Twin Cities Business Magazine - Foreign Exchanges Persist in a Drive for U.S. Listings

I am pleased to share some recent press coverage which focuses on foreign stock exchanges for U.S. company IPOs, namely Toronto's Venture Exchange and the London Stock Exchange's AIM.

Dave Beal, Business Editor, Twin Cities Business Magazine, Minneapolis, Minnesota, U.S.A.

Capital Migration - Foreign Exchanges Persist in a Drive for U.S. Listings - They're a Venue for Small-Cap IPOs That's Tough to Find at Home

For much of the past decade, stock exchanges in Toronto and London have tried to attract small-capitalization companies based in the United States.  They don’t have much to show for their efforts, but don’t expect them to stop trying anytime soon.

Consider TMX Group, which includes the Toronto Stock Exchange and its baby sister, the TSX Venture Exchange.  Last November, TMX brought its road show back to Minneapolis for an event that featured two panel discussions and private meetings with listing prospects.  TMX plans to send its recruiters to the city again in 2010.

Then there’s Mark McGowan, who runs AIM Advisers, a California-based consultancy that represents the London Stock Exchange’s AIM for small caps.  McGowan is crisscrossing the country to explain the workings of London's AIM in face-to-face meetings with small-business executives and the professionals who handle their legal and financial affairs.  He has penciled in a visit to the Twin Cities this spring.

These two exchanges differ in many ways.  “Small” is larger for London's AIM, where listed companies’ average capitalization is around $90 million.  It’s only $16 million on Toronto’s Venture Exchange, where companies are generally in earlier stages of development.

But advocates for both London's AIM and TSX Venture have one thing in common: They share a belief that for many reasons, the U.S. capital markets for publicly traded companies are not functioning well enough at the smaller end of the market.  Both want to be the needed alternative.

Minding the Gap

“We see a gap in the capital markets that we’re filling,” says Ungad Chadda, senior vice president of the Toronto Stock Exchange.

Studies of initial public offerings, done for the Grant Thornton accounting firm this year, define the gap. The latest of these reports is highly critical of the U.S. capital markets.

David Weild, founder of the New York firm Capital Markets Advisory Partners and a former vice chairman at NASDAQ, co-authored the reports.  He found that by 2008, listings on the three major U.S. exchanges (New York Stock Exchange, NASDAQ and American Stock Exchange) had fallen 55%, adjusted for growth in the economy, from their peak in 1996.  That was by far the worst showing among eight of the world’s leading stock exchanges.

The near extinction of small IPOs—those raising less than $25 million—has caused much of the decline in exchange listings in Minnesota and the rest of the country.  Weild calls this a “market structure” problem—the unintended consequence of a series of industry, regulatory, and technological shifts that sharply lowered investors’ trading costs and in turn choked off the resources that paid for research and trading in the stocks of small companies.  This was the mother’s milk that enabled tiny companies to go public and allowed a fortunate few to morph into tomorrow’s Medtronics and Best Buys.

Weild concludes that the U.S. faces a first-class market failure that’s costing America millions of jobs.  He is urging U.S. securities leaders to create a new market custom built to serve smaller companies.

A Hard Sell

So far, moving into the vacant space that the public market isn’t serving in the U.S. has proven difficult.

London's AIM, born in 1995, worked with the Faegre and Benson law firm to make presentations in Minneapolis in 2004 and again in 2005.  Today, McGowan says, only about 60 of London AIM’s roughly 1,100 listings are U.S companies, none from Minnesota.

Toronto’s Venture Exchange got started in 2002, after TMX acquired the Canadian Venture Exchange in

Calgary.  Both of the TMX exchanges have targeted Minnesota because of its strong suits in technology and life sciences and its proximity to Canada.  At present, 62 U.S. companies are among the 2,184 listed on the Toronto Venture Exchange, and only one—Rapid Brands in Chanhassen—is from Minnesota.

Rapid Brands, a franchisor that refurbishes and remanufactures printer and laser toner cartridges, went public in May of 2007 on the Toronto Venture Exchange.  It was the first U.S. company to participate in the venture exchange’s “capital pool company” program.  Under this program, Black Mont Capital, a Toronto investment firm, raised $4 million for Rapid Brands in a deal that enabled the company to become public by merging with a shell entity already listed on the venture exchange.

Rapid Brands (TSX: RAP-V) has been hit hard by the recession, which led to store closings.  Early on, its stock reached a high of $3, but in November it was trading for only seven cents a share.

Getting More Attractive

Companies on the Toronto Venture Exchange are subject to many of the same disclosure rules as in the U.S., but Rapid Brands CEO Roger Block estimates that his company would have spent $500,000 more a year for compliance costs had it been listed in the U.S. rather than in Canada.

“It would have been out of the question to even discuss going public in the U.S.,” Block says.

Several mining companies active in Minnesota have raised money from the Toronto exchanges, including Washington-based Franconia Minerals Corporation, which hopes eventually to mine copper and nickel deposits near Babbitt.  Franconia (TSX: FRA) went public on the venture exchange and then graduated to the Toronto Stock Exchange, raising a combined $30 million from the two markets.  New York investment bankers “won’t get out of bed for less than $50 million,” says Franconia CEO Brian Gavin.

AIM Advisers’ McGowan was also the CFO of DDD Group, a London AIM-listed company in California.  He says the number of U.S. companies that have completed IPOs on the London Stock Exchange's AIM “hardly scratches the surface” of what’s possible.  In his prospecting efforts, McGowan targets companies with potential valuations ranging from $25 million - $500 million.

“Fear of the unknown” is one factor that foreign exchanges have to contend with, says Rick Brimacomb, a Twin Cities financial adviser who helped TMX drum up attendance for its latest Minneapolis event.  But he believes that small companies locally are now more receptive to the pitches of foreign exchanges than they were five years ago, given the difficulty of doing IPOs domestically.

If he’s right, persistence might eventually bear fruit in Minnesota for foreign stock exchanges.

London's AIM - IPO Activity - 2009

This London AIM IPO post takes a different format than previous posts and simply seeks to answer three main questions:

1. After 13 months (Aug. '08 - Aug. '09, inclusive) with only 4 London Stock Exchange AIM IPOs, are the 11 London AIM IPOs during the last four months of 2009 indicative of a return to more 'normal' levels of London AIM IPO activity? 

2. Have investors abandoned London's AIM or the London markets more generally?

3. What criteria are London AIM Nominated Advisers (Nomads), who solely determine the suitability of companies for listing on the London Stock Exchange's AIM, and London AIM Nominated Brokers, the proxy for London AIM investors, looking for from potential London AIM issuers?

The answer to the first question is no, not in the short-term.  The answer to the second question is no, as evidenced by the exceptionally strong market for secondary offerings on London's AIM.  The answer to the third question is that the bar is set high for London Stock Exchange AIM IPOs but is not insurmountable ... see towards the end of this post for the details.

Given the sparse activity on the London Stock Exchange's AIM over the last two years, it is necessary to examine London's AIM at a more granular level in order to spot trends, if any, that may exist.  After five quarters (Q3 ’08 – Q3 ’09, inclusive) of virtually no London AIM IPO activity, there were two London AIM IPOs in September 2009 and three in each month of Q4 2009.  On the surface, this may appear to be a very positive sign of future London Stock Exchange AIM IPO activity but the vast majority on London AIM IPOs were for ‘investment vehicles’, funded to target distressed real estate / commercial businesses, or small specialty finance companies.  During 2009, 10 of the 13 companies listing on London's AIM (77%) were for ‘investment vehicles’ whereas during 2008 only 13 of the 38 companies listing on the London Stock Exchange's AIM (34%) were of this nature, consistent with the historic levels of 39% and 38% in 2007 and 2006.

Quarter	Number of London AIM IPOs	Gross Funds Raised (in £ millions)	Investment Vehicles	Operating Companies
Q1 ‘08	11	275	2	9
Q2 ‘08	20	555	9	11
Q3 ‘08	6*	85	2	4
Q4 ‘08	1	3	0	1
Q1 ‘09	0	0	0	0
Q2 ‘09	2	222	2	0
Q3 ‘09	2**	34	1	1
Q4 ‘09	9	354	7	2
Total	51	1,528	23	28

*              Five of which were in July.

**           Both of which were in September.

The lack of ‘operating company’ listings on the London Stock Exchange's AIM is also evident in the chart below.  These companies typically raise between £7.5 million and £50 million ($12 million - $80 million) of growth capital on London's AIM and/or to take out existing shareholders.

 

While any London AIM IPO activity is a necessary precursor to the possible return of more ‘normal’ activity on the London Stock Exchange's AIM, it is reasonable to question whether there are other factors, structural or otherwise, that may impede the eventual resurgence of ‘operating company’ listings on London's AIM or the London markets more generally.  In addition to AIM, the London Stock Exchange operates three other markets; the Main Market, the Professional Securities Market and the Specialist Fund Market.  In the aggregate, only nine IPOs were completed on these three markets during 2009, six of which (67%) were for ‘investment vehicles’.  Seven of the nine IPOs (78%) were on the Main Market with the other two markets capturing one IPO each.  Interestingly, the three largest IPOs on the London Stock Exchange's AIM during 2009, which raised an aggregate of £472 million ($755 million) of the £610 million ($976 million) total (77%) are, in theory, better suited for the Main Market or the Specialist Fund Market but chose London's AIM primarily because of its sensible regulatory model and the speed at which London Stock Exchange AIM IPOs can be completed without the ‘interference’ of the UK Listing Authority (UKLA) and the Financial Services Authority (FSA).

At first glance, the table on the next page leaves one with a positive impression of the robustness of the secondary offering markets in London during 2009, particularly the Main Market; however, it is important to understand the types of offerings and why they are occurring.

Rights Issues are often undertaken by companies facing severe financial distress where new investors can not be identified and existing shareholders don’t necessarily want to invest more, therefore, all shareholders are faced with a choice; invest to hold their positions or face dilution and the possible collapse of the company, the ultimate dilution!  Rights Issues on the Main Market spiked in 2009 to £51 billion ($82 billion) from £28 billion ($45 billion) in 2008.

Placing & Open Offers are not necessarily good or bad and consist of a Placing tranche, consisting of new shareholders and/or existing shareholders eager to invest to hold or increase their positions, and an Open Offer tranche, an invitation to the balance of the existing shareholders to participate which can be for the positive reasons of their being broader appetite amongst existing shareholders and for good corporate governance or the negative reason of the Placing tranche not being adequate to finance the continuing operations of the company.  Placing & Open Offers on the Main Market held firm in 2009 and 2008 at £19 billion ($30 billion).

Placings are straight issuances of shares for cash, perhaps to new and/or select existing shareholders, without extending an invitation to participate to the balance of the existing shareholders.  Placings on the Main Market are not too common given the increased shareholder protections compared to London's AIM.  Placings on the Main Market decreased substantially to £6 billion ($10 billion) from £13 billion ($21 billion) in 2008.

In summary, secondary offerings on the Main Market attracted an additional £16 billion ($26 billion) during 2009, however, it was all directed towards Right Issues and Placings dropped by £7 billion ($11 billion), which was also directed towards Rights Issues.

London's AIM is much easier to analyze in terms of secondary offering activity since the vast majority of transactions take the form of Placings.  Indeed, during 2008, £3.1 billion ($5.0 billion) of the £3.2 billion ($5.1 billion) raised on London's AIM in secondary offerings were through Placings which increased by 16% during 2009 to £3.6 billion ($5.8 billion).

While Placing & Open Offers are rare on the London Stock Exchange's AIM (there were only three during 2008 which raised an aggregate of only £25 million ($40 million)), 2009 witnessed three large transactions which raised an aggregate of £1.0 billion ($1.6 billion) of the £1.1 billion ($1.8 billion) total on the London Stock Exchange's AIM.  All three transactions were for real estate investment, development and management companies with one moving up to the Main Market a few months later.

In order to conclude on the health of the secondary offering market on London's AIM, one needs to dig a little deeper into the Placings.  There were 580 Placings on London's AIM during 2008 which raised £3.1 billion ($5.0 billion) for an average Placing of £5.34 million ($8.54 million).  During 2009, there were 673 Placings on the London Stock Exchange's AIM which raised £3.6 billion ($5.8 billion) for an average Placing of £5.36 million ($8.58 million), virtually identical averages.  The differentiating factor however is the relative number of companies that were able to access the secondary offering market on London's AIM; only 36% during 2008 but 54% during 2009, which is consistent with the historic levels of 57%, 50% and 48% in 2007, 2006 and 2005, respectively.  This is a good sign that the London Stock Exchange's AIM has expelled the vast majority of the weak and is enthusiastically supporting those that remain.

Type of Secondary Offering	Main Market	Gross Raised (in £ billions)	Average Raised (in £ billions)	London's AIM	Gross Raised (in £ billions)	Average Raised (in £ millions)
RI*	50	50.699	1.014	2	0.008	4.000
P&OO**	36	18.747	0.521	21	1.123	53.476
Placing	81	5.773	0.071	673	3.607	5.360
Other	153	1.092	0.007	66	0.123	1.864
Total	320	76.311	0.238	762	4.861	6.379

*              Rights Issue

**           Placing & Open Offer

The future for London AIM IPOs.  What are AIM Nominated Advisers (Nomads) and AIM Nominated Brokers looking for from companies hoping to list on London's AIM?

In order to answer this question, I undertook an informal survey of the vast majority of AIM Nominated Advisers (Nomads) and AIM Nominated Brokers.  Since the 60 AIM Nominated Advisers (Nomads) and 100 AIM Nominated Brokers generally serve different types of companies in terms of size (i.e. proposed capital raises and opening market caps.) and sector (i.e. industry), I posed the same questions to other key London AIM market participants who may have a broader view of the market; securities lawyers, accountants in the areas of audit and corporate finance, financial PR/IR firms, etc. as a cross-check on the views expressed by the AIM Nominated Advisers (Nomads) and AIM Nominated Brokers.

At the macro level, the general belief is that London Stock Exchange AIM investor appetite for larger, typically Main Market IPOs will first have to return before serious consideration can be given to investor appetite returning for London AIM IPOs.  Many of these larger, Main Market IPOs will likely come from Private Equity portfolios; however, the obvious challenge will be synchronizing valuation expectations.  Caution surrounds the UK economy, which has the dubious distinction of being the only G20 nation still in recession (Q3 ’09 GDP shrunk by -0.2%), there is an upcoming general election to be held no later than June 3^rd where current indications are that there will be a change of government and tax rate increases are likely given UK debt/GDP levels comparable to the U.S.

From a sectoral perspective on London's AIM, there has always been appetite in London for commodity-focused companies given the development of the North Sea oil and gas assets in the 1970s/80s which attracted world-class equity research analysts to London's AIM and a sophisticated institutional London AIM investor base.  Oil and gas and mining, such as gold, other precious metals and gems, should continue to prove attractive for listing on the London Stock Exchange's AIM.  Positive comments were also made about the technology sector in general, and cleantech in particular, renewables and/or industrial technologies that promote energy efficiency, since technology companies listed on London's AIM are inherently international and often have high growth prospects.  There is definite apprehension towards consumer-facing business listing on the London Stock Exchange's AIM, those in the consumer goods and consumer services super-sectors on London's AIM, given the fragile state of the UK economy and the perhaps even more fragile state of UK household finances.

The consensus view for H1 2010 is that London AIM investors will continue to focus on supporting the companies listed on London Stock Exchange's AIM, are performing well and are in need of additional growth capital.  AIM IPOs during H1 2010 will largely be confined to the same types of ‘investment vehicles’ which listed on the London Stock Exchange's AIM during 2009; those focused on distressed real estate / commercial business and small, niche players in the specialty finance space.  London AIM investors will look for signals from the Main Market, in the form of larger company IPOs, before more broadly entertaining IPOs of companies that have been the traditional mainstay of the London Stock Exchange's AIM.

While the bar is set high for ‘operating companies’ wishing to complete a London AIM IPO during 2010, it is not insurmountable.  The fundamental debate often comes down to valuation, and rightfully so, in some respects.  A key feature of London's AIM is the breadth and depth of its secondary offering market.  Companies that are willing to accept a reasonable valuation, with a view towards proving that they can meet or exceed their operational promises and financial targets while listed on London's AIM, will have ready access to London AIM's secondary offering, presumably at ever increasing valuations.  The net effect is often less dilution.  Companies joining the London Stock Exchange's AIM at an unrealistic valuation where the share price plummets, liquidity evaporates and trust is lost leaves the London AIM-listed company with little ability to raise additional capital or use its new public shares as an acquisition currency.

The following is a non-exhaustive list of the criteria that AIM Advisers' uses to vet potentially suitable U.S. company for London Stock Exchange AIM IPOs, effectively looking through the lens of prospective AIM Nominated Advisers (Nomads) and AIM Nominated Brokers.  Obviously, overall consideration necessitates the use of judgment.  These points are meant to provide a starting point for discussions.

1. ‘Growth-oriented’ company[1]
2. Minimum opening market cap. upon listing on London's AIM of £30 million ($48 million), with  acquisition strategy[2] 

• At least $24 million of annual revenue and $2.4 million of net income[3]

3. Minimum opening market cap. upon listing on London's AIM of £50 million ($80 million), without acquisition strategy

• At least $40 million of annual revenue and $4.0 million of net income

4. Maximum opening market cap. upon listing on London's AIM of £250 million ($400 million)[4]
5. International scope to the London AIM-listed company (sales and/or operations), current or post-IPO, preferably UK/EU[5]

6. Outstanding management team with a real track record[6]
7. Solid Board of Directors or the ability to formulate one during the London AIM IPO listing process[7]
8. Willingness to fully and fairly disclose any potential ‘skeletons in the closet’[8]
9. Sound internal controls and good corporate governance, or willingness to put in place

10. Reasonable valuation expectations, willingness to take a long view[9] (see prev. page also)
11. Free float of at least 25% post-IPO, ideally around 50%[10]
12. Strategic investor(s) and/or existing shareholder(s) anchoring the London AIM IPO[11] 

While historically 15% of the U.S. companies that have listed on London's AIM have been backed by VCs/PEGs, given the changing landscape of London's AIM and the factors above, the future outlook is that closer to 50% of the U.S. companies listing on London's AIM will come from VC/PE portfolios.

---

[1]  This would be characterized by growth of revenues and/or profits of at least 20% per annum, whether organic or through acquisition.

[2]  Current market appetite is for a minimum opening market cap. upon listing on London's AIM of £50 million ($80 million), however, with a credible acquisition strategy that can executed with the capital raised from the London Stock Exchange AIM IPO and/or the company’s new London-AIM listed shares over the first year or two on London's AIM, the opening market cap. upon listing on London's AIM can be as low as £30 million ($48 million).

[3]  This is a rule-of-thumb.  Valuation is ultimately determined by reference to the company’s DCF model.  There is no requirement that companies listing on London's AIM be profitable, however, the London's AIM is currently risk adverse, therefore, companies will either already be profitable or will be able to clearly demonstrate self-sufficient post-IPO.

[4]  Above this level, U.S. companies are better served on the U.S. public markets from the perspectives of valuation and liquidity and should be large enough to bear the internal and external costs of Exchange Act reporting and SOX compliance.  London’s Main Market might be a consideration but the rationale is weak.  No U.S. company has its primary listing on the Main Market.

[5]  Many technology companies listing on the London Stock Exchange's AIM meet this test since they are often not reliant on physical locations.  London-based AIM investors will not accept U.S. companies seeking to raise capital on London's AIM as the ‘venue of last resort’ and/or because of an inability to be able to comply with the Exchange Act or SOX; however, a conscious decision to avoid onerous U.S. regulation for companies in the $48 million - $400 million market cap. range upon listing on London's AIM is viewed as sensible.

[6]  An added bonus would be a management team that has previously made money for public company investors.

[7]  In a U.S. context, many companies considering London's AIM are quite small and often need to augment their Board of Directors.

[8]  Voluntary disclosure of any personal bankruptcies, corporate bankruptcies, companies that havc gone into administration, liquidation, etc. will typically not cause a company / management team to be deemed unsuitable.

[9]  If these are present, companies that consider completing an IPO on London's AIM during 2010 should be able to negotiate lower professional fees, given increased competition for fewer listings on London's AIM, and attract meaningful media attention.

[10] UK institutional investors on the London Stock Exchange's AIM are very reluctant to invest in London AIM-listed companies that will not have a free float of at least 25% (this is a requirement on the Main Market) for fear of Special Resolutions being ‘crammed down’ and to increase the chance of achieving strong aftermarket liquidity on London's AIM and the derivation of a ‘fair’ share price / market cap. upon listing on London's AIM.  The 50% free float target is usually achieved through a combination of new shares issued by the company in the London AIM IPO for cash and existing shareholders reducing their positions.

[11]  Given current London AIM market conditions, this would likely be a requirement in the ultra-high-risk biotech space, however, moving down the continuum of less risky sectors, the traditional view of London AIM institutional investors is that pure financial investors can exit entirely at the time of the London Stock Exchange AIM IPO and insiders / management can sell down 20 - 25% of their holdings, all on a case-by-case basis.