, making it one of the top equity markets in the continent. Foreign investors accounted for about 23 percent of the $68 million turnover.

The flurry of activities by these investors augurs well for African stocks. They buy stock when attractive listings are posted and cash out when other stocks in Asia or other markets are introduced.

Activities by American institutional investors are a relatively new phenomenon. Their late entry is attributed to the kinds of issues that Chinese investors also face: daily volatility, an illiquid environment and slowing growth in Europe.

But Chinese investors have advantages in investing in Africa. Aly-Khan Satchu, an investment analyst, says existing engagement between China and the continent provide its investors with an easy entry point into attractive capital markets.

Africa resembles China 30 years ago, he says, and the opportunities of an expanding economy create an environment that may be easy for Chinese investors to navigate in.

"China understands Africa better than the rest of the world. Infrastructure projects have given them opportunities to intuitively read its pulse and know where and how to invest."

The business case for investing in Africa seems straightforward enough. The first attraction is a burgeoning population, growing at 2.25 percent a year, stronger than in any other emerging market. In 20 years its labor force will be greater than that of China, resulting in an already expanding middle class that wields discretionary spending power that gives a tremendous fillip to retailing, as is happening in China.

The Chinese experience has shown that urbanization boosts consumer spending, first on grains and vegetables, and then on more expensive goods. This phenomenon is now beginning to be seen in Africa, with figures showing that the continent is urbanizing quickly.

Innovation in telecommunications coupled by rapid penetration of mobile phones has resulted in transformation in other sectors such as banking, insurance and agriculture. The Chinese companies ZTE and Huawei have fueled this growth by developing infrastructure in remote areas in addition to increasing the availability of affordable smart-phone handsets.

The International Monetary Fund says that more than half the world's fastest-growing economies are in Africa. These include: Angola, the Democratic Republic of Congo, Ethiopia, Ghana, Mozambique, Nigeria, Rwanda, Sierra Leone, Tanzania, Uganda, Kenya and Zambia.

The continent can trace its fortunes to the 1990s, when a commodity boom led by China prompted a surge of economic activity and a gradual shifting of currencies' dependency on global commodity prices. Previously, high prices would result in the currencies gaining ground, while falling prices crippled economies.

But with economic reforms and more diversification in the manufacturing and service sectors, the continent has become an attractive destination for capital investment.

In short, Africa is the last frontier.

"The last great convergence with the rest of the world is Africa, so we will continue seeing the world's money coming to Africa, especially from China's rich reserves," Satchu says.

The Chinese Ministry of Commerce says that in the first 11 months of last year, the country's outward direct investment totaled $89.8 billion. Africa received $3.4 billion in ODI in 2013, 33.9 percent higher than in 2012.

Analysts are optimistic that increased engagement between the two will eventually bring investment flowing into stock markets.

"It is sensible economic management for the Chinese to take advantage of the bullish performance seen across Africa," Satchu says.

Manufacturing, agriculture and infrastructure offer prime opportunities for Chinese investors.

Being aware of the continent's needs and acting accordingly is a safe bet for those who want to avoid obvious pitfalls, Satchu says.

"Play it simple and go for the very basic things, such as beer, telecommunications: things that two billion people need."

And with the lifting of foreign investors caps, Chinese investors have opportunities to jump on the bandwagon of shares that are highly valued. Recently Kenya's capital markets authority announced it would abolish the cap on foreign investment in local companies, which was set at 75 percent. This is expected to create liquidity in the market, increase demand for shares and push up the share prices of the companies affected.

Tanzanian authorities set the trend in freeing up its tightly controlled market in September, when the government revoked a regulation on foreign investment caps.

The move will affect stocks of companies whose float has been oversubscribed.

"Kenya will turn into a middle-class economy by 2020 and Nairobi will enter the Global Financial Centre Index ranking of financial centers published by Z/Yen Group," says Ndung'u of Dyer and Blair.

However, econimists say Chinese investors will stick to areas they are strong in, such as infrastructure and construction.

"They bring the ability to design and implement, and they even bring professional labor," says Kwame Owino, chief executive of the Institute of Economic Affairs, a think tank in Nairobi that advocates free markets. Unfortunately, due to the infancy of this sector, bourses do not have many listed companies that are specialized in the area.

China has demonstrated its interest in and knowledge of Africa's agriculture sector by reclaiming arid land through modern practices such as irrigation, Owino says. Investments in energy are also giving a fillip to manufacturing.

Chinese businesses seem to "have identified and are working on key economic drivers, and this is where we are going to see them for some time before they migrate to the capital markets", Owino says.

He points to the size of the market and illiquid nature of most bourses and says many capital markets have exchange controls. All these factors are a deterrent to investors, he says.

"But if they have an appetite for risk, then bourses are the place to be, especially now that gas and oil has been found in new countries in the continent," he says, referring to Kenya, Tanzania and Uganda. Chinese investors would not only be in the crux of the transformation but would also be moderately involved in its excavation costs.

"Whether the government will decide to float these companies to market resources or leave them as state-owned is a different matter all together," Owino says.

If floats are the preferred route, he sees Chinese companies such as China National Oil Corporation coming in.

However, unforeseen circumstances and upheavals in the continent always need to be taken into account. There was a lot of talk in 2012 about Africa becoming the new economic wunderkind, but that talk looked decidedly overblown when Nigeria and Ghana found themselves in tough economic straits.

The two countries had become the darlings of foreign investors because of their oil and gold reserves, but their gains were reversed when oil prices tumbled, putting their currencies under strong pressure.

One alternative for Chinese investors is to buy shares listed in other advanced bourses such as the London Stock Exchange, where companies such as Tullow Oil Pty, which has investments in Africa, are listed .

"But this means betting on geologists and miners instead of directly getting involved in Africa's Renaissance," Owino says.

Another alternative for investors is the financial sector, in which banks, especially in East Africa, are enjoying a bullish run.

Anyone deciding to invest money through African stock exchanges also needs to be aware of past problems. For example, in 2008, as a result of poor regulation of the Nairobi Stock Exchange, several well-known brokers were forced to close because of irregularities.

"This is one market where transparency and honesty are invisible," says professor Abel Kinoti, dean of the school of business at Riara University in Kenya.

But things are beginning to change on the Nairobi exchange, and new systems and regulations have been introduced or are planned to protect investors. These include an automated trading system, more stringent capitalization and disclosure requirements, adoption of a standard brokerage platform and the eventual demutualization of the bourse.

A minimum capitalization threshold requirement in particular has brought about big changes. Investment firms that did not reach the Kenyan shilling 250 million ($137,000) capital threshold were relegated to stock brokerage status, which requires a minimum capitalization of KSh50 million.

Kinoti says taxes such as a new capital gains one in Kenya will make the bourse more straightforward. A 5 percent tax is now levied on share sales.

Cultural differences between Africa and China are one barrier to Chinese investment in African stock exchanges, Kinoti says.

"The chasm between the two is wide, especially in the legal sphere."

One way of dealing with this is to have continuous engagement with potential new investors, he says . This has worked with US investors because African fund managers have reached out to their counterparts.

Francis Mwangi, head of research and investment at Standard Investment Bank, a financial advisory firm in Kenya, and who attended the inaugural Africa investment summit in Hong Kong 18 months ago, says: "The Chinese now have local agents whose capacity is known. This has created a sense of comfort needed in this partnership."

There have been calls to speed up regional integration as a way of creating regional stock exchanges that are bigger than the present ones. The Johannesburg Stock Exchange has offered members of the Committee of Southern African Development Community Stock Exchanges use of its system at less than market cost, but Namibia has been the only taker.

Apart from the investment opportunities for Chinese companies in the public market, private equity is an alternative full of promise.

A report issued last year by a Kenyan research and consulting firm says: "Players in Sub-Saharan Africa are still principally investing in the traditional markets of Kenya, Nigeria and South Africa where the majority feel that there is more certainty. However, interest in other countries like Ethiopia, Rwanda and Cote d'Ivoire, where players are looking for affordable deals, is rising. In terms of the sectors, consumer driven sectors are most popular, even though some private equity firms narrow their focus on sectors like energy or real estate."

Mwangi, the analyst with Standard Investment Bank, says: "We may see Chinese private funds coming earlier and quicker than public funds."

This may be true in sectors now dominated by Chinese companies such as infrastructure, construction and manufacturing. In Kenya, a government regulation says transport contracts not negotiated at the government level must incorporate 30 percent local content.

lucymorangi@chinadaily.com.cn

Kwame Owino, chief executive of Nairobi think tank Institute of Economic Affairs, says it is a good time for Chinese investors to come to African stock exchanges, especially when new oil and gas resources are discovered. Photos provided to China Daily

(China Daily Africa Weekly 02/13/2015 page1)