The UK has a two-speed market problem

Dear reader,

It is good practice in life and journalism to check your precedence from time to time. This week's Lex column published two charts that provide a reason to consider ours.

The first was this:

Small biotech company Redx Pharma this week announced its intention to pull out of the London mini-market, blaming Aim for its cash-strapped exit. The company's rumblings haven't been entirely bullish: its revenues have shrunk, losses have mounted, and its free trading volume has been small enough to mean it qualifies for the Aim All-Share index. You can read Lex's opinion here.

But life is undoubtedly tough for small businesses in the UK at the moment, with the Aim All-Share Index trading at an all-time low compared to the FTSE All-Share Index.

What surprised me, after Lex's Andrew Whiffen crunched the numbers, is that London has seen a rise in liquidity this year, defined by the market's average daily trading volume compared to a company's outstanding shares.

This stands in contrast to the prevailing gloom surrounding the London market this week, even as the FTSE 100 index repeatedly threatens to rise above its all-time high. “If we continue on this path, we will end up just like the Irish market, which is dead,” the head of independent investment bank Bill Hunt warned of a hollowing out of London, amid a dearth of listings.

This followed the bank's head of research bemoaning the “relentless” pace of equity demonetisation, the low valuation of UK companies and the volume of UK outflows, which have now continued for 34 months.

The market-wide liquidity numbers don't make for particularly cheerful reading, to be fair. Order book figures released by the London Stock Exchange Group show that total daily volumes are down 4 per cent year-to-date, compared to the same period last year.

Honestly, you know things have gotten bad when a journalist feels compelled to try to pierce the darkness. The stock dump is a global phenomenon, with JPMorgan analysts warning this week that the global supply of common stocks is shrinking at its fastest pace in at least 25 years. The number of listed companies in the United States has fallen from more than 7,000 to less than 4,000 since 2000. (This data is almost certainly not proverbial, but for reference, the number of companies listed on the London Stock Exchange fell from more than 3,300 in 2007 to about 1900 according to Statista).

The United States is a much larger market, with larger companies. But analysis from both the LSE and Nasdaq suggests that the difference in terms of liquidity, based on average trading volume, is not significant between New York and London (or indeed other markets). Nasdaq figures suggest that London has fewer star names, and commands much more attention and turnover than the market average, which makes sense.

Unpacking the Lex chart above, and looking at the stocks that have been rising, tells an interesting story. Companies like DS Smith and Mondi are gaining attention due to the takeover struggle. St James's Place is, essentially, in crisis mode.

But Halion, the consumer health group spun out of GlaxoSmithKline, also stands out. Both of its major owners, GlaxoSmithKline and Pfizer, have put significant amounts of shares on the market in recent months. The two sellers found strong demand and offered the shares at a deep discount to the market price: Pfizer's massive $3 billion sale last month (which incidentally equals the market value of St James's Place today) was done at a 4 percent discount.

There have also been a series of large IPOs on the London Stock Exchange and EGG itself, by owners led by Blackstone and Thomson Reuters, the most recent in March at a discount of 0.7 per cent. This – and this may seem low but it is worth saying amid the drumbeat of misery from around the City – suggests that the main market is doing well in terms of depth and liquidity for some global names.

Moreover, some global companies that might logically choose to shift their listing to the US reject (either publicly or privately) the idea as a distraction: British American Tobacco was one of the latest companies to question the benefits. At the same time, Smith & Nephew is trying to create a new structure to bridge the pay and related governance disparities between the two markets. One hopes that by this summer the major administrative reforms that promised to level the playing field between London and other markets will be implemented.

This is all good news if you are a larger company considering a London listing, or indeed, one of the diverse and intrusive advisors benefiting from this activity. The IPO pipeline isn't completely blown, according to capital markets bankers, but it's also not completely dry.

All of this raises the question of whether London's problems are turning into a two-speed market problem, says Simon French of Panmure Gordon. The consolidation of institutional investing and the rise of index investing is pushing money toward larger index components, leaving almost everyone, especially mid-cap or small-cap companies, in the lurch.

As usual, it is the household names that have received the most attention in this discussion, in terms of the challenge of attracting or retaining major global names. It is now worth separating out these different issues – not least because the appropriate treatments, to ensure that promising, smaller companies are able to raise money in London, are likely to be different from those exercised in other parts of the market.

Another chart Lex posted that caught my attention this week was this:

The recent exceptional performance of European banks – a sector long associated with lackluster returns, value destruction, and political interference – has sparked much debate among the Lex team. The huge payouts to shareholders that led to this rally don't look sustainable across the sector (and you can read why here).

But some European banks – and this week Leaks looked at ING – are distributing money to shareholders from a position of relative strength. ING may also have an answer on how to proceed from here.

In Lex this week

Why is troubled luxury group Kering spending €1.3 billion on a landmark building in Milan? Buying real estate isn't the smartest use of luxury cash flow — even leaving aside the challenges Kering is facing with its flagship brand Gucci. Read more.

In other tales of troubled management, Endeavor Entertainment Group agreed to a deal to take itself private by a star-studded group of majority shareholders this week. Public investors won't even get a vote on the deal, which is a fitting end to the sorry showing of this company's time in the market. Find out more.

The UK's windfall tax on oil and gas production was supposed to lead to capital flight from the sector. So why would UK-focused Ithaca Energy consider doubling its efforts in the North Sea through a deal with Italy's Eni? Read it here.

What I enjoyed this week

Maybe “enjoy it” isn't the right word, but a New Yorker article about what 14 years of Tory rule has done to Britain was a must-read this week.

As an sufferer myself, I read with interest this article about the “Allergy Apocalypse” from The Atlantic's daily email.

On a lighter note, I've been mainly listening to the Dish podcast and Beyoncé's new country album, which is excellent.

Have a nice weekend,

Helen Thomas
Prime Lex