Investors worldwide recognize the potential for investments in Africa, especially through public-private partnership (PPP) structures. But taking advantage of these opportunities requires a proper understanding of the risks—and how they can be mitigated—to optimize the project’s invest-ment return and development impact. The Africa Finance Corporation (AFC), through its active involvement on the continent as a project investor, financier, and developer, has participated in a number of notable PPP projects and learned valuable lessons along the way.
“Too good to be true” probably is
For many investors, especially those new to the dynamics of working in Africa, political risk remains a big cause for concern. With many politically fragile states on the continent, the apprehension is often justified. But the reality is that the most worrisome political risks do not relate to political violence or forced expropriation, which concern many people, but rather to unfavorable renegotiation of contract terms (“creeping expropriation”).
For example, during the decade of civil unrest in Côte d’Ivoire, well balanced and structured projects such as the Azito power project continued to perform well. In contrast, many mining contracts all across the continent have been renegotiated. These “creeping expropriations” often arise because governments are not as skilled or as experienced in negotiating such agreements as their counterparts and cannot afford the advisors that will best assist them. Corruption is also the culprit in some cases.
Investors can mitigate this risk by avoiding projects with concessions that are too good to be true—especially those that have either emerged from less than transparent processes, or were awarded on a discretionary basis. The downside to such one-sided concessions is that they are often scrutinized after the fact, and withdrawn or renegotiated by new governments or administrations.
Immature markets require strong partners
Pairing a young country with mature advisors and experienced private sector partners makes all the difference to a successful project. Côte d’Ivoire’s Henri Konan Bedie Bridge reached financial close in 2012 after 14 years under development, surviving two periods of civil unrest. In this case, the government partnered with Bouygues S.A., funded by international financiers and partly arranged by AFC. Having a strong sponsor to navigate the local environment was crucial to the project’s success.
Strong partners and financiers can also withstand the financial ups and downs that sometimes occur in the African business environment, and experience gives them a nuanced understanding of real project risks. Lacking this understanding, projects may be over-engineered to protect against risks that are very unlikely to crystallize. This makes them more expensive than they need to be, while not properly accounting for real risks that could affect the project’s outcome.
Avoid projects with concessions that are too good to be true—especially those that have either emerged from less than transparent processes, or those awarded on a discretionary basis.
Risk profiles are as varied as borders
New investors and analysts outside the continent often see Africa as one country, making the mistake of thinking that the same risk profile applies throughout the continent and across projects. This is not the case.
Risks differ from one country to another and from one project to another, given the differences in policies, structure of government, level of reforms and development, and physical and human capacity. It is important to develop different structures and solutions to mitigate the specific risks identified in each market and for every project.
There is also often a temptation to adopt foreign templates and assumptions that are not realistic in the local environment and to apply those templates across all African markets and projects. For example, while it may be acceptable to apply higher leverage ratios (80:20/90:10) in more mature and advanced countries, this may not necessarily be sensible in the local environment, where larger equity cushions may improve project outcomes.
In evaluating project assumptions, it is important to ensure that project fundamentals are clear to all. For example, in a power project, the off-taker and fuel supplier should be known in advance and their ability to meet their obligations under the agreements be well established. Valuation and cost competitiveness is also critical, as overpaying for an asset is a painful and usually irreversible error.
The uniqueness of the challenges and risks on the continent requires innovation in approaching and evaluating PPP projects. This is particularly true with respect to financial products. For example, while AFC is focused on a few key sectors (natural resources, transport infrastructure, telecoms, power, and heavy industries), it offers a broad range of financial products and services that allows participation across the spectrum of the capital structure. Other financiers with a more limited set of offerings can find it difficult to meet the needs of these varied projects.
Projects are often over-engineered to protect against risks that are very unlikely to crystallize, making them more expensive than they need to be.
There are over 20 development finance institutions (DFIs) operating in Africa, and the evolution of the banking sector and financial markets has made debt financing relatively easily accessible. However, two things are lacking. There is a paucity of well-structured projects that are bankable, and too little access to long tenored financing.
Sponsors very often underestimate the resources required to develop their projects, which can be as high as five to ten percent of the total project cost. In addressing this problem, AFC and the Dutch DFI, FMO, recently launched a $15 million project development facility aimed at providing early stage capital to projects in order for them to become bankable.
In addition, AFC provides tenor extension facilities aimed at providing longer tenored financing for projects that most domestic banking institutions are unable to provide due to statutory and regulatory requirements. These products—in addition to other key services like technical and financial advisory, mezzanine, and acquisition finance—have been central to AFC’s success on the continent.