Back to the complete issue
Thursday, 7 February 2019

Sherif El Kholy — partner and head of Middle East & North Africa, Actis

2018 was not an easy year for private equity — not globally, and certainly not in our neck of the woods, where the collapse of onetime regional and EM champion Abraaj shook both the industry and those who invest in it. Sherif El Kholy, partner and head of Middle East & North Africa at Actis, the premier emerging market PE firm, knows a thing or two about navigating challenging circumstances. A veteran of the finance industry, El Kholy got his start at EFG Hermes and then moved to HSBC doing structured finance. Since joining Actis in 2004, he has been focused on North Africa, taking the lead on key transactions, executions and exits. Actis’ regional portfolio spans from Honoris United University (Africa’s largest private higher education network, which reaches from Morocco to South Africa) to Egypt’s Integrated Diagnostics Holdings (led by Dr. Hend El Sherbini, who appeared in our 2019 CEO Poll on Sunday). Actis has invested some USD 1 bn in Egypt across sectors including food and beverage, healthcare, and power and has completed landmark investments in market-leading businesses including CIB, Edita Food Industries and El-Rashidi El-Mizan.

2018 was the year of uncertainty for the private equity industry, not just in Egypt, but globally, for a variety of different reasons — not least of which is the emerging markets volatility and how the trade war between China and US had an impact on the attractiveness of emerging markets.

For PE, I think 2019 will be a year of stabilization and momentum buildup. And for Actis it is a year of growth across our markets. We are augmenting our presence and activities in Egypt and in Africa, as well as building on our global financial services sector expertise by launching a global fund dedicated to that sector, with a dedicated global sector team. Our aim is to reaffirm our position as the leading emerging markets private equity firm.

The biggest challenge in 2019 will be ensuring the reform program Egypt continues at pace — and that the side effects can be absorbed by people, especially the middle class, and that social costs of the reform program can be manageable. I think the reform program is absolutely essential and there’s been a lot of very tangible improvements achieved in the past 24 months. It is important to press forth in earnest. I think it’s important not to take any U-turns, but to keep an eye on the social costs of that program and ensure that there is sufficient attention and funding given to welfare programs such as Takaful and Karama.

The biggest opportunity of 2019 is to capitalize on Egypt’s increasing focus on Africa and to use Egyptian businesses to build bridges across the continent. We are strong believers in the importance of building sizeable, scalable businesses that are pan-African and that’s why we’ve previously created Africa’s largest payments platform — Emerging Markets Payments — which was ‘born’ in Egypt and then diversified through acquisitions and organic growth all over Africa. We’re now doing the same thing in higher education through our education business Honoris United Universities, which is spread out across all of Africa and is in the process of entering the Egyptian market. With Egypt heading up the African Union in 2019, there’s an opportunity to create more business ties between Egyptian and African businesses and capitalizing on the investment opportunities that arise as a result of that.

Over the past two years, there has been a much bigger focus by the government given to Egypt’s relations with Africa and I’m very pleased to see that. It’s very healthy and encouraging to see Egypt focusing on occupying a much bigger space in the African investment ecosystem.

I feel positive about the prospects of the Egyptian economy in 2019. From a growth standpoint, from a stability, and health standpoint, I feel more positive about it in 2019. I think a lot of the improvements will depend on what happens with foreign direct investment (FDI), which is certainly improving and accelerating. It’ll be important to see an acceleration in the pace of equity flows into the country and new private sector projects getting funded by foreign investors.

The health of the economy will also depend on the continued recovery of tourism. I think there will be a recovery in tourism in 2019 and that the positive trajectory the sector is taking will continue. The third thing is the continued recovery of consumption, which was hard hit after the EGP float and saw volumes fall across many sub-sectors. Those volumes are starting to come back from the second half of 2018 and I would expect them to continue recovering in 2019 as the markets rebalance and consumers start to absorb the inflationary shocks that have happened over the last couple of years.

Why hasn’t FDI grown as fast as the gov’t was projecting? I think there are two reasons. The first one is related to global markets: Emerging markets have been on a turbulent path for the last couple of years. It’s not just Egypt — most emerging markets and capital flows into emerging markets, particularly on the equity side, have been impacted by that and there’s been multiple reasons for that. These include Brexit and the trade war between China and the US. We’re seeing a lot of international investors channeling their investments into developed markets, particularly the US. The second reason is the higher interest rate environment which has made the carry trade in Egypt more attractive and a safer route for deploying international capital into the Egyptian market, and more attractive than long-term FDI into equities and projects. Investors have had the opportunity to make low risk returns by channeling their investments into debt instruments.

That said, the investment regulations are there and investment promotion and support to investors from the Investment Ministry is there. What I hope will happen is that as interest rates go down and growth accelerates, we will see a pick-up in equity flows and setting up new businesses, and setting up new hubs for multinationals in Egypt to capitalize on Egypt’s relationships with a variety of other markets in the region. That’s why I’m hopeful that investment activity this year is going to pick up, both on the portfolio flows front and the projects front.

Our approach to compensation in 2019 will be very much consistent with our approach in prior years. Actis has a well-designed performance management system, and a fixed salary and a variable performance bonus system. Salaries are benchmarked according to market rates of pay. And then there’s a merit based performance bonus to reward high performers. And, yes, I expect that there will be raises in 2019.

Our business is all about investing in well managed, high growth, privately owned businesses. And what’s been happening over the past two years is that the environment of high interest rates has constrained the appetite and capability of a lot of Egypt’s private business to implement capital expenditure programs via the use of bank funding. So I feel that overall growth in the private sector has been impacted by the environment of high interest rates which obviously has an indirect impact on the private equity industry.

I certainly hope interest rates come down in 2019. I think it makes sense that they start to come down this year, hopefully sooner rather than later, especially with inflation starting to come under control.

We continue to have investment appetite even when interest rates are high. But I think what will happen when interest rates come down is that by definition, businesses will be able to borrow more at more competitive rates which will catalyze capital expenditure programs which will translate into growth. And growth is one of the most important ingredients that private equity looks for, so it’ll have a positive impact on our investment appetite within our focus sectors, which are energy (particularly renewable power), the consumer sector, education, healthcare, and financial services.

Education is a high priority sector for Actis. We had invested in it before in China and Brazil and we’ve decided to enter that sector across Africa in 2014. That is why we created Honoris United Universities which today has over 30k students spread across 30 cities in nine African countries. And we met with the Higher Education Minister and there was support for Honoris to enter Egypt. We’re working on two different approaches into the Egyptian market. The first one is an organic route by setting up an international branch campus for one of our universities, Regent’s business school. The second route is investing in existing private universities and we are looking at a number of those.

We believe Egypt has good K-12 prospects and we’re interested in replicating our successful example of Honoris by starting a similar platform for it. Egypt is one of the very attractive markets in that space so it would be the same Africa “string of pearls” strategy that we used in higher education. We are actively looking at the K-12 sector in Egypt.

Inflation has been a very big issue in 2018, because inflation manifested itself in a variety of different ways. The most notable of which was its negative impact on the consumer sector and, as I mentioned earlier, volume drops within the consumer sector. I think high inflation has meant that interest rates needed to remain high, and that in turn has depressed private sector borrowing. It’s all interconnected and that’s why getting inflation under control is a very important aspect. The CBE’s policy of inflation targeting is absolutely the right policy to make sure that inflation gets under control to enable interest rates to come down. This will then enable capital expenditure programs to accelerate which will in turn have a positive impact on the private sector investment at large.

I think the IPO outlook this year will be more subdued than 2018. 2019 is the year we will see more M&A activity than IPO activity. There is been a healthy flow on the IPO side over the last 18 months or so. But there are a variety of reasons why I would expect IPO activity to be lower than in 2018. Part of that is investor appetite. There will always be investor appetite for IPOs in defensive sectors. But now there has been a pause in IPO activity since 4Q2018, because of mostly emerging market sentiment, and because of all the noise with the state privatization program. I think the program has to be timed well to be successful to make sure these assets are priced optimally. But another relevant factor to take note of is how the regulations are governing IPOs going to evolve, especially in the aftermath of the Sarwa IPO.

I think M&A activity will improve in 2019. With inflation coming under control, that has positive impacts on a variety of different sectors and on the investment sentiment. The acceleration of growth in GDP is going to give investors more confidence. Continued pace of reforms and support from the IMF will continue to provide a positive impetus. A lot of private businesses will look for replacement capital and expansion capital transactions — these are transactions that happen on the private level, like sales of significant minority stakes or buyouts. We’ll also see an increase in what’s called pre-IPO investment — where a private equity investor comes in with a stake in the business and then helps the business get ready for an IPO. That’s very similar to what we did in our investment in Edita Food Industries, which was very much a pre-IPO investment ahead of the company’s very successful IPO on the EGX and the London Stock Exchange.

From a private equity sector mapping standpoint, I would expect the payments sector and fintech to be outperformers. I expect the education sector to enjoy growth. Medical diagnostics and medical services, as well. And small ticket non-discretionary spend consumer goods, particularly within the food and beverage space.

Real estate is expected to underperform along with discretionary spending sectors, and any sector that rely in a big way on imported raw materials for their inputs. Banks are also expected to underperform as a result of the new tax treatment and yields on treasuries coming down.

Where am I investing? I very much like the food sector. Particularly businesses that are small ticket, geared towards the consumption of the middle class. I also see investment opportunities within the education space.

Is Egypt at risk of over-regulation? I think Egypt has a prudently-regulated market with very good levels of governance as it concerns the corporate world. The issuance of the Investment Act and the Bankruptcy Act, from a regulatory standpoint, are very welcome steps. But I think the biggest risk in Egypt at the moment is a risk of over-regulation. A good example of effective regulation lies in the electricity sector, where private sector participation has been enabled in a big way and as a result, there has been an explosion of growth in that sector with a very positive outcome for the country. The same needs to happen from a regulatory standpoint in other similarly strategic sectors.

I want to point out education and healthcare as two such sectors, where there are still barriers to entry, particularly for foreign ownership. Until today, a foreign investor cannot own 50% or more of a private university unless they open an international branch campus. Buying and selling shares in companies in the healthcare space requires approval from the Health Ministry. More liberalization is required on this front to enable the transfer of know-how and to enable private sector and foreign participation in those sectors. So I think the over-regulation risk is sector-specific. But overall, Egypt is prudently-governed, investor protections are there, the ability to litigate and get what’s due to you is there and it’s robust, especially when compared to other comparable economies.

Egypt’s fundamentals put it at an advantage over other economies: Egypt is a high priority market for Actis. We’ve been on the ground for over 16 years. We’ve invested and committed close to USD 1 bn across a variety of different sectors including energy, financial services, food, and healthcare. We’ve invested consistently throughout periods of challenges to the economy. And that’s because we believe in the long-term prospects of Egypt from a demographic standpoint and from a growth standpoint and a diversification standpoint. But at this point, the number one priority for me in Egypt is making sure that private sector participation is as deep and as enabled as it should be and that there isn’t any crowding out of the private sector by the government or quasi-governmental players. Egypt’s long term growth can only be guaranteed and sustained by a healthy and flourishing private sector with both local and foreign investor participation.

…And Egypt is in competition with other emerging markets for international capital. International investors have choice and they choose to channel their money into the most attractive markets. Accordingly, to ensure growth in private sector participation and equity flows and FDI, the Egyptian market needs to continue providing a healthy investment landscape as well as actively encouraging and enabling the private sector to occupy a bigger space.

If I were to start a new business today, it would be an education business. I would get into setting up my own private university, which I think is a good business, with very good social returns. It’s a fascinating sector with a lot of latent demand.

The biggest issue in private equity in emerging markets today is perception. There have been unfortunate events that have happened in the emerging markets private equity space which have colored the views of investors of that industry. The dark cloud that has loomed over emerging markets private equity in 2018 because of the bad coverage is probably the biggest challenge we see today. And one of the challenges for emerging markets private equity firms today is to deliver positive outcomes that counter the negative perceptions.

What can PE firms do to change that perception? I think it is a good opportunity for strong private equity firms to distinguish themselves and show investors how they run themselves and approach investment management and corporate governance. I think it’s an opportunity for the well-governed, professional players to distinguish themselves from the pack. I expect there to be a “flight to quality” within the industry. Investors are now more discerning than ever and are carefully picking who they put their money with. Track record thus becomes very important.

The most common question we get from LPs on Egypt is will the EGP devalue this year. We will see. I think if the EGP slides a bit, it will be healthy. It would certainly help exports. So I won’t be surprised if there was a little devaluation over the course of 2019, but not of a big magnitude.

What have you not asked me? How about this: Why am I still an Arsenal fan?

Enterprise is a daily publication of Enterprise Ventures LLC, an Egyptian limited liability company (commercial register 83594), and a subsidiary of Inktank Communications. Summaries are intended for guidance only and are provided on an as-is basis; kindly refer to the source article in its original language prior to undertaking any action. Neither Enterprise Ventures nor its staff assume any responsibility or liability for the accuracy of the information contained in this publication, whether in the form of summaries or analysis. © 2021 Enterprise Ventures LLC.

Enterprise is available without charge thanks to the generous support of Commercial International Bank (tax ID: 204-891-949), the largest private-sector bank in Egypt; EFG Hermes (tax ID: 200-178-385), the leading financial services corporation in frontier emerging markets; SODIC (tax ID: 212-168-002), a leading Egyptian real estate developer; SomaBay (tax ID: 204-903-300), our Red Sea holiday partner; Infinity (tax ID: 474-939-359), the ultimate way to power cities, industries, and homes directly from nature right here in Egypt; CIRA (tax ID: 200-069-608), the leading providers of K-12 and higher level education in Egypt; Orascom Construction (tax ID: 229-988-806), the leading construction and engineering company building infrastructure in Egypt and abroad; and Act Financial (tax ID: 493-924-612), the leading activist investor in Egypt; and Abu Auf (tax ID: 584-628-846), the leading health foodmaker in Egypt and the region.