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9 August, 2015

Executive Summary

  • Fixed Income: The shilling gained 1.2% during the week as the MPC retained the policy rate at 11.5%;
  • Equities: NASI and NSE edge up 1.4% and 0.2%, respectively, on the back of gains in large cap stocks;
  • Private Equity: An increase in the number of entry and exits of PE investments in Kenya's financial sector highlights the attractiveness of the industry and deepening of the market;
  • Real Estate: Private hospital developments attracting investor's interest in Nairobi, while hotel developments are on the rise in Kisumu;
  • Focus of the Week: Employee ownership schemes offer attractive ways for employers to attract and retain top talent, especially in professional services businesses;
  • Company Updates: We have recently established our share ownership plan that includes both a discounted share purchase and a share grant. This makes Cytonn one of the few companies where all full-time employees, irrespective of rank, hold shares.

Fixed Income

Undersubscription of Treasury bills continued during the week. However, there was a significant improvement in total subscriptions to 89.3%, compared to 39.8% the previous week. While the subscription rate improved across all tenors, it is notable that the market was demanding significant premiums as evidenced by the weighted average market bid rate at 14.2%, 15.9% and 15.6% for the 91, 182 and 364-day papers, respectively. The CBK was keen to maintain rates at current levels as they rejected most bids and hence the yields on accepted T-Bills remained relatively unchanged; at 11.5%, 11.9% and 13.5% from last week's 11.6%, 11.8% and 13.1%, for the 91, 182 and 364-day papers, respectively. On the interbank market, the tight liquidity situation during the week led to a significant increase in the interbank rate to 22.9% from 19.2%. There was a reopening of the 2-year bond, and we shall give the expected average rate next week.

The MPC met during the week and as expected (see our last week's report), held the Central Bank Rate at 11.5%. The committee sighted (i) non-risk of inflation, which is within target, (ii) stabilization of the currency, and (iii) slight improvement in economic performance as some of the key indicators justifying holding the rate. In our view, any further increases would further slow down the economy. The committee noted that they may continue with the tight liquidity mop up to avoid speculation on the shilling. The Kenya Shilling gained slightly during the week by 1.2% to end the week at 101.3 against the dollar.

We continue to maintain our recommendation that investors should be biased towards short-term fixed income instruments due to uncertainty in the current interest rate environment.


During the week, NASI and NSE 20 edged upwards by 1.4% and 0.2%, respectively, as foreign investors continued to be net buyers. The rise was supported by improved performance in large cap stocks including Equity Bank, EABL, and Safaricom, rising by 10.4%, 3.4% and 1.0%, respectively. Since the February peak, NASI and NSE 20 are down 15.2% and 19.7%, respectively.

Earnings release from banks during the week still exhibited slower growth as compared to historical averages. Equity, Kenya's largest bank by customer base, registered an 11.8% growth in profit after tax supported by a 10.6% increase in net interest income and 29.9% increase in the non-funded income. The loan book grew by 27.0%, while customer deposits grew by 39.7%, bringing the loan to deposit ratio to 79.0%, in line with the bank's historical average of 80%. The quality of the loan book remains good with 3.7% non-performing loans ratio. The cost to income ratio however increased to 54.0% in H1 - 2015 from 52.0% in H1 - 2014, and is attributed to the roll out of Equitel and the regional expansion. With the stiff competition in the banking industry and the compression of Net Interest Margins, revenue diversification and operational efficiency will be the key drivers for growth going forward. As such, Equity Bank's launch of Equitel and its planned expansion to nine other African countries in the next five years, if successful, will boost its earnings in the future. The bank's earnings growth of 11.8% came in slightly below our expectation of a 12.5% long-term growth, as discussed in our banking report.

During the budget there was a proposal to increase banks' core capital to Kshs. 5 bn, but last week the CBK Governor, Dr. Njoroge, differed with the Treasury's plan to raise the core capital requirements for banks to Kshs. 5 bn by 2018, citing a number of reasons. First, that core capital requirements are based on the riskiness of the investments which banks undertake, and second, small banks play a niche role in the market. About half of the 42 banks will be affected by this requirement, forcing them to either (i) merge with other small banks, (ii) seek a strategic investor, or (iii) be acquired by larger banks. The big banks would be more dominant, resulting into closing of smaller branches eventually reversing the gains of financial inclusion that have been achieved so far. He also cited financial entrepreneurship will be undermined and the dream of Kenya being Africa's financial hub will be lost.

Nation Media Group released its half-year results, recording a decline of 5.2% in revenues to Kshs 6.1 bn. The decline was as a result of depressed revenues from the television division, due to disruption of broadcasting during the analogue-digital signal transition in the beginning of the year. Consequently, PAT decreased by 5.7% to Kshs 1.0 bn. With the digital signal migration, the number of channels have increased, hence stiff competition in the industry leading to depressed earnings.

The high interest rate environment will lead to a slowdown in economic growth, which will negatively impact the performance of listed companies. For banks, high interest rates environment may result into an increase in the non-performing loans, thus weakening quality of the loan book. Given that the market has come down considerably, almost a 15% drop from the February peak, most listed stocks now seem fairly valued. Consequently, we maintain a neutral stance on equities.

Private Equity

Interest in Kenya's financial sector continues to rise, attracting increased number of private equity investments. This is evidenced by a Mauritian fund manager, Axis, which has acquired ApexAfrica Capital, a Kenyan stockbroker, for Kshs 470 mn, making it one of the highest valued acquisitions of a market intermediary in East Africa. Axis' acquisition, which was through its local unit Mauritius Kenya Investment Holding, will see Axis enter the Kenya stockbrokerage market for the first time. ApexAfrica earned Kshs 122 mn in revenues in 2014, and has a large pool of individual and corporate clients in the region. The acquisition is at 3.8x revenue, which appears pricey. Axis offers a wide range of financial services, including fund management, investment advisory, establishment of trusts and tax shelters in the Seychelles, Mauritius and Kenya. The transaction has happened at a time when foreign investor participation dominates trade at the Nairobi Securities Exchange.

Helios Investment Partners fully exited its investment in Equity Bank this week, selling its remaining 5.5% to the National Social Security Fund (NSSF). This is the first time the NSSF has invested in Equity Bank, and highlights the fund's increasing interest in Kenya's banking sector, having earlier invested in National Bank, Kenya Commercial Bank and Housing Finance for stakes of 48.1%, 6.1% and 2.2%, respectively. We estimate that Helios made an annualized compounded return of 30% per annum during the 7 years it was an investor in Equity Bank. The investment by Helios, a high profile private equity investor in Africa, into Equity Bank, an equally high profile brand in the region, and then being able to fully exit within seven years and realizing an annual compounded return of 30% is very positive for the private equity industry in Kenya. Such realized exits by private equity funds continue to be a positive indicator that the region is sufficiently deep for PE investors to find liquidity to exit investments. The ability to exit will continue to increase the appetite for PE funds looking to invest in the region as they can take up huge ticket deals, which in turn increases the amount of capital to fund the region's growing economy.

Real Estate

A team of doctors plans to develop a new cardiac hospital in Ridgeways Estate, Nairobi. The proposed private hospital development will sit on 2.5 acres and will constitute a total gross built up area of 7,926 square meters with a 130-bed capacity. The project was originated by three Kenyan doctors and is receiving Kshs 1.8 bn financing from a consortium comprising of the IFC and Abraaj Group. The project consortium also includes a renowned Indian hospital group that is coming in as the strategic operating partner. It is anticipated that the project will be completed by end of 2017. There has been a notable increase in consumer spending across all sectors of the economy. For the health sector specifically, this increased spending power has manifested itself through increased demand for quality healthcare, with consumers gravitating towards private hospitals, which are perceived to be superior in terms of service delivery compared to public hospitals. Consumer willingness to spend on quality healthcare is prompting more private investors to invest in developments of private hospitals in the urban areas of Nairobi.

Mayfair Holdings Ltd, owners of Kisumu's Imperial Hotel, have built a new Kshs 400 mn facility, which is set to officially open on August 17th 2015. The hotel, Imperial Hotel Express, is located along Oginga Odinga Street, which is the main street in Kisumu CBD. It comprises of 55 rooms with minimum occupation rates set at Kshs 5,000 per night. Still in Kisumu, Simba Corporations, which owns Kempinski Hotel, also opened up a Kshs 450 mn hotel facility called the Acacia Premier, less than three months ago. It is evident that there is an increase in hotel developments in Kisumu in a bid to tap into the fast growing demand for business travel, events, and conferencing facilities, estimated to be growing at 20% p.a. We attribute the growth to devolution, which is opening up other regions for real estate developments.

Focus of the Week: Employee ownership schemes and their effects on firms

Having recently introduced a share ownership plan for all Cytonn staff, we focus on the topic to demonstrate its importance to growing businesses in the country. At Cytonn, staff have both a grant of shares, at no cost, and a share purchase plan at a discounted rate.

Employee ownership schemes are an attractive form of giving employees an opportunity to participate in the ownership and decision making of their company. An employee share ownership plan (ESOP) is an arrangement between an employer and an employee, whereby the employee is granted rights to own a defined number of shares in the company, usually at a discounted price and upon fulfillment of pre-set conditions.

A company can implement ESOPs in a number of ways including; (i) issuing shares directly to its employees, (ii) allowing employees to buy into the shares of the company, often at a discount, and (iii) grant its employees an option to buy shares in the company at some future date. For any ESOP, there are 3 important stages that have to be followed:

  • Grant - this is when the employee is given the right to acquire shares of the company, usually prospectively upon fulfilling pre-set conditions;
  • Vesting - this is the unconditional right to acquire the shares accruing to the employee, who can then exercise their rights to acquire the shares. In most cases in Kenya, shares are allocated to ESOPs trusts and these are to vest to participating employees over a given period of time depending on the conditions outlined in the ESOP trust deeds;
  • Exercise - this is when the employee acquires the vested shares at the share price agreed on the grant date.

Employee ownership schemes have been used as an employee compensation strategy for over 50 years in some parts of the world like the U.S. Since the turn of the millennium, Kenyan companies have also started adopting ESOPs, and more companies are now considering the potential benefits of such arrangements. Providing employees with ownership interest could motivate employees by aligning their interests with those of shareholders, boost employee morale and increase productivity.

ESOPs also increase a company's competitiveness and attractiveness to employees, thus enabling them to attract and retain top talent. Especially for professional services firms, talent is the defining factor in competitiveness, hence employers must consider innovative and long-term ways of incentivizing their employees, and ESOPs is one of such ways.

ESOPs are also favoured by small and medium size enterprises when developing an incentive compensation structure, as they do not involve a direct cash outflow, like a bonus payment would.

Some of the challenges in adopting an ESOP as a way of compensating employees include the employee demographic profile, which relates to their risk profile. Some older employees tend to be more risk averse and would generally prefer a compensation structure that is more certain, such as higher contributions to a pension plan and a cash bonus. Also, a challenge in the uptake of ESOPs arise from the fact that they may take a long time to vest, around 3 years for a number of Kenyan firms, which may limit their appeal to employees.

In Kenya, public companies can set up ESOPs subject to approval by the Capital Markets Authority, in order to be in compliance with the Capital Markets (Collective Investment) Scheme Regulations 2001. A number of private companies have also taken up the adoption of employee ownership schemes.

Research linking ESOPs with firm performance vary in terms of results. The relationship between ESOPs and a firm's performance, productivity and stock performance appears minimal, though a positive association exists. Advocates for ESOPs agree an ESOP alone cannot produce improved firm performance; instead the ESOP must be combined with employee empowerment through participatory management and significant participation in the ESOP programme in order to achieve improved firm results.

Below is a list of listed companies in Kenya that have ESOPs. Equity Bank has the highest ESOPs as a percentage of total shares and total value of the plan.



ESOPs as a % of total shares

ESOPs Value (Kshs)


















ARM Cement




I&M Bank




Housing Finance




Standard Group







Source: Company Annual Reports

This data shows that only 14% of the 64 listed companies have an ESOP program. However, it is notable that other than Equity Bank with ESOP at 3.9% of the company shares, the rest of the corporate ESOPs as a percentage of all shares are negligible, with most at less than 1% of shares in ESOPs. This is in stark contrast to more developed markets such as the US where of the 900 large listed companies, 24% of the companies have a substantive ESOP program. We believe that the establishment of more ESOP programs by both listed and private companies should improve corporate performance and also help with attracting talent, not just from the local market but also from the global markets.

One key limit of both the emergence of ESOPs and the increase in the size of existing ESOPs is the prohibition by the Company's Act of corporations buying their own shares. When corporations issues shares to employees in an ESOP, it dilutes existing shareholders. This dilution can be cured by a company buying back, in the open market, an amount of shares equivalent to what has been issued as ESOPs, hence avoiding dilution.

Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.