Foreign VC Will Dominate Nigeria for a While: Here's Why

[Editor’s Note: A few weeks ago, Chinaza ‘Naz’ Onuzo posted a series of tweets in which he suggested that local investors were likely to miss the local tech opportunity because they couldn’t grasp how fundamentally different it was from what they were used to. We reached out to him to write an article explaining his position and finally got it a few days ago. It couldn’t have come at a better time considering the content of the first Techcabal Sessions. Enjoy]

The World That Was

Here's an Investment for You — Here’s an Investment for You

These are the financial projections of a typical target for Nigerian private equity.

$ ‘000	2013	2014	2015	2016	2017
Revenue	1,000	1,200	1,440	1,728	2,074
Growth		20%	20%	20%	20%
EBITDA	400	480	576	691	829
Margin	40%	40%	40%	40%	40%
PAT	200	240	288	346	415
Margin	20%	20%	20%	20%	20%

Looks boring right? 20% growth year-on-year. Doubles revenue over five years. Probably sells soap, or plastics or fruit juice. Looking for an investment to build a new plant, or expand a line or something. You tech types may not love it, might even swan dive off a molue to avoid working in a business like this, but businesses like these are what many a “model and bottle” dream is made of. I call this company a 20/20 – a company that grows at 20% per annum and has profit margins of 20%. If you find a potential 20/20, you’ll do the deal on a damn napkin. The reason why you will do this deal on a napkin is because it’s a typical 3×5. A 3×5 is the gold standard of private equity deals in Nigeria. A 3×5 as the name implies gives you 3x your investment over a 5 year period. You do enough of these and your model and bottle dreams will become a reality. Bye Bye danfo, hello Nana.

So when you find a 20/20, the valuation is also pretty straight forward. You are going to paying somewhere in the region of 4x EBITDA. EBITDA is very bad short hand for the amount of cash that a business generates in a year. So when you say that you are paying 4x EBITDA you are effectively paying for 4 years of the business cash flow. 4x EBITDA is typical for a 20/20 business and the valuation table below shows why:

2013 Valuation
EBITDA Multiple	4x
Company Value ($ ‘000)	4,000
2017 Valuation
EBITDA Multiple	6x
Company Value ($ ‘000)	12,442

TMB	3.11 x

If you pay significantly more than 4x EBITDA, you aren’t going to make your 3x money in 5 years and the model breaks down. Technically you could pay more than 4x EBITDA, but then you’d have to lever up your investment with debt. So your overall investment will make less than 3x; your equity investment makes 3x. This bit is the extra credit portion to spare me from all the people who will read this and say “but… but…”

The World That Is

Times are changing. The staid 20/20’s have been replaced by the sexy hockey sticks. A hockey stick is a company whose growth trajectory looks like this:

$ ‘000	2013	2014	2015	2016	2017
Revenue	1,000	1,750	3,063	5,359	9,379
Growth		75%	75%	75%	75%
EBITDA	200	350	613	1,072	1,876
Margin	20%	20%	20%	20%	20%
PAT	100	175	306	536	938
Margin	10%	10%	10%	10%	10%

This company expects to increase revenue nine-fold in five years. Compare that to the 20/20 that plans to double revenue in the same time frame. Now imagine that you are a private equity gal that is used to searching for 20/20 deals and then a hockey stick walks in the door. What are you going to do? First of all you are going to offer your standard 4x EBITDA. You are going to tell the entrepreneurs that their projections are very very high, that 75% revenue growth per annum is pie in the sky etc and that they should accept your valuation of 4x EBITDA because it adequately reflects the risks in the transaction. However the hockey stick entrepreneur not only believes the projections, she also has a financial adviser. Her adviser will tell her that if she agrees to this 4x EBITDA, this is the return she is giving to the private equity gal.

2013 Valuation
EBITDA Multiple	4x
Company Value ($ ‘000)	800

2017 Valuation
EBITDA Multiple	10x
Company Value ($ ‘000)	18,758

TMB	23.45 x

So the entrepreneur is unlikely to be willing the private equity gal a 23.5x return, and the private equity gal isn’t going to be willing to pay more than 4.0x EBITDA, so therefore:

NO DEAL!

After the hockey stick entrepreneur has stormed of private equity gal’s office, the adviser remembers that he has a friend from business school who is living the dream as a late stage VC. The Adviser shoots his fried a teaser about hockey stick. The friend goes all googley-eyed when he sees the early stage of a billion dollar business in a country with a large consumer market. Venture capital investor shoots off a term sheet to hockey stick entrepreneur. The Adviser reviews the term sheet and shows the hockey stick entrepreneur the type of return this deal implies:

2013 Valuation
EBITDA Multiple	20x
Company Value ($ ‘000)	4,000

2017 Valuation
EBITDA Multiple	10x
Company Value ($ ‘000)	18,758

TMB	4.69 x

After the hockey stick entrepreneur stops dancing in delight, they send their one-word answer back to the Venture Capital investor:

DEAL!

The World That Will Be

This state of affairs is not going to change for the foreseeable future. The private equity girl will not be able to do tech deals because the valuations are completely outside her understanding. She knows too much about Nigeria to accept the risk implied in these valuations. Some of these deals will make mega money – there should be a few $500 million – $1 billion companies made off the back of the various raises being done in the market right now. As a result Private Equity Girl will no longer be the only local investor in town. Springing fully formed like Athena from the head of Zeus, Nigerian Venture Capital Girl will arise. Unlike Private Equity Girl, she will be tasked specifically to invest in these hockey stick opportunities. Her Chi will be strong and she will do many deals in the market. Until then tech folk, be nice to your foreign investors, they are likely to be the only ones you’ll get for a while.