1. Investor Description

Steelmakers is a Kenyan steel maker that has invested in a new Zimbabwean mini-mill. It has considered other products including building materials as well. Steelmakers is a medium-sized company employing 100 and is 20 years old. Its facilities are old but productive.

2. Opportunities

The shortage that Steelmakers has always faced has been in the availability of raw materials. Steelmakers has always been able to sell all of its goods, although it never has sold goods into Zimbabwe before it opened the facility. In a 1996 conference run by ZISCO, management saw the opportunities in Zimbabwe to establish a new mini-mill. They were then visited by Zimbabwean President Mugabe. The opportunities existed in opening a new mill to serve Zimbabwe, Mozambique, Malawi, and Zambia. They noticed that currently most of the scrap (the primary raw material for mini-mills) was being exported from Zimbabwe unprocessed.

3. Investment Process

Steelmakers has never sold into Zimbabwe, but the opportunity here lies not as much in the market but in the ready access to supply. The marketplace is terribly constrained by a lack of available raw and intermediate materials, and hence there is a significant opportunity for Steelmakers. The investment process began in 1996 with the plant being commissioned in 1998. The investment is phased in three stages, with the first two (rolling mills and melting and manufacturing of billets) having already been commissioned. The next stage of direct reduction iron has not yet been scheduled, but will be necessary when the available scrap runs out in 5-10 years.

4. Decision Process

Cost of Investment: Steelmakers was required to spend considerable money taking time away from their Kenyan operations to visit Zimbabwe and make preparations. They were supported greatly by the Zimbabwe Investment Center and the Mayor of Redcliffe (the site in which they ultimately invested).

While high level authorities were highly encouraging and supportive, bureaucrats imposed several hurdles on the investment. Immigration officials made the import of technical personnel from Kenya and India very difficult. Other aspects of the investment took longer than Steelmakers anticipated given the high level support it had.

Steelmakers anticipates a need to expand, but must locate an equity partner to do so. Current interest rates and their inability to get fixed rates of interest make borrowing unfeasible for plant expansion.

Revenues: It appears that Steelmakers can sell everything it can make. It is constrained by supply now, and will require a new source of scrap within 5 to 6 years. Presently 40% of Steelmakers production is sold into Botswana, Zambia, and Malawi, with intentions of expanding into Mozambique and South Africa as supplies allow.

Costs of Doing Business: Steelmakers’ biggest concern was the costs associated with managing two facilities in Kenya and Zimbabwe. Steelmakers is a family owned company and must divide its management over the two facilities. With the costs of communication and transportation, this requires able full-time management at both facilities

However, Steelmakers Kenya was able to establish a management system that has been in place for some time so that they were able to dispatch key management personnel into Zimbabwe. Steelmakers replaced management bound for Zimbabwe with imported managers from India and supplemented the management staff in Zimbabwe from India.

Risks: After making a decision to invest in Zimbabwe, duty free exemptions on capital equipment were repealed, creating a high cost item that was unbudgeted in the original model. Steelmakers imported 70% of their equipment from India (it was not available locally). Steelmakers is still worried about what it considers a not yet stabilized policy environment.

5. Analysis

This case is intended to illustrate the effect of risk on the investment decision-making process. To most steel and steel products manufacturers, the market is there, the raw materials are getting there, and the infrastructure for trade, while in poor conditions in some places, isn’t bad and is improving. Most firms do export goods, usually coordinated through sales offices. Very few have made outward investments in exporting via sales offices, warehouses, and productive facilities however, with Steelmakers a notable exception.

The steel and steel products industry appears to provide the greatest promise for cross-border investment in COMESA. Most companies are not greatly threatened by foreign competition, although South Africa’s productive capacity, capable marketing force, and knowledge of the region make them formidable. Perhaps the most fundamental constraint is the supply of raw materials. Some suppliers have increased their capacity, but still do not meet the demand that exists region-wide. Steelmakers has managed to see opportunity in this limited supply by introducing a relatively new technology to take advantage of available scrap.

It is important to revisit the investment formula at this stage and introduce the concept of the hurdle rate. This can be expressed in several ways depending upon the source of financing. The most common application is that rate at which the investor can get on his money through alternative means. Should the project’s return on investment exceed the hurdle rate, the investment is typically made.

Steel products manufacturing typically provides a low rate of return on what is usually a large investment. The products are fundamental, and are resistant to recessions although not immune. Steel products need low risk environments to proliferate, including an uninterrupted supply of raw materials, the ability to realize profits, and no threat in the loss of the fixed asset investment.

Whether risk is perceived or real is immaterial. However, Steelmakers’ decision to invest was partially predicated on the availability of supply, but mostly made on the manner in which they perceived risk: the risk of getting their money back to Kenya. High level representation was critical to their assessment.

It has been mentioned frequently that companies that operate in Sub-Saharan Africa enjoy the greatest profitability in the world. If examined in the context of the formula established earlier in this report, this is likely the result of the region imposing the greatest risk in investment. Only firms that anticipate high returns on investment are willing to invest due to the perceived risk of investment.

Steel makers therefore perceived risk in four areas:

1. Would they have access to a supply of raw materials on an uninterrupted basis? Manufacturers have limited options for acquiring raw materials, and these sources have not been able to meet demands, particularly over the past several years. In the case of Steelmakers, it is likely that the supply will be gone within 10 years. They also have some risk that the one steel manufacturer, ZISCO, a government owned body, will not continue to provide supply to the mini-mill.
2. Will they be able to repatriate their profits regularly? Will the exchange rates hold up? Will their clients be able to pay them without fail? On a low return-on-investment project, loss of profits through unpaid invoices and exchange rate losses are magnified. There is considerable risk when borrowing, as interest rates fluctuate, sometimes wildly.
3. There are many concerns, both perceived and real, regarding the property rights that manufacturers will enjoy. There have been very few nationalisation of industries over the past decade, and few signs that this is a threat. Nonetheless manufacturers always have this in the back of their mind.
4. Will the incentives that were offered to them persist? Steelmakers was stung once by the promise of an incentive that was later repealed. They will, most certainly, figure this into future estimates when evaluating add-on projects.

6. What COMESA Can Do

Lowering risk requires large scale, long-term programs, many of which COMESA already has underway. Long-term impacts on investment will come from monetary harmonization and nationalization insurance funds.

COMESA should ensure that all countries maintain free movement of capital and profits throughout the region. Some countries that have recently been through severe shortages of hard currencies have placed bureaucracy and blockages of movement of capital and profits. That these policies even go into effect in one country would lead to investor’s perceptions of risk of another. Regional stability in this regard is critical for the perception of risk to be reduced.

Monetary policies, inflation and interest rates are, for the foreseeable future, national issues that have impacts on regional investment. Most COMESA nations practice solid monetary policies that include reducing inflation and maintaining real interest rates. However, many countries are burdened with debt-laden budgets putting pressure on interest rates. This is a long-term problem on which COMESA’s impact can only come through provide support and guidance.

A recurring theme throughout this study is the need to continue to disseminate information to investors, traders, and the public at large. As mentioned earlier, what is important on an investor’s decision is not the real risk, but the perceived risk. In the absence of information, perceptions of risk often magnify existing issues and, in some cases, create issues where none exist.

Many countries have maintained stable policies for over a decade, but most investors don’t perceive that to be the case. COMESA would do well to publish investment codes and propaganda, publicizing the stability of some of these codes and investors’ success stories to reduce the perception of investment risk.

Harmonized investment incentives would not cure the perceived problems of instability with regard to incentive policies, but it would go a long way towards comforting investors that feel that governments are all too prepared to change incentives with the change of government. If Member States were to bind themselves to agreed upon incentives that could only be removed multi-laterally, investors may feel more comfort in that the incentives they signed up for will last the duration agreements.