Currency devaluations and inflation erode investment returns, reducing a company’s valuation and the value of its total addressable market (TAM). However, several sectors have demonstrated resilience in such conditions and can actually generate substantial shareholder value in difficult economic times. A major example is Egypt which suffers from an inherent current account deficit and imports most basic commodities, including food. In markets like this, currency devaluations result in nearly a 1:1 inflation pass-through to customers.
Non-bank lending and payments offer the best investment opportunities in Egypt’s current macro environment. We estimate that there will be at least $500m in transaction value amongst companies in the non-bank lending and payments sectors in 2023, which investors can potentially capitalise on. Moreover, there is financial and strategic investment appetite in those two sectors, as demonstrated by various successful exits, enabling investors to eventually realise significant profits.
The impact of currency devaluation
The impact of a currency devaluation on a sector and company level can be broken down into 3 buckets:
These are typically capex-intensive businesses, particularly those in the industrial sector where capex is denominated in foreign currency. Non-exporting manufacturers are also particularly hard hit as they rely on imported raw materials.
Companies and sectors that fall under ‘Neutral’ divide into two groups. The first is businesses in inflation pass-through sectors, such as retail and consumer staples. Such businesses can quickly adjust their prices in response to currency devaluation and the resulting imported inflation.
Retail/consumer staples tend to fall into this category, which can be extended to various sectors that depend on retail activity such as groceries, B2B commerce, payments, etc. These tend to be companies and industries that generate revenue via a take rate mechanism linked to ‘consumer staples-like’ GMV (i.e., grocery for Food Tech business/B2B commerce such as Breadfast and MaxAb or bill payments in the case of e-payment companies like Fawry).
The second group consists of businesses in sectors that may not be able to raise prices enough over the short to medium term to offset the impact of currency devaluation. As consumers seek ways to alleviate the squeeze on disposable income, gig economy companies benefit from demand-led growth, offsetting their inability to raise prices enough to combat devaluation. Examples of such sectors in the gig economy include ride-hailing, freelancer marketplaces, and home rentals.
The winners are typically lending companies and export-oriented industries such as manufacturing and tourism. Specifically, lending businesses benefit in three keyways:
- Larger ticket sizes due to inflationary pressures
- Higher volume of lending due to an inflationary-driven squeeze in consumers’ disposable income
- Higher net interest margins (NIMs)/lending spreads resulting from rising interest rates designed to curb domestic and imported inflation
Due to government intervention, investors have viewed Egypt’s manufacturing sector as largely unattractive because the private sector was competing with the state, which investors deemed a losing battle. Late last year, the International Monetary Fund (IMF) imposed restrictions to cut the state’s footprint and level the playing field, potentially opening up investment opportunities and unlocking the $3bn extended arrangement Egypt needs. However, the net impact here remains yet to be seen.
Non-bank lending & e-payments are poised to deliver exponential returns
Egypt’s non-bank lending and e-payments sectors have proven resilient to FX depreciation, and investors can expect them to continue delivering exponential returns in the years to come. The non-bank lending sector benefits from effective cash collection policies with NPL ratios for the companies mentioned earlier in the single digits range. Investors have achieved 4-10x (USD) returns despite the country experiencing a series of currency devaluations and political turbulence. The non-bank lending sector, in particular, benefits most from currency devaluations as imported inflation results in larger ticket sizes, lending volumes and interest rate margins.
Provided the proper governance structures and processes are in place (i.e., effective cash collection, low NPLs, profitability, etc.), the non-bank lending sector is one of the most attractive sectors to invest in across both early and late stage because companies can generate meaningful profits and positive cash flows early in their development. Both sectors also benefit from structural growth drivers, given 73% of Egypt’s 110 million population is underbanked.
This may offer opportunities for companies in adjacent Fintech verticals as more mature players seek horizontal and vertical integration via inorganic growth/acquisitions. For example, Paymob and Khazna’s partnership to expand access to digital financial services and Tanmeyah’s acquisition of Fatura (a B2B e-commerce marketplace) in mid-2022 in order to fill the credit gap in the B2B market are examples of the appetite and opportunities for Fintechs to vertically and horizontally integrate.
Moreover, the acquirer types are diverse in nature, including corporate (i.e. CI Capital & EFG’s acquisitions of Reefy and Tanmeyah respectively), quasi-sovereign (Chimera’s acquisition of GB Auto’s stake in MNT), and sovereign (PIF’s acquisition of DPI’s stake in B.Tech). This provides investors with a wide range of exit options to turn investment returns into cash much more quickly, and more certainly, than in many other sectors of the African growth landscape.
We have identified 20 non-bank lending and 3 mature e-payments businesses in Egypt, of which there are nearly 10 businesses are at growth stage. Based on last year’s fundraising activity, recent Fintech fundraises and secondary transactions in Egypt and exit time horizons for existing investors, we believe those businesses will be seeking transactions in the region of $50m-100m+ each in the form of primary and/or secondary capital. In conclusion, there will be at least $500m in transaction value in the non-bank lending and e-payments sectors which investors can potentially capitalise on in Egypt’s current macro-environment.
Omar Makkawy, is an Investment Banking Analyst at DAI Magister. Omar has over ten years of experience in the financial sector, having previously worked at EY, TAC Partners, and Kepler Cheuvreux.