PRIVATE EQUITY IN

FRONTIER MARKETS

Winter 2014

SOLAR PV IN AFRICA

Ali Gara

Gib Lopez

Igor Leroux

1

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

2

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 World Bank: 2 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

3

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 Cons

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

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.

4

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)

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

5

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 Cons

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

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)

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

6

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 Cons

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

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

7

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.

8

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

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 EIA Country Data 12 http://rayofsolaris.net/misc/kenya-electricity/

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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

10

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

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 EIA Country Data 14 Source: Eskom 15 Business Monitor International - Industry Forecast - Energy & Utilities - South Africa - Q4 2012

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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.

12

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

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.

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Kenya South Africa Nigeria

2012 2013 2012 2013 2012 2013

Gross domestic product (GDP)

at purchasing power parity

(PPP) in US$, bil USD 74.99 79.82 576.75 597.07 262.6 285.9

GDP at purchasing power parity

(PPP), divided by population,

USD 1,736 1,800 11,009 11,310 2645 2794

Percentage change in real GDP,

over previous year. 4.56% 4.80% 2.47% 1.90% 6.5% 6.7%

Mid-year population estimate,

million 43 44 52 52 170 174

Percentage change in consumer

price index in local currency

(period average), over previous

year. -6.90% -6.10% 5.75% 5.77% 12.2% 8.5%

National currency per US$,

period average 84.53 86.12 8.20 9.64 156.81 155.38

Rate on commercial banks

unsecured loans and advances

to the public. 19.70% 17.30% 8.75% 8.50% 16.8% 16.6%

Current-account balance as a

percentage of GDP. -10.45% -9.00% -5.24% -6.60% 7.9% 7.6%

Net flows of direct investment

capital by non-residents into

the country, Bln $ 0.26 0.70 4.63 7.89 7 5.5

Corruption Perceptions Ranking 139 136 69 72 139 144

Starting a Business, Rank 132 128 56 64 114 122

Getting Electricity, Rank 162 163 148 151 184 185

Electricity Generation, Total,

TWh 8.3 8.8 246.5 248.9 30.2 32.6

14

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

(+)

50% of Nigerians lack access to

electricity.

(+)

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

Direct

investing in

large projects

(- -)

High competition in tenders,

resulting in very low PPA prices (10

cts per kWh)

(+ + +)

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.

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 Source : World Bank, http://data.worldbank.org/indicator/EG.ELC.ACCS.ZS 17 Source: Lightning Africa, 2012 18 Source: The Guardian: http://www.theguardian.com/global-development-professionals-network/adam-smith-international-partner-zone/nigeria-power-electricity-africa 19 Source: Nigerian Energy Commission

15

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.

16

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

17

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:

Initial costs

$ per Watt

installed

Total Range / Comments

Permitting 0.020 $/W 2 Mln $ Varies between 1,5 and 3 Mln$

Origination fee 0.020 $/W 10 Mln $ Varies between 3% and 8% of CAPEX

Grid connection 0.10 $/W 10 Mln $ Depends on distance to grid. Typically between

5 and 10 Mln$

EPC (Service only) 0.50 $/W 50 Mln $

Racking 0.30 $/W 30 Mln $

Inverter 0.30 $/W 30 Mln $

Panels 0.75 $/W 75 Mln $ Conservative estimates. Can be as low as

0.65$/W

EPC total 1.95 $/W 195 Mln $ Lowest possible: 1.1$/W in Europe. 1.8$/W

would be great in Nigeria

Total 2.07 $/W 207 Mln $

General

Value Range / Comments

Investment start 6/1/2014

Operation start 1/1/2015

Capacity 100 MW

Tax rate 30%

Solar resource 2,000 kWh/m/year Depends on location. Varies between 1600 and 2200. Nigeria does not have great direct irradiation.

Initial Performance Ratio 82.00% 79% guaranteed by EPC contractor. Could be up to 85%.

Initial Gross Yield 1,640 kWh/kWp/year

Degradation 0.50% Conservative. 0.3% considered realistic by project developers

Contract Price 0.250 $/kWh

Contract Price growth 3.00% Linked to US $ inflation

18

Recurring cost

per W Total

O&M 0.030 $/W 3 Mln $ Includes plant insurance against damages

Other 0.010 $/W 1 Mln $ Shit happens!

Insurance 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

Land lease 0.010 $/W 1 Mln $ Highly location dependent. Varies from 0.5 to 1.5 Mln $ per year

Finance

Value Range / Comments

Leverage 70% Considered standard in Africa. Goes up to 90% in North America

Debt interest rate 7.0% Would be 11% if provided by commercial banks, but IDF are willing to finance. 7% obtained for similar project in Rwanda.

Initial finance fee 1,358,000 $ Set as 1% of debt issued

Equity expected returns 20.0% Used to valuate project on exit at the end of the third year of operations

WACC (pre-tax) 10.9%

WACC (post tax) 9.4%

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

RESULTS Unlevered IRR 13.72%

Equity IRR 16.91%

Resale after 3 years IRR: 27% 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

Bad scenario IRR: 9% 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)

Nightmare scenario IRR: -2% MoM : 0.91 Construction experiences delay, no penalties are paid by the EPC company and the first year of revenue is lost

19

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.

20

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

21

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.

22

Model for returns on Nigerian project

Income Statement(Investment)

2013 2014 2015 2016 20170 1 2 3 4

Production Coef. 0 0% 100% 100% 100%Max Production MWh 0 0 164,000 164,000 164,000

Losses % 0 0.5% 0.5% 1.0% 1.5%

Output MWh 0 0 163,180 162,360 161,536

Sales Revenues Mln$ 0 0.0 43.3 44.4 45.5

Others Mln$ 0 0.0 0.0 0.0 0.0

Revenue Mln$ 0 0.0 43.3 44.4 45.5

OPEX Mln$ 0 0.0 (4.2) (4.4) (4.5)

Insurance Mln$ 0 0.0 (0.9) (0.9) (0.9)

Land lease Mln$ 0 (1.0) (1.1) (1.1) (1.1)

EBITDA Mln$ 0 (1.0) 37.1 38.0 38.9

Depreciation Mln$ 0 (11.9) (11.9) (11.9) (11.9)

EBIT Mln$ 0 (12.9) 25.3 26.2 27.1

Income taxe 0 3.9 (7.6) (7.8) (8.1)

Unlevered Income Mln$ 0 (9.0) 17.7 18.3 18.9

Interest payment Mln$ -1.449 (10.1) (10.7) (9.3) (7.9)

Net Income Mln$ 0 (19.2) 7.0 9.0 11.1

Cashflow Statement

Unlevered Income Mln$ 0.0 (9.0) 17.7 18.3 18.9

(+) Depreciation Mln$ 0 11.9 11.9 11.9 11.9

() CAPEX Mln$ (207.0) 0.0 0.0 0.0 0.0

() Increase in WC Mln$ 0.0 0.0 0.0 0.0

Unlevered Free Cashflow Mln$ (207.0) 2.8 29.5 30.2 30.8

() Interest payments (1.4) (10.1) (10.7) (9.3) (7.9)

Free Cashflow Mln$ (208.4) (7.3) 18.9 20.8 22.9

(+) Net borrowing 144.9 7.3 (18.9) (20.8) (22.9)

Free Cashflow to Equity Mln$ (63.5) 0.0 0.0 0.0 0.0

Debt Level

Debt 144.9 152.2 133.3 112.5 89.6

Miscellaneous

Discounted flows

Disc - Unlevered free cashflow 100.7 (207.0) 2.6 24.7 23.0 21.5

Disc - free cashflow 60.1 (208.4) (6.7) 15.8 15.9 16.0

Disc - Tax Shield 11.3 0.0 2.7 2.6 2.1 1.6

Disc - Cashflow from Debt 0.0 144.9 (2.6) (25.8) (24.6) (23.5)

Disc - Cashflow to Equity (19.3) (63.5) 0.0 0.0 0.0 0.0

Other item

MoM (63.5) 0.0 0.0 131.0

Tax shield 3.0 3.2 2.8 2.4

Levered valued 307.7 305.1 280.5 257.4 236.0

23

Cost of Solar PV modules Downward trend

Figure 8: Solar panels price trend 1985-2011

Source: Various, consolidated by costofsolar.com