The UK market is feeling sorry for itself. After all, life doesn’t feel much fun as America’s humdrum cousin, watching from afar as New York woos glamorous tech stocks and go-go pharma groups. The envy has deepened since a flurry of homegrown businesses moved or started to consider moving their primary listings across the Atlantic. But notwithstanding the flaws of the City of London, is there a risk that the American dream proves just that – a false reality?
The health of UK public markets has been under scrutiny since Brexit. But things stepped up a gear in March when it was revealed chip designer Arm planned to list solely on Nasdaq, defying hopes of a dual listing in London. CRH (CRH), the world’s biggest building materials supplier, decided to drop its UK listing around the same time. Gambling group Flutter (FLTR) could be next in line for the exit to the US.
The global initial public offering (IPO) slowdown is increasing the City’s anxiety levels: companies are leaving and not being replaced. UK IPO proceeds in the first quarter of 2023 were 80 per cent lower than the equivalent period in 2022, and 99 per cent lower than the record sums generated at the start of 2021.
The direction of travel is clear: there were more than 2,400 companies trading on the London Stock Exchange in 2015. Now there are fewer than 2,000.
Land of milk and money
The companies mentioned above all have specific reasons for relocating to the US. Flutter, for example, generates a third of its revenue in the US, and the UK market is in the grip of new gambling regulations. Meanwhile, plumbing group Ferguson (FERG) – which moved its primary listing to New York last year – had sold off its UK business entirely. Tthe option of shifting abroad isn't as enticing to all businesses.
The option of shifting abroad isn’t as enticing to all businesses. “When I see switches, it’s usually for a specific reason,” says Scott McCubbin, capital markets partner at EY. “Very rarely do I see established businesses get a value pop because they changed domicile.”
Nonetheless, relative valuation is a key part of America’s allure. Panmure Gordon’s chief economist, Simon French, says a “very clear” valuation gap has emerged in UK equities since 2016, and the London market’s outperformance in 2022 only had a “small impact in narrowing this spread”.
According to French’s analysis, the UK trades at an 18 per cent discount to the rest of the world (and the global market is dominated by US exchanges). This figure is adjusted to account for different sector weightings, meaning the spread can’t be blamed exclusively on a lack of technology stocks or a preponderance of mature companies in the UK. Instead, French argues that the discount – and the resultant increase in the cost of equity capital – is bigger than underlying characteristics seem to justify.
So what’s going on? The sheer size of the US market is one significant factor. US investors have deep pockets which, in turn, increases their appetite for risk, as a few bad decisions are unlikely to have such severe consequences. This is particularly important for young technology and healthcare businesses, which might not be generating any profits yet – or even sales (looking at you, Rivian Automotive (US: RIVN)).
“The US has a bigger pool of capital for biotech, and a deeper pool of experienced investors in the space,” says Stifel analyst Max Herrmann. “There are a lot of biotech and healthcare-focused hedge funds, and the amount of capital they have to invest is far greater than equivalents in the UK and Europe.”
The bigger investor pool also provides better liquidity. “There’s much more buying and selling… Nasdaq is seen as a more mature and sophisticated market than Aim,” Herrmann added.
This is echoed by French’s analysis, which found that just 100 of the UK’s largest public companies trade more than $5mn (£4mn) per day, compared with almost all the companies in the S&P 500. “We have long thought that this is becoming an increasing impediment to the UK market re-rating in line with its growth characteristics,” he says.
Patchy analyst coverage may also play a part in this. UK research budgets have shrunk in recent years following European regulatory reforms known as Mifid II, which forced asset managers to separate the cost of broker research from trading commissions paid to brokers, in a process known as ‘unbundling’.
Prospective investors enjoy “much greater expertise on the sell side” in US biotech compared with the UK, according to Herrmann. “And similarly you have much greater expertise on the buy side because you have the greater pool of capital.” Of course, it’s easier for analysts to make sensible calls when there’s an abundance of companies to compare with one another – and so the vicious cycle continues. This relative lack of coverage in the UK, while creating opportunities for private investors, creates issues at an index level.
America’s ample resources only explain so much, however. Other drivers of the valuation gap lie closer to home. “The natural buyer of UK equities has been reducing its exposure over time, so the pool of capital was smaller than it was,” says Richard Marwood, head of income at Royal London Asset Management.
In the mid-1990s, the average UK defined-benefit pension fund had 75 per cent of its money in equities, and 71 per cent of that in domestic stocks, according to Schroders. Now, less than a quarter of the pot goes into equities, and just 13 per cent of that is invested in the UK.
“We are happily funding our global competitors,” says Lorna Tilbian, executive chair of Dowgate Capital. “Our pensions are going to make other companies bigger and better than ours.”
There’s a risk of oversimplifying things. Defined-contribution (DC) schemes are an increasingly important part of the pension landscape, for example, and Schroders notes these schemes allocate “lots to equities”. DC assets are due to grow significantly in the coming years, too. However, the overall picture is clear: forces from at home and abroad mean UK companies are going cheap, and management teams aren’t happy.
Reality check
Chief executives have another reason to favour New York. “If you are the management team of a US business, you are under less scrutiny around what you are paid,” says Marwood (see page 11 for more on executive pay). Other awkward topics are also easier to dodge. “ESG is less of a concern for many US investors than it is in Europe... the general view is that the European asset management industry is much more developed on those fronts.”
These dubious perks are slightly offset, however, by the complexity and cost of floating and existing on the US market. Quarterly reporting doesn’t come cheap, nor does compliance with the Sarbanes-Oxley Act, which requires management to assess and report annually on the effectiveness of the company’s internal controls.
Small companies are particularly vulnerable. One consultancy estimates the average Aim IPO costs 7 per cent of gross funds raised, compared with an average Nasdaq IPO cost of 12 per cent. Once listed, Aim stocks spend around $300,000 (£241,000) a year on ongoing professional fees and insurance, compared with $2mn-$3mn for their peers in New York.
One of the reasons that US insurance is so high is because companies are often exposed to lawsuits. In 2022, 208 securities class action suits were filed in the US, including 34 against non-US issuers. Simon Olsen, capital markets partner at Deloitte, says UK litigation is “extremely rare” by comparison.
Higher costs aren’t the only risk. When a company switches exchanges, investors with a UK mandate may be forced to sell, as happened when BHP (BHP) left the FTSE 100 last year and moved back to Sydney.
“There will be a lot of UK sellers,” said Tilbian. “And while American investors might buy a company in the beginning because it’s exciting, deep down it’s still a UK company, and if they want exposure to UK regulation, governance, transparency and management they will buy a pure UK company.”
Shares could prove jumpier over the longer term as well, given the different investor base. “What’s FTSE 100 over here is small in the US,” says EY’s McCubbin. “You go from being instantly invested in by long-term holders like pension plans to suddenly not being.”
For private investors, there are also tax implications: stocks that trade on Aim typically count as inheritance tax-exempt assets. UK investors holding US shares also need to fill out a W-8Ben form, which reduces the dividend tax payable on relevant US shares – from 30 per cent to 15 per cent unless the shares are held in a Sipp in which case no withholding tax is deducted.
When it comes to dividends, companies themselves should be keeping an eye on the way that US industrial policy develops in the months ahead. The Biden administration has started adding caveats to the US Chips Act, for example, specifying that companies can’t use federal funds for dividends or buybacks. While this is not the case for the Inflation Reduction Act subsidies, it’s not inconceivable that the rules will change, and some of that funding will start to come with more strings attached.
Cautionary tales
Enough hypothesising, though – how are UK businesses actually performing in the US? Ferguson, which activist Trian said prior to the introduction of a US listing was trading at a discount to US peers, is still doing so – albeit this discount has narrowed slightly. The company trades at an enterprise value to next year’s Ebitda ratio of 11.6 times, compared with 13.3 times for Home Depot (US:HD). The gap has closed by around one percentage point over the past four years.
But data for newer businesses does not paint a pretty picture. According to data from the London Stock Exchange and Refinitiv, UK issuers who chose to fall in line with the recent US craze for special purpose acquisition companies (Spacs) – ie, merged with the blank-cheque companies in order to go public in the US – have lost 87 per cent of their value on a simple average price performance basis.
To make matters worse, almost half have received a deficiency notice for failing to comply with minimum bid price requirements – in other words, theirprice fell below $1 for 30 consecutive days.
High-profile flops include used car retailer Cazoo (US:CZOO), which listed in New York in August 2021. At the time of the deal, it said it had explored a UK IPO but that high-growth companies are “better understood by US investors”. UK digital healthcare service Babylon (US:BBLN) has been similarly burnt, with its chief executive describing its post-float performance as an “unbelievable, unmitigated disaster”.
That’s not to say the UK hasn’t had its fair share of disasters. However, it does cast doubt on the idea that the US – with its long history of outperformance – automatically gives listed businesses a better time of it.
The blank-cheque boom seems to be behind us, but newly listed stocks are still struggling in the US. Companies that floated on Nasdaq in 2022 – excluding Spacs – have seen their share price fall by an average of 43.3 per cent, according to data from the London Stock Exchange and Refinitiv. By contrast, shares in groups that listed on London’s main market at the same time are down by just 1.6 per cent.
Dealogic data shows that UK companies that raised over $100mn in domestic IPOs in 2020 enjoyed returns of 19 per cent over the course of the year. By contrast, UK issuers in the US only saw shares rise by 4.2 per cent. The pattern reversed in 2021, when newly listed companies in the UK experienced steeper declines, but the figures further complicate the belief that success is only a plane ride away.
All the same, there is still pressure on the UK to change perceptions: looking at the IPO market as a whole (rather than solely the UK companies choosing to list at home or abroad), just six companies have listed on London markets so far this year, according to Financial Times figures, compared with more than 50 in the US and over 30 elsewhere in Europe.
Homeward bound
Is this an inevitable decline? “I think London will [still] have its fair share of companies that decide to list in the UK for the right reasons,” says Svetlana Marriott, head of UK capital markets advisory group at KPMG.
One sector that looks particularly promising is ‘challenger banks’, which US investors tend to shun due to Europe’s complex regulation. “A number of those looked at US Spac deals, but US investors aren’t interested,” says Deloitte’s Simon Olsen.
Emerging markets businesses are also drawn to the London Stock Exchange, which is the second-largest African exchange in the world behind Johannesburg, hosting more than 100 African companies. This sizable peer group has bred better investor understanding, which can be seen at a company level.
Shares in London-listed Helios Towers (HTWS), for example – which builds telephone masts in Africa and the Middle East – have held up significantly better than those of US rival IHS Holdings (US:IHS), since they listed in October 2019 and October 2021, respectively. Based on geographical attractions alone, the UK will remain attractive to global businesses like these.
Medtech is another area with potential. “We have had a lot of US medtech companies coming to Europe to list – to the UK specifically,” says Stifel’s Herrmann. “The companies are not quite as capital intensive as biotech companies – you don’t need $100mn to develop a device, whereas you might need that to develop a drug. Therefore UK and European investors are much more willing to invest.”
Oxygen treatment developer Belluscura (BELL), cancer detection firm LungLife AI (LLAI) and cell engineering company MaxCyte (MXCT) are three interesting examples.
Regulatory reform
The UK is certainly trying to retain its relevance. In December 2021, the Financial Conduct Authority (FCA) overhauled listing rules, allowing as little as 10 per cent of a company’s shares to be offered in an IPO, down from a minimum of 25 per cent. It has also changed the rules around dual-class stock, allowing founders extra voting rights in certain circumstances. Both moves put London more in line with New York and are designed to entice forward-thinking, young companies.
Other reviews are ongoing, and earlier this month the FCA announced further reforms, simplifying its plan to combine premium and standard listings, as well as scrapping the need for shareholder votes on transactions between listed companies and “related parties” – a provision seen as one reason why Arm opted for a US listing.
It will take a while for the effects to be felt. In the meantime, UK retail investors look to be in a good position. Accessing a range of overseas investments is easier than ever before and – more importantly – there’s still an abundance of bargains to be found at home that look poised for a re-rating.
The question is: for how long? Over the last few weeks there has been a new burst of private equity deals, with Dechra Pharmaceuticals (DPH), Sureserve (SUR), Hyve Group (HYVE), Medica (MGP) and THG (THG) – along with several others – all receiving bid approaches. For all the talk of a US decampment, it is buyers who are swooping in and having a more material impact on the pool of investment opportunities. As we fret about American dreams, therefore, public-to-private buyouts are rapidly becoming the reality.
