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The Aim IPO process

A company seeking admission to Aim appoints a corporate broker and bookrunner to ‘place’ shares with chosen institutional investors. These institutions are principally made up of fund managers overseeing collective investment schemes, but also include private client brokers investing on behalf of their clients. As the majority of private investors now choose to buy and sell shares through low-cost, execution-only brokers, they are sadly excluded from the IPO party. Those private investors interested in participating in IPOs and willing to pay a bit extra for dealing and management should consider talking to a traditional stockbroker or portfolio manager. A relatively modest fee may open up the possibility of IPO participation to help boost investment performance.

Prospective institutional investors are able to read the draft ‘Pathfinder’ Aim admission document, with the quantum of funds being raised and pricing information left blank, and also any supporting ‘pre-IPO’ research. They would also typically attend a presentation made by the company’s management. While private investors don’t have access to this information prior to admission, the final Aim admission document is available on the company’s website on the day of admission and provides a wealth of information.

Pricing

The ‘cornerstone’ investors supporting the IPO set the price they are willing to pay. Thankfully, major institutions supporting IPOs appear to have become slightly more demanding with pricing over the past few months, especially where a large percentage of the money being raised is going to selling shareholders. This is a far cry from a few years ago when institutions seemed far less discerning and were happy to pay high prices to private-equity sellers.

The result of this is that IPOs are arriving on the stock market at much fairer prices, thereby supporting the quick margin to be made in the first few days of listing and, indeed, over the following weeks.

How have IPOs fared in 2018?

The performance of the 19 admissions to Aim so far in 2018 (to 18 June) has been very positive, with an average gain of 37 per cent and median gain of 12.5 per cent. While popular stocks performed strongly on the first day of trading, many of the gains were made over subsequent weeks and months. So what helps an IPO get off to a good start?

As you can see, there is a wide range of returns, therefore it’s important to choose wisely.

Pick your sector

The year 2018 has seen institutions drawn to companies operating in fashionable, high-growth sectors with broad global appeal. This was illustrated by the recent admission of video game developers Team17 (TM17) and Codemasters (CDM) to Aim, both of which received strong institutional backing and subsequently attracted plenty of retail buyers as well. 

Aim-traded Keywords Studios (KWS), a technical service provider to the global video game industry, has delivered a stunning performance over the past few years, and investors are no doubt eager to grab a slice of the next star in this rapidly growing market – up until recently there weren’t many alternatives in the UK market.

To gauge sector popularity look no further than the US market – what’s hot in the US is ultimately bound to find its way to the UK.

While Team17 and Codemasters are well-established businesses, the shift to digital and the growing mobile market is allowing publishers to sell video games to a wider audience. eSport, where consumers compete online and watch others compete, is also a growing area of gaming.

At the other end of the excitement scale, legal services and litigation has surprisingly also become another popular sector. Spurred on by the phenomenal success of litigation funder Burford Capital (BUR) and more recent success of legal services platform Keystone Law (KEYS), whose shares have doubled since their arrival on Aim in November 2017, Rosenblatt (RBGP), which includes one of the UK’s leading dispute resolution practices, has been well received by investors since its admission to Aim in May 2018. 

At the time of writing Anexo, a specialist credit hire and legal services group focused on providing replacement vehicles and associated legal services to ‘impecunious’ (those having little money) customers who have been involved in a non-fault accident, was preparing to float and is worth watching. Anexo’s business model appears to sit somewhere between a Burford Capital and Redde (REDD). Knights, another legal services provider, starts trading today (29 June).

UK headquartered

Following a number of scandals involving companies headquartered overseas, there has been a clear preference for UK-headquartered companies in recent years, where management is more accessible to UK investors. This is not to say that the companies don’t have international operations or address international markets, but it seems more important than ever that the primary point of contacts are in the UK. 

Institutional backing

The support of a number of large institutional investors is, generally speaking, a good sign that the shares will be well received. A popular IPO may also see allocations cut back and those institutions desiring a larger, more meaningful holding for their funds may therefore be keen to buy more shares on admission, thereby pushing the share price higher. So, always take a look at the shareholder information section on the company’s website to see who the large shareholders are. This may also be contained in the section titled ‘Aim rule 26’.

Small free float

The nature of an Aim IPO is to see some shareholders sell (old money) and new money being raised to help support the growth of the business or pay down debt. Institutions supporting the IPO generally demand that selling shareholders are ‘locked-in’ for at least 12 months, which prevents them selling more shares in the short term and therefore can result in a relatively small free float of available shares.

Lock-ins are, however, not quite as rigid as implied by the terms of the Aim admission document. This was illustrated in September 2017 by a secondary placing of shares in K3 Capital (K3C), a business sales and brokerage business, whose shares had performed strongly in the five months following Aim admission. At this point, shareholders who were apparently locked in for 12 months, were permitted to sell another large tranche of shares, apparently to satisfy strong institutional demand.

Large institutional investors, only receiving a relatively small allocation of shares on IPO, may wish to buy more shares following admission to secure a meaningful position for their fund. Private investors may also be eager buyers pushing the shares higher. Strong demand and a lack of available shares pushes the share price higher.

Founder-led businesses

Founder-led businesses, enjoying the support of other highly regarded backers, operating in a rapidly growing sector where the free float is small, constitute the perfect ingredients for a successful IPO. This situation is perfectly illustrated by the March 2018 Aim admission of GRC International (GRC). 

GRC provides a range of services addressing IT governance, risk management and regulatory compliance. It has seen a significant increase in training and consultancy revenue directly related to GDPR, which touched a huge percentage of the population in May.

Although still very small, GRC has grown strongly over the past two years and results for the six months to 30 September 2017 show revenues up over 100 per cent to £5.8m.

Andrew Brode, the chairman and largest shareholder of one of Aim’s most successful and largest companies, RWS (RWS), is also non-executive chairman of GRC and, more significantly, holds a 19.6 per cent stake in GRC. Alan Calder, the chief executive officer, founded the business in 2002 and sold very few shares at IPO and continues to hold a 50.8 per cent stake. Nigel Wray, another well-known UK small-cap investor, has a 3.13 per cent stake.

The market capitalisation of GRC on Aim admission was £40.2m, but with approximately 80 per cent of the shareholders locked-in or in the hands of very reluctant sellers, the free float was effectively less than £8m. As a result of its small size and small free float, large institutions were effectively prevented from investing in this business. However, strong demand from private investors, and very limited supply, has seen the share price soar over 300 per cent since Aim admission, pushing the market capitalisation to £174m. While it is growing rapidly, this now looks a very rich valuation to us for a business anticipated to generate revenues of only £15m for the year ending March 2018 and profits that may not touch £2m.

The risks of a small free float

The booming share price of GRC also highlights the risk of a small free float where small investors bid up the share price to unrealistic levels, far removed from the realistic value of the business. It’s hard to believe that the admission price of GRC, which will have been decided following serious consideration, was so wide of the mark, especially given the absence of really supportive newsflow since IPO. 

Technology, technology, technology...

VR Education (VRE) is a very early-stage – revenues for the nine months ending 30 September 2017 were only €468,000 (£410,000) – virtual reality (VR) technology company focused on the education space. It joined Aim in March, the same month as GRC.

The group’s core focus is the development and commercialisation of its online virtual social learning platform called ENGAGE, which provides a platform for creating and sharing VR content for educational and corporate training purposes.

The announcement at the beginning of May that its Apollo 11 VR educational experience had been selected to be part of the launch collection for Oculus Go, Oculus’s new all-in-one VR headset, has helped push the shares sharply higher pushing the market capitalisation to over £40m; Oculus is owned by Facebook.

The founding directors of VRE hold 40 per cent of the equity and other enthusiastic institutional technology investors hold large stakes, resulting in a very small free float. 

The valuation of a small early-stage company of this nature with minimal revenues and an unproven product is very hard for many investors to understand. Furthermore, much like GRC, it is too small and illiquid to attract large institutional investors. However, if the technology is in the spotlight, which is the case with VRE, and with momentum on its side, companies such as this can deliver substantial quick-fire returns for private investors. 

What to avoid

Generally speaking, the opposite of the above. The disadvantage of a potentially unstable shareholder register is illustrated by OnTheMarket (OTMP), which was admitted to Aim in February 2018.

OnTheMarket is the parent company of Agents’ Mutual, which owns and operates the UK online residential property portal OnTheMarket.com. Agents’ Mutual was formed in January 2013 by several leading estate and lettings agents to create a new residential property portal as a challenger to the two existing major portal groups, Rightmove and Zoopla.

Agents’ Mutual was set up as a company limited by guarantee, with ‘members’ each having a single member’s interest. On admission to Aim, the members approved a conversion of their interests in Agents’ Mutual to ordinary shares in OnTheMarket plc, the new parent company, in which they currently hold a 50 per cent plus interest.

Prospective agents are encouraged to sign up to OnTheMarket by the added incentive of equity ownership in the listed company, should they remain contracted for a given time period. The pitfalls of this approach for existing shareholders who aren’t agents are spelled out in the section covering risk factors in the Aim admission document, which states: “The group’s policy of issuing shares to estate agents in return for listing contracts...may give rise to greater than anticipated dilution.”

Most of the shares issued to estate agents are subject to lock-in provisions restricting the timing of sales of the shares over the next few years. However, approximately 6m shares of the existing agent shareholders are not subject to lock-in arrangements. That’s a significant 10 per cent of the issued capital, and many of those shareholders may be eager to cash in following the IPO, thereby resulting in short-term downward pressure on the share price or a market overhang. This could be a contributing factor behind the lacklustre performance of the group’s shares, despite generally positive newsflow.

We have seen this on several occasions where companies list, yet many legacy shareholders are not locked in, resulting in regular selling over the weeks following IPO, forcing the share price ever lower. It’s often hard to understand why legacy shareholders would continue to sell as the share price falls well below the IPO price. However, it’s important to remember that these original investors may have originally purchased shares several years earlier at a fraction of the IPO price and are still making a nice profit. Something to avoid.

Private equity exits

The private equity model requires private equity holders to sell out of a company at some point. However, if the history of IPOs is any guide, it’s a cause for concern when private equity holders sell out entirely on IPO. Liquidity concerns, notwithstanding, it is indeed surprising that institutional investors are prepared to back IPOs where private equity holders aren’t willing to retain a holding for 12 months post IPO. This could create a market overhang 12 months out, but surely gives confidence to new holders on IPO. 

Decline of resources

While technology, video gaming and legal services are current popular sectors, the resources sector has struggled to attract much interest in recent years. This is very different to 2007, when Aim reached a peak of just under 1,700 companies and resources dominated, with Aim’s three largest companies from the mining, oil and gas sectors.

The worst-performing IPOs in 2018 are Cradle Arc (CRA), an African-focused base and precious metals exploration company, and Crusader Resources (CAS), an Australia-based company engaged in mineral exploration in Brazil. Neither of these companies possess some of the other desirable attributes highlighted above, and there is a notable absence of large reputable institutional investors on the shareholder register of either.

Recent/current IPOs

Chris Boxall is founder of Fundamental Asset Management (www.fundamentalasset.com), a specialist investment manager with a focus on Aim and smaller-quoted companies. Fundamental Asset Management owns shares in some of the companies mentioned in this article.