Europe has recently seen an acceleration in the number of companies buying in their free floats and taking the decision to “go private”.
The trend to delisting may be bad for stockmarkets in the long term, but will benefit small cap investors in the short term.
In recent years, more companies have been exiting stock exchanges across the world than have been coming to the market. In the US, the number of quoted companies has fallen from 5500 in 2000 to around 4000 today.
In the UK, it has decreased from 2400 to 1775 during the same period. In continental Europe, the number of companies that have delisted year to date has already exceeded the totals recorded in each of the past four years (see chart).
The reasons for this phenomenon are multiple: new stock listings have become rarer as many companies have chosen to go with private equity backers; regulation, be it financial or ESG-related, has become heavier. Moreover, with mega caps performing so well, institutional investors have not bothered with smaller companies.
So, if the number of quoted companies is shrinking, then surely this will limit investment opportunities in the future? We would not necessarily agree. Certainly, in the long term – and if the trend continues 10 years or more from now – a shrinking investment universe would be negative for stockmarkets, brokers and the local economy and would also clearly narrow investment opportunities.
However, in the short term it is likely to be favourable for the performance of small caps and small cap funds. In Europe we have recently seen an acceleration in the number of companies buying in their free floats and taking the decision to “go private”, often with exit premiums of 50-60 per cent. This can be a useful fillip to performance as these premiums will drive up prices in the small cap indices.
In addition, it brings cash back to institutional investors, including managers of small cap funds such as us, who then have new ‘dry powder’ to go out shopping for new ideas.
At times like now, when there is little in the way of money coming into funds, this extra cash can be very useful.
Why go private now?
But why would companies choose to go private now? What is notable about European companies is that they often have a family shareholder. This is true from the largest companies, such as BMW, LVMH, Daimler, to the very smallest ones. An example are three small companies we own in our fund: SABAF, producing gas burners and hinges, Exail Technologies, specialising in marine drones and inertial navigation equipment, and Sarantis, which makes household products.
Families can sometimes seize the opportunity when they feel that their company – where they may own, say, 30-50 per cent of the capital – is trading at an unreasonably discounted level. In the past two years we have seen several examples of this: a French office supplies company that went private with a 60 per cent premium; Rothschild & Co (26 per cent); electrical engineering group Schaffner (60 per cent); and laser group Prima Industrie (76 per cent), to name but a few.
Swiss supplier of production lines for packaging companies Bobst is one of our portfolio companies that decided to delist last year. The company was founded in 1890, listed on the Swiss stock exchange in 1978 and the Bobst family still owned 53 per cent of the shares.
Its family CEO explained to us his frustration as a listed company and the reasons for taking his company private. While there are advantages and disadvantages of being listed, with recent lack of interest in small caps and the ensuing low valuation, the advantages were losing weight, he said.
He highlighted increasing regulatory constraints, the need to communicate in detail about his business strategy and current trends, sometimes to the unintended benefit of competitors. Also, the low valuation meant that potentially a large attractive acquisition could not be financed by issuing shares, as the market valuation given to his company was far lower than privately owned peers.
Frustration around low valuations and disinterest from investors is what we are increasingly hearing from the managements of listed smaller companies across Europe. If institutional investors don’t buy the undervalued small caps in Europe, then companies will accelerate their buying back of their own shares, taking themselves private at a premium.
On the offer side, private equity funds are complaining that the stockmarket as an exit route for their companies is effectively ‘closed’. This means that valuation multiples (EV/Ebitda) there are lower than those they have paid at competitive auctions and that investors are only bidding at Ebitda multiples of 7/8x for companies they have bought at 12x.
At the same time, companies are avoiding issuing new shares for their expansion projects, as valuations are too low and would dilute existing investors.
The next move is likely to be a return to the natural wave of consolidation as companies opportunistically bid for listed peers trading at low valuations. Indeed, with companies trading at discounts to accounting book value, it now makes more sense, for example, that a German company bid for its Italian competitor rather than build a factory there.
So, with few IPOs and capital raises, the supply of equity is dwindling while the lack of financial investor demand is being replaced by corporates buying back shares themselves and core shareholders buying out the minorities.
This at some stage should lead to outperformance of small cap indices, which institutional investors will start to notice.