Combating Poverty

I was brought up right in the periphery of a mushrooming slum (everyone was later evicted from the land early 2000) and I believe I had a first-hand experience in understanding the dynamics surrounding poverty and could use the experience to offer possible explanations on why most efforts are yet to completely eliminate poverty and why some might reverse progress made so far. We shared same public schools and other social facilities with the extremely poor (by social facilities I mean slid down the same muddy hills, played same games and swam in same dangerous filthy waters). The saddest bit is that in my former congested class of around seventy pupils, only about ten of us made it past high school and about three of us past the university. Female members were the most affected with a majority starting families prematurely. This is despite serious efforts by donors at providing free lunch (diet that consisted of corn and vegetable cooking oil), water, electricity, books and sponsoring students to raise school attendance (long before the advent of free primary school education).

To begin with, I would like to expressly state that I don’t believe there is a single approach with which we can completely eliminate poverty but rather contend that fighting poverty requires a combination of approaches. For instance even if donors were to hand out money directly to poor families without educating them on good money management practices, the kind of inflation that would accompany such an effort would make the effect too temporary and maybe even aggravate the situation(by making them less willing to work hard, raising crime rate and sponsoring drug abusers/traffickers). Efforts to educate too could be hampered by lack of jobs in the economy; lack of jobs for the skilled labour would discourage unskilled labour to acquire the education they need to improve their human capital. It means, if you have a government that consistently mismanages the economy; poverty is almost guaranteed as a perpetual aspect of the economy. The poor due to possibly poverty induced desperation and low education levels may be unable to regulate the government. Philanthropists recognize this and people like George Soros sponsor whistle blowers who expose incidences of mismanagement and exploitation in governments and private entities. The government too no matter how willing, might be incapable of eliminating poverty on its own without external financial assistance (could be through grants, providing markets for goods, stable external and internal economic environment and very low interest loans).

Education

I recently attended university graduation party of an about twenty six year old girl who had managed to get a degree in education (specializing in geography). In recognizing her efforts we had hoped to inspire other children into following in her trail by providing a visual end result and showing that it is achievable (they too can excel in academics). It was a well-attended ceremony and the local area political leader was present. The ceremony was a big deal for the community because very few girls, if any, in the area have acquired full secondary school education let alone university education. Part of the reason why few girls in the area have taken education seriously is because no one in the community has proved as being distinctly better off in terms of living conditions because they were more educated, showing that there lacked incentives. In fact those who were married off early looked like they were better off than the slightly more educated who were still languishing in poverty some of whom have turned to prostitution. The worrying question about her was; would she be able to get a good job and advance far enough in the society for the rest of the community children to emulate her and to provide enough reason for the parents within the community to push their children into achieving higher education? This is why government support in job creation that rewards more those who are skilled than those are unskilled could be pivotal. Yet some local governments fail in creating reward for effort by discriminating and opting to employ based on relation and or even seeming to prefer those with low levels of education (diplomas rather than university education) thereby distorting the desirable incentives. The only comforting bit would be if the educated were to turn back to their community and enlighten them on what should be the appropriate long-term governance good for the community.

In the community I was brought up in, it was observable that most of those who attended high schools that had boarding facilities managed to complete high school education compared to those who attended day schools most of whom dropped out for a variety of reasons. I believe it still plays a role in poor communities. It is difficult to get all children into boarding facilities but as an alternative, there have been commendable efforts by people from outside these poor communities to mentor young people still within the vicious poverty cycle and even taking them away from the community into well-established universities for tuition on weekends and holidays. This is helping introduce the boarding school effect being promoted in certain poor states in the US. Children from poor families especially in slums are different from those in middle or high income families since they face distinct distractions/challenges. Some of those I watched drop out of school dropped out mostly because of influences from members of the communities and problems within families. For instance a former classmate had to drop out after the sole bread winner in his family, step-father, died alone in the house from cancer. If he had been taken away into a boarding facility, he would probably have not felt the need to quit education to provide for the mother and siblings. Others get affected by uneducated people they interact with who introduce them into drugs and have lacked mentors or the opportunity to have the proper incentives for working hard in education.

Some of these problems in education could be solved by continuously encouraging children from these communities to go through formal education, creating visible incentives, having people from outside the communities mentoring and interacting with them, providing support in terms of education and books. I do not think free education alone would be enough to raise skill levels in way that can attract investments that absorb skilled labor from these communities.

Misconception around community currencies in slum areas

I have nothing against innovations that seek to improve the welfare of a community but at the same time I believe that it is appropriate for these innovations to undergo high levels of criticism so that they do not end up creating bigger problems in the long-run. Personally, I had done studies around the subject and feel I could contribute to the debate around their viability.

Community currencies are simply an alternative means of exchange other than the main currency accepted in a sovereign that seeks to allow community members to utilize ‘idle resources’ through a system of credit extension. A grocery that could have wasted perishable goods such as vegetables, they argue, would be able to benefit by giving out the vegetables on credit to a person who runs a hotel (the grocery receives the alternative currency as a measure of the quantity exchanged), in turn the hotel instead of wasting away excess food could sell to the grocery thereby balancing out and smoothing cycles. It all seems perfect from there and is a well-intentioned scheme. Statistical data has shown that there has been increased level of profitability for businesses involved. The rise in profitability makes sense because members are able to consume more than they otherwise would have, member businesses also have guaranteed customer loyalty since they would tend to purchase from each other goods and services. But is it really beneficial in the long-run? I doubt.

From my understanding of slums and most poor clustered communities, they are net spenders (they consume more than they are able to generate from within the community). Most of the goods and services are either sourced from outside or involve components that have to be sourced from outside the community. This means that the system would be creating a wrong incentive, instead of encouraging saving for investments in opportunities some of which are outside the community; it encourages members to live beyond their means. The grocery spends more in buying foods from outside the community because it is able to generate more sales and it has to use the main currency to do that. Isn’t it in effect promoting certain members of the community into earning a lot more at the expense of pushing other members deeper into poverty? Wouldn’t it erode progress made within the community in learning how to manage personal finances? Wouldn’t it be better if instead alternative programmes that seek to create skills that generate revenue within the communities and marketing products from the community to outside markets were encouraged?

Having a community currency also means that it could close out the community from the rest of the economy. The currency is usually not accepted outside these communities. Users of the community currency would tend to use facilities within the community that accept the community currency. They would use medical facilities that are poorly equipped and attend schools with poor quality education within the community. Without interaction with other social classes, poor people interacting with only poor people, it might create less incentive to work harder in order to escape poverty thereby enhancing the vicious poverty cycles rather than eliminating them. Members may also be unwilling to venture out, invest and relocate to areas with better jobs, of the community outside where community currency would not be acceptable.

On a broader perspective, these communities are still part of the economy and are even worse affected by downturns in the economy. Central bank monetary policy tools that seek to control certain aspects such inflation could be hampered since even if they tighten money supply, these communities would be able to sustain demand through the alternative currency meaning that during episodes of high inflation, rates may have to be raised higher than they would ordinarily have. This is besides other factors such as the community currency use reaching a point where it creates enough incentive for fraudulent individuals to start creating counterfeit currencies.

The subject of community currencies which was introduced in the country for experimental purposes needs to be extensively debated and abolished if seen not to be beneficial to the economy just as some developed countries have banned crypto-currencies.

Conclusion

There is no magic bullet for fighting poverty. It needs combined effort from donors and community members both within and outside affected areas as well as a supportive government. It is important that efforts aimed at alleviating poverty be carefully weighed so that the fight continues to be progressive rather than regressive.

UPDATED:Can Kenya Airways Stocks Take Off Again

I remember around early 2000 local popular Sunday Newspaper ran a story in its pullout, Lifestyle magazine, on how people who had managed to get in the National Airlines shares (Kenya Airways) had grown incredibly wealthier from the investment. Some of them had got into the share when it very cheap and managed to register super-normal profits in paper form, since I do not recall any of them saying they had liquidated though they probably did later. At that time the general perception towards the airline industry was that it was a very lucrative investment and that there was, no way one could not turn a profit if made long-term investments in the business. The share managed to rally sharply to above a 100 shilling a share (barely above a dollar at current rates) before peaking and plummeting to present value of around 7 shilling a share (account for dilution through rights issues as it raised money to fund expansion). From a very remarkable growth and promising future great profits, about slightly over a decade after, the airline is now staring at insolvency and has been actively looking for more debt financing aside from most recent extended KSh. 4 Billion. This year it reported half-year losses of about KSh. 10 billion and as expected  (considering financials & managing director press release statements (funding wages through other debt) Kenya Airways has reported a record Sh25.7 billion loss after tax.

Kenya Airways reports loss

Kenya Airways Loss record:

2012 = 4.2Billion

2013 = 7.8Billion

2014 = 10.4Billion

2015 = 25Billion

What is ailing the business? There is a high possibility there is two sides to it, an industry with historically very low margins (net profits made against sales made) and an airline that has lagged its peers in terms of efficiency and competitiveness.

Airline Business

Ordinarily, you would expect if an investment is high risk, it should offer high returns to compensate for the risk but this is hardly the case in airline businesses. Airlines earn the lowest return on capital yet face the second highest volatility of returns and risk (among businesses surrounding airline businesses). According to a 2013 IATA report, airlines have earned the lowest returns on invested capital among all industries over the last 30-40 years. Warren Buffett famously remarked during one of his lectures, in response to a student’s question, that he had a special line he calls when he is about to make an investment in an airline business so that they talk him out of the idea. Obviously, it was for a reason, he had burnt his fingers while buying into an airline because it was an attractive security (on valuation) only to learn through loss of his investment that it was a bad business.

This is not to say that no airlines consistently deliver value to investors, there are but very few of them manage to do this. In most instances returns are usually, just enough for servicing debts but hardly leave anything for those who buy shares in the business and risk capital while there were alternative high return investments.

National airlines

National airlines serve national interests as primary before profits. This is because they help in for instance marketing economy and enabling trade, that is why governments are usually very willing to bail them out. Very few of them are generating profits, Zimbabwe and South Africa airlines were earlier on in the year insolvent and have got help from their governments.

Kenya Airways

Most other network airlines around the world have faced stiff competition from low-cost carriers (airlines that target cost sensitive clients) who not only are low-cost but also on average record higher return on investments. But in the local context, there is only one low-cost carrier which is a subsidiary of Kenya Airways but which also appears (from impression created) to be struggling to break even.

Kenya Airways has found itself falling deeper and deeper into debt, initially due to its ambitious expansion plans and now because of inability to break even. Debt isn’t necessarily an evil, in fact it is recognized for its usefulness in economies compared to re-investing internally generated profits since it tends to make the company that uses debt more efficient so that it can be able to finance cost of the debt (in form of interest). What happens when a business that is struggling to break even, is inefficient and has most of its financing in form of debt? It means it very easily falls into a debt trap that inevitably leads to insolvency.

The business is very low margin (estimated at around sh256 a seat-IATA $2.56), it has to operate efficiently otherwise it would not be able to generate profits. It does not take much of government tax, demand stock or rise in costs to eliminate profits. This makes it questionable how it will fare in a high interest rate environment unless again its debt was guaranteed by the government.

The problem with airlines where the government is big shareholder is that it is easy to hide internal inefficiencies through the problems inherent in airline industries outside their control. Contacts within the airline have highlighted low employee morale (later denied during recent senate probe). There have also been alleged cases of lost baggage especially on the West Africa flights. Due to information asymmetry issues (management knows better), it is difficult to determine what exactly is going on and as to whether rumors that have been swirling around are true. Something that is quite for sure is that even if debts were restructured, operating a network airline (not sure about LCC) without superior customer service and improved efficiencies will make it an unsustainable business model.

My take would be that most of the issues raised are addressed and accompanying measures such as requiring more efficient suppliers/external service provides, subsidized airport charges be effected.

Maybe low fuel costs will help improve profitability and new routes especially to the US, but it will be no mean feat to turn around a company facing serious debt overhang problem denominated in a foreign currency while the domestic currency is depreciating but will be watching commentating from the sidelines how it fares. In the meantime, my view is that it is still a too high-risk investment even for a contrarian although it is highly probable government will try to rescue it.

 

Can Kenya Airways Stocks Take Off Again?

I remember around early 2000 local popular Sunday Newspaper ran a story in its pullout, Lifestyle magazine, on how people who had managed to get in the National Airlines shares (Kenya Airways) had grown incredibly wealthier from the investment. Some of them had got into the share when it very cheap and managed to register super-normal profits in paper form, since I do not recall any of them saying they had liquidated though they probably did later. At that time the general perception towards the airline industry was that it was a very lucrative investment and that there was, no way one could not turn a profit if made long-term investments in the business. The share managed to rally sharply to above a 100 shilling a share (barely above a dollar at current rates) before peaking and plummeting to present value of around 7 shilling a share (account for dilution through rights issues as it raised money to fund expansion). From a very remarkable growth and promising future great profits, about slightly over a decade after, the airline is now staring at insolvency and has been actively looking for additional debt financing aside from most recent extended KSh. 4 Billion. This year it reported half year losses of about KSh. 10 billion and it is reasonable (considering financials & managing director press release statements (funding wages through additional debt)) to expect second half losses much larger than first half losses enough to more than wipe out its previous total equity.

What is ailing the business? There is a high possibility there is two sides to it, an industry with historically very low margins (net profits made against sales made) and an airline that has lagged its peers in terms of efficiency and competitiveness.

Airline Business

Ordinarily, you would expect if an investment is high risk, it should offer high returns to compensate for the risk but this is hardly the case in airline businesses. Airlines earn the lowest return on capital yet face the second highest volatility of returns and risk (among businesses surrounding airline businesses). According to a 2013 IATA report, airlines have earned the lowest returns on invested capital among all industries over the last 30-40 years. Warren Buffett famously remarked during one of his lectures, in response to a student’s question, that he had a special line he calls when he is about to make an investment in an airline business so that they talk him out of the idea. Obviously, it was for a reason, he had burnt his fingers while buying into an airline because it was an attractive security (on valuation) only to learn through loss of his investment that it was a bad business.

This is not to say that no airlines consistently deliver value to investors, there are but very few of them manage to achieve this. In most instances returns are usually, just enough for servicing debts but hardly leave anything for those who buy shares in the business and risk capital while there were alternative high return investments.

National airlines

National airlines serve national interests as primary before profits. This is because they help in for instance marketing economy and enabling trade, that is why governments are usually very willing to bail them out. Very few of them are generating profits, Zimbabwe and South Africa airlines were earlier on in the year insolvent and have been getting assistance from their governments.

Kenya Airways

Most other network airlines around the world have been facing stiff competition from low cost carriers (airlines that target cost sensitive clients) who not only are low cost but also on average record higher return on investments. But in the local context, there is only one low cost carrier which is a subsidiary of Kenya Airways but which also appears (from impression created) to be struggling to break even.

Kenya Airways has found itself falling deeper and deeper into debt, initially due to its ambitious expansion plans and now because of inability to break even. Debt isn’t necessarily an evil, in fact it is recognized for its usefulness in economies compared to re-investing internally generated profits since it tends to make the company that uses debt more efficient so that it can be able to finance cost of the debt (in form of interest). What happens when a business that is struggling to break even, is inefficient and has most of its financing in form of debt? It means it very easily falls into a debt trap that inevitably leads to insolvency.

The business is very low margin (estimated at around sh256 a seat-IATA $2.56), it has to operate efficiently otherwise it would not be able to generate profits. It does not take much of government tax, demand stock or rise in costs to eliminate profits. This also makes it questionable how it will fare in a high interest rate environment unless again its debt was guaranteed by the government.

The problem with airlines where the government is big shareholder, it is quite easy to hide internal inefficiencies through the problems inherent in airline industries outside their control. Contacts within the airline have been highlighting low employee morale (later denied during recent senate probe). There have also been alleged cases of lost baggage especially on the West Africa flights. Due to information asymmetry issues (management knows better), it is difficult to determine what exactly is going on and as to whether rumors that have been swirling around are true. Something that is quite for sure is that even if debts were restructured, operating a network airline (not sure about LCC) without superior customer service and improved efficiencies will make it an unsustainable business model.

My take would be that most of the issues raised are addressed and accompanying measures such as requiring more efficient suppliers/external service provides, subsidized airport charges be effected.

Maybe low fuel costs will help improve profitability and new routes especially to the US, but it will be no mean feat to turn around a company facing serious debt overhang problem denominated in a foreign currency while the domestic currency is depreciating but will be watching commentating from the sidelines how it fares. In the meantime, my view is that it is still a too high-risk investment even for a contrarian although it is highly probable government will try to rescue it.

 

Private Equity in Kenya

In wealth creation there is various investment vehicles that one can choose to use to grow their money and secure their old age. Private equity happens to be one of the ways to invest your hard earned money and watch it grow over a specified period of time.

The PE Concept

The concept is simple; fund managers pool money from high net worth individuals and institutional investors to invest in companies not listed at the securities exchange. The underlying principle is that of getting a controlling stake in the companies through purchase of majority of their equity, improving efficiency in the companies and later on selling off the companies after their value has grown.

The steps sound very easy and fast to achieve, but there are a number of things one must put in place before venturing into the PE industry.

Requirements Before Starting a PE Fund

For first-time fund managers with an interest in the PE industry, a little house keeping is in order before you swallow the bullet. A little it is, but it might take a long time and be very exhausting before you finally can turn on the engines of your PE fund and start sailing through the stormy waters of the PE industry.

First of all you need to have a track record of having successfully grown other companies in the past thus creating value for investors in the companies. Without proof of a superb performance in the past, you are unlikely to get anyone interested in your PE fund. No one wants to risk their money with amateurs! So if you want to one day own and run your own PE fund, you better be getting down hard and dirty in creating value in existing companies and driving them to excellence.

The second most important thing in the PE industry is networks. No other place is social capital a necessity than in PE fundraising. To successfully raise enough funds for your fund, you need to be well networked with respectable business leaders in town. Your former employer and your fellow former employees should be able to sell you for free to investors they are connected to. Your business partners should be your marketing agents and walking billboards all over. In summary, you need to have a strong positive reputation among your peers and in the industry as a whole for you to launch your PE successfully.

The other fundamental requirement is that you should be having your own capital to invest in your PE fund. The investment can range between 1% to 5% of the fund; and it helps the investors to also have faith in the fund by having the owners of the fund investing their money in it too.

Finally, you need to have a placement agent to help you link up with the institutional investors and high net worth individuals. These are the people who help you market your PE fund to the potential investors and help you mobilize the funds you need to launch it. They are very vital in that they are well connected to the investors and will assist you in doing due diligence before getting investors on board. On the other hand, they can advise on the strategic plan for the fund and ease your pressure so that you concentrate on portfolio management rather than the day to day running after investors.

With the above in place you are then good to try your boat in the sea of private equity investments.

In Kenya the PE industry is not as vibrant as in the developed world. This can be attributed to the fact that we are still a developing economy and our financial markets are still growing. However, foreign investors in PE from the West are moving towards the East in China and India as emerging markets; and we can only expect the tide to turn to Africa very soon as our markets mature.

A guest post by RIRO JEREMY of fieconsult.co.ke