A Closer Look at PE in South Africa: An Interview with Nhlanganiso Mkwanazi of Medu Capital
Nhlanganiso Mkwanazi is a cofounder and Director of Medu Capital, a South Africa-focused private equity firm with more than ZAR2 billion (approximately US$200 million) assets under management. Nhlanganiso discusses the current private equity landscape in South Africa, as well as macroeconomic challenges facing the country, including the general elections and recent currency volatility.
You cofounded Medu Capital over a decade ago. Can you tell us about the firm’s strategy and focus?
Medu Capital focuses on investing, through both majority and minority control stakes, in mid-market companies located in South Africa. Our mandate allows us to invest a portion of our capital in the broader African continent; however, our primary focus is on South Africa. Medu Capital has raised three funds: a ZAR250 million (approximately US$40 million) 2003-vintage fund which is fully invested and fully exited, and a ZAR900 million (approximately US$120 million) 2007-vintage fund which is fully invested. Our third fund was established in September of 2013 and has a target of about ZAR2.25 billion (approximately US$225 million).
Given your extensive experience with private equity investing in South Africa, how would you assess the current landscape for the asset class in the country?
In general, the private equity asset class in South Africa is fairly well established and is improving in line with improving macroeconomic conditions. This year, South Africa celebrates the 20th anniversary of the new democratic government in the country, and 2009 marked the only year we experienced a recession in 20 years. The industry certainly had to deal with a more difficult environment following the global financial crisis in 2008 and 2009, which affected fundraising prospects, the rate of new investment, access to the debt capital markets and the performance of underlying portfolio companies. Given the tougher economic environment and a recession in 2009, a fair amount of capital invested in the years after that was to support portfolio companies.
However, the recovery from the lows of 2009 has had a positive impact on the private equity market. We have seen increasing levels of capital raised and deals completed, and most importantly, we have seen recovery in terms of returns. In addition, investing in South Africa, we are blessed with a diverse economy that throws opportunities to us from a variety of sectors. At about 20% of GDP, financial services are the biggest component of the economy, but beyond that, it has significant diversity. As a result, Medu Capital does not focus on one or two sectors. Through our three funds, we have invested in over 20 companies across many sectors, including healthcare, industrials, manufacturing, education, construction and various service businesses.
A number of emerging markets currencies faced volatility over the past year, including the South African Rand, which fluctuated significantly between Q3 2013 and Q1 2014. What affect has this volatility had on the country and how does it affect the economic outlook?
The Rand is one of the most liquid currencies within emerging markets (EM). It is often used as a proxy for EM risk appetite and is not pegged to leading currencies around the world, so we do experience volatility. However, we do not anticipate a significant weakening in the Rand from the current rate, and based on the forecast of the leading local and international economic research institutions, the expectation is a slight strengthening from the current level.
In terms of negative impact, the recent volatility certainly affects the inflation outlook. South Africa’s inflation target is currently between three to six percent. We are expected to extend a bit beyond that range later this year and then retrace back. We have also had a 50 basis point increase in our benchmark interest rate, which has increased borrowing costs in the local economy.
On a positive note, the currency fluctuation has actually benefitted some of Medu Capital’s export-oriented portfolio companies. Because costs for these companies are predominantly in Rand and they are exporting in Euro or US dollar, the receipts are higher due to the exchange rate, relieving pressure on margins. Furthermore, the weak Rand has been a boost for some local industrial companies that compete with imports. While there are negative aspects to the Rand’s recent fluctuation, the local economy has become a bit more competitive in global trading terms.
As you mentioned, this year marks the 20th anniversary of the current democratic government in South Africa. What has been the public’s sentiment in the run-up to the election and how it may affect the economy of South Africa?
There is an active debate about the issues facing the country. Among the opposition, there is a heavy focus on the quality of governance in the ruling party – the African National Congress (ANC). The election has also highlighted the need for job creation, as South Africa has a relatively high unemployment rate, a very topical concern.
Within the tripartite alliance—a coalition that includes the ruling ANC, as well as the Congress of South African Trade Unions (COSATU) and the South African Communist party—some politicians are calling for a breakaway to form a new worker-oriented party. For now, they continue to support the ANC, but looking forward, that dynamic is interesting, as it could result in an important constituency competing for political power. Labor unions in South Africa are well-organized and command a significant membership base; if they formed a separate party and competed against the ANC, it would certainly change the political landscape in the country. However, this is more of a scenario for the future.
What have you read recently that was particularly interesting or that you would recommend?
A recent issue of Fortune featured an article on the unsuccessful changeover of leadership at the U.S.-based department store J.C. Penney. The article provided very insightful lessons about the new CEO who wanted to take the company forward but tried to implement radical ideas quite aggressively, without much success. It was interesting because we are going through the process of appointing a new managing director for one of our portfolio companies. We partnered (through a minority investment) with a founder of the business who is retiring, and we have acquired his stake and now own over 90% of the company. The article highlights a few areas where the J.C. Penny CEO could have done better, so it was insightful to put into perspective what a new leader should and should not do. Link to article: http://money.cnn.com/2014/03/20/leadership/jc-penney.pr.fortune/