CHAPTER 12

Africa

AFRICAN RENAISSANCE

A good friend of mine just returned from Kampala, the capital of Uganda. He said the casino in Kampala was hopping. But the patrons were not Ugandans, they were Chinese. In fact, many of the signs are in Chinese.

Africa is enjoying a selective boom of sorts as the Chinese are making their presence felt by financing mega natural-resource-related projects. However, the selectivity is not so much boom related as it is country specific. Many people, investors included, tend to view sub-Saharan Africa as one giant country. It’s far from that. From the jungles of the Congo to the coastal cities of South Africa, the continent’s population is quite diverse, and most of the countries share little in common other than ancestry. In the Congo, French is the language of commerce. In South Africa, one should have a grasp of Afrikaans and English. In the Ivory Coast, again, French is dominant. Most countries also have several distinct native languages. In Kenya, for example, Swahili is the local language, but the 800,000-strong Massai speak their own language, which is more closely related to that spoken by tribes in Tanzania. The ruling party for many years, the Kikuyu, who number some 6 million (about 20 percent of the population) speak a variation of the Bantu language. And, so it goes on this continent of more than 54 distinct countries and over 1 billion people. It also presents a difficult proposition for investors because few can navigate through the variety.

Earlier I spoke about the opportunity presented in North Africa after the fall of the age-old regimes in Libya, Egypt, and Tunisia. The best way to play the upcoming renaissance in the North African region is through Egypt, in my opinion, and I outlined the reasons why earlier.

South Africa is also relatively easy to analyze as it is far ahead of most African countries in terms of development. East Africa (Kenya, Uganda, and Tanzania) is also well developed, in an emerging market sense, as these countries have been explored and developed by European colonists for many, many decades. Smaller countries really have very little to offer from an investment point of view since many, like Somalia, barely offer their local populations opportunity, let alone foreigners. The West Coast of Africa offers pockets of opportunity, but many countries in the region are also not really suitable for inexperienced investors, nor experienced ones in many cases. My focus will be on the countries where opportunities exist, whether on the ground or through the stock market, either locally or through exchange-traded funds or mutual funds. It would be easy to have written Africa off in the past, but for the past decade the continent overall has been the second fastest emerging market growth story behind South America and even ahead of Asia. Granted, the starting point is very low and growth, while impressive, is not on the same total dollar scale as that of Asia or South America. Fifty percent growth in the past decade sounds impressive, but as my old statistics teacher used to say, numbers don’t lie, people do. Africa’s boom is narrow and in order to buy into it, you’ll need nerves of steel and lots of hope. And, as the Chinese have discovered, lots and lots of patience, as well.

East Africa

I have yet to see a place as beautiful as East Africa. I know it well. I was born there. From the beautiful coastal cities of Kenya and Tanzania to the inland lake country of Uganda, there are few places that can compare in natural and abundant beauty. From the snow-peaked summit of Mt. Kilimanjaro, through the plains of the Serengeti, to the Tsavo and Amboseli national parks, and the shores of Lake Victoria, East Africa is teeming with life. I was reminded of this on a recent trip to the Grand Tetons and Yellowstone with my daughters. I offered them a dollar for each different animal they spotted on our drive through the Teton National Park. It was a very cheap excursion. I remember driving through Tsavo with my parents on our way from Mombasa to Nairobi. It was not unusual to see tens of thousands of animals at any given time on the plains. And, if the herds were migrating, the numbers could multiply tenfold.

I was born in Mombasa, a coastal city that first appeared on the European map when Portuguese explorer Vasco da Gama stopped there in 1498. The Portuguese later sacked the city and ruled it until the mid-1600s. Situated on the Indian Ocean, Mombasa was and is an important port city that has played a major part in the subsequent colonization of Kenya by the Arabs and then the British, who were the last colonial power to rule Kenya until 1963, coincidentally the year I was born.

The Kenya I grew up in was far different from the one that exists today. It was better . . . though not necessarily for everyone. My family came to Kenya in the 1800s as traders and merchants, following the British from northern India. My father worked hard to build a business as a distributor for Mobil Oil in the coastal cities. I enjoyed a lifestyle that could only be described as the best that colonialism had to offer. Servants, a large estate home overlooking the Indian Ocean, nannies, private schools—the works. Of course, the price of all this luxury was the low cost of labor and the massive inequality between the local African population and that of the merchant class, which was made up mostly of Asians and Europeans. After gaining its independence from Britain, Kenya and East Africa in general began to exude a different atmosphere. While never personally endangered, I clearly recall the extra security we would hire after stories of marauding panga gangs made the rounds. A panga is a machete, and victims of the gangs were usually hacked to death. The Kenyan independence movement was a result, in part, of the efforts of the Mau Mau uprising (the letters are an acronym for a phrase that basically said Africa is for Africans and the foreigners should go back home). The Mau Mau movement was a violent movement of Kikuyu origin, which had as its goal the return of the lands to the native population. Parts of the violent strain continued to make waves after independence. The first Kenyan president, Jomo Kenyatta, was a member of the Kikuyu tribe.

However, Kenya was a harmonious Eden compared to its neighbor Uganda. Uganda gained independence from Britain in 1962 in a more peaceful fashion than Kenya. A decade later, peace was not even in the Ugandan dictionary. In 1971, a military commander, Idi Amin Dada, seized power through a military coup. He turned the country upside down in a period of seven years, destroying every shred of commerce, human rights, and prosperity in the process. Shifting alliances from the West to those who opposed the West, like the U.S.S.R., Idi Amin went on a nationalist rampage that involved the expulsion of the Asian and European population and nationalization of all of their businesses and homesteads and any possessions that they could not physically carry out of the country on planes, by car, or by train. He destroyed Uganda’s economy, and he was responsible for upward of 100,000 deaths and maybe as many as half a million of the local population in purges, power grabs, and ethnic cleansing. Only today has Uganda begun to recover in earnest from the stone age that Amin left the country in when he was ousted in 1978.

An excellent movie, The Last King of Scotland, depicts the life and times of Amin and his brutal rule quite accurately.

Tanzania shared a similar story to that of Kenya and Uganda, but less violent. It was ruled during the first part of the twentieth century by the Germans and then the British. It gained independence in 1961 and proceeded to ally itself with China and took a path toward communism and nationalism. The country went through a major period of economic contraction after nationalizing many independent businesses in the 1970s, and it was not until the 1990s that the country began to regain some footing after abandoning the communist/socialist path.

All three countries of East Africa have been courting their former residents, the very same Asians that they either booted out or made life uncomfortable for, hoping to entice them to return and to set up business ventures. Uganda has returned many properties and businesses the prior regimes had illegally confiscated. The Asians are returning, though most have since settled in Britain, Canada, and the United States, and are contributing to the rebirth of the respective economies. It’s not the same, however, and following a recent trip to Mombasa by a family member, I was informed that power outages and food shortages for certain products are not unusual, and there are six families occupying the home I grew up in. Fortunately, the countries have embraced the capitalist path once again, and the future looks brighter today than it did 40 years ago.

Frontier Investing

All three East African countries offer stock exchanges that are friendly to foreign investors as long as the rules and regulations are understood. The Dar es Salaam exchange, in the capital of Tanzania, offers foreigners the opportunity to invest locally but limits foreign-owned share ownership. Foreigners have been investing in the Nairobi Stock Exchange for decades, and some foreign-based companies have maintained local listings for just as long. Uganda’s exchange is relatively new but offers the ability to buy shares through appropriate channels. Be aware though, that each market is very small and price swings and currency volatility will impact returns significantly.

For more information on investing directly in these markets you can use the following links:

• Tanzania: www.tanzaniainvest.com/
• Kenya: www.nse.co.ke/
• Uganda: www.use.or.ug/index.php

There is not a large domestic investing population in any of the exchanges as compared to a developing market simply because the people are, for the most part, poor. There are only two classes in East Africa, the super rich and everyone else. A middle class is forming slowly and education in East Africa is quite good compared with other African countries. Long-standing ties to Britain have helped these countries develop much faster and in a more stable and understandable fashion than others in the region, despite the hiccups brought on by independence.

Each of the countries is looking hard for foreign investment—not only in the form of a stock market purchase but in areas like factories, agriculture, tourism, and infrastructure. It can be hugely profitable for active investors to look to these East African nations as relatively stable and attractive entry points to the continent.

The cost of living in each country, as you can imagine, is quite low. However, it is low for a native lifestyle. If you wish to replicate a lifestyle enjoyed in a place like the United States, it can be as expensive as back home. Land is cheap. Oceanfront property is abundant and also inexpensive depending on location.

The biggest concern is safety. While not as bad as some parts of Africa, safety in major cities like Nairobi can be of concern for foreigners. Corruption is still the rule of the day and around election season bloody violence is not unusual.

East Africa has potential, lots of it. But successful investors must possess a frontier mentality and the ability to hustle like the locals and deal with bloated and corrupt bureaucracies. In this respect, the region is no different from most in Africa, Asia, or South America when it comes to investing.

There are other ways to invest. These ways include exchange-traded funds and, in some cases, country funds. However, most of these funds are not specific to one country, which provides a lot of diversification but will not deliver the types of on-the-ground profits and opportunity that can be had if you’re willing to hop on a plane and do some legwork. English is the official language for business in East Africa and communication is not an issue. The probability of these countries reverting to the types of governments that ruled in the 1970s and 1980s is not great, but political and tribal tensions are an issue and tend to mar many positive developments that are occurring. In terms of where to invest in order of safety, infrastructure, and general business environment, I would rank Kenya and Tanzania ahead of Uganda. Uganda suffered the most and has been the slowest to recover. At the end of the section on Africa, I will offer some more general funds and investment ideas that encompass more than just East Africa.

Fleeting Signs of Success

Will the real South Africa please stand up? No country in Africa comes close to South Africa in terms of having the infrastructure in place needed to succeed. When I first began writing about the country there were two plays that dominated the headlines. First, there was the South African utility company Eskom, which had bonds yielding over 15 percent in the early 1990s, and then there were the resource plays, which have long been the source of great wealth for South Africans lucky enough to own the sector.

In the film Diamonds Are Forever, there was a scene at a South African mine where workers smuggled diamonds out in cavities in their teeth. If caught, workers were not just terminated but also likely suffered physical punishment, as well. It was the 1970s after all, and apartheid was the order of the day. For younger readers not familiar with apartheid, it refers to the legal division of South African society by the ancestors of the colonialist Dutch Boers, on the basis of race. In other words, if you were a black South African, your life was hell.

After suffering decades of embargos, diplomatic pressure, violence, and global ridicule, the ruling National Party began formal negotiations to end apartheid and engage in national elections, open to all races, in 1990. The culmination of these negotiations occurred in 1994 when the African National Congress, under the leadership of the formerly jailed political prisoner Nelson Mandela, assumed power in the country. It’s been less than two decades since that day and South Africa has come a long way in many respects, but it has also failed to deliver on much of its potential in other respects.

As expected, the period immediately after the end of apartheid was a difficult one as the country’s inner core, which was controlled in monopolistic fashion by the white minority had to transition to a new process. Government was now multiracial, businesses had to change their practices, and many people left the country for fear of retribution.

What did not change, though, was the immense opportunity for making money in South Africa. But, the South Africans, unlike the Zimbabweans further north, did not illegally redistribute the property owned by nonblacks. In other words, the transition was smoother, relatively speaking, and this allowed for the former rulers, the minority population, to remain engaged in the commercial community. Still, some vestiges of apartheid still remain, and race relations can be strained and retribution still occurs.

In some cities, like the largest city, Johannesburg, violence is a fact of life. Much of it is not directed at anyone in particular, just a seemingly random daily occurrence in a country where poverty and class division are still the rule and not the exception. The economic freedoms that are more widely enjoyed by all since the demise of apartheid are still, for the most part, tilted toward the white population. While many are seeing an improvement in their circumstances, poverty is still a major challenge with more than 25 percent of the population living on the equivalent of less than $2 per day. Consider that the cost of living for a family of four to live a middle-class lifestyle in a Johannesburg suburb is between $2,000 and $3,000 per month, and you can imagine the tenuous relationship that can develop between those who have and those who don’t. Income distribution is actually getting worse. In 1995, the white population was earning, on average, four times more than the black population. (The per capita average annual income of $10,000 is quite high by African and emerging market standards, however.) Today that number is approaching six times. After the fall of the National Party, a massive exodus took place. That has since reversed and whites are returning to the country.

South Africa relies heavily on its strong resource sector. The country produces 90 percent of the world’s platinum and more than 40 percent of the world’s gold. It’s an export-dependent economy with a healthy trade balance. China is its biggest customer and also the biggest exporter of goods to South Africa, which makes sense as China is basically devouring the natural resources found in most of Africa.

Yet, the money made from most of the country’s commerce finds its way onto the books of a relatively small number of companies, long established in the region. The internal economy is primarily service driven, a strange situation to be sure for an emerging market. It has to do with the fact that South Africa is less of a true emerging market in terms of growth and more like a mature market, as it has been an established commercial country with strong European ties for centuries. Fully 65 percent of the working population can be found in the services sector. That is not a good sign for the country’s growth prospects vis-a-vis places like China and Vietnam where a greater percentage of the population is engaged in the manufacturing sector. South Africa also suffers from a high rate of unemployment. Almost 25 percent of the potential working population is unemployed. Part of the problem is the lack of skilled labor and poor government planning post apartheid.

With a strong resource sector buttressed by strong market prices and demand for commodities, South Africa should be posting growth far greater than the 2 percent-plus in the past couple of years. South Africa is an emerging market in the sense that it has a lot of growth potential and is in a fairly volatile region that is dependent on the agriculture, commodities, and tourism sectors. It lacks internal diversification and that could present a problem going forward.

South Africa is also facing several crises borne of its proximity to countries like Zimbabwe from which people are fleeing in droves after the failed policies of the despotic regime of Robert Mugabe have rendered the country economically unviable. On my desk sits a bank note from my travels, which speaks volumes about the problems in Zimbabwe (see Figure 12.1).

Figure 12.1 Zimbabwe Currency

Hundreds of people are crossing the borders daily resulting in a massive refugee problem for a country already suffering from massive unemployment. Tensions are high and violence is common in a country that is now engaged in xenophobic behavior—something that comes as a bit of a surprise considering its history of overcoming major racial intolerance. South Africa is also facing a major health epidemic. Fully 11 percent of the population, over 5 million people, is infected by the HIV AIDS virus, straining an already poor health care system. The country also continues to suffer from racial disharmony, a holdover from the apartheid days. This is not surprising, but it has lead to perceived unsafe conditions for many visitors and foreign business people. It is not advisable to walk the streets of Johannesburg at night, regardless of the distance, without adequate security. The problem is less acute in the suburbs, but many of my colleagues and friends have said little to dispel the current perceptions.

Investing in South Africa

There are many listed companies of South African origin that are tradable by investors. The country boasts the continent’s largest market and its currency, the rand, is among the most actively traded emerging market currencies. The rand is a volatile currency, but in recent years has endured stability and growth against the U.S. dollar appreciating by more than 90 percent since late 2001. In December 2001, the rand fell to its lowest level against the U.S. dollar, dropping to approximately 14 rand to 1 dollar. The decline was due to two factors. First, there was fear that the land grab in Zimbabwe would spread to South Africa and the events of September 11, 2001, decimated many emerging market currencies. In 2011, the rand had retraced all the way down to the 7 rand to 1 dollar level on the strength of both the South African economy and the weakness in the U.S. dollar on the world stage.

The easiest way to invest in South Africa is through the MSCI South Africa Index Fund (NYSE:EZA), which offers excellent diversification amongst several sectors. It is heavily weighted in resources and financials. Over the past five years the fund has returned an average of more than 11 percent per year aided by a whopping 38 percent return between June 2010 and June 2011, a time when markets like China actually fell in value. One of the main reasons is the country’s heavily weighted resource sector. Table 12.1 lists the top 10 companies in the MSCI South Africa Index Fund.

Table 12.1 Top Monthly Holdings as of 8/31/11

Source: http://us.ishares.com/product_info/fund/overview/EZA.htm.

As I mentioned earlier, South Africa produces an incredible 41 percent of the world’s gold and fully 50 percent of all the gold above ground has come from a South African mine. It’s a sad state of affairs when a nation that dominates in the production of high-end resources such as diamonds, gold, and platinum still has a massive health and poverty crisis. South African companies are doing better at making their employees wealthier through greater ownership in companies, but only because they have little choice in the matter. To make money as a minority, you have to pacify the majority, and that means allowing equity participation, something that was unthinkable 20 years ago.

One of the companies that offers such participation and is a major philanthropic player as well is Sasol (NYSE:SSL) an international integrated energy and chemicals company based in South Africa. The company is a huge conglomerate involved in everything from fuel refining to polymer technology, and it is one of the best run and most profitable local companies. The exchange-traded fund I mentioned above owns shares of Sasol, as well. Earnings and earnings per share increased at double-digit rates in 2011 on the back of a very strong energy market in the early part of the year and an even stronger market for the company’s polymer division, which saw year-over-year growth of over 60 percent.

Sasol’s share price will follow that of oil prices. It gives you strong exposure to the South African economy, the currency, and the energy sector and is a worthy addition to any portfolio at the right price. Over the past five years, that right price has been in the mid $20s to mid $30s.

South Africa also offers a host of gold mining companies for investors looking to the resource sector. The two largest are AngloGold Ashanti (NYSE:AU) and Gold Fields (NYSE:GFI). Both companies are multimillion-ounce gold producers and own mines with significant reserves. Ordinarily, and in the past, companies like AngloGold would have appeared at the top of the list in terms of producers and cost. But the cost of doing business in South Africa is the high cost per ounce of gold, which is well in excess of $600 per ounce—great when gold is trading at $1,800 per ounce or more but not so great compared to its competition, which produces the metal at costs in the mid $400 per ounce range. The only reason I would invest in AngloGold or Gold Fields would be as part of a global resource portfolio. As you can see in Table 12.1, both companies are well represented in the MSCI fund.

The Other South Africa

South Africa is known for many negative things: AIDS, apartheid, and violence in Johannesburg and the surrounding black townships. But, it is a land of immense beauty, as well, and it recently hosted the Soccer World Cup, which was incident free and a huge gold star for the country. It also boasts one of the most beautiful cities on Earth in Cape Town on the tip of the African continent at the Cape of Good Hope. It offers both mountainous terrain and coastal views and is a favorite destination for tourists and expatriates alike. Inland, the country boasts some of the best wildlife viewing on the continent at places like Kruger National Park, which offers the best infrastructure of any African game park and is a perfect place for do-it-yourself safaris.

South Africa is perhaps the country in sub-Saharan Africa with the most potential to succeed. It has excellent infrastructure, massive natural resources, a booming tourism sector, a tradable currency, a multicultural population, and a somewhat transparent government. The question remains whether the country can come to grips with issues like its past and, more urgently, issues surrounding its problems with AIDS and poverty. The country is wealthy enough to match many first-world countries if managed properly. For investors looking to diversify into Africa, South Africa needs to be part of that portfolio.

Guns and Chocolate

West Africa is a mess. Over 50 percent of the population lives on less than $1 per day. Economic growth in the region is less than 2.5 percent, while the population in the region is growing at almost the same rate. That type of population growth requires economic growth of almost triple where it is today. Of the 15-odd countries that make up the region, 9 of them have experienced war or conflict in the past 20 years. Today, five countries—Ivory Coast, Guinea-Bissau, Liberia, Nigeria, and Sierra Leone—are still experiencing conflict. Two of the countries, the Ivory Coast and Nigeria, have strong global economic drivers. Ivory Coast produces 43 percent of the world’s cocoa and Nigeria is the world’s 11th largest oil producer. Both countries are rife with conflict and although both have supremely viable goods for sale, the majority of their populations are poor.

Risky Business

I remember writing about the “Nigerian scam” in the early 1990s, long before it made it to 60 Minutes. It was my introduction to the region and has always left a poor taste in my mouth.

Nigeria has huge amounts of resource wealth, an educated population, and a developed economy. Yet, there are few places on Earth that are more corrupt. The government not only turns a blind eye to the corruption, it virtually sanctions it. There have been dozens of instances of government officials either involved directly in banking schemes or allowing their names and titles to be used in the schemes to bilk foreigners of their savings.

Nigeria’s massive oil wealth and huge agricultural sector have not helped the majority of the population. Nepotism is the rule of the day in the government and a very small segment of the population benefits immensely from the export of oil. Ethnic strife and religious tensions are rife, and personal safety is an issue in the country. But, the biggest problem is the rampant corruption that requires payoffs and bribes to be factored in as costs of living and doing business. Foreign investors can invest in the volatile Nigerian Stock Exchange. But, despite its stellar performance on occasion, the risk here is both loss of capital to volatility and possibly loss of capital to fraud. This combination makes the country a lousy choice for even the most adventurous investor.

The Ivory Coast is a different story. A former French colony, the Ivory Coast was an economic powerhouse (by African standards) in the 1960s and 1970s. In the 1980s economic mismanagement and the collapse of world timber prices led to the country amassing massive foreign debts, which subsequently tanked the economy and the government. Conflicts then arose between rival groups leading to a civil war that has lasted for more than three decades with brief moments of respite. Reasons for fighting ranged from citizenship issues surrounding the elected president to land grabs, corruption, and ethnic rivalries. Whatever the reason, the country is still in the midst of a nascent recovery from the most recent conflict in 2010/2011.

The rest of West Africa is made up of poor countries for the most part, although some do have oil revenues and a couple are actually quite stable. Countries like Mauritania experienced growth approaching 20 percent in the middle of the last decade . . . but the GDP was less than what Warren Buffett and Bill Gates give to charity every year! However, outside of investments in land for agriculture, few opportunities exist in the emerging market investing sense. Difficulty in investing due to illiquid currencies, poor legal protection, and potential for physical harm really make this entire region one to avoid in the short-term and likely also for the foreseeable future.

One-Stop Shop

There is an investment fund that will give you actively managed exposure to Africa through investments in some quality companies. It’s called the Nile Pan Africa Fund (NAFAX), which is available through any brokerage house.

It’s a very small fund, with less than $12 million under management and carries a pretty stiff management fee—around 5 percent. The management fee is not unusual as it is a very specialized fund. As an actively managed fund it can give you better exposure to a volatile region without having to worry about trying to trade in individual markets and setting up several accounts in several countries and using a host of currencies—another reason for the higher fee.

You can find more information about the fund and its manager by visiting the fund’s home page at www.nilefunds.com/NilePanAfricaOverview.html.

Your broker will likely have never heard of the fund, and it’s not going to be what you will hear people talking about at cocktail parties. But, if you want to catch a very early trend with massive potential, you may want to throw some play money at this fund.

Strengths

People power—Africa has more than 1 billion people and while very poor for the most part, the continent is growing in economic power. Natural resources—the Chinese are active investors in Africa looking to exploit the continent’s huge mineral resource base. Tourism—Africa’s national parks are huge foreign-currency-earning powerhouses that have yet to be exploited fully. Regional powerhouses like South Africa and East Africa offer strong opportunities for investors looking for growth that exceeds that of most regions in the world. However, the old saying about “return of capital” as opposed to “return on capital” should dominate any investment decision.

Weaknesses

Ethnic strife is still quite common. Corruption is the rule of the day. Africa is not a country, and it would be a mistake to consider it as a single entity. North Africa is much more developed than any other part of the continent. Lack of transparency, poor legal protections, and weak financial and government institutions are significant barriers for investors.

Opportunities

The resource sector is massively underexploited.

Threats

The lack of confidence in individual governments continent-wide has made long-term investing decisions impossible. In North Africa, the Arab Spring of 2011 continues to sow uncertainty in the minds of investors. In West Africa, conflict and corruption sap confidence. In East Africa, ethnic rivalries could derail government efforts at reform in places like Kenya. South Africa faces massive issues with crime and corruption. These are all threats that can be overcome with government policies that do not favor a very small segment of the population—a problem that has not abated despite the intense violence and even genocide in several countries. Investing in Africa is not for the faint of heart, but if timed well, the returns can outpace those of any other region in the world.