PRIVATE EQUITY IN FRONTIER MARKETS

Winter 2014

SOLAR PV IN AFRICA

Ali Gara Gib Lopez Igor Leroux

Abstract
Solar photovoltaic (PV) is poised for tremendous growth in Africa over the next decade. The modularity and cleanliness of solar PV allows for new generation to be installed much closer to final consumption, an essential characteristic in a region where the grid is often saturated or non-existent. The current prices for PV systems makes their installation profitable, even for the sole purpose of offsetting the fuel expenses of the diesel and oil generators that are widely used across the continent. Is this an investable thesis? In this paper, we consider briefly four different business model to harness the value created by solar PV expansion across Africa, and assess their attractiveness in three very different countries: South Africa, Kenya and Nigeria. We then proceed to take a deeper look at the best investment opportunity we encountered during our research: an equity investment in a 100 MW solar project in Nigeria. Finally, we describe the strategies used by the project developer to minimize risks and estimate the profitability of this investment under a baseline scenario, as well as the potential downsides.

Table of content
Abstract ......................................................................................................................................................... 1 Power in Africa - A snapshot ......................................................................................................................... 2 Business models How do you invest? ........................................................................................................ 3 IPPs Residential & Commercial .............................................................................................................. 3 Micro-grid operators ................................................................................................................................. 4 Equity investment in utility scale projects ................................................................................................ 5 Diesel hybridization .................................................................................................................................. 6 Country Overviews........................................................................................................................................ 7 Kenya......................................................................................................................................................... 7 South Africa............................................................................................................................................... 9 Nigeria ..................................................................................................................................................... 11 Attractiveness matrix .................................................................................................................................. 14 Deep dive: Project investing in Nigeria ....................................................................................................... 15 Rationale of the investment ................................................................................................................... 15 Dealing with risk...................................................................................................................................... 16 Returns .................................................................................................................................................... 17 Conclusion ................................................................................................................................................... 19 Appendix ..................................................................................................................................................... 20

Power in Africa - A snapshot

Based on our research into the drivers below, we believe that solar photovoltaic (PV) power generation will see tremendous growth in Sub-Saharan Africa (SSA) over the next five years. Further, we think that there are attractive opportunities within the industry where private equity investments could earn attractive, risk-adjusted returns. Below are the main drivers that build the investment case, followed by our thoughts on where investments are possible. SSA power consumption lags far behind every global average and will increase with time. Currently, power consumption in SSA at 124 kWh per capita per year, is only a tenth of that found elsewhere in the developing world, barely enough to power one 100-watt light bulb per person for three hours a day)1. As the middle class in Africa grows, we expect they will use more electricity and put upward pressure on the demand for electricity on the continent. SSA power is expensive relative to other developing regions. Currently, the average effective electricity tariff in Africa is USD $0.14 per kWh but ranges as high as $0.20 and $0.30 in many countries both of which are many times more expensive than $0.04 per kWh paid in South Asia2. This means that there is an opportunity for cheaper forms of electricity generation to play a role. Diesel power generation is prevalent, expensive, and likely to become still more so. Africa still generates a significant portion of its consumption from diesel generation with a fuel cost of over $0.30 per kWh. Solar productions costs are low and declining. LCOE3 for solar PV is near $0.07 per kWh in California for utility scale projects4 and $0.12 per kWh for commercial projects. Given infrastructure challenges, Africa may have higher costs but it also has significantly more sunshine (25% more than Germany) and is one of the most appropriate places for solar power generation. African governments are interested in solar. Significant interest has been demonstrated by African governments and solar friendly policies and procurement programs have already been implemented. For example, the South African government committed to procure up to 1.4 GW of solar PV capacity5 and already signed contract for about 1 GW6.

Given the factors listed above, we believe that the demand for solar power could be dramatic and represents potential for attractive, risk adjusted returns. However, there are many ways to be involved in the industry and some are more appropriate than others.

1 2

World Bank: African Development Bank: The High Cost of Electricity Generation in Africa 3 LCOE: Levelized cost of energy. Includes depreciation and all OPEX. 4 Latest results of PG&Es Renewable Auction Mechanism (RAM) 5 South Africa DoE: http://www.ipprenewables.co.za/#page/303 6 http://www.pv-tech.org/news/south_africa_closes_third_stage_of_reippp_bidding

Business models How do you invest?

Initial research also demonstrated that African countries have widely dissimilar energy markets. We quickly became convinced that having the right business models for a given country was the most important step towards capturing this growth opportunity and producing the outsized returns we are aiming for. To this end we short listed five different business models for evaluation. In the following section we will go over some of the types of business models that would profit from strong PV penetration. This is meant to be a short overview of their characteristics and risk / reward profile and then we will focus our efforts and dive deeper into the country and business model combination that is the most attractive.

IPPs Residential & Commercial

IPP stands for Independent Power Producers. Some IPPs build large power plants, but others invest in distributed systems located on clients premises, retaining ownership of the generating asset. The revenues come from long term off-take agreements signed with the customers. This is similar to the business model of Solar City for commercial projects in the USA. Given the very high retail rates for industrial customers, there is a strong demand for behind the meter power production. For example, when we interviewed Mauro Ometto, Business Development Manager for Enel Green Power in Kenya, he reported having been approached multiple times by large electricity consumers that wanted to have part of their consumption satisfied by on site generation operated by a power company. An example of this type of company is SolaireDirect.

Pros Can gain upside from increasing electricity rates over time Better economics because competition is with retail rates not wholesale rate Opportunity to invest in power generation with minimal government interaction

Cons Needs large access to capital, or mechanism to enable third party finance Customer will renegotiate if contract price becomes higher than utility rates Maintenance problematic (need to access client premises) Unless net metering exists, system size limited by client consumption Credit risk is high; repossessing assets in case of default is expensive Very few investments options. Solaire Direct is the only one we found.

Micro-grid operators
In many rural parts of the world, grid electricity is simply not available. The populations of these areas either pay a high price for electricity coming from diesel generator or completely lack access to electricity. Some companies are stepping up, and building small micro-grids based on solar power and batteries. The costs are high, but so is the willingness to pay (compares to kerosene spending on lamps and time spent to charge cellular phones). Rural electrification is quite a challenging space, and some of the organizations trying to solve the problem are actually non-profit (example: Egg Energy). This being said, the winner of this race will receive a rich prize as over 10 Bln $ a year is currently being spent on Kerosene for lighting purpose across Africa7. This number grows exponentially as more appliances can be added once a micro grid becomes available. Director for Business Development of PowerGen Re, Eve Meyer is very optimistic about the prospects of her company, but acknowledge that to attracting capital is proving to be challenge
Figure 1: Sub-Saharan population Distribution by Settlement type Source: Foster and Briceno-Garmendia, 2010

Examples of for profit micro-grid operators are PowerGen Renewable, Standard Microgrid (Namibia) and Devergy (Tanzania). Another interesting company (but a more VC-like investment) is PowerHive8 who is developing an integrated micro-grid solution including pre-payment made through customers mobile phone. Pros Cons Potential access to cheaper development debt from DFI Natural exit through an acquisition by national utilities as grid expands Client captive once grid is built Client base sparse and with limited financial resources CAPEX intensive business Rapid technological innovation might create obsolescence of assets deployed (battery integration, payment systems)

Source: http://www.climateinvestmentfunds.org/cif/sites/climateinvestmentfunds.org/files/IFC%20%20Lighting%20Africa.pdf 8 http://powerhive.com/

Equity investment in utility scale projects

Large solar projects have already gained access to project finance in some part of Africa but a significant share of equity is still required. During an interview, the VP of Business Development for a global solar project developer affirmed that South African commercial banks were willing to finance up to 70% for such projects in South Africa and East Africa, as long as all the permitting was done and a PPA had been signed. This has been confirmed by other interviewees as well. Developers often have small balance sheets (unless they are also involved in other parts of the value chain) and are unable or unwilling to shoulder all the equity risk for large projects. In the US, equity investors would join in to enjoy the tax benefits (ITC, MARCs) that are too large for the projects to fully utilize on their own, but such preferential tax treatment is not present in African countries. Solar has only recently been cost competitive with diesel generation, and investors are not yet familiar enough with the technology to finance large scale deployment across Africa, with the exception of South Africa where the auction for solar projects has attracted a large number of international buyers. The major risk for such long term investments is a PPA renegotiation during the plant life (30+ years). This risk is obviously higher when there is excess availability of cheaper electricity sources. For example, one interviewees warned about the possible availability of cheap gas (~4$/mmbtu) in East Africa over the next 5 to 10 years due to the gigantic offshore recently identified near Mozambique9.

Pros Attractive return on equity investment attractive (except in South Africa) Potential for exits by selling assets to infrastructure funds once the plant is up and running Developers with worldwide experience and reputation, with capability to deliver performing plants No risk linked to execution or management once project is completed

Cons Returns are expected to come down as capital providers across the board are becoming more comfortable with solar and Africa. Equity returns in South Africa already weak due to structured tender process Highly dependent on the national utility for payments PPA renegotiation a large risk (especially when more expansive than newer power sources)

http://www.nytimes.com/2013/10/04/business/eni-of-italy-considers-large-gas-project-inmozambique.html?_r=0

Diesel hybridization
We believe there is an opportunity to purchase companies running large diesel generator fleets (either for telecoms or micro-grids) and have them install solar panels to offset part of their diesel consumption.

Figure 2. Levelized cost of solar PV compared with Levelized cost of Diesel generation and fuel cost, $/MWh Source: Lazard 2013

As we can see on Figure 2, the difference between the fuel cost and LOCE (Levelized Cost of Electricity) for diesel generation is very small. This is because diesel generators are inexpensive, but fuel costs are very high at over $0.30 per Kwh. Because fixed costs are so low for diesel generation, a diminution of the capacity factor10 does not have a strong impact on the LOCE of diesel: a reduction of the capacity factor from 80% to 30% only increases the LOCE of a diesel generator by approximately 7%. Co-locating solar PV generators would offset a significant portion of the fuel expenses, replacing a fuel cost of ~0.30 $/kWh by an LOCE of ~0.15$/kWh. Assuming the power is sold at 0.40 $/KWh, this represents an opportunity to quadruple EBITDA for the operating company. Thika Power Limited is an example in this industry.

Pros
Straightforward path to improve economics of existing business Diesel and oil power generation currently on the rise in many African countries. Existing customer base and sales agreements at high prices

Cons
Control stake with hands on investment approach required to change the business model Future grid expansion puts a risk on profitability Additional capital requirements after acquisition to install PV panels Availability of suitable land near existing facilities might prove an issue

10

http://en.wikipedia.org/wiki/Capacity_factor

Country Overviews
Kenya
GDP growth and distribution:
Kenya has a broad based economy, which reduces its vulnerability to external shocks and provides basis for resilient growth. Rapid economic growth in other East African countries is expected to spur demand for Kenyan goods and services. The GDP is expected to grow 5.6% in 2014 and 5.7% in 2015, helped with relatively cheap credit and improving global conditions. GDP growth is expected to remain strong in the following years. The main drivers of growth will be private consumption and investments, especially in infrastructure. Despite the new investment, the fast growth is expected to highlight transport and power bottlenecks.

Currency: Inflation and foreign exchange rates

Average inflation fell to 5.7% in 2013. Kenya is expected to adopt more rigid inflation targeting policy in the coming years and inflation is expected to be 6.3% in 2014 and 5.8% in 2015. Two main determinants of inflation are weather and global oil prices, and barring a serious disruption in them inflation should remain in the range of 4.5-5.2% range until 2018. The weather determines inflation level due to its impact on agriculture and hydroelectricity prices. As the monetary policy becomes more sophisticated and competition in financial sector increases, the lending rate is expected to fall from 17.3% in 2013 to 11.3% in 2018. The shilling is currently valued 86.31 KSh/USD in 2013. The currency is expected to remain under pressure from global monetary tightening, declining tea export earnings and local demand for foreign exchange due to brisk economic growth. Barring major shocks, the exchange rate is expected to continue to depreciate at a moderate pace and slide to 102.5 KSh/USD by 2018. The steady increase in exports, tourism and remittances is expected to help narrowing the current account deficit from 9.3% of GDP in 2014 to 4.3% of GDP in 2018. However, dependence on short-term investment flows leaves the economy vulnerable to external shocks.

Politics and regulation

Current President Uhuru Kenyattas clear victory in 2013 and subsequent peaceful transition of power marked an improvement in political stability. Corruption, high taxes, over-regulation and weak governance continue to be the main drag on the development of private sector and foreign investment. However, the government has demonstrated commitment to business friendly economic policy. Foreign investments usually receive the same treatment with the local investments and multinational companies make up a large portion of Kenyas industrial sector. A handful of sectors, including power, is considered strategic and remains in government control. However, there has been some liberalization and recently a number of deals with independent power producers have been signed. 7

Tax regime
The main tax rate is 30% for locally incorporated companies and 37.5% for foreign firms. Companies newly listed on Nairobi Stock Exchange pay a tax rate of 20% for 5 years. Dividends received by resident company are usually exempt from tax. Non-residents pay 10% withholding tax they receive on dividends. VAT is charged at 16% on most transactions.

Africa Factors
High levels of corruption and infrastructure problems discourage local and international investors. Ethnic divisions is a potential source of instability in the country, ongoing conflict between different ethnic groups can potentially boil over into violence especially during the election period. Civil wars in neighboring Somalia and South Sudan are another main source of security risk and regional instability. Climate is another risk factor for Kenyan economy - poor rain would hurt agriculture production, trigger high inflation and strain balance of payments position.

Energy Supply11
Total Generation (TWh)
20 15 Renewables 10 5 0 Coal Hydro Oil

Figure 3: Electricity Generation in Kenya, actual and forecasted Source: BMI, World Bank Electricity costs are quite high in Kenya, ranging from $0.20 to $0.24 per kWh12 and can vary by 20% to 25% year to year. Further, given the reliance on hydropower, energy costs are dependent on variable rainfall. In January 2014, Kenya's government announced very ambitious plans the power sector, aimed at grid extension, geothermal generation and solar power (1.2 Bln$ for solar alone, with the government to providing 50% of the cost).

11 12

EIA Country Data http://rayofsolaris.net/misc/kenya-electricity/

South Africa
GDP growth and distribution
South Africa is the largest and most advanced economy in Africa. It is an open economy exposed to global developments and trends. The economy grew 1.9% in 2013 and is expected to grow by 2.5% in 2014 and slightly accelerate in 2015-17. The main drivers for growth will be consumption and investments.

Currency: Inflation and foreign exchange rates

Consumer price inflation was 5.8% in 2013 and is expected to be 5.6% in 2014. The main driver of inflation is sharp depreciation of rand which pushes up the import costs. Rises in electricity tariffs, wage increases and currency depreciation will continue to exert upward pressure on inflation, however the inflation is expected to remain under check within the central banks 3-6% target range in the coming years. The average exchange rate was 9.64 R/USD in 2013, but weakened to 10.88 R/USD in January 2014. Barring any exogenous shocks and drastic negative policy changes, rand is expected to slightly rebound after the elections in April and later resume the tendency of gradual depreciation and hit 11.00 R/USD range by 2018.

Politics and regulation

South Africa enjoys relatively strong and independent institutions. Even though African National Congress has recently weakened, it is still dominant and this ensures political stability and policy continuity. The ruling ANC is expected to win the elections in May, and President Jacob Zuma to serve a second five year term. South Africa also has an effective legal system that enforces contracts and regulations are usually effectively implemented. Property rights are well protected and foreign investors do not have any restriction for property ownership. There are no controls over the repatriation of income and capital gains by foreign citizens. South Africa is one of the least corrupt countries in Africa, even though its profile has slightly deteriorated in the recent years. The main threat to long term stability is big divide in the society due to inequality. Even though South Africa is the most developed country in Sub-Saharan Africa, poverty is widespread. According to the UNDP, 42.9% of the population lives on less than 2 USD per day. With dissatisfaction rising among poor black South Africans who form the majority of the population, sudden disruptive events such as the escalation of industrial unrest that took place in 2013 remains a risk.

Tax regime
Foreign investments can benefit from 50% or 100% tax allowance if the investment is approved and managed through Strategic Industrial Project Program. Standard corporate tax rate is 28%. The tax rate for foreign companies operating through a branch or agency is 34%. A standard VAT rate is 14%. Capital gains are tax free and dividends received by a South African company are tax exempt.

Africa Factors
Structural shortcomings will continue to hamper South Africas long-term economic growth. Years of
9

underinvestment in education has resulted in skills deficit, which is the main reason of structural unemployment. High unionization increases cost of labor for foreign investors. High HIV/AIDS prevalence and high crime rate are two other factors that decrease the countrys attractiveness for foreign investors. Problems in the power sector could be another important deterring factor for foreign direct investments.

Power Supply13
Total Generation (TWh)
350 300 250 200 150 100 50 0 Renewables Hydro Oil Nuclear Coal

Figure 4: Electricity Generation in South Africa, actual and forecasted Source: BMI, World Bank Currently, energy is relatively cheap in South Africa ($0.08 to $0.16 per kWh14). However, this rate can be substantially higher as municipalities charge extra fees on top of the national utility (Eskom) rates. As a result of years of underinvestment state utility company Eskom is unable to meet the increasing demand for power. South Africas also supplies a significant portion of the neighboring states needs. To continue supplying other countries as well growing domestic demand, Eskom is planning aggressive investments in expanding generation capacity through more coal-fired plants, nuclear plants, and renewables. Eskom, they will need to borrow 3 Bln$ a year for up to five years to finance their expansion plans15.

13 14

EIA Country Data Source: Eskom 15 Business Monitor International - Industry Forecast - Energy & Utilities - South Africa - Q4 2012

10

Nigeria
GDP growth and distribution:
With a population of around 150 million, Nigeria is the most populous country in Africa. A centrally located, oil-rich and pro-reform Nigeria can potentially reap huge advantage from increasing investor interest in Africa. The average growth is expected to be 6.4% in 2014-15 and 7% in the following years if the new government is able to concentrate on economic growth after 2015 election. Oil production is going to increase only slightly, so the non-oil sector is expected to be the main driver of economic growth. Weak and unreliable power supply has been one of the main factors hindering development of local industries. So, improvement in local energy supplies after the recent privatization program is expected to support growth in these sectors.

Currency: Inflation and foreign exchange rates

Due to strong government spending in the election period and high import demand inflation is expected to remain high at around 10%. Central Bank pursued tight monetary policy in the recent years to control inflation, so whether the new leadership of the Bank will have the strength to continue the same position will be critical. Exchange rate was 155.4 N/USD in 2013, it is expected to be 165 N/USD in 2014 and continue this slide to 190 N/USD by 2018. General downward trend in oil prices and increasing imports due to infrastructure spending and consumer imports will decrease the current account surplus. Overall the current account surplus as percentage of GDP is expected to narrow from 8.1% in 2014 to 6.8% in 2018.

Politics and regulation:

Nigeria has high risk of political instability and terrorism. Threats to political stability come from different angles. The ruling PDP expects a major challenge in the upcoming presidential election in 2015. The ethnic and regional differences can lead to defections in PDP coalition prior to the election and a close election result can trigger an extended period of instability. At the same time, the risk of Islamic insurgency in the North and militancy in the Nigerian Delta spreading to commercial centers can harm investors confidence and hence countrys economic prospects. Overall stability is expected to continue, however it cannot be overruled that an unfortunate chain of negative events can lead to a military coup or civil war in the extreme case.

Tax regime
Foreign firms are allowed full ownership of companies operating in Nigeria, with the exception of the oil sector. Nigeria has relatively low taxation, with VAT just 5% and main corporate tax rate at 30%. A 10% tax is imposed on capital gains. Dividends and interest are both subject to a 10% withholding tax.

11

Africa Factors:
Long-time political instability, corruption, inadequate infrastructure and poor macroeconomic management have been the main impediments for Nigerias growth. High oil revenues have not trickled down to population, 90.8% of Nigerians are living on less than 2USD per day, creating conditions for civil unrest. Militancy in the North and oil-rich Niger Delta region has risk of spreading to other parts of the country and this would deteriorate the overall business environment. Nigeria is one of the most corrupt countries in the world, which is a major constraint both for business development and policy improvement in the country. Problems in the energy sector come on the top of Nigerias infrastructure shortcomings. In a recent survey, 54% of manufacturers cited unreliable power as the most binding constraint to efficient production.

Power sector
Total Generation (TWh)
60 50 40 30 20 10 0 Renewables Hydro Oil Natural Gas

Figure 5: Electricity Generation in Nigeria, actual and forecasted Source: BMI, World Bank In 2011, Nigeria produced just 25 terawatt-hours, or about 150 kilowatt-hours per person, which is 32 times less than the per capita generation in South Africa. Nigeria has long sold its power below cost, thus discouraging investment in the sector and compounding chronic electricity shortages. The situation is changing and a major tariff review was introduced in 2012. The increase was massive, ranging from 28% to 88%, from an average price of about 6 cts/kWh. But price is not the issue, but availability is. More than half the population is without grid access, and even those on the grid experience frequent outage. Most Nigerian actually resort to own generation through expensive diesel generators, spending over 13 Bln$ a year on fuel.

12

Kenya 2012 Gross domestic product (GDP) at purchasing power parity (PPP) in US$, bil USD GDP at purchasing power parity (PPP), divided by population, USD Percentage change in real GDP, over previous year. Mid-year population estimate, million Percentage change in consumer price index in local currency (period average), over previous year. National currency per US$, period average Rate on commercial banks unsecured loans and advances to the public. Current-account balance as a percentage of GDP. Net flows of direct investment capital by non-residents into the country, Bln $ Corruption Perceptions Ranking Starting a Business, Rank Getting Electricity, Rank Electricity Generation, Total, TWh 2013

South Africa 2012 2013

Nigeria 2012 2013

74.99

79.82

576.75

597.07

262.6

285.9

1,736 4.56% 43

1,800 4.80% 44

11,009 2.47% 52

11,310 1.90% 52

2645 6.5% 170

2794 6.7% 174

-6.90% 84.53

-6.10% 86.12

5.75% 8.20

5.77% 9.64

12.2% 156.81

8.5% 155.38

19.70% -10.45%

17.30% -9.00%

8.75% -5.24%

8.50% -6.60%

16.8% 7.9%

16.6% 7.6%

0.26 139 132 162 8.3

0.70 136 128 163 8.8

4.63 69 56 148 246.5

7.89 72 64 151 248.9

7 139 114 184 30.2

5.5 144 122 185 32.6

13

Attractiveness matrix
South Africa Nigeria Kenya

(+ +)
IPPs Residential & Commercial
Interesting business model due to strong property rights and access to capital. Especially attractive if retail rates are raised according to current plans. High potential demand in mining sector.

(-)

(-)

Low per capita GDP and electricity consumption, Weak rule of law and credit risk

Low per capita GDP and electricity consumption, Weak rule of law and credit risk

(-)
Micro-grid operators
75% of South Africans is already connected to the grid, and it quite reliable16

(+)

(+)
Only 18% have access to electricity today, but purchasing power is a major issue. Estimated 2$/month spent by a family on kerosene for lightning purpose17

50% of Nigerians lack access to electricity.

(- -)
Direct investing in large projects

(+ + +)
Projects currently offered with very attractive risk adjusted returns. See deep dive below for more information

(- - -)
FiT tariff relatively low at 12 cts per kWh. High regulatory uncertainty. Cheap gas coming online in the medium term increase PPA renegotiation risk.

High competition in tenders, resulting in very low PPA prices (10 cts per kWh)

(-)
Diesel hybridization
Diesel used mostly as back-up, or self-operated by industrials. Better entry through IPP model.

(+ +)
Over 6000 MW of installed diesel generator installed capacity18 and over 13 Bln $ is spent annually on fuel19. Need to find the right company/ business model

(+)
3 new fuel oil 80 MW plants have just received approval for construction, but seasonality in demand (thermal use mainly during dry season)

16 17

Source : World Bank, http://data.worldbank.org/indicator/EG.ELC.ACCS.ZS Source: Lightning Africa, 2012 18 Source: The Guardian: http://www.theguardian.com/global-development-professionals-network/adam-smithinternational-partner-zone/nigeria-power-electricity-africa 19 Source: Nigerian Energy Commission

14

Deep dive: Project investing in Nigeria

The project that captured our attention during our research was a 100 MW solar farm developed by Nigeria Solar Capital Partners, a JV between GigaWatt Global (a worldwide project developer) and Industry Capital (a real commercial real estate American Private Equity firm with about 1.5 Bln$ AuM). We interviewed Joel Abrams, the Managing Director of Nigeria Solar Capital Partners. Nigeria Solar Capital Partners is acting within the Framework of President Obama's Power for Africa initiative. Their target investment is 1 Bln$, out of which 300 Mln$ of equity and the rest from project finance. This is the equivalent of 400 MW of solar PV plant. They already have one project signed that is being built in Rwanda.

Rationale of the investment

Industry Capital is concerned about their ability to continue to provide the solid cash generation in American real estate that their LPs are requiring and are looking for alternatives. They partnered with GigaWatt Global, and are financing the development costs (approximately 4 Mln$) for solar projects in Nigeria. Nigeria Solar Capital Partners will retain a small portion of the equity for the first project, and invite an infrastructure fund or another Equity firm to participate (According to them, around 10 funds are considering this opportunity, among which Abraaj and MacQuarie). The objective is to showcase the viability and profitability of such projects to their current LPs and to develop the next projects for themselves. The choice of Nigeria was very deliberate. Here are the main drivers behind this decision: Thanks to large oil revenues government should be able to pay a long term contract denominated in US$ Because is a large deficit in electricity generating capacity (40 GW today, getting worst as country grows over 5% annually), and its drag on growth the government is willing offer advantageous terms to attract investment Electricity prices are very high. According to Nigeria Solar Capital Partners, in some regions in Nigeria electricity costs 15 cts per kWh (where natural gas is available) but in many others, the cost is closer to 40 cts per kWh, as diesel generator are required. The capital market for large solar project is very early stage, and proprietary.

In South Africa, the auction process we mentioned earlier combined with low perceived political risk drove the contract price for electricity to very low prices (during another interview, the Manager of Business development for Enel Green Power in Kenya confirmed that their winning bid was only 10 cts per kWh), whereas Nigeria Solar Capital Partners was able to negotiate a price well over 20 cts per kWh.

15

Dealing with risk

There were two reasons Nigeria Solar Capital Partners decided to invest in a greenfield project. Firstly, attractive options to invest in solar energy assets in Nigeria are lacking. Secondly, Industry Capital was unwilling to take on risks linked with an existing business in Nigeria, such as tax liabilities, property right, corruption, potential pending law suits, etc. Their preference was to start on a clean sheet. The PPA is the central agreement to any solar projects, and a sine qua non condition to obtaining project finance. Because the Nigerian government keen to attract foreign investment in power generation, the PPA terms are extremely favorable: a high price denominated in US Dollars and adjusted by inflation. A major risk for any project is the renegotiation of the PPA if it becomes uncompetitive compared to other electricity source. However, power systems are not as fast moving as consumer goods, and it seems almost impossible to us that a surplus of installed capacity could appear over the next six years: the 40 GW of current deficit will take decades to be fully resolved. As long as there are no excess capacity in the system, the risk of negotiating the PPA is somewhat limited. To further limit this risk, First Nigeria Solar Capital Partners will subscribe to a breach of contract insurance, either through MIGA, Lloyd's, or as a cheaper alternative, Sinasure (Chinese government sponsored insurance institution)20. Because this is a new type of investments, banks were not comfortable to finance this project over a long period of time, so all free cashflows after interest payments will go towards principal repayment. Hopefully future projects will be able to derive more benefits from the interest tax shield by attracting longer term debt. Because the economics are so attractive, the debt will be paid down in six years, a duration the lenders are more comfortable with. The CFO of Sunfunder (a crowdsourcing finance platform based in Tanzania), Dustin Kahler, warned us about technical risks for a PV project in Africa. According to him, Chinese panel manufacturers tend to send their lowest quality lots in Africa, leading to projects unable to operate at specification. Nigeria Solar Capital Partners mitigates that risk by selecting a global EPC company that will also take care of the operation and maintenance of the plant and provides a full guarantee on the performance. It remains uncertain if this guarantee will take the form of a Letter of Credit or a Corporate Guarantee, as the EPC contract is into its final negotiations phase, but the contractor will guarantee a performance ratio of 79%, which is only slightly lower than average values for such projects (~82%).

20

http://www.sinosure.com.cn/sinosure/english/products_short.htm

16

Returns
We evaluated whether this project could generate the kind of returns expected by the LPs of a private equity fund by building a model based on the information provided by Nigeria Solar Capital Partners, other interviewees and our own research. Snapshot of the models is provided in the appendix. Here are the inputs for the calculations: General Value Investment start Operation start Capacity Tax rate Solar resource Range / Comments 6/1/2014 1/1/2015 100 MW 30% 2,000 kWh/m/year Depends on location. Varies between 1600 and 2200. Nigeria does not have great direct irradiation. 82.00% 79% guaranteed by EPC contractor. Could be up to 85%. 1,640 kWh/kWp/year 0.50% Conservative. 0.3% considered realistic by project developers 0.250 $/kWh 3.00% Linked to US $ inflation Initial costs $ per Watt Total installed 0.020 $/W 2 Mln $ 0.020 $/W 10 Mln $ 0.10 $/W 10 Mln $ Range / Comments Varies between 1,5 and 3 Mln$ Varies between 3% and 8% of CAPEX Depends on distance to grid. Typically between 5 and 10 Mln$

Initial Performance Ratio Initial Gross Yield Degradation Contract Price Contract Price growth

Permitting Origination fee Grid connection

EPC (Service only) Racking Inverter Panels EPC total

0.50 $/W 0.30 $/W 0.30 $/W 0.75 $/W 1.95 $/W

50 Mln $ 30 Mln $ 30 Mln $ 75 Mln $ Conservative estimates. Can be as low as 0.65$/W 195 Mln $ Lowest possible: 1.1$/W in Europe. 1.8$/W would be great in Nigeria

Total

2.07 $/W 207 Mln $ 17

Recurring cost O&M Other Insurance per W Total 0.030 $/W 3 Mln $ Includes plant insurance against damages 0.010 $/W 1 Mln $ Shit happens! 2.00% To cover breach of contract. According to NSCP, MIGA insurance would cost 2% of revenues. They planned to insure 80% of revenues. Sinasure would cost less than half of that 0.010 $/W 1 Mln $ Highly location dependent. Varies from 0.5 to 1.5 Mln $ per year Finance Value Leverage Debt interest rate 70% 7.0% Range / Comments Considered standard in Africa. Goes up to 90% in North America Would be 11% if provided by commercial banks, but IDF are willing to finance. 7% obtained for similar project in Rwanda. Set as 1% of debt issued Used to valuate project on exit at the end of the third year of operations

Land lease

Initial finance fee Equity expected returns WACC (pre-tax) WACC (post tax) Inflation

1,358,000 $ 20.0%

10.9% 9.4% 3% Used to increase inverter cost (replaced every 10 years)

RESULTS
Unlevered IRR Equity IRR Resale after 3 years IRR: 27% 13.72% 16.91% MoM : 2.06 Assumes an infrastructure funds acquire the project after the third year, expects 20% return on equity, and is able to maintain a 70% leverage throughout the project life MoM : 1.55 Exit after 5 years, and PPA is renegotiated with a 30 % discount (takes in account insurance payout for 80% revenues for the next 15 years) MoM : 0.91 Construction experiences delay, no penalties are paid by the EPC company and the first year of revenue is lost

Bad scenario

IRR: 9%

Nightmare scenario

IRR: -2%

18

Conclusion
To invest in the solar PV opportunity in Africa, we would consider three options: A minority equity stake in an IPP in South Africa. While the sector is not extremely attractive with the current low level of electricity retail rate, the planned increase in rates could provide a significant upside if it were to materialize. The main challenge for this type investment is to find the right company with the right management team to execute. A majority stake in the operator of a diesel generator fleet in Nigeria, followed by additional investments in solar panels to offset fuel consumption. This is a large opportunity as Nigerians spend 13 Bln$ annually on diesel for power generation. It implies a significant change of business model for the acquisition target and hence would require a very active participation from the operations team of the investing fund. An equity investment in a utility scale solar plant project in Nigeria. South Africa was not attractive for this type of investment because the strong international participation in solar procurement auctions resulted in low electricity prices and meager returns for investors. In Kenya, the potential impact of recent gas finds on electricity prices, as well as concerns on exchange rates made us uncomfortable about such a long term investment.

Ultimately, we selected the third option developed by Nigeria Solar Capital Partners. Their project offers effective and convincing ways to mitigate the risks inherent to a utility scale solar project (PPA renegotiation, technical failure) while offering attractive returns with an Internal Rate of Return of 27% and Money on Money multiple of slightly over 2. According to our estimations, even if the PPA is renegotiated, the investment remains profitable with a MoM multiple of 1.55 thanks the breach of contract insurance. It is highly improbable that this level of returns will be only available on the long term. Once a track record for solar PV project in Nigeria will be established, profitability will go down as more investor will be willing to provide capital. We consider this project to be an excellent investment opportunity, and advise our investment committee to consider it.

19

Appendix
List of interviews performed
Mauro Ometto, Business Developer Manager for Kenya, Enel Green Power VP for India and Africa, Global Dustin Kahler, CFO, Sunfunder Eve Meyer, Director of Business development, PowerGen Renewable (Kenya) Joe Abrams, Managing Director, Nigeria Solar Capital Partners Associate investment office, IFC Cemile Hajibeyoglu, Analyst at IFC (Kenya) Cody Steele, Senior Associate, MacQuarie

20

Solar resource overview

There are two type of measure for the amount of light received: Global and Indirect.

Figure6. World global irradiance (left) and direct irradiance (right) Source: http://meteonorm.com/ We can make two conclusions from these 2 maps: Africa has some of the best global irradiance in the world. Northern and southern Africa have very high direct irradiance.

Figure 7 Africa Global irradiance. Source: http://solargis.onfo As a rule of thumb, when operating temperatures are high and light more diffuse, a developer should use thin films panels with a direct band gaps (CadTel or CIGS) for best results. Projects in equatorial Africa will therefore perform better with thin films panels. This might prove a hindrance since most of the worlds production capacity is for silicon based solar cells.

21

Model for returns on Nigerian project

Income Statement
(Investment) 2013
0

2014
1

2015
2

2016
3

2017
4

Production Coef. Max Production Losses Output Sales Revenues Others Revenue OPEX Insurance Land lease EBITDA Depreciation EBIT Income taxe Unlevered Income Interest payment Net Income

MWh % MWh Mln$ Mln$ Mln$ Mln$ Mln$ Mln$ Mln$ Mln$ Mln$

0 0 0 0 0 0 0 0 0 0 0 0 0 0

0% 0 0.5% 0 0.0 0.0 0.0 0.0 0.0 (1.0) (1.0) (11.9) (12.9) 3.9 (9.0) (10.1) (19.2)

100% 164,000 0.5% 163,180 43.3 0.0 43.3 (4.2) (0.9) (1.1) 37.1 (11.9) 25.3 (7.6) 17.7 (10.7) 7.0

100% 164,000 1.0% 162,360 44.4 0.0 44.4 (4.4) (0.9) (1.1) 38.0 (11.9) 26.2 (7.8) 18.3 (9.3) 9.0

100% 164,000 1.5% 161,536 45.5 0.0 45.5 (4.5) (0.9) (1.1) 38.9 (11.9) 27.1 (8.1) 18.9 (7.9) 11.1

Mln$ Mln$ Mln$

0 -1.449 0

Cashflow Statement
Unlevered Income (+) Depreciation () CAPEX () Increase in WC Unlevered Free Cashflow () Interest payments Free Cashflow (+) Net borrowing Free Cashflow to Equity Mln$ Mln$ Mln$ Mln$ Mln$ Mln$ Mln$ 0.0 0 (207.0) (207.0) (1.4) (208.4) 144.9 (63.5) (9.0) 11.9 0.0 0.0 2.8 (10.1) (7.3) 7.3 0.0 17.7 11.9 0.0 0.0 29.5 (10.7) 18.9 (18.9) 0.0 18.3 11.9 0.0 0.0 30.2 (9.3) 20.8 (20.8) 0.0 18.9 11.9 0.0 0.0 30.8 (7.9) 22.9 (22.9) 0.0

Debt Level
Debt 144.9 152.2 133.3 112.5 89.6

Miscellaneous
Discounted flows Disc - Unlevered free cashflow Disc - free cashflow Disc - Tax Shield Disc - Cashflow from Debt Disc - Cashflow to Equity 100.7 60.1 11.3 0.0 (19.3) (207.0) (208.4) 0.0 144.9 (63.5) 2.6 (6.7) 2.7 (2.6) 0.0 24.7 15.8 2.6 (25.8) 0.0 23.0 15.9 2.1 (24.6) 0.0 21.5 16.0 1.6 (23.5) 0.0

Other item MoM Tax shield Levered valued

(63.5) 307.7

0.0 3.0 305.1

0.0 3.2 280.5

131.0 2.8 257.4

2.4 236.0

22

Cost of Solar PV modules Downward trend

Figure 8: Solar panels price trend 1985-2011 Source: Various, consolidated by costofsolar.com

23