- De-equitisation pace is ‘relentless’
- AIM received largest number of bids last year
- Fund flow reverse ‘can happen quickly’
Broker Peel Hunt (PEEL:AIM) has warned that the ‘relentless’ pace of de-equitisation driven by depressed UK stock market valuations will likely continue unless action is taken and ‘impacts quickly’.
Low valuations are making the UK stock market an attractive hunting ground for acquirers and are a key factor behind the ‘minimal’ IPO (initial public offering) activity of the last two years which needs to be ‘actively addressed’, according to the broker.
ACCELERATING THE PACE
Peel Hunt’s head of research Charles Hall pointed out that the pace of UK merger and acquisition (M&A) activity accelerated through 2023, a year in which 40 transactions worth more than £100 million were announced.
Last year’s takeover activity was predominately targeted in the smaller company space, with no bids for FTSE 100 firms and a mere three offers for FTSE 350 companies.
In contrast, the FTSE Smallcap and AIM indices witnessed 13 and 20 takeovers respectively, according to the broker.
While AIM received the largest number of bids, including for restaurant group Fulham Shore, premium chocolatier Hotel Chocolat (HOTC:AIM) and stockbroker Numis, the highest proportion of takeovers compared to the size of the index was actually in the FTSE Smallcap.
The latter index lost the likes of car dealer Lookers, funeral provider Dignity and teleradiology services firm Medica, and saw bids for Wagamama-owner Restaurant Group and ten-pin bowling play Ten Entertainment (TEG).
DEPRESSED VALUATIONS
The average bid premium in 2023 was 50%, noted Peel Hunt, which reflected the depressed valuations of so many UK smaller companies, not helped by 30 consecutive months of outflows from UK funds exerting selling pressure.
2023 saw greater activity from overseas acquirers eager to bag UK stock market bargains, with the technology and leisure sectors receiving the most bids, seven and five respectively.
‘Although the overall trends are concerning,’ said Hall, ‘there is an even bigger issue at the sector level. A number of sectors are effectively being hollowed out, which leads to lower interest from investors and analysts and reduces UK expertise in these areas.’
REVERSING THE TREND
Hall stressed this negative trend is ‘self-fuelling’, since the poor showing from UK equities makes them look less attractive to fund managers and retail investors and the reduction in liquidity also reduces appetite from overseas investors.
However, the Peel Hunt scribe said increased fund flow would be the key driver for a reverse scenario, one which ‘can happen quickly’ and could come from increased appetite from retail investors driven by the launch of a British ISA or changes to capital gains tax or dividend tax on UK shares.
Other possible drivers could include an increase in share buybacks, rising demand from overseas investors, should they see a material change in UK fund flows, or the reduced cost of ownership and the benefits of higher liquidity that would arise if the government addressed the UK’s ‘penal level’ of stamp duty compared with other markets.
‘This could all be achieved without a change in the economic outlook,’ explained Hall, which would be ‘the icing on the cake, with reducing inflation driving the prospect of lower rates and an improvement in economic activity.’ If we do see increased demand for UK equities, then valuations ‘should improve materially, which would make an IPO a more attractive option’, according to the analyst.
That said, Hall highlighted some ‘deep-rooted issues in the UK regarding IPOs and the health of equity capital markets, which have material consequences for long-term economic growth. The fact that more UK companies of material size listed in the US rather than the UK in 2023 shows the extent of the issue.’
