Keys to Financing Industrial Projects in Africa - A Thought

Industrialization has been viewed as a key driver towards a country and region developing economic security and improved stability. This concept has a strong basis historically by looking at the growth of the United States and Europe, along with more modern times with China and other parts of Asia. Industrialization overall improves the economy by creating jobs, increasing a country’s exports, improving regional trade ties along with an increase in the tax revenue for the country. These are all well-known and established precedents. What has not been established is how can an individual country or region achieve these industrialization goals.

In the 1970’s, a study was conducted which compared a number of countries in Asia to Africa. In the post-colonial period which closely coincided with the post-war era, many African and Asian countries were relatively on par in terms of GDP and per capita income. One particular portion of this report noted that in the mid1960’s, Kenya and South Korea were just about equal in a number of metrics. By the late 2000’s, a follow up study showed what had become fairly evidence, which was that South Korea had far surpassed not only Kenya but all of Africa. Based on GDP alone, South Korea at $1.8 trillion roughly equals the GDP of the entire Sub-Sahara Africa at $2 trillion. With very few natural resources, the answer lies in South Korea’s manufacturing capacity. A number of Fortune 500 companies are based in South Korea which are Hyundai, Samsung, Kia and LG Electronics. These are all global titans and are the result of their nation’s industrialization push from the 1960’s and 70’s. ?Manufacturing has allowed South Korea to surpass not just Africa but much of the world within a generation.

One of the key factors which led to South Korea’s growth and allowed the country to accelerate industrialization and infrastructure. One key area was establishing a partnership with the United State’s Army Corp of Engineers. This agreement allowed for the South Korean government along with international partnerships to access funding along with expertise to build industrial giants at a heightened pace. Between 1978 and 1998, South Korea’s economy grew from a GDP of $10.6 billion in 1972 to $1.6 trillion in 2022. Within that time frame, a number of South Korea’s major industrial corporations were either established or made significant strides to become globally recognized organizations. In fact, the South Koreans have a term for these groups which is known as Chaebol, which is generally understood to be a giant South Korean firm with a truly global presence. The term was coined in 1972 which gives further credence to the impact of government and companies providing a unique focus on industrialization and manufacturing. This type of growth does not occur with tourism or relying upon aid from wealthier nations. It’s a result of a country focusing on industrialization.

From a practical perspective, it’s not possible for any African country to seek a similar partnership with the US Army Corp of Engineers. While it was certainly a noble effort for the US Army to support the development of South Korea, it was largely a product of the Cold War environment and the need to improve the country’s infrastructure and stability in the event of a war with North Korea. However, if we look at contemporary modern opportunities for partnership, they are numerous. The United States Export Import Bank (US EXIM) has sought to increase funding to Sub-Sahara Africa by at least $3 billion and have invested over $20 billion in the past 20 years. The Development Finance Corporation (DFC) has funded close to $10 billion in projects in Africa. The African Development Bank (AfDB) has financed billions of dollars in projects since its inception and remain a committed partner on the continent. All of these institutions can allow for African nations to partner with global corporations to build manufacturing and industrial hubs which can significantly improve their economies. From Asia, Sinosure and the Chinese Export Import Bank have played a major role in securing numerous projects for Chinese companies in Africa. These range from rail projects, housing, roads to airports. This has allowed Chinese companies to penetrate the African market in an unprecedented manner. From Europe, there is SACE from Italy and FinnFund out of Finland. All of these have a commitment towards financing projects in Africa and have great track records.

From the corporate US angle, the John Deere Corporation signed an agreement with Equity Bank in Kenya. Other American and global corporations have agreed to develop projects across Africa as the region is viewed as one of the last frontiers for business. But the key question in all of this becomes, who is paying for it? One key point I’ve always told business and political associates is that multinational companies rarely use their own money to invest abroad. They have a healthy track record of delivering projects and have years of financial growth so they simply access global financial institutions to borrow money for their expansion. These institutions offer long-term lending which is essential in the industrial and manufacturing sector.

Many businesses in Africa are interested in such partnerships but there are a few significant road blocks which can prevent such opportunities. The first is that global financial institutions rarely will finance a project 100%. Thus local companies will need to bring at least 15% equity to the project and this can be a challenge. If a group wants to build, for example tomato processing plant, which may cost in the range of $20 million, they’ll need to have a minimum of around $3 million in equity to contribute towards the project. Many African companies and entrepreneurs seek to use their land as equity but this generally not viewed as a viable form of equity by most international financiers. It can be next to impossible for an international group to validate the actual amount listed and if the funding has to be recouped through the confiscation of the land, real estate property laws can make this a legal challenge and absolute mess.

The most practical and accepted option for this is for local banks to offer a guarantee to the international lender. This is viable but at times, many banks will then require collateral or may ask that the group seeking to receive the guarantee must have a similar amount in their account. Thus for a good number businesses, the discussion ends there. They simply don’t have it and view this as the end of the opportunity.

However, as times have evolved and the demand for industrialization has increased, local banks have become more flexible in their terms to offer a guarantee. Additionally, regional institutions such as the African Guarantee Fund are a great vehicle to support this type of funding arrangement.

One option which many have pursued and to which I’ve played a role is with venture capitalists and investment funds. The venture capitalist model is intriguing and such groups certainly have the ability to finance large projects. The major drawback many have come across is that venture capitalists have a model in which they inject funds into a greenfield or brownfield project and expect their return with interest within 60 months (5 years). In real estate and trade, this is realistic as these are sectors in which returns can come relatively fast and can satisfy an investor.

However, in the industrial and manufacturing sector, investors seeking a return in 5 years may find challenges. The first two years are generally a grace period for payback because this will be the construction phase. Unlike real estate or trade, there will be no down payments or forms of revenue for the project. If the project secured a loan for the rest of the funding, while they are not making any payments during the grace period, the interest will have accumulated during that time. Therefore, a portion of the project’s first year of revenue will go towards servicing the accumulated interest. This will result in even lower returns during the first year of revenue.

One key area here is that in the industrial sector, the depreciation will be a significant cost of the expenditure during the first two years. This notes that within the industrial sector, the new machinery and equipment will take some time to become efficient and will require a good deal of maintenance and supplies.

The depreciation is coupled with another significant issue in the industrial sector which is that production will generally be low within the first few years. In many sectors, output may only be 50% in the first year, 60% in the second year and reach 75-80% by the third year. If the facility begins to run efficiently, it may run at 90% by Year 4 or 5.

Thus if we look at the lower output along with high depreciation costs, this will mean a relatively low revenue stream over the first 4-5 years. It is only after Year 5 and 6 in which the facility will begin to reach peak production and start to turn a heavy profit. However, if the venture capitalists were expecting to exit around this time, they’ll be disappointed by the proposed numbers. Within this scope, the key feature is identifying investors who understand and value long term growth and the potential of a facility when deciding to inject capital.

If we look at the overall model for financing industrial projects in Africa, there must be a minimum level of local investment to secure outside institutional financing. Within this respect, local companies will need to continually identify potential partners both in their countries and abroad. Three key aspects that many companies tend to overlook are the following:

• Bankable financial projections
• Third party technical analysis and design
• High level marketing plan

This is all captured in a feasibility study which is an essential aspect of any large scale industrial or manufacturing project. This is a topic which I’ll be revisiting in another article but overall, it’s mandatory for any project. This document ensures that the project has been vetted technically, market scope and most importantly, it makes financial sense. Once a high level feasibility study has been developed, this can be presented to local and regional investors because they recognize that the project is no longer just a dream of the business owner but has actually been verified and tested by independent groups.

The above ingredients show that it’s evident that funding projects in Africa will continue to require a plan which involves global and regional partners. One thing I’ve noticed while living on the continent is that what exists on paper, is not always applicable in real life. Many businesspeople and those in government complain about the requirements of global financial institutions. They note that offering a sovereign guarantee from the government or a private company receiving a bank guarantee are very difficult to obtain. These are challenges but if we look at the South Korean model and other countries, it’s a challenge that is worth the risk of taking.

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