UK Listed Equities- The Shrinking Pool

Lady Cobham doesn’t like it and the proposed £4bn takeover of Cobham PLC, the aerospace and defence group bearing her family’s name, is generating lots of noise. Framed by some as an early test of the new government’s industrial strategy, the announcement of US private equity interest also prompted a surge in the share prices of similar UK companies thought to be vulnerable following the slump in the pound.

If it goes ahead, the deal will see another major UK listed company exit the stock market, continuing the trend known as “de-equitization”. The causes of this trend are well established – debt is cheap, and equity is expensive. As a result, UK listed companies have bought back and cancelled shares to enhance earnings (£66bn over two years), while private equity funds now have an estimated $2.5 trillion of so called ‘dry powder’. The total number of shares listed in London has shrunk by 3% since the start of 2018 while the number of companies listed in London has reduced by 300 since 2015 (the pool is now down by a third on its peak of 3000). Concerns are growing for smaller UK listed companies in the wake of the collapse of the Woodford Equity Income Fund, which has led to increased scrutiny around the liquidity of companies with a market capitalisation of below £500m. Many of these will be under pressure to go private.

Does any of this matter? After all, enhanced earnings and M&A premia are good for anyone invested in the stock market. The answer, if you are worried about the reputation and future of democratic capitalism, is yes.

We already know that trust in business is low and having fewer public companies only means less transparency and accountability. Of course, conducting business behind closed doors can help companies that are under pressure. Boardrooms can have disagreements, without headlines. A difficult period of trading can be seen for what it is, rather than a sign of a brand in decline. The share price is not hovering over you in daily judgement. For a PLC board feeling the heat, less transparency can be a legitimate reason to sign off a takeover.

But the declining numbers point to a problem. If too many important UK companies go private, and less is publicly understood about how they are financed, or how people are rewarded, it’s bad for public trust. There’s a reason why full accounts, remuneration reports and related party transactions are disclosed. It’s in the interest of a wide group of stakeholders that includes employees and suppliers, as well as investors and senior management. Transparency ensures a fairer balance of risk.

Then there is the problem of who gets to access high quality investments. According the FT, the rise of private capital has made partners at buyout companies the new “masters of the universe, mirroring the kind of returns and investments we saw from hedge funds in the 1980s.” Meanwhile, as another columnist put it, de-equitisation “closes off big business and the wealth it generates to ordinary people.”

Of course, it’s not the job of PLC boards to worry about the public to private drift. As the Chief Executive of Cobham said: “There was only one logical outcome, and that’s what we are paid to do. We’ve done the right thing for shareholders.” And he’s right of course. But a continuing trend of private equity takeovers, if it continues, will help to legitimise an uncomfortable question – in whose interests are the capital markets now operating? For ‘the many’ or ‘the few’?

Those looking in on the City, especially the young, may draw their own conclusions; which is one reason why asset managers have rightly prioritised ESG (Environmental, Social and Governance) at the listed companies they own. They know society’s expectations are changing. As one asset manager put it: “Being a company director, and in particular a chief executive, requires a broader context. It requires a personal motivation that goes beyond simply amassing a fortune. It requires an understanding of where the company sits within the society within which it operates.”

This is the kind of lens through which business as a whole is now being assessed and so a continuing erosion of our base of listed companies has important consequences. Some argue the trend is cyclical and that the tide will turn – and they may be right. But others believe action is needed to help boost the pipeline of newly listed companies, by cutting the regulatory burden attached to IPOs and offering a tax cut to listed companies. Once the smoke of Brexit clears, we must hope this country’s leaders pull behind the City and the UK companies it helps to finance. They need to show more interest. If they don’t, the pool of gold standard UK listed companies may continue to shrink unchecked.