Stock market shrinkage

Like parliamentary majorities and Christmas Toblerones, the stock market is slowly shrinking.

As has been widely commented on, de-equitisation – the substitution of equity for debt – has been accelerating in recent years, largely through the growth in share buybacks. However, the shrinkage of the stock market seems to be taking on a new form in the UK at the moment, as acquisition activity accelerates whilst new-issuance continues to languish at multi-year lows.

Unless there is a dramatic change in market conditions, I would expect 2019 to mark a 20-year low for Initial Public Offering (IPO) activity in the UK. The chart below illustrates this falling level of IPO activity across London Stock Exchange (LSE) – Alternative Investment Market (AIM) listed companies and the broader LSE – Main Market listed companies. At peak levels, there were nearly two IPOs per working day in 2005. Comparatively, by 2018, this had fallen to less than two per week. The dearth of IPOs in 2019 has been so pronounced, that by 31 October 2019 only 31 new companies had come to market since the start of the year.

The reasons for this fall are not surprising; investor sentiment is low given the macro risks of Brexit, Trump and trade wars, and investors have been scarred by the collapse in certain high-profile new issues in 2018 – notably Aston Martin and Funding Circle – both of which have fallen c. 80% from their issue price.

By contrast, acquisition activity is picking up. At the time of writing, ten FTSE-350 companies are in agreed takeover negotiations – Entertainment One, Charter Court Financial, Greene King, BCA Marketplace, Cobham, EI Group, Inmarsat, Just Eat, Merlin Entertainments, Sophos – and one other, London Stock Exchange, has recently rejected a takeover offer. Whilst the motivations behind these takeovers vary, ranging from trade-buyers to private equity buy-outs to Hong Kong billionaires acquiring UK real estate, the combination of a weak sterling and record-low funding costs is undoubtedly driving the pick-up in activity.

In the short run, fund managers invariably welcome takeover approaches, as they boost short-term performance and deliver material gains for end investors. However, longer term, the shrinkage of the stock market, due to the dearth of IPOs should concern us all.

A vibrant IPO market is the life-blood of any stock market: if this tap is turned off, developing businesses suffer as they can’t access new growth-capital, whilst investors as a whole suffer as the wider pool of investment opportunities shrinks.

Looking ahead, I doubt the Christmas Toblerone will ever return to its original size. However, I am optimistic that IPO activity will rebound if the uncertainty of Brexit subsides, and that the number of UK-listed companies can start to grow again.

Sources: The London Stock Exchange and the Takeover Panel


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