Treasury Management in Sub-Saharan Africa

The prospect of investing in Sub-Saharan Africa often sends shivers down the spine of many an investor. The continent has an aura of impossibly difficult markets with a suppressive regulatory environment, rampant corruption and nightmarish logistics.
Nonetheless, GDP growth has been impressive (average of 6% for most sub-Saharan countries) and increasing efforts are being made by modern African governments to promote capital markets and private investment. Indeed, those pioneer firms, who have had the ‘audacity’ to enter the African market with the right business model at the time when few dared, have reaped impressive returns on their investments. Dutch telecommunications firm Celtel, which was acquired by Zain of Kuwait in May 2005 for US$3.4bn, is certainly one example of those who dared.

Formed in 1998 as a private sector business to focus on mobile telecoms infrastructure in Africa, Celtel had annual revenue of US$266m and earnings before interest, taxes, depreciation and amortisation (EBITDA) of US$66m back in 2002. At the end of 2008, Celtel (now rebranded as Zain Africa) is expected to generate annual revenue of US$4.4bn and an EBITDA of US$1.6bn.

Robust treasury operations and working capital management, aligned to sub-Saharan Africa business reality, is crucial to translate those impressive profits into liquid assets. The risk-laden and volatile African financial environment demands a solid but realistic treasury framework that acknowledges the above-mentioned constraints. The latter should encompass not only cash management but also currency, interest and commodity risk management, as well as the implementation of a viable funding strategy for the African operations – sourced both locally and abroad.

Treasury

Treasury regimes, corporate banking services and the financial markets in sub-Saharan Africa are comparatively underdeveloped. Financial risks are high, while the tools available to the treasurer for managing those risks are quite limited. Due to the above-mentioned constraints, the African treasurer would need to rely more heavily on the right mix of pragmatism, creativity and resourcefulness than his western counterpart to help transform those healthy profit margins into an equally healthy cash flow.

Cash

Cash management should certainly be at the top among the functional priorities of the African treasurer. Cash and paper based payments, as well as collections, are prevalent in the African economies in which Zain/Celtel operates. As such, cash handling controls, physical safekeeping and guarded transport of cash, as well as regular verification and reconciliation of the amount of cash on hand, achieve high importance in the daily cash management process.

Collections

Celtel’s experience clearly showed that local subsidiary treasurers in Africa would need to master the skills and discipline needed for managing cash-associated risks and that adherence to the holding treasury set of policies is of critical importance.

The most widely used collection methods are over-the-counter cash deposits of currency and placement of cheque receipts from dealers and shops at the various POS locations throughout the country. At a few of the Celtel operations, a loose cash concentration system has been implemented to consolidate bank balances and other POS cash receipts into a minimum number of accounts. The latter had facilitated fund deployment: disbursements, loan repayments and funds up-streamed to Celtel International in Amsterdam.

In some African countries such as the Democratic Republic of Congo, Celtel makes use of so-called ‘agents de transfert’, third party collection agents which are sort of local Western Union-type operations, who have found a niche for themselves in the transfer and eventual conversion of local currency from remote areas where banks branches are completely non-existent.

African subsidiaries of Celtel would strive to maintain major accounts only with top banks located mostly in the capital cities and with reliable international networks. The latter often helps minimise notorious bank transfer delays usually attributed to foreign exchange inadequacy interwoven with central bank red tape.

Automatic sweeping of surplus funds from the operations to Celtel is not yet achievable. This is mainly due to: exchange controls, involving permission requirements for cross-border transactions; restrictions on inter-company financing that may affect the creation of pooling structures; and the existence of other regulatory considerations. All transfers are manually instigated and the process of up/down-streaming of funds in the form of dividends, management fees, inter-company loan repayments and holding treasury deposits is governed by Celtel’s cash concentration policy, which constitutes a very important section of the corporate treasury manual.

Payments

Cash and paper-based payments are predominant across sub-Saharan Africa. Reliability and efficiency of many of these countries paper-based systems is impaired by an inefficient postal and cheque clearing systems. As such, mitigating those payment method-specific risks becomes essential for local treasurers, probably more so than elsewhere in the developed countries. While the long-term objective is to eliminate cash payments from the disbursement process, the latter would be difficult to achieve until advances are made in electronic-based payment systems and until the new generation of Internet-based banking is widely established.

Capital expenditures, driven by continuous base station and network rollouts throughout Africa, necessitate significant number of international payments, both in terms of volume as well as number of transactions. International payments from some of these countries tend to fall prey to settlement related risks – mostly of the sovereign nature. In addition, related bank charges can be punishing. Hence, a careful selection of banks to do business with – at least if a choice is available – can help overcome payment failures.

Having a global bank with fully-fledged branches in the countries where one operates can help streamline the international payment execution process.

Cash Forecasting

As mentioned earlier, fund transfer and cash repatriation from/to African operations is weighed down by a number of regulatory red tape and banking inefficiencies. In such an environment, reliable cash forecasting remains the most valuable tool treasury has to gain the necessary lead time for the preparation of the legal and fiscal groundwork to support cash repatriation. Celtel treasury has focused on cash forecasting and invested in treasury tools to streamline the forecasting process. One such system that is being used is a subsidiary cash forecasting and cash position reporting module within a treasury management system (TMS) Avangard Integrity, available to subsidiaries on a CITRIX platform.

Each month the African operations submit a rolling 15-month forecast, and the TMS automatically consolidates the local currency forecasts into a US dollar consolidated report. In early 2008 (just before this author’s departure from Celtel), the company was in the process of implementing Citi’s Treasury Vision architecture throughout all its operations. If the implementation succeeds, the system should be able to provide consolidated global cash position on a daily basis for more than 22 Zain operations.

Foreign Exchange

An obvious challenge to the African treasurer is foreign exchange (FX) and/or the lack of liquidity for the execution of spot conversions into convertible currencies. Luckily, due to the recent boom in commodity prices and an increase in foreign exchange inflows as well as reserves, the FX market in most African countries has somewhat improved in recent years.

Celtel operations are instructed to maintain only a minimum amount of local currency denominated cash. All local currency cash collections, reduced by the amount reserved for planned local currency payments, would need to be converted at spot into Celtel’s functional currency, which is the US dollar.

There are two distinct euro-based monetary unions in west and central Africa still functioning today, providing exchange rate peg to the euro with full convertibility.

Euro/US dollar movements affect Celtel’s revenues from any of the countries mentioned in the table above, since the XOF and XAF are pegged to them as they are Zain/Celtel’s functional currency. Fluctuation in euro/US dollar may thus affect EBITDA significantly, and can give rise to a poor interest cover in highly volatile environments while possibly triggering debt to EBITDA ratios – endangering financial covenants. This CFA exposure was managed ‘by proxy’, i.e. derivative solution which aimed to hedge the euro equivalent of CFA revenues versus US dollar.

The financial markets in most of the African countries where Celtel has been operating are prone to experience highly volatile exchange and interest rates – thus the need for managing both FX and interest rates risk (whenever possible) is high priority.

While the derivative market is still underdeveloped in most African countries, international banks can sometimes offer customised synthetic hedging constructions, involving local currencies such as the Nigerian naira, Kenyan shilling, or the Zambian kwacha. Below are some examples of FX/interest rate products available in some of the African countries in which Celtel operates.

A number of related sets of factors have constrained Africa’s ability to tap both foreign and local currency markets to raise long-term finance for infrastructure. Despite the above-mentioned, Celtel has managed to raise approximately US$2bn in debt finance at the local level through a number of optimally subscribed syndicated loans and local bond issues.

In 2004, the major portion of Celtel’s loan portfolio consisted of a holding company, i.e. Celtel International senior loan facility, placed with a syndicate of European and South African commercial banks together with a number of direct foreign investors (DFIs) – DBSA, EAIF, Finn Fund, and Coutts, the DFI’s also serving as so-called ‘credit enhancers’.

The interest margins on the above-mentioned facility was extremely high, ranging from tranches set at Libor +4% to Libor +12 % – reflecting the assumed risk associated with doing business in Africa.

The rest of the borrowing at the holding level consisted of hybrid instruments, such as a mezzanine loan with warrants, arranged with FMO and EAIF, and quasi-equity securities with IFC consisting of convertible redeemable preference shares and a private equity construction secured by an American put option.

During the same time the total of all local loans by Celtel African subsidiaries was no more than US$70m in 10 separate loan facilities. These were mostly US dollar denominated loans, securitised by pledge of assets, project fund retentions, political risk guarantee and sometimes limited recourse to Celtel International’s shares. Most of the latter agreements also contained covenants restricting dividends, asset disposal and additional indebtedness.

The factors that played a major role in eventual change of Celtel’s corporate finance strategy were the following:

• In recent years, significant revenue and EBITDA growth of Celtel African subsidiaries, and a highly improved creditworthiness, has enabled them to tap local branches of global commercial banks and domestic counterparts, instead of relying solely on DFI loans. DFI debt had become relatively less attractive for Celtel’s African operations (expensive, restrictive and US dollar denominated), the latter creating a practically unhedgeable FX exposure for the local entity.
• Loans at the holding level would be inefficient from a tax perspective if a non-operating shareholding entity (such as Celtel International BV) does not generate profits and hence could not benefit from an income tax shield.
• Withholding tax disadvantage when up-streaming interest on external loans.
• An unfair benefit for the local shareholding partner (required by law in most African countries) regarding security and down side exposure.

In the end, the model that Celtel followed is that of a mix of co-borrowings of holdings and operating companies, the former to be mostly used for business development and new license acquisitions and the latter mainly for network rollouts and expansion in existing operations. The emphasis has been on a minimum number of facilities, tax efficiency, commercial rather then DFI, and flexible in respect of future events such as initial public offerings (IPOs) and waivers.

The above-mentioned strategy has not only helped Celtel International replace part of outstanding shareholder loans with local financing but has also helped in the natural hedging of local currency denominated revenues.

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