Binge investing: Lessons from KQ and Mumias

Out of 10 investment projects, two or three at most will survive rigorous appraisal, thus, when a company goes on an investment binge, it is very likely that it is investing in low return projects, writes David Ndii

Two of Kenya’s corporate icons are in trouble. Kenya Airways has flown into heavy financial weather and Mumias Sugar has turned sour. While the two companies are very different in most respects, the source of their current woes is similar. Both have been pursuing ambitious, debt financed investment-led growth.

At the other end of the scale you have two other corporate icons, Safaricom and Equity Bank, which continue to grow by leaps and bounds. You seldom hear either of them announcing big investments. They have two things in common. They are aggressive marketers, and are plagued by congestion. The congestion tells us that their investment lags growth of their market.

So we have here two alternative investment strategies. KQ and Mumias strategy seems to be “if you build they will come”, while the Safaricom and Equity Bank strategy seems to be “when they come we shall build”. There are two reasons why shareholders of a company should be very wary of investment binges.

SURVIVE RIGOROUS APPRAISAL

First, there are usually not that many high return investments at any point in time. In my experience, out of every 10 investment projects, typically only two or three at most will survive rigorous appraisal. Thus, when a company goes on an investment binge, it is very likely that it is investing in low return projects.

Why, for instance, would Mumias Sugar go into water bottling — a low entry barrier, low margin business that is now literally a jua kali industry?

Second, and more fundamentally, we do not know what the future holds. Let us predict that the market will grow by 50 per cent over the next five years. There are two critical uncertainties, whether indeed the market will grow as predicted, and what the competition is likely to do.

Markets can, and do, change very suddenly. Think for instance of what has happened to the price of petroleum. All of a sudden, the money that was flowing into exploration and development of new oilfields has dried up.

A disruptive competitor, technology or product may be just around the corner. Nokia, market leader by miles, did not see the smartphone coming. Less than a decade later, it is past tense.

This column has raised issue with the mega infrastructure projects that we continue to be told are going to deliver double digit economic growth and banish poverty from the land.

If investment binges are a bad proposition for shareholders, what makes the same a sensible strategy for the country?

A recent World Bank Public Expenditure Review report that made sensational news for rating the performance of counties, also made the following observation:

“Kenya recorded an average growth rate of about 4.6 per cent in the recent years. The composition of growth during the three growth periods 2003-07, 2008-11 and 2012-14 shows that investment contribution to growth has declined to 1.3 percentage points in the recent years, compared to 2.4 percentage points during the high growth period 2003-07. The declining contribution of investment to growth coincides with rising government investment, which raises the question of efficiency of ongoing investments.”

REDUCED BY HALF

The report goes on to cite a previous one which had concluded that our infrastructure investment requirement “could be reduced by half through efficiency gains.”

In effect, the World Bank is suggesting that the decline in investment contribution to growth is on account of bad and inflated public investment projects. You may think that a decline of one percentage point of GDP is loose change. It is not. One percentage point of GDP is in the order of $500 million or Sh45 billion at current exchange rates, about the cost of the new Thika Road.

The mega project disease, which has been limited to the energy and transport infrastructure, is now spreading to other sectors. Recently, the Ministry of Health out of nowhere, was forcing high-tech medical equipment on the counties.

Reports put the cost of this equipment at close to $300 million. I have no issue with equipping hospitals with high tech equipment, but is equipping hospitals in every county in one fell swoop the best way to do so?

We know that the highest economic and social returns in the health sector are in primary health and control of infectious diseases. Would it have made more sense perhaps for the national government to take back and equip the Level 5 (former provincial hospitals), which it is financing anyway, with a view to transforming them into a single national referral hospital system, instead of offloading expensive unsolicited equipment on county facilities?

I have read in the papers recently that the construction of the first three berths of the Lamu Port is about to begin. To the best of my knowledge, the Government has yet to secure funding to build infrastructure from the port to the hinterland.

The idea, I am told, is for the port to start out as a transhipment port, like Dubai, where big ships offload cargo from Asia which is then loaded on smaller vessels to take it onward to final destinations — West Africa for instance.

COVER UP

My own sense is that this argument is a fig leaf to cover up the fact that the much hyped project has failed to secure financial backing. This then begs a question I have raised before. Why did we decide to put Sh300 billion-plus of borrowed money on a second Mombasa-Nairobi railway line instead of building one from Lamu to Thika?

A line from Lamu to Thika would have connected the Lamu port to Nairobi and onwards, as well as continuing along the existing old line to Nanyuki, thus connecting South Sudan and Ethiopia to the Lamu port sooner and at much lower cost than the proposed Lappset routing.

Whether the Lapsset infrastructure will find any funders is doubtful.

The only commercially attractive project was the oil pipeline and that too is doubtful given the prevailing uncertainty in the industry.

To complete the standard gauge railway all the way to Malaba will require another Sh300 billion-plus. There is no lender with a limitless exposure policy on a client, and that includes the Chinese.
But when it comes to mega project folly, the 5,000 megawatts initiative has no rivals.

For starters, the figure is not based on any analysis. It was plucked from thin air. It is the ultimate “if we build they will come” strategy.

You may or may not have heard of a company called Tesla and its visionary Chief Executive Officer Elon Musk. Tesla is the world’s leading manufacturer of electric cars. The selling point of electric cars is environmental responsibility. They do not pollute.

Environmentally conscious consumers don’t just want a car that does not pollute. They want it to have the lowest possible carbon footprint that is one whose production is also environment friendly.

The most critical and polluting component of an electric car is the battery. Tesla has set out to build a mammoth battery factory known as Gigafactory 1 in Nevada that will be powered only by clean renewable energy. It will be powered by a combination of solar, wind and geothermal power. The entire roof of the factory, the size of 174 football fields is to be covered with solar panels.

Tesla’s ambition, according to Mr Musk is to “change the fundamental energy architecture of the world”. How so?

The cost of solar and wind power generation has come down dramatically in recent years and is now comparable to conventional sources. The main challenge with it is the resources cannot be switched on and off at will. Wind is erratic while solar is available during the day, while peak domestic power consumption is in early evening.

Electricity can be stored but conventional battery technology is inefficient, bulky and expensive. Tesla is one of several companies that is in the race to revolutionalise electricity storage both in terms of scale and cost, using lithium-ion batteries, the same technology in your cell phone battery.

THE KEY DRIVER

Earlier this year, Tesla launched a range of domestic power packs and it is planning to launch industrial scale ones as well.

In short, we are on the cusp of an energy revolution.

Very soon, domestic energy will be just one of the fittings that come with a house. Your fridge will come with a power pack to store its own power, just like your phone.

Even large industrial and commercial establishments buildings will be able to self-provide a significant amount of their power cost effectively. The key driver of all of this is environmentally conscious consumers.

Soon, tourists will want to know the carbon footprint of a hotel before they set foot there. This revolution will do to power utilities and dirty fuels what the internet and mobile phones did to the old mail and telephone utilities.

This is where the world is going. And where are we headed? Not only are we in a mad rush to add generation capacity without demand, we have awarded a concession to add 1,000 MW of coal power to the grid. This, for a country which claims to have over 10,000 megawatts of geothermal potential, where the sun shines 365 days in a year, and with millions of acres of windswept wastelands. We could offer investors the cheapest renewable power in the world.

Instead, we are building coal plants that nobody, including us, needs. Far from attracting investors, adding coal power to our energy mix is more likely to keep them away.

David Ndii is Managing Director of Africa Economics. [email protected]