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Investment bank Peel Hunt has warned that a significant number of companies might exit the London Stock Exchange over the next four years due to large buyers capitalising on low business valuations.

Peel Hunt’s head of reserach Charles Hall noted that there has been minimal IPO activity for the past two years. 

Moreover, he highlighted that the number of listed companies on the FTSE Smallcap Index – made up of companies outside the FTSE 350 – has also shrunk in recent years.

Excluding investment trusts, the number of businesses on the index has fallen from 160 at the end of 2018 to 114 at the end of 2023.

Peel Hunt warned that if the current trend continues, the last remaining company will be scheduled to leave the FTSE Smallcap Index in 2028.

Capital flight

Hall noted that an extended period of capital flight has triggered significant shifts in the investment landscape, prompting a surge in mergers and acquisitions (M&A).

The bank reported an uptick in M&A activity, with 12 transactions exceeding £100m announced in Q1 2024, continuing the momentum from Q4 2023.

The underlying issue has been the “scale of the fund outflows”, which has led to depressed valuations, making M&A an attractive option for potential buyers. 

Moreover, the investment bank noted that management teams are increasingly questioning the benefits of remaining publicly listed, while boards are more inclined to entertain acquisition offers, thereby increasing the likelihood of deal completions. 

Shareholders, driven by performance and liquidity concerns, are also more readily accepting buyout offers.

Peel Hunt said it has been particularly noticeable in recent months that corporates were the main acquirers. 

“This suggests greater confidence in the economic outlook and the interest rate environment. It also shows the attractiveness of UK companies and the potential for synergies in a low growth environment.”

However, the firm stressed it “has been surprising to see relatively low activity from private equity, given the c. $4tn of dry powder currently available.”

Hall said: “Although interest rates have peaked, the reality is that debt is still relatively expensive and higher equity tickets are required given the cost and ability to secure leverage.”

The firm added that the fundraising market for private equity had been challenging, with the larger funds taking a material share of new money.

A similar picture in iGaming

Peel Hunt’s observations coincide with developments in the iGaming sector. 

While the competition for listings has intensified in the last two years, Flutter Entertainment’s decision to move its primary listing to the US serves as a key example of London losing out to New York.

Flutter cited access to “much deeper capital markets” and new US domestic investors as primary reasons for its US listing. 

Whether Flutter’s switch sets a precedent for other European companies with a large US customer base remains to be seen.

However, the fact that the business is pursuing a primary US listing should raise concerns for the UK government, said Neil Shah, director of research at Edison Group.

Shah previously noted that Flutter’s departure follows a worrying trend of listed companies losing trust in the City, and therefore urged the government to accelerate listing reforms.

It also mirrors the experience of small-cap iGaming CEOs seeking funding on capital markets. 

Despite the perceived benefits of being listed, raising capital during market downturns can be challenging. 

In a recent NEXT INSiDE, one CEO revealed that being publicly listed had worked against their business during market downturns, leading the company to shift its focus to the private market only to encounter similar challenges and a lack of success there as well.

Breaking the cycle

While the current scenario appears bleak, Peel Hunt suggested a reversal is possible with the right catalyst.

“This all sounds very negative – but the reverse scenario can happen and can happen quickly. It really needs a trigger to break the cycle,” the firm noted. 

Increased fund inflows could be spurred by various factors, including policy changes favouring retail investors, reduced ownership costs, and greater allocation by institutional investors.

An increase in share buybacks, reflecting low valuations and tax differentials between capital gains and dividends, could also attract investment, the firm said.

The firm suggested that appetite from overseas investors may also rise if they perceive a significant change in UK fund flows. 

Moreover, an improvement in the economic outlook driven by reducing inflation and the prospect of lower interest rates could lead to enhanced economic activity and investor appetite.

“If we do see increased demand for UK equities, then valuations should improve materially, which would then make an IPO a more attractive option,” Hall concluded. 

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