Ludovic Phalippou: Hello, welcome to Private Equity Laid Bare podcast. Today, I have Joe with me from CDC, I believe a South African office, and we are going to talk about private debt, yet another private debt podcast, but this time focusing on Africa. So in previous podcasts we talked about American private debt, European private debt, and Asian private debt, and now we are looking at Africa. And in fact, Joe, it seems to me that when Africa private equity started really in the '40s with CDC and, a bit later, IFC, it started with private debt, not really private equity. A lot of investments in Africa private markets was private debt. And so did it then go away and then coming back now? What's the landscape. Joseph Mate: Ludo, thanks. Thanks for having me, firstly, and I think you are right, I think a lot of the initial investments within that space reflected convertible instruments, which had a feature both of equity and of debt. And then obviously more recently the development of private equity has been well documented, but in terms of the landscape as it currently sits, if we take a step back, what CDC had done just under two years ago was do a mapping exercise and try to evaluate the current landscape of private credit, private debt on the continent. And some of the key features, I'm happy to unpack on this podcast, but obviously the market has shifted significantly. It is quite nascent, still very early stage, and at the moment dominated by mezzanine funds, which are providing more bespoke, more tailored risk capital with debt features and some equity upside instruments as well. Ludovic Phalippou: So then these mezzanine fund are offering instruments like the ones it was in the '40s, '50s, '60s in CDC and others, and IFC, and the like, right? Joseph Mate: So these mez funds are typically, correct, so they're providing instruments that have features of debt, so they would typically have a coupon, typically have downside protections, and also have the flexibility to provide some level of upside in their funding. But I think the key feature is these are focused on the mid-market space more broadly, which is quite different perhaps from the development mindset of, as you mentioned, the '40s and '50s, which was looking to provide risk capital across the spectrum of opportunity. So beyond just corporates, there was obviously thinking around infrastructure funding, reflective of an underdeveloped capital market at that time. But then those funds that we look at, and that we're working with, and that we captured in that market mapping exercise, I think it's fair to say, are focused on mid-market corporates, and that's an important distinction. Ludovic Phalippou: And so you're saying this is quite new. And so there is no things like [unitranche 00:03:59] vehicles? The private debt in Europe and in the US is very much this unitranche lending. So you don't have that in Africa, it's only mezzanine. So the senior debt is still provided by banks, I guess. Joseph Mate: Yes, that's correct. I think, as I mentioned, the market is still nascent, still new, but is evolving. So my background's mostly been in banking on the continent, and when I joined CDC late last year, looking to focus on private credit funds and developing the asset class. Ludovic Phalippou: Sorry, when you say on continent, which continent? Joseph Mate: Sorry, Africa. Ludovic Phalippou: Okay. Joseph Mate: Right, so when I joined CDC late last year, certainly my sense was I was quite surprised by how quickly the opportunities had, in terms of senior credit strategies or proposals, evolved. So the initial portfolio construction is dominated by mez funds, but over the last eight months, we've seen a lot of opportunities in the senior credit space in the high yield senior opportunities. Ludovic Phalippou: So it is converging to a European model or American model of basically offering unitranche very quickly. Joseph Mate: I think it is evolving, and there's a few drivers for that, and I think that's where we want to see the market go because, as you would imagine, it means that there's more opportunities for capital in the mid-market space, it's got the best chance of scaling. And so the hope really is that Africa is able to evolve in that direction, but perhaps more quickly because of the need, because of some key drivers, because of the need to get capital into the corporate space. Ludovic Phalippou: Maybe that's a side question, but why is it CDC is going via funds? You say I'm reviewing these funds to invest in mezzanine and so on. It's especially striking me because CDC started, again, in the mid '40s by direct lending to companies in Africa, they hired you out of a bank, and yet they go via the fund and paying an extra fee in order to land into companies in Africa. You have a pretty good coverage of Africa, why do you have to go via intermediaries and leave money on the table rather than just you directly lending money? Joseph Mate: So I don't think it's a question of either/or, I think the idea really is to assess the opportunity, so to the extent that the CDC has a presence in a specific geography and has access to those markets, the CDC can either invest or lend directly, but the idea is to compliment that footprint and that ability with an intermediary model. And in that instance, then work with strong fund managers that have the origination capability, strong structuring capability, and then work with them and provide [inaudible 00:07:15] to those markets using those intermediaries. So it's very much a complimentary strategy. The idea really is to get the right type of capital into the markets that need it the most, either directly or via the intermediary model. Ludovic Phalippou: But if you move towards more senior lending, it's usually seen as a bit safer and easier, so maybe you can do more direct there maybe, no? Joseph Mate: Well yes, you could do more direct lending in the senior space, but I think the important element is financial additionality. So to the extent that the banks are able to do it or indeed some of existing structures within an ecosystem are able to provide that senior capital, I think it's fine for them to do that. I think what CDC and other DFIs would want to play a significant role is where there is a dislocation, and we are then able to provide some level of financial additionality. Ludovic Phalippou: So what is the main dislocation then in Africa banking? Why aren't the banks in Africa lending to viable businesses? It's always hard for an economist to understand that, so if you can get a normal interest rate at a normal risk level, why don't you do it as a bank? So what's the problem? Joseph Mate: Well, several reasons. I think from an African perspective, one of the factors is ... Sorry, Ludo. Can you still hear me? Ludovic Phalippou: Yes, sorry. Joseph Mate: Okay. One of the factors has been a focus on asset-based lending as opposed to cashflow lending. So that limits the ability to get risk capital or flexible financing into corporates or SMEs. And that's driven by several factors, again, underdeveloped capital market, banks are highly regulated, so they have specific capital constraints. And so by their very nature, they then become certainly more conservative in their approach. And I think that's been exacerbated in the current environment where the risk view has just been heightened and banks are perhaps then looking to back names that they are comfortable with or that they know well as opposed to funding new growth opportunities. And that dislocation is where we see an opportunity, particularly for private credit to play a meaningful role. And that's one of the reasons we're very keen to develop that asset. Ludovic Phalippou: But it does mean you're taking extra risk because you're backing names that are less proven and more frontier, so you are taking extra risk. So are you compensated properly for this extra risk or you think it was not that much riskier, just banks are being silly? Joseph Mate: Well, I think what you'll find with a lot of the managers that were looking to work with is ... Well, there's two elements. One, they are strong technically and they have great relationships. And the idea really is that these fund managers are looking to fund corporates that are bankable names, but perhaps they're not on the bank's radar in terms of relationship names that they want to bank, or perhaps they're looking for funding that is perhaps more bespoke and more structured, particularly to achieve the growth that they need. And the banks just simply aren't fair in terms of their [inaudible 00:10:43], particularly African banks where, as I mentioned, it's more asset-based funding. So for example, if they want to have a fixed asset worth $5, which is quite different from a cashflow view, which then looks to see what's the cash generative ability of that business. Ludovic Phalippou: Where do you think this comes from? Why would English banks been pretty comfortable with cashflow lending, whereas you're saying banks in Africa, I mean I'm conscious Africa is very big and diverse, but are more asset-based. What is it they don't see or why is that? Joseph Mate: Ludo, I think it's really just I think the market is shifting and is continuing to evolve, but I think the reality is it is still developing and relative to some of the more developed markets. And you're right, I mean Africa, it's not fair to paint it with one brush. There are most sophisticated markets within the African landscape, South Africa being one, and a few other markets where banks are able to take a cashflow view, a more nuanced view, and provide the bespoke funding. But I think more generally, particularly for the risk capital where the other credit funds are able to play. I think one of the challenges they face is, as I mentioned, capital constraints. And in an environment like we are in at the moment, it's almost a natural reaction to be risk off and take a view of let's see how this plays out. Joseph Mate: And so I think it's less about an ability or [inaudible 00:12:27], I think it's certainly the reality of banks is they are highly regulated, they manage depositors money, they have to be careful with how they fund. And in an environment like we're in now, it's expected that they would perhaps lean towards larger corporates or businesses that they're more familiar with. But the reality is in this environment, this is when the capital needs to be funded. The SMEs and the mid-market corporates actually need this growth capital. And that financial additionality is where we see an opportunity particularly for this asset fund. Ludovic Phalippou: The diversity of Africa is something that strikes me, and I always have difficulties understanding that because you're sitting in South Africa and, like you said, the banks have more of a cashflow lending view, et cetera. And when we are talking about debt provision in Africa, but I mean you would have Angola, Gabon, Mauritania, Sudan, they are so far away from South Africa, both in distance, both in economic context, how is it possible for CDC, even if they have an office in South Africa, to be exposed to these sorts of countries? Joseph Mate: Well, I mean there are several ways of achieving that, Ludo. I think, as you mentioned, one is the intermediary model, the other is a direct model. And I think it's fair to say the CDC continues to look at these markets, and explore ways to access those markets more directly and in an effective manner. Obviously very challenging in the current environment with limited travel, but I think it's fair to say, we've got strong region offices in east Africa, west Africa, and in South Africa, as well as in Egypt, more recently we opened an office there. And we haven't had any challenges in reaching markets, or challenging markets, or frontier markets in Africa and in south Asia, because of our ability to operate in those markets and the relationships that we have. You have to remember, Ludo, CDC is over 70 years old of supporting businesses in Africa and south Asia. Ludovic Phalippou: Yeah, I know. Joseph Mate: [crosstalk 00:14:56] so very experienced in impact investors. I don't think there's necessarily a challenge in reaching the markets and the opportunities given our experience and given our continuing growing presence in these markets. Ludovic Phalippou: It's funny you mentioned Egypt, it came up also on recent forecast. I think Egypt seems to be the latest hot country in private equity out there. So you mentioned that the opportunities for mezzanine lending and senior lending, there is dislocation, so there is a way to get decent returns lending to all these companies in a continent that is underserved by banks generally. The problem is that this money needs to come from somewhere, I mean DFIs provide money, but outside of DFIs, the usual suspects would be the patient funds, [inaudible 00:15:54] funds, et cetera. And when it comes to Africa, it seems that most patient funds who are sitting in the Netherlands, or US, Canada, are a bit nervous about sending and committing money to Africa, same for [inaudible 00:16:11] funds. Is that something you're observing or is that changing? It seems that people got burned a bit in the late 2000s in Africa and are a bit reluctant to go back there. Or is that something that is now very much changing? Joseph Mate: I'm glad you brought that up, Ludo, and I think that's a key strategic objective for our team and for CDC. I think that in our minds, the growth of private credit, the DFIs will always play a critical anchor and catalytic role, but ultimately in order for this asset class to scale, and to actually get the right forms of capital into these markets and into the corporates that need the capital, it's important that we're able to mobilize commercial investors into this asset class. And I think what we're trying to position private credit is for investors looking to diversify and increasingly those that are taking a risk-adjusted view on opportunities, it is an interesting and a compelling case for the reasons I stated, downside protection, strong business, strong managers that are able to structure market comparable returns. Joseph Mate: And indeed, so ultimately what we're trying to do is position this asset class to, as you mentioned, institutional investors more broadly, particularly ones that are focused on emerging markets. But I think the way we see this evolving is if we're able to mobilize this capital, if we're able to show that this is an interesting asset class and it performs well, ultimately the African institutional investors will start to look at this asset class and deploy their capital into that space. And suddenly what you then have is a lot more innovation, you suddenly have opportunities to get local currency funds raised, and you suddenly have regional funds that are able to get local currency at a longer channel, which is still quite new outside of, again, the more developed ecosystems in Africa. Joseph Mate: And so ultimately that's really where we're heading, it's in positioning an asset class that it's anchored by DFIs but has a compelling story for those that are able to take a risk-adjusted return view because, at the moment, it's still very nascent. And I think, as you rightly pointed out, typically investors looking at Africa take an absolute view and have high return expectations. But I think for private credit, there is an opportunity to enter into an interesting asset class that can provide solid returns for a decent amount of risk in markets that are growing and that are beginning to get exciting, even in this current environment. Ludovic Phalippou: Let's put a number, to be concrete. So how much money was raised by Africa private debt, from the whole of Africa, in a given year recently? What kind of numbers are we talking about? Joseph Mate: So I mean more recently, some of the stats that we have, just north of $300 million was raised in 2018, which was the recent number that we have for private credit in the African space, which relative to emerging markets more broadly, and obviously if you compare to Europe and the US is small, and again reflective of the nascent nature of the asset class. But I think it's ... Sorry, go ahead, Ludo. Ludovic Phalippou: No, I just wanted to put it in context for people to visualize that, when you say it's small, it really is small. $300 million is basically the average equity check in an LBO in the US or Europe. It's a single deal. That's the kind of money that will be deployed on one deal in the US or Europe in a product equity transaction. And that amount, this $300 million, is what has been raised from the whole of African continent, which again is pretty big, for private debt. So when we are talking about small and nascent, we are really talking small and nascent. Joseph Mate: That's true, but a lot's happened in the time since. I mean, I can't mention names, but already the fundraising activity for 2021 is making us quite excited at the opportunity set. I think we'll be announcing a few funds over the next coming weeks and months that easily surpass that figure. And there's a couple of drivers that I've already alluded to, increasingly institutional investors looking at this asset class, the need for credit and funding into the mid-market space, the market dislocation, again, driving some of that activity. So 2018, as recent as that sounds, a lot's happened in the time since. And it's fair to say a lot of it's been driven by our current economic situation and the need to address the market dislocation. And of course, CDC and its partner DFIs have been a big part of that movement, a big part of that drive. And ultimately, I think to continue that trajectory and indeed to accelerate it to an extent, it will be important to get commercial capital into this asset class to help develop it. Ludovic Phalippou: And we've talked about the need of getting more commercial people involved, like the patient funds in Europe, America. For a lot of these players, the idea that you're going to lend money to a company based in Angola or Zambia is pretty wild. You're going to make a loan to a company we are not sure how does accounting standard works? How do we check the numbers? Can we be sure that we would be repaid? What kind of recourse do we have if they don't repay? People are a bit nervous about the institutions in these countries and how much trust they can put. Do you have any comments on that? Is it exaggerated? What's the situation? Joseph Mate: Well, there's real risk and there's the perceived risk of investing on the continent in Africa, and ultimately to get that capital flow into these markets, one has to bridge that gap between the real risk and the perceived risk. And a lot of that is going to involve educating these investors about an African continent and the opportunity set. And you're absolutely right, I think for a lot of the institutions outside of Africa, the continent can be nebulous, it can be a bit out there, but ultimately the idea is if you can look at some of the DFIs providing, and anchoring these opportunities, and committing capital into these market, some of them which are quite difficult, the hope is that the commercial investors will start to see this opportunity and will get some comfort from investing alongside the likes of CDC in these markets, firstly. But I think you're absolutely right, I think there is an education that has to be had. There is almost a handholding exercise that needs to take place. And ultimately, to develop any new asset class, that has to happen. Joseph Mate: Whether it's in Africa or even in a more developed market, ultimately when you're offering something new to an investor, there is going to be an education process that takes place. And I think Africa suffers from that perceived risk, but ultimately what we're hoping is, and I think we've done a lot to try and achieve that, and certainly as the world shifts its focus into impact investing, I think, again, that gap is being bridged significantly because of that new focus and the availability of information. A lot of these markets, as much as they appear frontier, have evolved significantly in the last 10, 15 years. You mentioned accounting standards, you mentioned legal ecosystems. The world is a much smaller place than it was decades back, and I think because of that availability of information, because of the roles that DFIs can play in showing the commercial investors where the opportunities are and how to invest, I think we should be able to start to bridge that gap between the real risk of investing in Africa and the perceived risk. Ludovic Phalippou: So you're saying the institutions are now sorted, it's just a matter of education. People still think Africa is still in the 1990s and it has evolved a lot, and so it's just a matter of education. Joseph Mate: Well, I think that's an important element. I mean the risk is there. There's no two ways about it, some markets slightly more frontier than others, but ultimately I think the opportunity remains for an institution or an investor looking to generate solid returns to do so on the African continent, I think it's [inaudible 00:26:13]. Ludovic Phalippou: And maybe to finish on CDC, all the DFIs have an impacting role. You mentioned impact just earlier. When it comes to direct lending, the impact is obviously very direct, you give directly money to businesses. So are there some industries where you do not invest? Are there are some criteria? Do you use criteria like additionality, which you mentioned earlier? There were some controversies about IFC when they came to Africa, they backed things like Domino pizza in South Africa and some luxury hotels in other places, and that was controversial because I would certainly call junk food a negative impact investment, and luxury hotel is probably not really an additional investment. So how do you look at these things of additionality, impact? Do you choose certain sector? Do you exclude certain companies? Do you impose certain rules on them, et cetera? Joseph Mate: I think it's fair to say that impact is at the heart of what CDC does and it is the important element in every investment, either directly or via intermediaries. And I think particularly for the intermediary model, particularly for private credit funds, I think where CDC is beginning to add a lot of value and showing a lot of value is in helping the newer funds, and indeed even the more established ones, achieve best in class standards from an environmental, and social, and indeed governance perspective. And really starting to work with these fund managers and showing them that ultimately being best in class in this space not only mitigates your risk at a portfolio or a fund level, but actually has commercial benefits. It improves your valuations, it opens your business and your fund to increased pools of capital. Joseph Mate: And ultimately, I think that's the value we show, and we're seeing that not only DFIs, Ludo, but even commercial investors are really starting to apply their minds on impact, but also really just a lot of these themes, like environmental social standards, like governance standard. And indeed at the moment, climate is such a topical issue, and we're seeing commercial investors and DFIs actually helping a lot of fund managers and direct investee companies think through how they can start to work towards a climate policy and a roadmap towards adherence to the Paris Accord. So I think that's where we certainly are continuing to add value. And like I mentioned, I think impact is at the core of what we're looking to do, and these things will continue to be important, especially now as we look to work our way out of this COVID environment. Ludovic Phalippou: Maybe a last one, and sorry if it's a bit on the spot, but do you have any example of a loan that you've refused because of ESG issues or some direct private credit fund that you refused to invest into because of ESG issues? Any examples like that of what that means concretely? Joseph Mate: Sure. I mean I think what I can say is, certainly based on our responsible investment principles, more recently we've got a fund that we're looking to invest in, we have excused rights to not have our capital invested in downstream oil and gas, and so that's based on our existing fossil fuel policy. But I think beyond just CDC, LPs, potential LPs, commercial investors, and DFIs are increasingly thinking through how they're aware that capital will be deployed even via intermediaries. And so I think what we're going to see is a trend towards not just exclusion rights but even at a fund level, where LPs require that fund managers think through climate policy and where the funding can be deployed, so excluding themselves from certain sectors that aren't quite aligned with the prevailing thinking around climate. So I can't obviously name any names, but certainly that's one way we try to reflect our thinking, and our climate policy, and our fossil fuels policy in how we've deployed our capital via an intermediary. Ludovic Phalippou: Fantastic. Thank you so much, Joe, for taking the time today and walking us through the private debt in Africa. It's a nascent asset class, but it's growing extremely fast, so it was absolutely awesome that we could catch it with you at the beginning of this journey. So this was private debt in Africa laid bare. Don't forget to subscribe and to rate it if you liked it. Congratulations on your acquisition of one more piece of knowledge. Ludovic Phalippou: (silence).