The decline in the number of ASX listed companies has caused:
- ASIC to act;
- The financial media to wade in; and
- Some of our clients to ask questions.
I have tried to tie together responses to each of these in what may seem a weighty article. Those with less time on their hands can read the below summary.
In summary
- ‘De-equitisation’ is occurring and is consistent with:
- lower demand for ASX listings;
- lower overall investment by corporate Australia; and
- higher regulatory costs.
- Unequivocally, having more listed companies is preferred to fewer listings.
- The quality of investment we can make at our scale to build suitable portfolios has not been notably reduced by the trend.
- Takeovers, which lead to de-equitisation, are a critical way in which we generate returns, and hence, de-equitisation is not all negative.
- We compensate for some value lost in de-equitisation by our use of private equity in clients’ Alternatives sub-portfolios and also exposure in International Equity sub-portfolios.
- Regulatory changes that strengthen boards in the direction of value creation rather than regulatory box ticking are required.
- Solving the problem of fewer IPOs cannot be done by simply reducing the requirements for information about the assets that are up for sale in the IPO process.
- Closer integration between companies, markets and public policy is required to increase investment rates in our economy. One of the benefits of higher investment, along with a stronger economy, is likely to be strengthened public equity markets. Finding a reformist public service and political movement that addresses this issue will remain relevant for the next decade.
The Market
Regulation of public markets…
Regulators, along with the regulations they monitor and enforce, play a vital role in maintaining the integrity of Australia’s public capital markets, essentially the Australian Securities’ Exchange.
However, the cost and time associated with meeting regulatory requirements is also a disincentive for some executives and business owners to participate in public markets. Instead, they prefer their business ownership to remain private.
This presents a potential problem for regulators as private capital markets are often outside of their scope and are generally more opaque. And investor protection is an important part of the regulators reason for being.
…causing private markets’ popularity
A growing shift by Australian companies towards tapping the less-regulated and less-scrutinised private equity and debt capital markets has caused ASIC (Australian Securities and Investment Commission – the corporate regulator) to recently release a discussion paper on the evolving dynamics between public and private markets.
Emerging from this discussion paper, it has announced this week that it is reviewing and streamlining the ASX listing (Initial Public Offer – IPO, or ‘float’) process in order to help reverse a decline in the number of companies seeking public markets for capital.
Accordingly, the topic is receiving some attention from various press outlets, which readers of Investment Matters may have seen. We summarise some of the issues below and offer some thoughts on the issue and how it pertains to listed investments in the ASX.
ASIC – encouraging an easier path to ASX listing
ASIC is taking the first step to make it easier for companies to join the ASX and bolster a dwindling market for floats. This move is considered by some to be the most significant change to listings for almost a decade.
ASIC will launch a two-year trial to expedite listing timelines, in what is expected to be the first of a raft of measures to streamline initial public offerings.
In its initial response released on June 10, “ASIC clears path to faster IPOs” the regulator has signalled it will informally review IPO documents under a new fast-track process two weeks before formal lodgement, reducing the timetable for the company to reach the ASX by a week. This is designed to prevent re-work of pre-IPO documentation as well as reduce the time to market, reducing the prospects for market volatility at the time of a proposed IPO to impact investor sentiment and consequently company valuations.
Additionally, under some circumstances, a company may also be able to accept retail investor applications during the public exposure period, to help compress the time to market too.
Figure 1: ASX float pathway – present and proposed
Source : AFR, ASIC
But is time taken the problem?
Still, we are sceptical about the extent to which the time taken to IPO a company is a big impediment to more companies doing so. It seems more likely that other factors, such as:
- the ongoing regulatory disclosure burden;
- cost to maintain an ASX listing; and
- executive time taken to brief and meet with market participants (as well as the scrutiny/oversight which comes with this)…
…are more likely to be inhibitors of more companies coming to market. But this trend is a global one.
But what about companies leaving the ASX?
De-equitisation 101
The net impact of fewer new listings combined with companies exiting the market (due to takeover, company failure or simply a decision not to continue remain publicly owned) is referred to as de-equitisation.
The net count of listed stocks isn’t always the best measure, but as shown in Figure 2 below, the number of listed stocks is indeed falling.
Figure 2: Aussie stocks are disappearing – Number of stocks listed on the ASX
Source: MST Marquee
The total number of ASX listed stocks is a function of not only new stock IPOs, which is the focus of ASIC’s latest tactical measures (see earlier), but also the number that are leaving.
De-equitisation is not all bad news
Of course, a company exiting the market may not be bad for investors. For many years, you will have heard First Samuel talk glowingly about the opportunities that takeovers (which created a delisting) represent.
Most years, we have generated strong position returns from this “de-equitisation” trend.
So, from an investor return perspective, de-equitisation may have a positive influence. We can worry about the long-term implications for the market quite separately.
If we disaggregate the influences of a falling number of ASX listed entities in recent years, there has been a fairly constant ‘run-off’ of around 6-7% of ASX stocks which de-list each year. The biggest shift in influence on the net number of stocks listed on the ASX has been the declining impact of new stock of companies which are successfully listing in the past 5 years where the required 5% of new listings has been absent from the market to replenish the run-off.
Figure 3: Falling new listing rate and more de-listings too
Listing vs delisting rate (as a % of stocks listed)
Is this necessarily a problem for investors?
Not in the near term. Recall that ~95% of the value/market capitalisation of the 2,000 listed companies is in the top 200 names, and ~85-90% in the largest/top 100 companies.
When we consider that a good portfolio only needs 30-40 stocks, there is arguably no “shortage” of stocks so long as the breadth of exposures (by industry, quality and size) can be maintained.
Perhaps more concerning for index investors is the fact that the size of the share market compared to GDP has been relatively constant in the past 30 years.
Figure 4: ASX Market size
Source : Minack Advisors, ASX, National Accounts
There are two possible explanations for this. Either:
- Australian listed companies are getting more internationally-focused (i.e. although listed here, their value relates to other countries’ GDP), or
- we are paying more for the same companies.
The answer is probably a mix of the two.
International influences
Some of our great companies (CSL, Brambles and Cochlear) and our miners generate returns from operations scattered around the world.
Many of our new tech companies, including some in clients’ portfolios, are predominantly overseas-based with international revenue and profit streams.
However, on a market capitalisation basis, we are undoubtedly paying too much for existing earnings growth, as shown below.
This is primarily a function of the price of the Australian banks, and CSL, neither of which we own at levels approximating market/index weights.
Figure 5: Price versus earnings growth – global markets
Source : Minack Advisors, various stock exchanges
The question this raises for me is why, in an otherwise expensive/fully valued market (i.e. reasonable prices to sell your company), is the ASX failing to attract new companies?
Like debates between nature and nurture, and the chicken and the egg, it can be challenging to distinguish outcomes from inputs, and as such, we can identify many factors.
Articles authored by Dimitri Burshtein in ‘The Australian’ How increasingly irrelevant ASX has plotted its own demise’ and AFR ‘Red tape driving shift from public markets to private equity’ suggests that:
- The direct cost but also the shifting burden of navigating the labyrinth of governance and disclosure requirements in listed markets is driving companies towards Private Equity ownership and away from public markets.
- Private market ownership may better recognise a business’ (higher) value.
Those authors’ opinions are reasonable, but concerns around governance and alignment when listed are perhaps overrated.
From my experience, the truth is that interacting with the market from a company’s perspective is hard, thankless, and time-consuming.
Those best at managing regulations are poor at running a business
The types of board members and management who are suited to this process may not be the best at also running the company.
Staying private may allow companies to have stronger boards and stronger teams, at least at points of highest uncertainty.
However, it doesn’t explain why more companies don’t opt for public markets and the ease of capital raising that such listed markets offer.
But public markets can be attractive
Large liquid markets are ideal for companies seeking to invest; companies with strong reputations can raise billions of dollars on short notice (less than a week).
And this is where we can tie up the themes. Australia has stopped investing at rates consistent with growing our economic capacity (see below), and hence the need for ASX listing fell alongside it.
As investment rates rebound—if they ever do—we expect to see higher demand for listings. From our perspective, the popularity of private credit markets isn’t the issue; rather, it is why our companies aren’t utilising both private credit and public markets to their full potential.
They are potentially limiting their economic opportunities.
Figure 6: Corporate investment remains subdued
Regarding changes to IPO’s proposed by ASIC and the ASX.
Regarding changes to IPOs proposed by ASIC and the ASX.
Returning to the death of IPOs problem, Dimitri Bursthein and others underestimate the risk in an IPO. Stock markets that trade mature companies have years of evidence and experience assessing how companies have responded to changing economic conditions and managerial challenges.
When an IPO process is not forced to prepare a set of forecasts that anticipate, to the best of its ability, the future (albeit short-term) expectations for a company, the alignment between the seller and buyer reduces considerably.
The principles of caveat emptor and full disclosure can clash, with the consequences, in my experience, often resulting in 60-90% of the stock’s value being affected, both positively and negatively.
In the short term, not having to provide forecasts will increase supply; however, in the long run, the higher risks associated with IPOs that don’t offer forecasts will drive down demand.
First Samuel’s approach
Our approach to IPOs for our clients is to either demand rigorous financial forecasts or provide sufficient access to operations and expertise to build our view of the immediate future. This view, however, needs to be tested with management. As such, an IPO process that did not allow for the generation of either IPO forecasts or rigorous consultation with the company would be highly problematic.
Perhaps the price for such companies could be cheaper enough to cover the risk, but this would not be easy to ascertain.
Could public markets be strengthened?
In a perfect world, the rotation of assets (companies) through their lifecycle is likely to include a range of funding and ownership models, including public markets. Naturally, companies can move from public to private markets and back again depending on economic conditions and individual circumstances. We saw this several times in the 2000s.
But the IPO process alone isn’t the only task. Some companies grow into being ready for the big time in listed markets.
We have experience with companies that have improved their responsiveness to investor needs over time, ultimately creating opportunities for them to raise significantly more capital than they would have been able to in private markets.
This type of partnership between investors and companies is more challenging due to today’s regulatory frameworks and may also be a factor in the reduced popularity of equity markets.
‘Private companies pay more’
Regarding the argument that private markets pay more, we are uncertain whether this is generally correct or a rule in particular circumstances. There are occasions when private equity will use more debt to finance an acquisition than the public market would typically approve – higher leverage can support higher prices for acquisitions.
But pre-event prices for growth companies that can demonstrate this growth are likely still higher in listed markets. Private companies that are looking to acquire new businesses to complement their existing ones will pay more, but this is due to the synergies involved rather than the funding source (private or public).
There are no private market players, nor industry comparables looking to acquire our most expensive banks or medical companies.
The broader concerns of board quality raised in the article, I suspect, hold regardless of the strength of markets.
In summary
- De-equitisation is occurring and is consistent with the triple drivers of lower demand for ASX listing, lower overall investment by corporate Australia and higher regulatory costs
- Unequivocally, having more listed companies and more movements between public and private markets is preferred
- The trend so far has likely not notably reduced the breadth or quality of investment we can make at our scale to build suitable portfolios
- Takeovers, which lead to de-equitisation, are a critical way in which we generate returns, and hence, the process is not all negative from an individual investor’s perspective
- We believe the role of private equity in clients’ Alternatives sub-portfolios and International Equity sub-portfolios exposure also helps ensure that some value lost at the edges of this de-equitisation process is captured
- Regulatory and governance changes that strengthen boards in the direction of the value creation rather than regulatory box ticking are required
- Solving the problem of fewer IPOs cannot simply reduce the requirements for providing information regarding the assets that are up for sale in the IPO process.
- Closer integration between companies, markets and public policy is required to increase investment rates in our economy. One of the benefits of higher investment, along with a stronger economy, is likely to be strengthened public equity markets. Finding a reformist public service and political movement that addresses this issue will remain relevant for the next decade.
If you are interested in to learn more about how we can help position your portfolio for growth, get in touch for an obligation-free consultation.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.