Frontier markets have gotten more attention from private equity funds in the last few years, but equity issuances have remained incredibly low. Market capitalization is just 3.5% of GDP across FM compared to 60.5% of GDP among developed markets and 17.4% in emerging markets. Market cap isn’t going to catch up to EM anytime soon, but Citi analyst Maria Gratsova thinks that equity issuances should perk up next year.
Frontier Market issuance pick-up
“There is as of yet no flood of paper on the horizon in Frontier Market,” writes Gratsova. “We do, however, expect a modest pick-up in issuance: on the basis of information in public sources, we count a total of c.70 equity deals in the pipeline across FM for the next couple of years.”
Frontier markets necessarily have a lower relative market cap than EM and DM simply because taking a company public isn’t part of the financial culture. Owners may not feel comfortable letting the world pore over their finances or giving up even partial control. But issuances have also been low over the last few years because debt has been cheap while valuations have been low, making equitization the more expense way to raise capital. But this is slowly changing. Gratsova points out that FM valuations have been re-rated 24% this year, and the trend should continue. Add in rising interest rates, and FM corporations looking for capex to expand capacity will have to think more seriously about an IPO.
Impact of privatization on issuance
Issuance will also increase as privatization continues in frontier markets, and as private equity firms (especially in sub-Saharan Africa) start looking for an exit. “We expect issuance in 2014 to surpass this year’s, which should make it the fifth-best year in the last decade – neither a flood, nor a drought,” writes Gratsova. “Furthermore, the outlook for issuance is far from uniform across the frontier markets.”
So far, Frontier Market issuance have been dominated by the Gulf countries (GCC), although some of them are being moved to the iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM), and by the financial sector.
Frontier Markets aren’t as efficient at setting prices as EM or DM, and the political risk is generally higher, so investing in Frontier Markets shouldn’t be done lightly. But they also experience explosive growth, outperforming EM by 1813 basis points so far this year, and having some of the lowest valuations in the world. For investors willing to work hard identifying quality stocks as they come to market, there should be a lot of growth in the next few years.