There has been good news for long-suffering investors in the UK stockmarket since the start of the year. Not only does M&A activity appear to be picking up, with a high profile bid for UK electronics retailer Currys, but the scale of company buybacks continues to accelerate. If it goes well, it could be the catalyst to generate self-sustaining momentum in the UK markets; however, it could also contribute to the lingering problem of de-equitisation.
The interest around Currys supports the view of many fund managers that if investors don’t take an interest in the UK stockmarket, other companies will cherry-pick the best firms. Currys rejected an unsolicited bid from US investment group Elliott Management, saying it significantly undervalued the company, but Chinese e-commerce company JD.com is now thought to be considering a cash offer.
Elliott’s offer was at around a 30% premium to the existing share price. The share price has jumped and stayed high. The problem in the current environment, says Ian Lance, manager of the Redwheel UK Equity Income fund and Currys’ largest shareholder, is that shareholders may be tempted to take too low an offer: “The risk is that long-suffering shareholders see the share price rise and accept an offer. We may think it’s worth twice that, but the offer goes ahead.”
See also: Can smaller trusts survive without consolidation?
He also highlights a secondary problem, that the UK equity market is no longer fulfilling its primary purpose of price discovery and efficient capital allocation. The widespread preference for the US market has, he says, resulted in pockets of the UK equity market being valued significantly below the true value of the businesses.
“Unless this changes, it seems likely that we will continue to see overseas corporate buyers step in to take advantage of the depressed valuations of UK equities with ownership falling into foreign hands and the number of quoted UK businesses will continue to decline.” He believes the UK authorities need to take action to incentivise investors to allocate to UK equities.
Buybacks
The buybacks in the UK market are also both a problem and a solution. At 6.1%, the total yield for the UK market (including dividends and buybacks) is now the highest of any major market. The equivalent figure for Europe ex UK is 4.5% and for the US, it is 3.2%. Lance says buybacks can be positive for share prices: “CEOs come to us with their heads in their hands over their share price performance, and we suggest they buy back their stock. All the evidence suggests that buying shares back at a low valuation is accretive for shareholders.”
Almost half of the UK equity market has bought back shares over the past 12 months. The only other time buybacks have been so high was during the global financial crisis of 2008-09. The problem is that this will shrink the equity market as well.
James Lowen, senior fund manager, JO Hambro UK Equity Income fund, says: “On average, 5% of each of our companies were acquired through share buybacks last year. This represents a colossal amount of de-equitisation that will enhance future earnings and dividends. With this year expected to see another large number (we estimate slightly less at 3-4%), the cumulative impact of these actions is material.”
The hope would be that the buybacks will ultimately start to create self-sustaining momentum in the UK market, raising the value of UK shares and bringing more buyers to the market. Lance says: “For the last few years, we’ve been asked ‘what’s the catalyst for the UK market?’ I would say that this is probably the catalyst and could create momentum in the market.”
See also: Are income investors turning a blind eye to the world’s dividend powerhouse?
However, unless IPOs come through to replace the equity lost, it could continue to weaken the UK market as a destination for companies to raise capital. While the IPO market has been extremely quiet over the past 12 months in the face of volatile stockmarkets and economic uncertainty, there are some exciting upcoming IPOs, including Monzo, Brew Dog, Zopa and Starling Bank.
It is noteworthy that other major UK companies, such as Revolut and Klarna have chosen to list in New York, but the UK is still seeing activity. There are also some AIM listings as well. For example, winemaker Chapel Down has announced its intention to raise money on the UK’s junior market this year.
There is a question of whether this de-equitisation matters. There may be an issue for passive flows, as the UK becomes a smaller and smaller part of the world’s major indices. For example, the UK’s weighting in the MSCI World index has more than halved over the past 20 years. That is just another reason for international investors to overlook the UK market.
It also matters for liquidity. Analysis by SocGen’s head of quantitative equity research Andrew Lapthorne and reported in the Financial Times shows that the UK is the only major developed markets where the number of stocks with a six-month average daily trading volume of $1m or more has shrunk over the past 20 years. There are just 319 UK stocks that now fulfil this criteria, he says. This compares to 869 in the rest of Europe there are 869, 1,411 in Japan and over 3,000 in the US. This is another reason for major international investors to avoid the UK market.
Buybacks and M&A should help realise value in the UK stockmarket. The hope is that this will boost share prices and give investors another reason to consider the UK. Certainly, the UK market – and its small and mid caps in particular – have performed better since the rally in November. However, they are not universally good news, and may contribute to the ongoing shrinking of the UK stockmarket.
