Avoid Aim's traps

But that doesn’t stop others coming to join the madness. The lax regulation and ease of accessing capital attracts many companies to the stock market, but many of these companies are little more than ideas and dreams. There are some key differences between Aim and the main market, which is the London Stock Exchange’s flagship market for more established companies, and these differences are striking.

For example – no trading record is required to list on Aim. That means pretty much anyone with an idea can propose a listing on Aim, and access private investor cash. A company does not need to be profitable, sustainable, or even generating any revenue, which is great for entrepreneurs, but often not so good for investors. Many companies that have failed to attract venture capital then decide to list on Aim – such as appScatter, which listed in September 2017. At the time, Edison forecast it to be making £1.5m in pre-tax profit for FY19. It was suspended in April 2019, and on 12 September, the chief executive was quoted as saying he was looking forward to the readmission of the enlarged group. A few weeks later, the company delisted from Aim. No explanation was given.

The weird and wacky world of Aim has seen many an investor lose their shirt. The Financial Times ran an article in 2015 called ‘Aim – 20 years of a few winners and many losers’, and found that in the first 20 years of Aim 72 per cent of all companies ever to have listed decreased in value. It was estimated that in more than 30 per cent of cases shareholders lost over 95 per cent of their investment.

Many like to argue that investing is a zero-sum game, with winners matching losers. But that’s not true – a quick look at the indices is enough proof that value is historically created by the stock market over a long enough period of time. But on Aim – it’s not even that. It’s a negative-sum game.

A better way of saying this is that it’s a ‘stockpicker’s market’. With such extreme value destruction, this means that Aim is not for widows and orphans. Companies with a market cap of less than £100m seldom attract institutional interest – liquidity is often an issue and funds that want to take large positions can easily end up owning sizeable chunks of the company, if they are able to get what they want at all. This then becomes an issue if they are a seller, because if they follow the rules (not all do) and notify when they move through required notification levels, the market knows they are a seller and often beats them to it. If someone is unwinding 20 per cent of a stock, few people will be rushing to buy until they have sold it right down.

There are only a few institutions that deal in small-cap stocks, Premier Miton being one of them, and often an institution will only buy their position through a placing. It’s not often that a fund will buy on the open market and drive the price up – which means that the prices are set mostly by retail investors.

This leads to an inefficient and illiquid market that can be punishing for those who pick the wrong stock, but highly lucrative for those who can pick a winner. It’s this lottery ticket mentality that continually draws people in. For every Asos (ASC), Boohoo (BOO), and Fevertree Drinks (FEVR), there are scores of failures – an exchange littered with broken dreams and battered portfolios.

Aim versus the main market

How Aim works and operates

The Financial Conduct Authority (FCA) is responsible for regulating the UK’s financial services industry. Many private investors don’t believe the FCA does enough, and one can only assume that this is a result of being understaffed and underfunded rather than inept. In order to divest some of the responsibility for the junior market, the ‘Nomad’ system was created. A Nomad is a ‘nominated adviser’, which is a corporate entity that is responsible for ensuring that the company acts within the regulatory rules. All companies must have a Nomad to remain listed, and any company that sees its Nomad resign has one month to appoint a new one, otherwise its shares will be cancelled and struck from Aim.

The problem here is that the Nomad should be an independent body. But it’s not – the company pays the Nomad. This means that the Nomad now has a vested interest in the company staying listed, and is now more likely to turn a blind eye to potential problems if it means the retainer keeps coming in. Whether or not these fees have ever influenced a Nomad to act in a different matter is another question, but the conflict of interest is real.

A few weeks ago on 21 October, Mporium Group’s (MPM) Nomad, FinnCap, resigned with immediate effect. Less than two hours later on the same day, an RNS appeared announcing that Begbies Traynor had been appointed as administrator to the company’s trading subsidiary. At the bottom of the RNS, there were two sentences describing how the “business and assets of [Mporium] was sold by the administrators to a new company where Charles Pendred and Tom Smith are directors”. Charles Pendred is the chairman of Mporium and Tom Smith is the chief executive, and all of the employees’ jobs have been saved. That’s great for them – but what about shareholders? Why would the directors of the new company care about appointing a new Nomad, if they fully own the old Mporium business that went into administration? Many of the company’s shareholders have been left feeling aggrieved, and there is very little they can do.

Further conflicts

Along with Nomads, companies have to appoint brokers to help them raise capital. These brokers may also take a retainer and charge commission on the funds raised, and the problem is that very often the broker is the same company as the Nomad. On one hand the corporate finance house is being paid by its corporate clients to oversee the company’s activities, but as a broker it is also being paid to raise money. This means there is a clear incentive to push the stock to its retail clients, and be overzealous in the research notes that it produces. There are supposed to be Chinese walls in place to prevent such abuse happening, but one would not be overly cynical if they did not hold these walls in such high regard. Anyone who has seen Wolf of Wall Street will remember how the brokers of Stratton Oakmont pushed anything they could because all they cared about was their commission – it pays to be wary of any broker pushing stock onto you.

As early as 2006, the FCA’s predecessor, the Financial Services Authority (FSA) fined broker Hoodless and Brennan £90,000 for pushing penny shares to customers who did not fully appreciate the risks. Twelve years later, that broker would go under as Beaufort Securities. Not only were clients at risk of losing more than the amount that was supposed to be protected by the Financial Services Compensation Scheme, but retail investors were unable to deal in their positions.

This was a problem, because a few weeks earlier Beaufort ran a £10m equity placing in Immupharma (IMM) for its clients. Top-line results for Immupharma’s asset Lupuzor were due in just a few weeks, but those who held stock in Immupharma through Beaufort were unable to deal. They were also unable to hedge their positions as borrowing on the stock to short was extremely limited, and there was no significantly correlated instrument as these results were a binary event: either the stock gapped up and multibagged, or it was going to get crushed into the ground.

Unfortunately, the stock opened up more than 75 per cent down from its previous close.

When the risks were read out over the phone – the brokers didn’t mention the risk of being unable to sell if the broker itself went under.

Acquisitions on Aim rarely require a GM

Another risk on Aim is that acquisitions can be done without shareholder approval first. This means that the directors can significantly alter the course of the business. Management Resource Solutions' (MRS) shareholders found this out on 28 March earlier in the year, when the business acquired Alerion Consulting Ltd, for £1.32m paid for with MRS stock. This was despite the company admitting that the business only had tangible assets of £47,650, and hadn’t traded because it was in the “technology development phase”. The company had never filed accounts with Companies House aside from a confirmation statement.

Two general meetings then ensued, with motions to remove directors submitted by disgruntled shareholders, which were both defeated. As a result of the distraction, and independent enquires (but paid for by the company of course), the fees in total for this were in an RNS as costing Aus$1.6m, and the company’s prospects had deteriorated significantly. As of 20 November, MRS was urgently seeking to avoid liquidation.

Placings

Equity raises are a necessary evil on Aim, as ‘growth’ companies often require cash to develop projects and invest in the business. However, many of these companies are not growth companies, but lifestyle vehicles for the directors. What may start out as an exciting dream to build a business eventually ends up in failure, but the directors have then become accustomed to increasingly higher salaries despite the share price going increasingly lower. A turkey doesn’t vote for Christmas – and so they hold on to their positions as long as they can. All of this, of course, is funded by the retail investor.

The company is a vehicle that pays the directors' salaries. It also pays the Nomad. It pays the broker (which may also be the Nomad), and it pays the PR agency. All of these parties, including the directors, have an interest in the company continuing, because without it they are all out of jobs. Therefore, there is always a new story or a new project to invest in – so long as retail investors continue to fund story stocks then the company will continue. If you are going to invest, it’s worth checking how much the directors have taken out of the business and how much of their own capital they’ve put in. Nil-cost options do not count – this is simply transferring shareholder cash into the directors’ pockets.

Placings leaked

Another risk of placings is that they are leaked. This helps nobody, as people sell, which drives the share price lower, which inevitably means that those providing the fundraising will want a bigger discount. Those who leak placings often claim that they are making everything fair for everyone – but those who are really hurt are the company’s actual shareholders. It’s value destruction with no upside.

One way to improve this would be to suspend the stock as soon as market soundings begin. The Australian exchange already does this, and many wish for it to be implemented in London too. Sadly, Aim is stuck in the paleolithic age when it comes to enforcing regulation, and so placings will continue to be leaked and value will continue to be destroyed.

Many people suspect that a broker will go short on a company, and then offer that same company cash through a placing. The broker then closes its short in the placing, and they are incentivised to offer as low a price as possible to maximise their own profit.

Online bulletin boards

Bulletin board providers are popular among many private investors – some of whom are incredibly well researched, and some of whom (to put it politely) aren’t. At the lower end of the market, these boards are used to encourage the naïve to buy into a stock. There are many who have multi-IDs who then literally have a conversation with themselves, in an attempt to generate excitement around the stock.

Should anyone post a contrasting opinion – they are called out as a ‘shorter’ or a ‘deramper’ and are the subject of abuse. Worse still, the group encourages everyone to ‘report’ the post in an attempt to have the post automatically deleted. This means that anyone viewing the board will only see one positive narrative because the posts that are automatically deleted are not reviewed by anyone. Those who own the bulletin boards don’t care about the actual content of the posts, because they’re not monetising the boards. What they monetise is the volume of traffic on the site, which they then sell in the form of advertisements and impressions. So, while the bulletin boards are free to use, there is almost no point in using them.  

Very little regulation

In a recent poll, I asked on Twitter if Aim was regulated enough to protect the retail investor. In 48 hours, there were 1,243 votes cast, with a landslide majority of 90 per cent saying that a lot more was needed. Several traders and investors commented that the regulation that exists would be fine if only it would be enforced.

The poll highlights the opinion of the retail market when it comes to frauds being dealt with and investors being taken seriously. This is a real problem of the Aim market, which is slowly withering. Companies that are delisting are not being replaced quick enough, and unless the trend is reversed then we may eventually see the end of AIM.

If you are going to take material trading positions in Aim stocks, then it may be worth checking the following:

• The balance sheet (cash at bank) and cash flow statements (cash burn) will alert you to when the company is out of cash.
• Check director holdings – directors who do not have material stakes will happily dilute and empire build rather than focus on value accretive acquisitions [that said, do not follow this blindly – the chief executive and chief financial officer of Conviviality spent over £160,000 buying stock and four days later the stock was suspended never to return].
• Check director salaries and bonuses – lifestyle vehicles are fine to trade but not to invest.
• Is there a catalyst? Things like a future oil drill, anticipated good results – something is needed to drive the price higher.

The final bullet point is especially pertinent. With so much hot money sloshing around Aim an unexpected delay in an oil drill or assay results can wipe millions from a market cap, despite the fact that the delay has very little impact in terms of future potential or cash flows.

Trading Aim shares is more about speculation on how the masses and fast money will react to certain events, as technical analysis doesn’t matter much if an oil stock has hit a duster. That stock is going down – how much it’s going down is what everyone is gambling on.

You can download Michael’s free book on the UK stock market from his website www.shiftingshares.com