Dr Ahmed Heikal is the founder of Egypt’s Citadel Capital, the leading private equity firm in the Africa and the Middle East, currently with investments of more than $9bn. Its 19 opportunity-specific funds control platform companies with investments in 15 industries including energy, mining, agrifoods, cement, transportation and retail. Since its inception in 2004, Citadel has generated cash returns of $2.2bn for its co-investors on investments of $650m – more than any other MEA private equity firm. Citadel Capital’s largest shareholder is its employees, who hold a 27% stake and voting control. The firm has $913.6m of its own capital invested across its funds and platform companies.
Prior to founding Citadel Capital, Dr Heikal was an executive board member and managing director of EFG-Hermes Holding, which he helped transform from a small financial consultancy into the leading investment bank in the Arab world and the second-largest full-service investment bank in global emerging markets.
A year after the Egyptian uprising, and what he believes to be lost months of economic growth, Dr Heikal speaks out to advocate for the role of the business community and private investment in building a new social contract in his home country. He argues forcefully in favour of reforming Egypt’s policy of subsidising basic foodstuffs and fuel, a policy that currently absorbs a significant proportion of the country’s budget. Subsidies account for 23.6% of total government spending, and energy for around 81.5% of all subsidy spending.
In this absorbing interview for African Business, he outlines his investment strategy for Egypt and sub-Saharan Africa. An optimist, he sees tough times but also outstanding opportunities ahead.
Interview conducted by Alexa Dalby
Q: You are advocating reform of the subsidy system in Egypt. What are your reasons? Do you think subsidies are discouraging private investment?
A: I have never advocated taking out the subsidy. What I have advocated is to replace the current subsidy system with a cash subsidy system. My reasoning is very clear.
Egypt suffers from two main problems. One is a budget deficit problem and one is a current account problem.
The current account problem can only be solved with a reduction in energy utilisation through efficiencies. Right now, when you have subsidies as broad as in Egypt, you are encouraging all sorts of wrong utilisation of energy; and extreme inefficiencies exist within the system.
So if you increase the price of energy to international levels, or close to international levels, we anticipate we are going to see around a 15% reduction in energy use, by, for example, using efficiency-enhancing tools like the River Nile or railways for transportation instead of trucking.
You need an incentive to drive more efficiency in generating electricity, but if you get energy very cheaply, that distorts a lot of things. You can, for example, use waste to generate energy and set into motion a long list of improvements that will drive down close to 15% of the energy consumption.
Egypt currently uses about 70m tons of various products including natural gas, fuel oil, diesel, gasoline, LPG and jet fuel, and if you cut 15% of that, that’s roughly 10m tons a year of reduction, which will probably improve your current account balance to the tune of $9bn, hence releasing pressure from the currency.
So the reformed subsidy system will play both ways. It will cut your budget deficit substantially and it will reduce your current account deficit, since you import a lot of these fuels. Even if you give a cash subsidy, the amount of savings that you can achieve will be enormous. You will be able to spend on more on education, on healthcare and so on, and it will allow you to reduce the budget deficit – all the while driving interest rates down as well. As it stands, the more you consume, the more you benefit from the subsidy programme. This consequently benefits corporations and the wealthy in a disproportionate manner. A reform of this system is what I am advocating.
Q: What, in your opinion, are the monetary and non- monetary costs of the subsidy system as it stands?
A: Egypt’s main assets – oil and gas, water, electricity infrastructure, mining and the Suez Canal – are underperforming, yoked to the inefficient subsidy programme that indiscriminately benefits anyone, rich or poor. As I have mentioned, the more you consume, the higher your subsidy. Therefore subsidies are the main source of inequality.
Reforms to use state assets better and phasing out energy subsidies over five years could free up to $50bn to be spent on other sectors that need the funds. A bold politician might end energy subsidies at once. More efficient use of state assets, and the end of food subsidies, would save $58bn annually – freeing $20bn for direct cash payments to qualified welfare beneficiaries and $38bn for health, education, job creation and cutting the budget deficit. Similar programmes have succeeded in Brazil, Mexico and Iran. These solutions are within reach, but demand decisive action by legislators willing to trust the business community.
Q: How do you see the role of private equity in this?
A: In Egypt, we foresaw this long ago and we have positioned our investment portfolio to make sure that when the day comes, we are there with the right platform companies to provide solutions to many of Egypt’s problems. Our Nile River transportation business is a play on a more efficient utilisation of energy. Our waste management company is in the forefront of providing alternative fuels out of municipal and agricultural waste. Another of our platforms is building a $3.7bn greenfield refinery that will produce diesel fuel – eliminating our dependence on imported diesel and preventing the release of more than 180,000 tons of SO₂ every year.
There are a number of other initiatives open to us and I would imagine that a lot of other people will be thinking along the same lines. But it is certainly the case that the government is not in a position to invest, given the very high budget deficit that exists today. So a total reliance on the private sector is the solution.
Q: What would make Africa more attractive for private equity? Is a lack of strong capital markets a hindrance?
A: Would I love to see more and deeper capital markets? Yes, of course. In the old days when I was at EFG-Hermes, we were trading a couple of million pounds a day – that was a big achievement. Today we are trading probably EGP600-700m coming down from EGP2bn in the run-up to January 2011.
Deeper capital markets will appear in Africa over time, and we have to be patient. I don’t think it’s hindering private equity because the returns and the growth in Africa are enormous. There are a number of very important factors in Africa. Democracy has taken – I don’t want to say taken root – but certainly there is a major shift in paradigm regarding governance in Africa. That’s very, very important.
Then you have demographics. Africa today is home to more than 1bn people, which makes for a huge potential workforce and consumer market. You see significant upsides over the next 20-30 years. It’s a very exciting time.
And finally, there are natural resources. So you have a combination of natural resources, demographics and better governance in Africa. The first two have always been there, but better governance is the new thing in Africa and it is the catalyst for the investments that we think will happen in Africa over the next 30 years. Another very important development is that the DFIs (development financial institutions) are open for business. The International Finance Corporation the European Investment Bank, the African Development Bank, the DEG (the German fund Deutsche Investitions und Entwicklungsgesellschaft), the FMO (the Dutch Entrepreneurial Development Bank), Proparco (the subsidiary of the French Development Agency) are open for business. This is very significant because you can get access to both debt and equity, but mainly debts.
Q: Why do you see infrastructure as so crucial?
A: I think it’s very clear that with high oil prices, efficiency in transportation becomes a key issue regarding the development of Africa. I think transportation and logistics in Africa lag behind and this is the main area of interest for Citadel Capital.
For instance, transport prices in East Africa are among the highest in the world due to reliance on trucking – less than 10% of overland transport goes by rail. So this suggests a unique opportunity for an efficient, cost-effective railway.
In 2010, we put together a major deal in Kenya and Uganda to turn around Rift Valley Railways (RVR), where we have a 51% stake through Africa Railways, our platform company for investing in Africa’s rail industry. We raised $234m to back the capital expenditure programme to improve the line. We estimate that an efficient rail network could, in time, reduce the costs of transportation in East Africa by as much as 35% because of operational and fuel efficiency.
Certainly infrastructure returns in Africa are much higher than in other places. We think Africa is one of the last places on earth where it is possible to think big about infrastructure investments of every form. It is the next great frontier where private equity investors can undertake massive greenfield projects in sectors ranging from electricity to transportation, from water to river transportation.
The numbers bear this out – spending on infrastructure in sub-Saharan Africa is $45.3bn a year against a need of $93.3bn, a deficit of $48bn, according to the African Development Bank Group. This splits into two opportunity categories for private equity investors: $30.6bn annually required for greenfield projects and capacity expansions, and $17.4bn for the so-called efficiency gap.
Mega-transactions, such as our Egyptian refinery and RVR underscore the simple reality: when properly structured with risk mitigation in place at every turn, it is possible to execute large, compelling deals in Africa’s infrastructure sector that are exceptionally appealing to LPs (limited partners) who have the ability to see beyond generalised political risk to the specifics of an individual nation and a specific opportunity. I would agree that it’s capital intensive and it’s long term. So you have to be patient.
Q: What effect did the Arab uprising have on your investment strategy?
A: Obviously, the change in environment has caused us to rethink our strategies. We saw different dynamics that led to the same results.
In many of those countries where their budget and the current account have deficits, the Arab Spring has increased the dynamic, so we are one of the few firms that will benefit. But it has also reduced the capital available because of higher risks; hence the equity capital for private equity that used to exist is no longer there. So that has put some strains on new deals that we were contemplating. Right now we are looking more at our existing investments to make sure that they are in the right shape and the right form and progressing in the right way as opposed to going out for new deals. That certainly is a change that was brought about as a result of the change in the global environment where there is less risk taking, including in our part of the world.
Q: What are your criteria for investment?
A: Broadly speaking, we focus on serving domestic demand with a secondary focus on offshore markets for value-added goods. Our emphasis is on building key infrastructure or producing for consumption at the local market.
Al-Takamol Cement, our regional platform in Sudan, serves domestic demand. Rift Valley Railways of Kenya and Uganda is the operator of the national rail concession. Sudanese Egyptian Bank offers financial services including trade finance solutions. Wafra, our agriculture platform, is developing large-scale farms in North and South Sudan that cater entirely to domestic needs. Our investments are in four different areas. The first thing we look for is industries with hard-currency revenue streams. We have gone into energy, mining, agriculture, and refining, which are all dollar-denominated industries. We are also heavily into the food sector. We are in industries that will benefit from energy deregulation that will happen in Egypt over the next couple of years. We have investments in Africa and the Middle East so we are well diversified outside of Egypt. The fourth area of our activities is industrial businesses that have a substantial component of their turnover in exports.
Q: Are you prioritising any particular sub-Saharan Africa countries in your investment strategy?
A: I like Mozambique, Tanzania, Kenya, Uganda, South Sudan and Sudan, I like Ethiopia very much. Egypt obviously is a very good place. Then you have Nigeria and Algeria, both of which are very important. Those are the countries where we are focused at this point in time but that does not mean that places like Rwanda or Ghana or Angola are not on our map. Iraq also is important for us. In East Africa we have a lot of investments already and we plan to expand within the companies that we have today.
Q: Are you raising funds at the moment? If so, how?
A: The DFIs are extremely important in filling the gap that was left by commercial banks and by risk capital. They are a big source of funding. Another source is recycling our own capital. Over the next couple of years we will mix a number of small exits that will free up a lot of our capital to re-invest in the growth of core platform and portfolio companies.
Q: What is the most important conclusion for us to draw from your assessment of sub-Saharan Africa?
A: From the direction Africa is taking, the next 30 years are the African years, because of the number of points that I mentioned regarding governance, resources and demographics.