Mindspeak- Karim Sadek Citadel Capital

A couple of weeks back, I had the chance to go for Mindspeak , Aly-khan Satchu's business club in Nairobi. The speaker was Karim Sadek, CEO of the Largest private equity fund in Africa, Citadel Capital.

Established in 2004, Citadel has 17  opportunity- specific funds with $9.5 billion under management, with around $800 Million being the partners' assets. It has since returned $2.3 billion in cash to its investors.

What struck me the most about Citadel's approach is its rather common sense approach towards investing in Africa. Karim spoke of Citadel's concentration in investments in 'bottom-of-the-pyramid' sectors. He contends that performance here is more consistent in comparison to higher-end markets. He brought up the example of the Egyptian Real Estate market which had for aeons been controlled by politically correct individuals and depended on a luxury offering. Its fortunes had adversely changed post the 2011 revolution bringing it to virtual collapse. He coyly made comparisons with the current real estate boom in Kenya and clearly stated that Citadel would not invest in Kenya's real estate market. That should be food for thought for anyone trying to invest in the real estate market in Kenya.

He also spoke of their bias towards energy-centric investments in Africa. He believes that the cost of energy will increase over time due to higher extraction cost. He talked of Egypt's over-reliance in energy subsidies where a litre of Diesel  retails at $15 cts. This has structurally messed the economy and its impact once dropped will fundamentally change Egypt's competitive edge. To this end, Citadel brought together a consortium to finance the Egyptian Refinery company (ERC) which will supply a bulk of Diesel in Egypt. It is the single largest FDI post the Egyptian revolution.

He also talked of Citadel not having a pre-determined exit strategy for any investment. He fell short of saying that they would hold an investment for an infinite time period but made it clear their investments are not short term in nature.

He commented on the interest garnered by Africa in the west which he welcomed but was quick to add that it hadn't translated into cheques!

Karim spoke quite plainly about the challenges they had face so far in investing in the region. Especially  with their flagship investment in  Rift Valley Railways ( RVR). He talked about the nature of Publi-Private Patrnerships (which RVR is) and the irrational expectations that governments have on concessionaires. Generally speaking, structuring a concession agreement is tough especially because Government's (justifiably so) on Private equity firms as vulture investors. The only way is to form very close working relations with the government and create a win-win proposition.

He spoke a length about RVR. The key points were;

• RVR will reduce transportation costs in the region by  about 35% by avoiding trucking. East Africa has among the highest transportation cost in the world.It costs more to transport inland than to import from major world port to Mombasa.
• Citadel has raised $300 Million ( from IFC, ADB & KFW) for a 5 year turnaround program. These includes; Surgical intervention to improve rail infrastrucuture, Implementation of automation in operations (MS Excel is the existing level of automation),Rehabilitating the fleet and the add new assets after 2014.
• Restructuring of RVR system wise will definitely lead to labour restructuring. The business' growth will lead to realignments within company, hopefully.
• The key challenges facing RVR are; changing the internal culture from parastatal to private sector and sensitizing the community along the rail regarding the importance of the rail ( Click here ). They are looking into out-sourcing  some services to members of the community.
• Managing expectations on delivery of projects and returns are key aspects ensuring a PPP works out.

The session went to question-time. One question centered on how Citadel was able to weather the revolution in Egypt. Citadel maintained distance with the Mubarak regime and consciously avoided questionable investments. He also talked of demographics as a key factor in the revolution. Mubarak started out as a war hero but couldn't ride through the revolution on the back of his past. The youth could care less. African governments have to deliver basic universal rights to avoid this.

On the question regarding how to manage relations with governments. Karim had free advise for governments;

Governments need to invest in regulators not assets. He thinks the private sector is best suited for managing businesses while the government should work to attract qualified talent to regulate industries.

On the question of  the Lamu Port Southern Sudan Ethiopia Transpoert Corridor -LAPPSET being a competitor to RVR and Citadel intentions in the project, Karim says he does not believe it is a competitor to RVR.  He also thinks that private sector involvement in this is not financially attractive. In as much as China has loads cash  devoted to Africa, its role in financing of LAPPSET is still unclear.  Also, recent t talks between Sudan and South Sudan throw more uncertainity in the future of the project. He was also also asked if a standard gauge railway would be a competitive threat to RVR; RVR has rights to participate in future standard gauge rail. He's therefore not worried if the government decides to build one be it in the LAPPSET project or elsewhere.

On Citadel's biggest investment failure; Karim spoke of a failed investment in oil and gas exploration in Egypt.  There were too many uncertainties and a higher capital requirement for exploration. The only way to fully verify a discovery is to pump it. This should be a red flag for those pegging the hopes of LAPPSET on the oil discoveries in Nothern Kenya.

He also talked Citadel's venture in farming in Southern Sudan and S. Sudan's legendary high cost of food ( ) He feels that the biggest problem in farming in SSA is financial intermediation. Banks not to keen on financing farming and that transportation also a problem.He went on ahead to criticize banks and capital markets not helping in financing the economies of  SSA. Banks are too keen in financing Real estate which is not not a very productive sector and enjoy obscene interest rates spreads are too high.

His advise to foreign investors seeking to invest in Africa-never go in on your own. Go in with locals.

With that , another insightful midspeak session was brought to a close.

The Discount Window:CBK's Gift or Curse?

The debate regarding the fall of the shilling  in 2011 rages on in parliament. What is being exposed by both sides of the divide is a lack appreciation of the other side's view. This is expected of politicians as each has an agenda they are pushing. On one hand, the MPs allied to the CBK Governor,led by the finance minister have chosen to blame the shilling's fall on the Eurozone crisis. On the other hand, MPs pushing for the adoption of the parliamentary select committee  report are blaming it on the banks. The charges include the hoarding of Forex and the abuse of the 'Discount Window' by the CBK.

This 'Discount window' has been the subject of discussion and would be the best place to start to unravel this controversy. Banks need money from time to time meet client cash withdrawals. They can access this in several ways:

• Selling of Assets such bonds 
• Borrowing from another bank (Interbank Market)
• Borrowing from the CBK ( Discount Window)

Banks usually use the Interbank market or sell bonds and reserve the Discount window as a last resort for funding. However, according to the PSC committee report, this appears to have drastically changed in 2011.  According to the report, cumulative borrowing over 2011 through the discount window was around Kshs. 600 Billion. This was driven by the discount window offering lower rates than the inter-bank market, which provided an arbitrage opportunity for banks borrowing from the discount window and lending on the inter-bank market.

This, in the face of a currency crisis in the country, was, and still remains a source of grave concern. How can such an anomaly remain unchecked? It points to loss of touch by the CBK of the market. Which begs the question, why haven't any heads rolled at the CBK?

How Vulnerable is the Kenyan Economy? Interest Rates

Interest Rates


The increase in Interest rates from 5.75% in March 2011 to 18% in December 2011 . This measure came along with increasing the cash reserve ratio from 4.75% to 5.25% over May to November 2011. Both these measures had the effect of squeezing the money supply in the economy in a bid to stem inflation which still remains in the higher teens.

The effects of these measures have been;

• A slowdown in economic growth due to expensive credit in the market. Currently, credit for both corporate entities and individual clients ranges between 20% to 35%
• A shift in investment from listed equities to Fixed income securities due to perceived better returns notwithstanding the fact that election years have traditionally meant poor performance in the stock market.

There has also been hue and cry regarding the egregiousness of spreads between the risk free rate of interest (the CBR rate which is around 18%) and the rate at which banks loan clients currently at around 30%. This has led to a move to curb these rates by parliament the introduction of interest rate caps. This would mean that a bank cannot charge more than a particular percentage over the Central Bank Rate. This has been met with resistance from the Banking fraternity and the treasury who say this is over-regulation and would adversely affect the banking sector.

Both sides of the divide have valid points but the approach has to be balanced. On one hand, capping of interest rates would stifle access to finance due to the fact that only highly creditworthy persons would be able to access loans. The rest would be given a wide berth by the banks. On the other hand, it is unjustifiable that banks continue to make double-digit growth in profit while the economy suffers. There is a sense that they have a disproportionate advantage in comparison with other industries in terms of passing on risk to its clientele. This can only be curbed by increasing competition within the financial services sector to 'force' banks to reduce their margins. This could also be done by encouraging other forms of financing for business via vehicles such as private equity firms, SACCOS and Venture capital funds which would increase choice of financing for entrepreneurs. Also, the CBK can institute regulation capping the portion of capital banks can use for trading securities and currencies so as to skew the capital towards the credit market. 

 

The Biggest Reason why Warren Buffet is a Winner

This morning, I came across an adaptation Warren Buffet's annual Letter to Berkshire Hathaway Shareholders. In case you are Martian, he happens to be the World's most successful Investor with a track record spanning over five decades. I happen to be a big fan for his common sense approach to investing, his down-to-earth lifestyle and lately his political views as President Obama's unofficial economic adviser. This 81-year old is showing no signs of slowing down.

Reading this letter  gives me insights to his way of thinking and is a free education for any aspiring investor. In this letter, Warren Buffet speaks of the folly of Beta. Beta is what Investment Gurus the world over use to quantify the risk involved in investing in a particular asset. Simply put, the higher the Beta, the higher the risk. Beta is part of the Capital Asset Pricing Model created and perfected by revered economists, three of whom received the the Nobel Prize for economics. The problem Warren Buffet has with Beta is the underlying assumption behind it chiefly, that assets with more volatile prices tend to be riskier than assets with less volatile prices. This makes Stocks appear more risky than Bonds. The little problem that no one appear to mention is that currencies to lose purchasing power over time. Thus, if your investment is currency based like Bonds are, you will suffer the inevitable loss of purchasing power due to the simple fact that  money supply increases over time. A stock represents a share of a business, an entity whose primary goal is to increase value for its shareholders. Thus, depending on price you buy the business at and its ability to increase its value( or as Warren Buffet puts it more elegantly,'the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power' ) you are more likely to get better returns over time than a bond investor.

This brings me to what, in my humble opinion, makes Warren Buffet successful: His independence of thought. He questions conventional wisdom, regardless of whom its from. Be it Nobel Laureates or your financial adviser. As long something passes his common sense test, it does not matter what the world thinks. As he puts it, so long as the man in the mirror is ok with it, then he's fine with it. 

You can get more of his letters to shareholders at http://www.berkshirehathaway.com/letters/letters.html . An adaptation of his latest letter by Forbes can be found here