Why do Nigerian companies find foreign exchanges attractive?

Two weeks ago, I wrote about why more Nigerian companies are not accessing the capital market, despite the various benefits they could derive by listing on the Nigerian exchange (NGX).

Capital markets enable business owners to raise money to bring their ideas to fruition or to expand. Without this option, business owners would have to save up their profits (which would take an absurd amount of time) and some very expensive bank loans that could impact profitability in the future.
 

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I spotlighted another benefit of going public (listing on an exchange): it helps spread ownership risk (person or people responsible for managing risks or threats). This could present opportunities for the business owner or early investors to cash in on returns on the equity they invested in the business's early days.

Today, I want us to consider a second question: why do some companies list on foreign exchanges?

I have to note that listing on foreign exchanges is not an uncommon practice. Companies do it all the time. We have foreign companies like Ecobank Transnational Incorporated (a Togolese company) and Airtel Africa (owned by Indian telecoms company Bharti Airtel), listed on the Nigerian exchange (NGX). 

Similarly, Nigerian companies like Seplat Energy and Zenith Bank Plc are dual-listed on the NGX and the London Stock Exchange (LSE). Even Airtel Africa is listed on the LSE.

However, the difference is that these companies are still listed in their home countries and have not completely deserted their home countries’ stock exchanges in search of “greener pastures”. 

The concept of dual listings on stock exchanges is known as cross-border listing and is encouraged by the NGX. In fact, a foreign firm seeking a dual listing on the NGX doesn’t need to have operations in Nigeria. It just needs to have an “operating track record of at least two years and be incorporated or otherwise established in a jurisdiction where the standards of shareholder protection are equivalent to those provided in Nigeria (as determined by the NGX). 

So this article will focus on why Nigerian companies would ignore their shores to go list on foreign exchanges.

I'll deliver the spoiler early—companies want access to a wider array of investors.

Let’s see how.

It's mostly about the investors 

One key thing to remember is the capital market is a good source of liquidity. 

However, liquidity depends on the market. For example, the NGX, with a market capitalisation (cap) of $62 billion (₦26.8 trillion) as of 12th September 2022, cannot have the same level of liquidity as, say, the London Stock exchange with a market cap of $3.17 trillion as of the same day.

This is because the larger exchange has more listed companies and covers more sectors of the economy (a.k.a depth of the market), offering a diverse range of stock options for investors to choose from. This is important to a company in deciding on which exchange to list on.

Think of the daily turnover in a huge auto parts market like Ladipo in the Mushin area of Lagos and compare it with the turnover in a small-scale auto parts market like Jakande first gate in Lekki. A new auto parts dealership may consider setting up shop in Ladipo market first just due to the thousands, if not millions, of potential customers he/she has access to by just situating the business in the heart of the market. 

A similar principle applies to companies considering listing on any exchange. They consider the depth and liquidity levels in the market, the type of investors present in the market and their behaviours (how they react to certain factors).

Because the NGX is majorly funded by domestic investors (85% of inflows), with limited capital to supply, listing on the NGX may not be attractive to a company looking to raise huge sums of capital. The company will typically aim to attract foreign institutional investors like global asset managers, hedge funds and pension funds administrators etc., who possess huge funds under management. For example, BlackRock—one of the biggest investment banks in the US, had about $10 trillion as assets under management in January 2022, juxtaposed against the total pension industry (Nigeria’s largest source of domestic capital) at $33 billion (₦14 trillion) in August 2022.

Furthermore, because these potential investors will now have a stake in the business, i.e. get to weigh in on the decision-making, business owners will typically aim to list in markets that offer investors with a more diverse set of skills and possess the capital needed by the company to achieve its goals and objectives.

So let's take the points individually.

I will begin by explaining investor behaviour. Since companies list mainly to access more investors, it's important to understand how investors think. How do macroeconomic factors like inflation and interest rates affect the returns investors make on investments? And how does this influence their supply of capital in the market?

High interest rates dampen valuations

At Stears, we have increasingly emphasised the dangers of persistently high inflation. Michael, our Head of Intelligence, correctly argues that double-digit inflation could wipe out any investment returns.

Inflation is the rise in the price of goods and services in the economy. With inflation at over 20% in July 2022, the cost of operations for any company in Nigeria would grow at a similar percentage range, thereby eroding profits.

Apart from eroding the value of profits made, thereby discouraging investment sentiments, the higher interest rates that usually follow high inflation often discourage companies from listing in Nigeria. 

If you recall, in July 2022, the monetary policy committee (MPC) raised its monetary policy rate (MPR) by 100 basis points (bps) to 14% in its bid to tame runaway inflation at almost 20% in July 2022.

The rise in interest rates negatively impacts the valuations of any company because the interest rate is a key factor involved in the valuation of companies. 

Company valuations involve forecasting the company’s free cash flows (FCF) into the future (typically five years). Free cash flows refer to how much is left after a company has settled all its debt obligations and funded capital expenditures.

It provides insight into the value of a company and the health of its fundamental trends, in that a company might be declaring a loss for the year under the income statement but has positive free cash flow, meaning there is still money left to share as dividends to the investors in the business or its creditors.

The FCF is typically adjusted for interest payments and borrowings—both variables influenced by the MPR. 

The MPR represents the cost of borrowing in the country against which other interest rates (like bond rate, mortgage rate, savings rate etc.) are benchmarked. 

Rising or high-interest rates translate into expensive interest payments, and higher inflation signals a rise in operating expenses, both of which mean lower profits and lower FCF.

As such, investors would price down the company's value and hinder its ability to raise funds.

This is a major reason why a Nigerian company would consider listing in advanced economies with relatively low levels of inflation and more favourable interest rates, like the US, with inflation at 8.5% in July 2022 and a US Fed rate (US’ equivalent to our MPR) with an upper limit of 2.5%.

A more stable macroeconomic environment favours company valuations, which affects how much they can raise in the capital market. For example, in Saudi Arabia, where the Saudi Riyal has remained at 3.75 against the dollar since 1986, and the inflation rate has averaged 2% over the past twenty years; Saudi Aramco (the Kingdom’s state oil company) with a $2.3 trillion valuation was able to raise $30 billion by just selling 1.5% of its shares.

Another factor that affects valuation in Nigeria is investor knowledge, which is a direct result of the shallowness of the Nigerian capital market.

It's like Douye Mac-Yoroki—an equity analyst with Renaissance Capital, a global investment bank with operations in Nigeria, put it “there is no depth in the Nigerian equity market and in turn, no liquidity”.

By depth, he means that the concentration of companies listed on the NGX is tilted towards the banking, industrial goods and, more recently, telecommunication sector. 

As we can see from the chart above, only about nine sectors of the vast sectors in the Nigerian economy are accounted for on the NGX, reflecting the shallowness of the market.

Our deputy editor, Adesola, previously lamented the lack of options on the NGX. She argues that the NGX has been unable to raise as much capital as its peers, Egypt and South Africa.

Over the last 16 years, the Nigerian Exchange Group (NGX) listed around 194 firms. 

Egypt and South Africa have significantly higher listings, averaging 355 and 333 companies over the same period, respectively.

The lack of depth often restricts investor knowledge about budding upcoming sectors (like fintech and telecom infrastructure sharing sectors) that are not represented by the NGX just due to the lack of exposure to these sectors. 

Such companies looking to list might consider looking outside Nigeria’s shores to other exchanges with similar companies that play in similar sectors. This allows for a peer comparison in valuation models by investors, who have the funds needed, and the technical understanding of the business and the sectors they play in, allowing them to better value the company’s actual worth. 

Let me explain what I mean.

When we compare the NGX to the Nasdaq exchange in the US, the NGX has just about 194 listed companies. In contrast, the Nasdaq has over 3,300, with 500 of the largest corporations by market capitalisation (cap), tracked by the S&P 500 index in the US. 

These companies include industry giants like Meta (formerly known as Facebook), Amazon, Apple, Netflix, and Alphabet (formerly known as Google)—popularly known collectively as “FAANG”. Each company is listed on the Nasdaq exchange and included in the S&P 500 index. Combined, these five companies had a total market cap of around $7 trillion as of Q1’22.

Contrast this against the NGX’s total market cap of $62 billion (₦26.8 trillion) as of 12th September 2022. 

The lack of depth on the NGX spotlights the lack of liquidity present in the market that could discourage companies looking to raise huge amounts of capital. 

Moreover, the liquidity and depth of foreign capital markets do not offer capital only in monetary terms but also human capital. As I mentioned earlier, the preferred investors to be given equity in the business would be those with the expertise to understand their respective industries, to not only improve valuation models but also provide better insight when deciding the company's future. 

Take Jumia and Flutterwave, for example. Jumia, pan-African e-commerce and payment solutions company and Flutterwave, a fintech company that provides a payment infrastructure for global merchants and payment service providers.

However, with an ICT sector largely dominated by Airtel Africa and MTN Nigeria (about 40% of NGX’s market cap), neither of which offers similar services to Jumia and Flutterwave, meaning Jumia and Flutterwave are not represented by any sectors on the NGX.

As such, if Jumia and Flutterwave were to list on the NGX, they would have been subjected to valuation by the domestic institutional investors (who make up 68% of all domestic inflows into the NGX) whose best pick for a comparable company is eTranzact, a switching and payment processing platform with a market cap of 0.07% (₦19 billion).

This is small compared to the valuations of both Jumia and Flutterwave, each valued at over $1 billion (₦430 billion at ₦430/$1).

Let's be honest, only a handful of investment bankers in Nigeria can build a fintech model from the ground up. But compare that to the numerous investment bankers that can model a traditional bank in the middle of their sleep.

It's not a matter of their qualifications but the lack of exposure to analysis of such sectors that are not accounted for on the NGX. 

So again, not only will these companies be unable to raise the level of capital they want, they would have limited access to investors with the technical know-how of how their businesses operate and a better understanding of the factors that affect the industries they play in.

Finally, foreign investors aren't even present on the NGX. Heightened exchange rate risk (fluctuations in the value of the Naira) have led to investment outflows and increased apathy toward the NGX. 

As such, foreign investor participation in the NGX has dwindled sharply from  51% in 2018 to 34% in 2020 and about 15% in July 2022. Domestic investors have been the major players in the local bourse (equity market), contributing 85% (₦1.5 trillion) of all inflows into the exchange. Of that sum, domestic institutional investors (like the PFAs) were responsible for 68% (₦1 trillion).

This brings us to our third reason why Nigerian companies are beginning to prefer listing on foreign exchanges. 

Patient investors

Due to the lack of depth in the Nigerian market, investor appetite is stirred towards dividend-paying stocks, with other stocks, especially loss-making ones ( a common feature with startups), left behind and punished for their inability to pay dividends. 

Top banking sector stocks (like UBA, Zenith, GTCO etc.), which according to the NGX, typically account for almost 40% of transactions ( a sign of investor appetite) on the NGX in a year, are investors’ favourites due to their consistency in paying dividends, while other stocks like Unity bank and Cadbury Plc are ignored.

This sort of investor behaviour is not favourable to loss-making growth companies like IHS Towers (a Nigerian firm listed on the New York Stock Exchange), or Jumia, which due to their business models and the industries they play in, are required to make sacrifices now in terms of not being profitable, in order to invest in innovative solutions that would yield profits later in the future.

Furthermore, this sort of dividend-seeking behaviour goes against the very feature of the capital market that is meant to make it attractive to companies looking to raise funds—investors engaging in equity financing are meant to be patient investors, not demanding frequent interest payments (returns) on their investments.

As such, most companies listed on the NGX are focused on making enough profit to share among shareholders and pump up stock prices at the expense of innovating and developing.

However, when you compare it with loss-making companies like Twitter, listed on the NYSE with a market cap of $32.9 billion; the social media giant made a loss of $221 million in 2021 and pays no dividend but is still actively traded by investors, the Nigerian market doesn’t seem to reward growth companies, who should typically list on the NGX.

So far, I have explained how factors like inflation and interest rates affect company valuation and how the lack of depth and liquidity in the Nigerian capital market is not favourable for certain company listings. Furthermore, we have seen how investor understanding affects company listings.

However, it’s worth noting the NGX’s recent efforts in deepening the market with the introduction of the Premium Board on the NGX in 2015.

The premium board is the listing segment for an elite group of issuers that meet the NSE's most stringent corporate governance and listing standards. As of 12th September 2022, eight companies were listed on the Premium Board with a market capitalisation of ₦10.97 trillion ($25.5billion).

According to the NGX, “the Board is a platform for showcasing companies who are industry leaders in their sectors. Premium Board features companies that adhere to international best practices on corporate governance and meet NGX’s high​est standards of capitalization and liquidity.”

On the back of the credibility that comes with being listed as a “trailblazer”, the premium board grants these eight companies access to some foreign capital from investors that would consider the premium listings when deciding what companies to invest in.

For instance, MTN Nigeria, a premium board member, raised about $244 million in 2021 after issuing new shares to the public.

Nonetheless, more work needs to be done by the NGX to deepen the Nigerian capital market, boost liquidity, and investor confidence in the NGX.

Moreover, from a structural perspective, we at Stears have often emphasised the role of a credible central bank in stimulating investor confidence in the economy. Policy somersaults, the current exchange rate regime and a complete lack of faith in the CBN Governor—Godwin Emefiele, are some factors dampening investor confidence and participation in the capital market.

As long as the aforementioned issues persist within the Nigerian capital market, we will continue to see a rising trend in the number of seemingly Nigerian companies listed on foreign exchanges.