It’s All Over
The financial media are writing off the UK as a home for listed equities, and their narrative is understandable. ARM has chosen NASDAQ for its relisting, and CRH is following Ferguson, Abcam and Indivior to the US as its primary listing venue. Last week, Shell let slip that its new CEO was part of a recent internal discussion that looked at moving the oil major’s listing alongside Exxon and Chevron.
Fiscal Draw
Meanwhile, UK companies increasingly see the US as a market to invest in, drawn by fiscal incentives. Energy companies see better green incentives from the Inflation Reduction Act and no windfall profits tax on hydrocarbons. The UK’s semiconductor companies are having their heads turned by the US’s Chips’ Act incentives and a UK government deaf to their needs. And UK defence companies are responding to US procurement requirements for much higher “Made in America” content for Defence Department spending.
Should I Stay or Should I Go?
On top of this, the UK’s recent currency and bond market collapses drew investor comparisons with Argentina and Turkey. Worse still, next month, the UK corporation tax rate moves from 19% to 25%, pushing the UK from 10th to 33rd in the league table of the World’s most competitive tax regimes. For good measure, Jeremy Hunt will also be cancelling much of the R&D tax credits previously available to small growing companies.
Fire Sale
Fund manager Richard Buxton of Jupiter commented this weekend on the de-equitisation of the London market in recent years. Whichever way you look at it, the number of listed companies on the market has reduced substantially. The Numis Indices review points out that the number of fully listed companies in the UK has fallen by 75% since 1955. Even the number of AIM companies halved from its peak in 2007. Recently, private equity has made bid approaches to, Hyve, Wood Group, and Ascential, while Macquarie Bank is reportedly eyeing up fund manager M&G. This represents the best part of £10bn of the equity value of UK companies in not much more than a week if confirmed.
Pension Derisking
Buxton says that de-equitisation has been exacerbated in the UK due to the unintended consequences of Robert Maxwell and the disappearance of the Mirror Group pension assets. Regulatory changes forced companies to account for pension deficits on their balance sheets which they needed to make good in the following ten years. As he points out, “companies were on the hook for any pension fund deficits but were unlikely to be able to share in any surpluses through contribution holidays. This asymmetry led them to close their defined benefit pension schemes. Once a pension fund ceases to have an infinite life, with new members joining as older ones retire, its attitude to risk changes materially. It is only concerned with meeting its final liabilities until its last member dies. This is at the heart of why the UK savings industry has become entirely risk-averse. Billions have flooded out of equities, which all long-term studies have historically provided the best real returns after inflation, in favour of liability-matching bonds. Regulation has prevented £1.5 trillion held in UK pension schemes from being available to invest in supporting growing UK businesses.”
Wilderness Years
In 2015 a fund manager of a large European investment firm told me that if the UK left the EU, we would be in the investment wilderness for a decade as far as global asset allocators were concerned. Nearly eight years on, he might be proven right. International investors only need exposure if they are highly convinced about a small asset class. The UK market represents just 5% of the global MSCI index. Since 2016 global investors haven’t needed to care about the UK.
Pariah State
More recently, meeting with American friends over Christmas last year, I was asked how things were in the UK with the type of concern we might enquire about Ukrainian relatives caught up in the siege of Mariupol. How many Prime Ministers have you had? Is the queen’s death the end of the road for the UK? Have you had to burn the family furniture to keep warm?
Irrelevant
The point is the UK has become an investment pariah. Rightly or wrongly, global investors and even our indigenous pension funds have shunned UK equities at no observable performance cost.
Little Wonder
It is reasonable to consider why anyone would choose the UK to list a company or in which to invest. If you believe our media, the UK is heading towards oblivion as a venue for financial and direct investment due to self-harm, ineffective regulation and economic irrelevance.
Value Drive
ARM and CRH are global businesses that derive most of their revenues outside the UK. Yet this is not why they decided to become US-listed companies. There is one overriding reason they choose not to list in the UK. These companies can become more valuable by listing elsewhere. Company boards have a fiduciary duty to act in their stakeholders’ best interests. Broker Panmure Gordon estimates that UK equities are more cheaply valued compared to the rest of the World than at any time since 1989. The trend of companies delisting in the UK will continue, whether through relisting on other markets such as NASDAQ or succumbing to bid approaches from private equity or overseas suitors.
Arbitrage
Valuation is subjective and influenced by human emotion. Economies and markets do not move in straight lines forever but through cycles and fads. Furthermore, equity valuations change more quickly than the fundamentals of businesses. Market efficiency hypotheses and the theory of rational expectations might suggest that arbitrage opportunities cannot persist in global stock markets. Reality suggests otherwise.
Eat or be Eaten
Shell let it be known that it considered a US listing for its shares because Exxon and Chevron enjoy twice the valuation multiple on their earnings. It also implies that if Shell doesn’t do something about this state of affairs (and interestingly, it is now aping the US majors’ hydrocarbon policies more closely), it is an attractive acquisition target for one of these US-listed peers. Acquiring Shell is probably a more attractive option for Exxon than battling with politicians and protesters to invest in new oil and gas exploration activity.
Just Wait
Beneath the headlines of ARM listing in the US or Shell’s chosen corporate domicile are hundreds if not thousands of UK corporate assets than are being sized up using the yardsticks of other market jurisdictions, operating models and costs of capital. As interest rates normalise, private equity interest might dissipate, increasing the role of foreign strategic buyers. Whoever is looking for attractively valued corporate assets will spend more time looking at the UK in future than in the recent past. What is the evidence for this view? Regardless of institutional constraints and political frictions, value is eventually exposed for what it is. While it is hard to know how long it might take, the theory of mean reversion kicks in.
Stormont Brake Off
Specifically, in the UK, the Windsor Framework proposes to remove political obstacles with its largest trading partner, the EU. A week later, no one in or near the government resigned. While it remains early, the next Labour government, today’s opposition, will almost certainly not seek to change this agreement, should it pass. When asset allocators appreciate this, a further time lag later, then UK equities might start to be considered worth a small overweight position. There is nothing like a re-rating from a low level by an off-the-run asset class for FOMO to kick in and narratives to shift. As ever, patience is an important investment trait.
Written by Jeremy McKeown
