HARD WAY, ONLY WAY: How to profitably exit Nigerian FMCG investments (1)

FACT: Investing in Nigeria is rough.

FACT: It’s rough because majority of the people are poor; the market is fragmented; the regulatory regime is both untenable and unpredictable; the infrastructure is weak; the talent is technically sub-par (for the most parts).

FACT: Any fool can invest in Nigeria. But it takes a special type of investor doing special-investor things to make significant profit from such an adventure.

FACT: This article is not about shortcuts to exits. It is about the hard way – possibly the only way – to invest in the belly of the beast (FMCG sector in Nigeria) and exiting not just alive, but alive and kicking (in a timely manner with considerable profit).

Got it?

Good.

Let’s dive in.

This is a 3-part article series solely aimed at providing a treasure map out of the biggest quagmire bedeviling almost every investor (founders or private investors) in Nigerian FMCG companies: how to, in a timely manner, exit an investment in a Nigerian FMCG company at a high valuation. The key words here are “certain exit”, “timeliness” and “high valuation”.

The series is broken down like this:

Part 1: The Best Exit Option (as advised by me)

Part 2: The Drivers of a Successful Exit (i.e. the factors that would guarantee the likelihood, timeliness and profitability of the ‘best exit option’)

Part 3: The Process (how to get the whole thing done from start to finish)

Now, let’s get started.

PART 1: THE BEST EXIT OPTION

Here’s how this would go down, I’ll break down four ‘textbook’ exit options and end by picking the one I consider to be the most-worth pursuing.

But before we review the options, I’ll lay down the 2 key qualities that typify a good exit.

Qualities of a good exit

(High) Valuation: This is essentially the value that the buying investor would place on the business which in turn would inform the profit (or loss) the selling investor would make on the sale. Valuations can be based on anything from the historical/projected revenues and/or profits of the business, historical exit valuations of comparable businesses, the strategic importance of the sale to the buyer amongst others. Needless to say that a high valuation is good for the selling investor while a low valuation is –how do you say– not so good.

(Low) Tedium: This represents the time and cost of executing the exit transaction. Worthy of note are the costs, activities (legal agreements, financial agreements, due diligence, regulatory work, negotiations etc.) and time involved. The less the tedium, the better the prospects and more beneficial the outcome of the exit for the parties involved.

Now back to the exit options.

The 4 exit options

Management buyout: The sale of investor shares to the management of the company.

Secondary sale: The sale of an investor’s stake to another private investment company. The buying investor would also seek an exit of its own down the line considering that it is not in the business of investing in FMCG companies indefinitely.

Strategic sale: This is the sale of the selling investor’s stake to another FMCG company. The acquirer is typically an immediate competitor (in the same market), a potential competitor (in another market seeking to enter the target territory) or a non-competitor (seeking to enter the target line of business). The buyer in this case is (more) in the business of acquiring another FMCG company indefinitely.

Public sale: This is the sale of selling investor’s stake to the public as shares of the company become open for sale to the general public, typically through an initial public offer (IPO).

Analyzing the options

Let’s analyze the exit options along the lines of the ‘good exit qualities’ listed previously i.e. valuation and tedium.

VALUATION

Management buyout: Low valuation. Management buyout is typically explored whenever the target company’s prospects appear bleak and the selling investor is under pressure to exit the business. This sale typically attracts a low valuation because a) the business would not be worth much anyways b) the management would be unable to raise significant sums of money in any case.

Secondary sale: Low to average valuation. Secondary sale exits can be explored when the company is either doing poorly or well. If it is doing poorly, the valuation would be low because the business is intrinsically of low-value. If the business is thriving (with prospects to do better), the valuation is typically average at most. Reason is that the buying investor would still seek to sell its stake down the line. If it pays too much of a premium (at a high valuation), it might struggle to resell same stake at another high valuation down the line.

Strategic sale: Average to high valuation. Strategic sales are typically priced anywhere from mid-ranged amounts to significant premiums. Unlike in the first 2 options, the strategic buyer is not driven by the target company’s financial performance alone. In practice, it is driven more by strategic considerations such as the target company’s moats (unassailable sustainable advantages), access to investee company’s intellectual property, need to eliminate competition, need to access new territories/markets with a short learning curve amongst other considerations. If it is highly incentivized to make the acquisition, it would pay a premium (at a high valuation). On the other hand, if the acquisition is more of a ‘nice-to-do’ than a ‘must-do’, it would pay a mid-range sum (at an average valuation).

Public sale: High to very high valuation. Public sales are almost always executed at high valuations due to the fact that only high-flying companies that have scaled rigorous regulatory hurdles are able to explore the option. Buying investors in most cases would be more than happy to pay a (significant) premium.

TEDIUM

Management buyout: Low tedium. Management buyouts are typically straightforward in terms of cost, process and time because a) the management and selling investors know each other and the target company well enough for the transaction not to require too much effort b) the selling investor is typically hard-pressed to exit and as such is further incentivized to hasten the process.

Secondary sale: Average tedium. The wahala (tedium) involved in a secondary sale is quite significant but not back-breaking. Due diligence is typically the major issue. Because the buying investor is usually not a domain expert in the target industry (in general) and company (in particular), it would have to expend considerable time and resources in ensuring that it is entering into the right transaction at the right price.

Strategic sale: Low tedium. Strategic sales usually rank at the lower rungs on the tedium ladder for the following reasons: a) the acquirer is usually familiar with the line of business and is hence less likely to conduct long, drawn-out due diligence. b) other activities and costs are also minimized because the acquirer either has experience executing acquisition deals and/or is highly incentivized to do the deal, hence limiting the tedium of the process.

Public sale: High to very high tedium. This goes without saying. The regulatory hurdles, underwriter scrutiny as well as the corporate ‘house-cleaning’ that the target company would have to undertake, make a public sale a very tedious, time-consuming and expensive affair that few in Nigerian FMCG would venture to attempt.

Choosing the best option

Only one option ticks the boxes of high valuation and low tedium: Strategic Sale.

Reiterating the superiority of strategic sale as the exit option of choice:

1)     High valuation driven by the fact that the buyer’s rationale for the transaction supersedes the financial performance of the target company. Rather strategic considerations such as moats, IP, access to new markets etc. weigh heavier on its raison d’etre.

2)     Low tedium driven by the fact the wahala involved is significantly reduced because the buyer has domain understanding of the target company’s industry, has experience in executing similar transactions and is highly incentivized to hasten the process.

The exit environment today

The number of exits consummated today currently sway in the direction of the secondary sale option.

The reasons are adduced as follows:

• Public sale, relatively a novelty in Nigeria, requires too much wahala to become a widely-explored exit option today.
• Management buyout, even at discounted strike prices, is still difficult to consummate because the management teams involved are unable to raise the money required. The lack of a leveraged buyout industry, wherein management teams can secure loans (backed by the company’s assets) to finance the exit transactions, further limits the prospects of this option.
• Strategic sale –the hidden champion– remains under-explored because selling investors do not clearly understand or are unable to effect the transformation required within their companies to attract the strategic investor cadre.
• Secondary sale predominates because private investment companies a) possess the capital required to effect transactions b) possess due diligence blind spots which selling investors can exploit to selling them ‘turkey companies’ c) serve as buyers of last resort when sellers are pressed to exit and are bereft of other options.

In Part 2, we would explore the drivers that catalyze strategic sale exits especially taking into account the trifecta of selling investor yearnings i.e. ‘certainty of exit’, ‘speediness of exit’ and ‘high valuation of exit’.

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