The following commentary was originally posted on FoolFunds.com, the website of Motley Fool Asset Management, LLC, on Jan. 9, 2013. With permission, we're reproducing it here in its original form.
"That we are surrounded by deep mysteries is known to all except the incurably ignorant."
-- Chinua Achebe
Tony Arsta and I were sitting in a restaurant in Lagos. I'd ordered the "Nigerian assorted-meat stew." Halfway through our meal, the chef came out to greet us and see how our meal was because he'd "never seen an expat order that dish before."
Such is life in Lagos. Due to Nigeria's massive oil industry, Lagos has long been home to thousands of expatriate workers, many of whom have tended to lock themselves into high-walled, razor-wire-topped compounds, well isolated from the crowds, protected from the more freelance forms of crime prevalent in the city. You could live for years in Lagos and never try Nigerian food. Apparently, many do just that.
In Nigeria they tell an anecdote that captures very well the spirit of the country's largest city. When you step off a plane, you're greeted by a sign that says "THIS IS LAGOS." The sign offers none of the cheerful civic-mindedness of other cities. It doesn't bother to welcome you, but it does show that someone is minding things enough to put up the sign in the first place. It's an announcement of utter indifference. "You're here. If you don't like it, feel free to go someplace else."
Having heard this story, I found myself oddly disappointed upon spotting a "Welcome to Lagos" sign. I did find an odd comfort when Tony asked what kinds of meat were in the stew and was told that it was "assorted."
When you think of the world's great investing opportunities, I doubt highly that the word "Nigeria" crosses your mind. But our investing group had found an exceedingly interesting set of companies based in Nigeria that were profitable, highly capitalized, and seemingly blessed with highly skilled managers. In some ways, the challenges of operating in Nigeria offer their own sort of barrier to entry -- this is one of the most difficult countries in the world in which to get anything done. But in order to get any kind of comfort with investing in Nigeria, I thought it incumbent upon us to come to the country and speak to the companies, as well as to others who know the market best.
What we found was a country that is every bit as challenging as advertised. Nigeria has an incredible energy, an undeniable sense of commerce, and a surprisingly deep bench of professionals running many of its institutions and companies. Nigeria remains frightfully poor and horridly governed, a place where little things are often difficult or impossible to accomplish without knowing and/or paying off someone who can make it happen. Yet this is not a nation full of people who have given up. These people are busy.
You say "Lagos," I say...
Lagos is a city of 16 million to 22 million people (no one really knows how many) seething with constant activity. Little of its infrastructure works very well: The roads are jammed, power outages are a daily occurrence, railroads have fallen into total disrepair. Even proud locals admit that the city is a result of a disastrous combination of overcrowding, poor planning, and a nonexistent culture of investing in maintenance. In my reading in preparation for the trip, the word I most often saw associated with Lagos was "hellhole."
And that's when it was mentioned at all. For the largest city in one of the most populous countries in the world, Lagos is, in many ways, invisible.
Lonely Planet, the world's most comprehensive travel publisher, offers guidebooks for obscure destinations like Afghanistan, Timor-Leste, Bangladesh, and even Antarctica. But its offerings on Nigeria are limited to a small section of the 17-country West Africa travel guide, or an even-smaller section of its 53-country Africa travel guide.
The only general travel guide I could find on Nigeria is published by Bradt, which seems to utilize a particular adverse selection process in determining what destinations it covers (it has an offering on North Korea, but not South Korea; Albania, but not France). The author of the Bradt guide uses her introductory paragraph to describe Nigeria thusly: "It is simply one of the world's most difficult places to travel in and the notion of travelling here conjures up a horrific reaction. It's far from a holiday destination, there's very little to see in the way of conventional sightseeing, and it's an environmental disaster." In its review of the Bradt Guide to Nigeria, The Independent, a British newspaper, states that "the author of this brave guidebook ... does not seek to over-sell the destination."
Indeed she did not.
In its 60 years of independence, Nigeria has been through countless dictators, each of whom in turn has stripped the country of its assets and robbed its wealth. Nigeria is one of the world's largest exporters of oil (the Nigerian National Petroleum Corporation claims that the country exports 2.5 million barrels of crude per day), and yet much of its populace remains mired in poverty. Transparency International's Corruption Perceptions Index for 2012 placed Nigeria at 136th out of 176 countries (Denmark, Finland, and New Zealand tied for first, Somalia, North Korea, and Afghanistan tied for last. The United States is ranked 19th).
In the weeks before I left, I heard the same question: "Why would you go to Nigeria?" Not "why are you," but more like "what would possess you to..."
Even five years ago, we would have hardly considered it. In 2008, the security situation in Lagos was so bad that robbers would simply walk from car to car in traffic jams and relieve occupants of their belongings. Even with the universally unflattering picture travel writers and journalists paint of Lagos, you could tell that there was something more to this place. In one breath they would warn visitors against venturing out at night, and in the next they would rave about Lagos' raging music scene and nightlife, which doesn't get cranked up until well after 10 p.m.
Behold, the giant awakes
In the last few years, something remarkable has happened: Nigeria, which for years has been thought of as "the sleeping giant of Africa," began to awaken. Lagos is still a bit of a mess, but we met a sizable number of foreign-educated and -raised Nigerians who have returned home to pursue opportunities there. For example, the CEO of the Nigerian Stock Exchange, Oscar Onyema, is a youthful professional who spent 20 years working in the American financial industry, managing equity trading at NYSE Amex before coming home to Lagos in 2011.
If the bustle of Lagos is any indication, their optimism about the future of Nigeria is well-founded. There are massive changes taking place, and they're reflected in the country's 7%-plus growth rate in gross domestic product. In 2010, for the second time in a decade, Nigeria witnessed a peaceful transfer of power. We found ourselves deeply impressed with the professionalism of many of the managers we met, and saw signs that Nigeria's traditional "patronage" driven system is being slowly replaced with something resembling a meritocracy. I doubt sincerely that even five years ago a 43-year-old would have been considered to be the head of the local stock exchange.
Power and who has it
The story in Nigeria is one of power. Obviously, in a poor country with relatively weak government institutions and a sadly strong tradition of official corruption, even incremental improvements in governance will create dividends. The view on the streets is that some of the country's reforms over the last decade have improved the strength of its institutions. This year, the president enacted a wildly unpopular reduction of government fuel subsidies, the kind of decision that in the past might have invited a military coup. Many believe the religious strife that has beset the northern part of the country (where we were unwilling to go) is largely driven not by fundamentalist fervor, but by politics.
Holding political power in Nigeria can be the difference between poverty and wealth. Nigeria's patronage culture means that politics is driven less by competing belief structures and more by visceral interests of having access to those who control the state's purse strings. It would be easy to make a parallel observation of the trappings of power in the United States, but there is an enormous difference. Nigeria has not been blessed in its history with a surfeit of enlightened leaders with an interest in raising the living standards of the average citizen. Instead, many have benefited from leaving the population plunged into poverty, hopelessness, and darkness.
Anyone who has experienced the constant power outages throughout Nigeria understands that darkness is not a figurative problem. While creaky power systems are a reality in many developing countries, Nigeria's offers a unique view into the challenges that face the country.
Because of the unreliability of the power supplied by the state utility, many residences and almost all formal businesses have large diesel generators on site as backup. The cost both of the generators and the diesel that fuels them is a massive tax on the country's commerce, and backup power costs is one of the key reasons foreign manufacturers have by and large avoided Nigeria. In 2010, South African telecommunications provider MTN disclosed that its cost for diesel to keep its Nigerian operations up cost the company US$5.5 million per month.
The "Diesel Chief"
Nigeria's lack of reliable power supply isn't a simple matter of incompetent management at the power company, nor is it one of demand growth outstripping planning. Rather, it's a case of people actively preventing improvements since they profit so madly from the rot in the system. The social and economic costs have been catastrophic. Nigeria currently produces about 4,000 megawatts (MW) of power. By comparison, South Africa, with one-third the population, produces 10 times as much.
This isn't just an inconvenience. Even beyond the direct costs for backup supplies, power insecurity has long robbed Nigeria of basic economic opportunity. Some economists estimate that Nigeria's annual GDP growth rate would rise from its current 7% to above 10% with reliable power. That's faster than any of the "glamour" growth markets -- including China. This past year, the Nigerian government privatized the power system. One of the winning bidders was the Diesel Chief, giving rise to the hope that the powerful elements that had previously profited from the lack of electricity security in the country will now profit from its improvement.
While most people associate the Nigerian economy with its oil dependence, we were not particularly interested in the extractive industries. Rather, our interest lies in the country's rapidly growing consumer class. Nigeria's population is now more than 50% urban, and it boasts a middle class (defined as households having more than $2 of discretionary income per day) in the tens of millions. Couple this with rapidly rising income levels, and it creates an ideal condition for rapid rises in demand for consumer products. This is a recurring trend across Africa. According to McKinsey & Company, by 2020 more than 50% of its 1 billion residents will live in households earning more than $5,000 per year. This creates an ideal condition for increased demand of consumer products. It should be no surprise that large multinational companies like Nestle, Unilever, Diageo, Heineken, and GlaxoSmithKline have invested heavily in the country.
International companies control large portions of Nigeria's branded consumer goods market. Securities laws require that foreign publicly traded companies list their Nigerian subsidiaries on the Nigerian Stock Exchange. So even though a foreign multinational owns the majority of its Nigerian subsidiary and controls much of its operations, investors can choose to invest directly in the subsidiary. In so doing, we have the opportunity to gain exposure to the potential for long-term growth in Nigeria via ownership in companies that are much more assured to conform to international reporting standards.
There were three things that surprised us about investing in Nigeria. The first was that its reporting and governance standards compared extremely favorably against many of the frontier economies that we have researched in the past. The Nigerian Stock Exchange is a highly professional organization, and it should be little wonder if it competes with or even replaces Johannesburg as the dominant African stock exchange over the next decade.
Second is that the single most impressive company we saw in the country was not the local subsidiary of some multinational -- it was the Flour Mills of Nigeria, a company nearly completely focused on domestic consumption that has proven extremely adept at operating within one of the world's most challenging environments. The situation with the multinationals was also fascinating, but the reality is that these companies have a disincentive to promote their stocks since the parent companies are fully aware of the rates of growth, and across the board are interested in reacquiring shares of their Nigerian subsidiaries. Guinness Nigeria, for example, is incredibly important for its parent company, Diageo, offering the potential for nearly demographically driven growth almost without parallel. Diageo, as a result, doesn't want Guinness Nigeria's stock to go higher, since they might want to buy it.
And third, while it might seem remarkable (a loaded word if there ever was one) that we went to go look for investing opportunities in Nigeria, the most shocking thing to me about our trip is just how unremarkable it was. Our Nigerian representatives, CSL Stockbrokers, told us that they've had a constant stream of visitors coming in from overseas to meet Nigerian companies. Given the news of unrest throughout the country, I would have expected the opposite. I'll be honest -- of everything we learned in Nigeria, this was the biggest bummer. We aren't early, and we aren't even alone. Lots of investors are anticipating that the sleeping giant of Africa will continue to awaken.
After the fact, I realize that this should not have been such a surprise. A few years ago the big trend in international investing involved the BRIC countries -- Brazil, Russia, India, and China. But Russia's lousy governance and the continued massive levels of fraud among Chinese companies have investors scouring elsewhere for long-term growth. Nigeria is a massive country with a huge, extremely industrious population experiencing sustained growth and structural improvements. It should have been no surprise that it had appeared on others' radar screens.
Was it worth it?
So, how was it traveling in Nigeria? Here's what I will say about Lagos -- I was shocked at how pleasant it was. I'm not naive; in Lagos one must always be aware of one's surroundings, yet at no point did we feel uncomfortable in Lagos -- a marked difference from places like Sao Paulo, Karachi -- or even Washington, D.C. The most remarkable thing about our time wandering about the city was how little apparent attention we attracted. Would I go back to Lagos? Absolutely. There are few markets on Earth with more potential. I fully expect there to be hiccups along the way -- no country in history has made a smooth transition from long-term poor governance to inspired leadership -- but Nigeria has a shot at it. And as bad as things have been there, it won't take much to make a massive difference.
For further reading, I suggest:
- Looking for Transwonderland, Noo Saro-Wiwa
- Ballad of Rage, by Toni Kan
- Half a Yellow Sun, by Chimamanda Ngozi Adichie
- The Trouble With Nigeria, by Chinua Achebe
- That awesome music you were talking about?: Femi Kuti, Sahara Al Stars Band Jos, Sonny Okosun
- Best independent source for news on Nigeria: Naija.com
- Where you would go in Lagos to get a Nigerian soccer jersey?: The National Stadium, Surulere
Editor's note: Bill Mann is not able to engage in discussion on the boards or in the comments section below. Bill does not own shares of any companies mentioned.