Virgin Nigeria - "Relocation with Immediate Effect"! : Recent Lesson in Managing Foreign Investors

There has been a lot said and analysed on the recent disagreements between the Federal Government and Virgin Nigeria (a subsidiary of the United Kingdom's Virgin Atlantic Airways). The rift was centered on the initial unwillingness of Virgin Nigeria to move from the Murtala Mohammed Airport's International Airport to the newly Built Domestic wing of the Airport, which was built by a Private Developer under a Build, Operate and Transfer (BOT) agreement with the Federal Government of Nigeria.

The stance of Virgin Atlantic and its chairman, the British serial entrepreneur: Richard Branson, was that the agreement they had with the government at the point of investing in Nigeria stipulated that Virgin Nigeria will always operate from the International wing, while the new Federal Administration continued to insist that the airline move its domestic flight operations from the international wing to the new domestic terminal despite the agreements signed by both Virgin Nigeria and the previous administration of Chief Olusegun Obasanjo.

What I find particuarly disturbing in the entire episode, or should I say Saga, is the manner in which the Federal Government ensured Virgin Nigeria's compliance with its directive. The Federal Government, using security operatives, physically "stormed" the company's offices and grounded its operations. As a result of this, the company had to relocate to the new domestic terminal in order to continue its operations. I believe the government was very wrong in grounding the airline's operations in order to ensure its compliance. Most, if not all, agreements have arbitration clauses which stipulate modalities for resolving disputes and/or disagreements which may arise during the course of the relationship between the parties.

The government should have sought other legal means, including arbitration and litigation, to ensure that Virgin Nigeria complies with its directive. This government has set a bad precedent through its actions, as many foreign investors will be skeptical about investing in Nigeria as they will be unsure of what course of action the government might take in the event of a business dispute or disagreement after they have made their initial investment. In my view, I think it is very important that the Yar'Adua administration tread very softly in dealing with foreign investors, as we do not want to be viewed as being unfriendly to investors. Nigeria needs a lot of
foreign money and technical expertise to drive our economy and we will not advance our

developmental aspirations/plans and our drive for higher Foreign Direct Investments (FDI) by alienating the foreign investors that are already in our economy (as evidenced by indications that Virgin Atlantic may be seeking a buyer for its stake in Virgin Nigeria)

The rule of Law and the democtratic/judicial process may appear slow and inconvenient when we seek quick results, but it is still the fairest and most equitable for resolving business disputes. The earlier we embrace dialogue, eschew unilateral action and institute investment friendly laws and investments, the qucker we wil realise our developmental goals.

Recent Stock Price Declines and Implications for Capital Raising

The recent decline in prices of stocks listed on the Nigerian Stock Exchange has significant implications for capital raising activities. Though few market watchers expect a full blown credit crunch or drying of the capital markets as witnessed in the US and Europe in the last twelve (12) months, it is widely believed that the markets will be a little more discriminating about the quality of the issues that will get financed. What this means is that while high quality companies with well-priced and well packaged issues will still be able to raise equity
capital, it will be more difficult for poorly run companies with questionable valuations to raise capital from the Nigerian Equity Capital Markets.

I believe a relative scarcity of capital is a good thing, as access to capital should be a reward for competent management, clear vision and efficient execution. A number of poorly run companies have been able to raise capital easily in the last one (1) year through Private Placements that were many times over-subscribed as investors sought to take a position in the company pending the eventual listing, and almost certain price appreciation, of the company's ordinary shares. This mentality copupled with ever rising stock prices, led people to invest in companies
they did not particularly undertstand as long as the companies were going to list on the Stock Exchange and scarcity effect was going to push up its share price.

The end result of this over-optimism was that little or no due-dilligence was done by prospective investors and many poorly run or ill-prepared companies were able to raise large sums of money from investors. I believe this situation has grave consequences for corporate performance and the Nigerian Economy as a whole as companies without the structures or operations to deliver good returns on capital employed were raising large sums of money. I believe one of the hallmarks of capitalism is "creative destruction" or the ability to "shoot the mortally wounded"
situations through which companies with crumbling operations and incompetent management are denied funding and allowed to die (to make room for new and innovative companies) instead of being propped up with infusions of capital that will be eroded through bad results.Giving
huge sums of money, in form of equity subscription, to poorly performing companies with questionable strategy and incompetent managements who do not feel the pressure or obligation to deliver value to shareholders is like giving an M16 Assault Rifle to a child soldier and will eventually lead to destruction of shareholder value and long term negative return on capital invested.

The difficulties that I believe poor performing companies will have in raising capital in the near future will have practical implications for the development of Private Equity industry in Nigeria. The ease with which companies have been able to raise money, has placed Private Equity funds in an uncomfortable position as promoters of many small, struggling companies have not been willing to work with such funds. Many promoters and managers of private companies, if given the choice, will opt for private placements rather than receive funds from a Private Equity
Investor. This is because capital raised through Private Placements or Public Offers comes with fewer strings attached to it than Capital raised from Private Equity investors. This is mainly because Private Equity funds usually have higher due dilligence requirements and take a more hands-on approach in monitoring the performance of companies in which they invest and this may not sit down well with company promoters and management that may not want to share control of their companies with a PE investor.

However if struggling companies become constrained in raising capital, they may have to turn to one or more of the new Private Equity funds that have been launched in the last 18-36 months. Private Equity investments can be mutually beneficial to both the PE firms and company promoters and management. This is because PE funds tend to be hands-on investors with significant financial, strategic and operations competencies and are in a position to add some value, apart from capital infusions, to companies in which they invest. The increased levels of monitoring by PE firms, through board memberships and direct executive appointments, will put management "on their toes" and is likely to lead to more disciplined management with the resultant improvements to corporate performance and shareholder value.

Policy Pronouncements and the Recent Performance of Nigerian Equity Capital Markets

Equity Capital Markets in Nigeria have been under considerable strain in the last three (3) months with week after week of sustained price declines and losses. The All Share Index (ASI), the major stock index in Nigeria has witnessed a Year-to-date return of 13% as at Friday, 25th July. The recent deeps in the capital markets have demonstrated the potential downside in investing in equities, as many Nigerian investors have only experienced the upside potentials of the market.

The ever appreciating stock prices had pushed valuations to astronomical heights and led to a capital raising frenzy in the country and many investors and market analysts have been talking of an imminent market correction. In my view the bearish run witnessed on the Stock Exchange was not due to a market correction and return to fundamentals-based investing. I believe the market correction is yet to take place, as the bearish run was precipitated by tightening of credit brought about by policy changes.

The first policy change to hit the markets was the restriction placed on banks from extending margin facilities to Stockbroking firms and from operating margin accounts. Since a large portion of the gains in the markets over the past few months has been due to the activities of leveraged investors with easy access to credit which could be rolled over or paid off from gains from capital appreciation. Hence, a tightening of bank credit, as a matter of policy, will prevent investors from rolling over their margin facilities hence they will have to resort to selling their shares to repay the facilities. This widespread, sustained selling of equities placed an enormous downward pressure on equity prices and led to a freefall of the All Share Index.

The second major policy shift that contributed to the decline was the directive from the CBN that all Nigerian Banks harmonise their financial calendar by having a uniform financial year end pegged at 31st December. Considering the fierce competition in the Nigerian Banking sector and the urge of the various bank managers to be seen as having the largest asset base, it was clear that they will all engage in an all out battle for deposits. Nigerian banks have always engaged in the practice of obtaining huge funds from the Interbank market to beef up their balance sheets towards the end of their Financial years. The uniform year end directive from the CBN led to a near freezing of the Interbank market as banks became reluctant to lend to other banks.

The banks' reluctance to lend coupled with a clear willingness to to attract deposits to boost their balance sheets led to a spike in interest rates and a boom in Money Market activities. When rising deposit and money market rates are viewed in the light of declining stock prices it becomes clear that a good number of investors will move their funds from the stock markets into fixed deposits and money market instruments. This move into money markets resulted in more selling activity on the stock markets with attendant declines in share prices. These policy shifts coupled with already high market valuations led the All Share Index into a negative 11.7% year return.

However, the markets have rebounded in the last one week in the aftermath of the CBN's postponement of the implementation of the Uniform Year End directive to December 2008 to December 2009. This policy shift reduced the pressure on Nigerian banks to engage in aggressive deposit seeking, hence leading to lower fixed deposit and money market rates. The downward pressure on money market rates coupled with the willingness of banks to engage in Margin lending on the stock markets has made more people willing to invest once again in the stockmarket. The sharp increase in Buying activity has resulted in daily gains on the Nigerian Stock Exchange.

I think the overall lesson from this episode of "crashing" prices is the fact that the general investing public now knows that the markets can swing both ways and policymakers will become more aware of the fact that their policy pronouncements can have far reaching consequences and may have a direct, quick and measurable impact on the Financial markets as demonstrated by the CBN pronouncements and the performance of the Nigerian Stock Exchange