International Development Committee - The Development Situation in Malawi Written evidence submitted by CDC

Introduction

1. The International Development Select Committee has asked CDC to submit a memorandum in respect of its inquiries into Zambia and Malawi and what CDC is doing in these countries. The Committee has also requested an update on what CDC’s forthcoming business strategy will mean for its investment programme in Africa.

2. This submission will start with an update on the forthcoming business strategy as this will give important insight and context to what we are planning to do across African economies including Zambia and Malawi. The submission will then address our existing work in the two countries.

The Forthcoming Five Year CDC Business Strategy and its Implications for CDC Investment in Africa

Context

3. CDC’s forthcoming strategy confirms and builds on the previously radically changed high level business plan produced in the summer of 2011. The strategy will lay the foundations for a distinctive, effective DFI with a greater appetite for risk and a sharply focused development mission, as agreed with the Secretary of State for International Development (the Shareholder).

4. The new strategy means we will tighten the geographies where we invest—our investments will now focus on Africa and South Asia and within these regions CDC will direct capital to target investments that are consistent with our mission to have high development impact and take greater risk, yet still achieve a return.

5. Three fundamental criteria will guide our investments in Africa:

building businesses and creating jobs;

directing capital to hard places; and

we will maintain a commercial approach to investing as no impact is achieved if businesses are not economically viable.

Taken together these criteria will ensure that our capital is invested in hard places doing hard things.

An overview of our new investment approach in Africa

6. The strategy also means we now have more ways of getting our capital to work beyond the fund-of-funds model. The three primary means at our disposal enable CDC to meet more of the needs of capital-deficient countries in Africa for different forms of patient investment. They are:

Fund investing—This will still be an important part of the strategy;

Debt—The direct provision of loan finance (in all forms) to businesses; and

Direct Equity Investing—CDC has a long heritage of investing directly in businesses, financial institutions and infrastructure and is returning to what is now a wholly new business area for us.

7. In addition to shifting its investment portfolio towards harder geographies, more developmental sectors and new ways of investing we will give greater focus to understanding and demonstrating our development impact.

8. The following section will give the Committee a guide to what we expect to deliver through the three primary means of investing.

Fund Investing—what the strategy means for investing in businesses in Africa through private equity funds

9. Currently, the risk capital market across Africa is currently about 1/5th the size of the market in London and S.E. England, but excluding South Africa and Egypt this figure falls by 80%. The market remains nascent despite the number of fund managers growing significantly in Africa in the last five years, from a small base to around 150. CDC’s capital represents about 13% of total raised by risk capital funds, making CDC an important player in this market. Fundraising remains difficult with DFIs like CDC still continuing to provide much of the capital for investment. CDC’s role in backing first-time investment teams has been and remains vital because most investors prefer only to support tried and tested teams.

10. Fund investing will continue to play an important role for CDC in developing Africa’s private equity markets but we will reorient our approach to match CDC’s development mission. We will be explicit about what we want to achieve with our capital: business building, creating jobs (directly or through vital infrastructure) and investment in harder places. We aim to commit over US$1bn in Africa over the next five years through risk capital funds.

11. Specifically, our new strategy will mean:

we’ll look at funds that help job creation in Africa, both directly by helping businesses grow and indirectly, by creating and improving the essential infrastructure which encourages the environment for job creation;

we want to have greater impact in funds backing infrastructure and SMEs, but also in access to finance and agribusiness;

we want to support funds that will get capital into fragile states. For example, we were the anchor investor in the first fund to invest in Ethiopia and we are currently looking closely at proposals to do more in Sierra Leone and Liberia;

we will also look at funds which invest in businesses likely to be able to scale-up at a regional level. This scaling-up will mean that businesses expand into neighbouring countries that would otherwise not be a direct target for fund managers;

we will maintain a balance of diversified strategies across pan-African, sector-focused, regional and SME funds;

a continued focus on developing the private equity sector, especially through supporting the creation of new funds. We would expect to commit similar amounts to new relationships and to existing relationships over the next five years, with on average around US$100m p.a. committed to each category; and

an increased risk profile which may lead to the risk of lower/negative returns. While we accept this risk, we will continue our investment discipline of only backing teams with the potential to deliver positive net financial returns, in order to protect taxpayer’s money.

12. This approach will ensure that CDC’s reach through our fund managers is significantly enhanced towards the harder countries in Africa. A number of our fund managers have demonstrated their ability to direct our funds to those target markets, and we will actively seek to extend our network via new, promising teams, aligned with our new and clear strategic direction.

Debt Investing—what the strategy means for CDC’s provision of loan finance

13. CDC’s current debt portfolio is the product of our 2004–11 funds based approach and is focused outside CDC’s current priority geographies. CDC has a very small share of the DFI/IFI debt market in Africa. Following the financial crisis, international commercial banks have reduced their exposure to Africa and CDC has identified an opportunity to help plug this gap. We are now building a team at CDC to execute the strategy and to deliver development impact and financial returns, particularly in economies where the need for debt capital, especially long-term debt, is very acute.

14. Our forthcoming strategy will mean CDC:

Looks to invest a range of ways, including debt funds, co-financing with other DFIs, risk sharing with selected international commercial banks and in direct loans to African financial institutions.

Builds a broad debt portfolio including infrastructure and corporate loans, credit lines to financial institutions and selective trade finance facilities focused on the more challenging parts of Africa.

Continues to invest in microfinance through microfinance private equity funds, microfinance holding companies, microfinance debt funds and direct investments in microfinance institutions.

Direct Investment—what the strategy means for CDC’s plans to provide direct equity in Africa

15. CDC has a long heritage of investing directly in businesses and infrastructure but in recent years has moved away from direct investing. We now want to re-connect CDC to the best of its heritage by returning to what is now a wholly new business area for us. Building a new direct equity investment portfolio means we can carefully target businesses with the best possible development impact. However, the process will take time and the recruitment of new staff and skills into our business.

16. The strategy will involve two approaches to direct investing which build on CDC’s advantages—the ability to provide patient, long term capital and, if necessary take majority stakes in businesses—but also reflects the reality that CDC is no longer an organisation with hundreds of employees located across Africa. In the first instance, through Co-Investment alongside partner organisations. The second, which is likely to come into effect later in the five year plan, will be what we call Corporate Pioneering, where we provide substantial, direct, long-term investment in businesses that we have chosen because of their potential for large-scale growth, high calibre management teams and development impact across poorer economies.

17. The Co-Investment approach will mean CDC:

Invests in businesses alongside private equity funds and other DFIs. This will allow us to build on our existing, strong relationships and to use the expertise, resources and local staff of our partners.

Supports businesses that are creating jobs and building infrastructure in Africa, prioritising the most developmental investments in smaller/more challenging countries.

Will be able to start investing quickly with investments of between US10 million and US$50 million for general businesses and between US$20 million and US$100 million for infrastructure projects.

18. The Corporate Pioneering approach, which will take between one and two years to begin, will mean that CDC:

Builds a small number (circa one per annum) of businesses, ramping up to become major investments over time ($50–200 million). These businesses will expand into new markets and countries, providing jobs and opportunities in some of the most challenging economies in Africa.

Develops high-calibre local management to achieve lasting development impact.

Invests over very long (10 years+) periods where, in some cases, returns can be very uncertain.

CDC in Zambia

19. We recognise that Zambia has made some good economic progress in the last decade and is now a lower middle income country. Rising foreign investment and good macro-economic policies have helped deliver improved prosperity but significant challenges remain for businesses and for investors. While considerable investment has gone into mining, the country now needs to take steps to encourage private sector growth in areas other than copper alone.

20. CDC currently has eight investments through funds in Zambia totalling approximately £5.2 million. This compares to FMO (the Dutch DFI) EUR55k investment in the country, DEG’s (Germany) at around £8 million and no current investment in the country by Swedfund. CDC’s investments include businesses in financial services, agribusiness, mining and real estate. Our biggest investment is in Golden Lay, the largest table egg producer in Zambia’s copper belt, accounting for 15% of the total Zambian market. However, under our new investment strategy we are now able to pursue direct investment opportunities and we are currently undertaking due diligence on an proposal that would far outweigh CDC’s current level of investment in the country.

20. CDC’s investments in Zambia represent just under 0.8% of our total Africa portfolio. Zambia’s large geographical size, relatively small population and lack of regional integration has meant that there have been few good opportunities to invest for the fund managers with whom we commit capital. We now see this changing as some of the new partners with whom we have recently invested are now targeting opportunities, particularly agribusiness, in the country.

21. CDC currently has only one fund manager, Aureos, with a physical presence in Zambia but we have worked closely with another SME fund manager, GroFin, to encourage and support them to set up an office in the country. Grofin’s decision to do so will mean the flow of capital to promising SMEs in the country is likely to increase.

CDC in Malawi

22. Malawi faces far more significant economic and development challenges than Zambia, with the last 18 months in particular seeing a very worrying trade deficit and falling foreign exchange levels. There are significant challenges to growth, not least the poor infrastructure and over-reliance on agriculture. Investment opportunities are few and far between and given the relatively undeveloped nature of the economy, CDC sees the more likely immediate investment opportunities to be in loan finance, to which our new strategy is returning, although there is an appetite to fund a small, pioneering private equity fund to stimulate the very nascent entrepreneurial if we could find a credible and talented local team to support.

23. CDC currently has two investments in Malawi, both made through funds, worth around £0.75 million. These are a stake in Celtel Malawi and a more recent investment (early 2012) in NBS Bank, Malawi’s third largest bank in terms of loans and deposits. This latter investment was designed to support its capital base and help it increase lending to small and medium enterprises, including those in the agriculture sector.

24. Diana Noble, the CDC Chief Executive is travelling with the Secretary of State for International Development to Malawi at end of May for a fact-finding mission and will be meeting President Banda. Given that the Committee has asked the Chief Executive to speak at an evidence session on 13 June, this may present the Committee with an opportunity to hear more from her about the opportunities and challenges for investing in Malawi.

23 May 2012

Prepared 23rd July 2012