The disappearing UK small cap market
If you want to own a UK small cap, your time might be running out. There are seven on going bids for UK 350 companies at the moment and 12 M&A transactions at a value of over £100m were announced in the first quarter of 2024 alone. That’s nice in one way. The bidders for UK companies have tended to be other companies - and there have been a few competetive bid situations that have bumped up prices. That suggests rising confidence in the UK economy as whole and that there is an increasing recognition of the value to be found in cheap UK small caps.
But in another way it isn’t nice at all. There have been very few new listings in the UK over the last few years (of any size) and if companies keep disappearing from our markets at this recentless speed (which seems likely given the bargains on offer), the FTSE SmallCap index will, says Charles Hall of Peel Hunt, “cease to exist” by 2028. At the end of 2018 there were 160 companies in the index. There were 118 at the end of last year. By the time the current lot of bids make their way through there will be only 100 - and their total market cap will be rather smaller than it was - down from £140 bn in 2018 to under 100 now.
You can see the problem. There have been outflows from UK equites now for 34 months in a row. That makes shares cheap. But it also makes management tense. They aren’t sure that being listed is working for them - what’s the point if the investors they hoped would support them just keep selling them? So when bidders come knocking they “agree more readily” to offers than they might have otherwise. None of this is good (assuming you think, as I do, that deep and effectively capital markets are a crucial part of a strong economy). But all is not lost. I wrote earlier this week about how fast things can turn in stock markets. In the run up to 2000 it looked like UK small cap value might never be of interest to anyone again. It was all about mega caps and tech (sound familiar). Over the next seven years UK smaller company and value orientated investment trust Aberforth rose around 200%. That could happen again - and quickly. All it needs is a little flow of funds in rather than out. That could happen organically - from investors noting that there is little space left for value expansion in the mega caps, that small caps tend to out perform over the very long term and that value always outs. It might come from an expansion in share buyback programmes from smaller companies (there are already more than there were) or from a government programme of some kind to push up interest from retail investors - the British ISA or a change to the tax regime on UK shares perhaps. There is also more and more talk of shifting incentives designed to push pension funds and insurance companies into UK equities - and given the shrinking size of the small cap universe it really wouldn’t take much of a move from some of the pension giants to shift the dial. Finally there is the UK’s inexplicably high level of stamp duty on equity trades - currently the second highest in the world, and at 0.5% by quite a long way. There is no stamp duty at all in the US. I wrote about this here (its very important) but more and more commentators are picking up on it - and attempting to engage politicians on it. One day they might listen. If they do things will change very fast indeed.
More on stamp duty and why it has to go https://www.bloomberg.com/opinion/articles/2024-01-16/personal-wealth-the-uk-makes-investing-in-its-own-markets-too-expensive
More on the disappearing world of UK small cap https://www.bloomberg.com/news/newsletters/2024-04-03/save-the-uk-stock-market-and-scrap-stamp-duty-tax-on-shares