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Dan Coatsworth explains how the junior market has come of age, and why it deserves to be taken seriously by investors

If you think Aim is in the doldrums, think again, London’s junior market remains a vibrant home for smaller growth companies. It has been relatively successful at maintaining its buoyancy despite choppy economic waters and has become the role model for a new wave of copycat exchanges around the world. It has lived up to its promise of nurturing growing businesses from home and abroad – several of which have since moved to the main market. Indeed, 2008 is set to see the biggest group of Aim participants graduating to the main board to date. In 2007, 13 companies moved up; this year nine are already poised to mature, food retailer Domino’s Pizza and media group Mecom having already done so.

It’s easy to criticise Aim for being over-crowded, illiquid and poorly regulated. These are fair points, but they don’t apply to every stock. Aim is becoming more streamlined. Micro-cap companies are struggling to survive in the current economic climate, which could clean up the messy bottom end of Aim. The LSE is clamping down on onerous nomads which aren’t policing the market properly, which means the more dubious players are being forced out. Those above the £300 million mark are enjoying more liquid trading and institutional interest from investors looking to back tomorrow’s business giants.

Sifting for quality

The growth of Aim has eased over the past 18 months as new listings slowed down and more companies delist, principally either through being taken over (the good ones) or going bust (the bad ones). The market is taking the direction of quality over quantity.

As of 1 May 2008, Aim was worth £90.7 billion with a fifth of its 1,675 participants being non-UK businesses. The number of international companies is, without a doubt, going to slow down as rival exchanges offer an alternative location for businesses, closer to home. ‘The London Stock Exchange has been heavily marketing Aim overseas for past six years or so,’ says Chris Searle, partner at accountancy BDO Stoy Hayward. ‘It’s been successful in attracting international companies but now there’s more choice in places like Dubai that could change where overseas businesses list.’

Ahead of the competition

Competition will keep Aim on its toes. It has already had to contend with Alternext, the junior market launched by Euronext in 2005. Now its stronghold in the lucrative Asian market is being challenged by Catalist, the newly-opened Singapore market for small caps. Add in the rise in popularity of Deutsche Borse’s Entry Standard, Borsa Italian’s Mercato Expandi and Warsaw’s NewConnect and you would think Aim’s future is under threat. That would be incorrect. Aim is the grandaddy of the small cap markets, has a global reputation and is firmly established in one of the world’s biggest financial centres.

‘Aim is 15 years ahead of Catalist,’ says Kripa Radhakrishnan, head of Collins Stewart’s capital markets division. ‘This new market may attract companies local to Asia who would have traditionally gone to Aim, but it is not serious competition in a worrying sense.’ Catalist is a good example of how Aim has triggered a new breed of junior markets. It’s a sign of respect and honour for Aim that Catalist is so clearly influenced by the UK peer. ‘There is no doubt it has been modelled on Aim. It’s the first sponsor-driven market in Asia,’ adds Radhakrishnan.

Collins Stewart is the only London-based nomad to have received authorisation to be a sponsor on the new Singapore market. It claims to have been approached because of its experience on Aim. Some eight mandates have already been made for the stockbroker to advise on new listings on Catalist – several expected to float this year. Although declining to reveal names, Radhakrishnan says the companies are from China, Korea, Japan, Malaysia and Singapore and work in industries including marine, technology and food production.

In recognition of such developments, the LSE has already taken steps to protect its position in Asia. It has forged ties with the Tokyo Stock Exchange to create its own replica of Aim outside of London. A joint venture will be launched in Japan by the year-end, using the same market model as Aim but directly targeting Asian investors.

Aim acknowledges that it faces competition from other exchanges targeting small growing companies but Marcus Stuttard, deputy head of Aim, insists it is the ‘only growth market with a significant international dimension across a wide range of sectors’. He adds: ‘Companies will continue to have a desire to be admitted to Aim alongside their international peers. For companies who are looking to raise capital principally from well-informed institutional investors, and to acquire international visibility, Aim provides a global platform which at present is not matched by any market in the world.’

Euronext would probably think otherwise, having spent the past three years building up its junior exchange, Alternext. Its head of European listings, Martine Charbonnier, claims that there are two dominant forces in the smaller end of the market – Alternext and Aim. Although she doesn’t believe there is too much rivalry for domestic listings in Europe, Charbonnier does say there is fierce competition for emerging markets. ‘Alternext was created from market demand to make listing easy and cost effective for mid and small cap companies. We have reached the initial objective of ?20 million - ?100 million market cap companies,’ she adds.

Off the mark

The European equivalent of Aim may have got off to a good start, but Alternext hasn’t escaped the market slowdown in IPOs and is wide off the mark for its annual target of adding 100 new listings per year. In the first two years, around 100 companies were signed up. Celebrating its third birthday this month, it has only added around an extra 30 firms. ‘If you look at any market in Europe, be it London, Frankfurt and everywhere, noone has performed recently with IPOs, says Charbonnier. ‘The main reason is the market conditions. When they get worse, it is the mid and small caps that suffer more than large caps. When the market is not so good, institutions privilege companies where liquidity is greater. I’ve seen cycles like this before – and the difference now is that companies are still performing financially.’

Aim may have paved the way for a new breed of international exchanges, but as an investment there have been disappointments. The FTSE Aim All-Share index nudged towards a four-year low in March at 939, a 24% drop over eight months, compared with the FTSE 350’s 18% decline over the same period (see chart).

It’s also no place for dividends, with the average yield on the Aim All-Share standing at 0.63%, against the FTSE 350’s more generous 3.55%.

Institutions have taken profits where possible and most hedge funds have deserted Aim altogether for fear of not being able to cash out an investment quickly. ‘People sell what investments they can in these economic times. If someone wants to turn in a cash profit, it can sink the share price,’ says Simon Rigby, chief executive of Aim-quoted utility services group Spice.

Despite a planned move to the main board in July, Spice says that nearly four years on Aim has served it well during a busy growth period and more relaxed rules meant it could act quickly on deals without having to be held up with shareholder consultations. The time has now come for Spice to lift its reputation and mix with the big league. ‘We’re moving to the main market as we’re getting on the radar of more international investors,’ says Rigby. ‘If we hadn’t been on Aim, three recent acquisitions would have failed the class test – where any purchase above a certain size would have required shareholder approval.’

If the cream of Aim are leaving for the main board and some funds are taking a cautious stance to investing in small caps, are we in trouble? Of course not, as nearly all institutions still have dedicated money for small caps. There may be a stagnant period among Aim stocks until market sentiment improves, but that doesn’t mean plans aren’t being drawn up behind the scenes to swoop on companies left with weakening valuations. Ruari McGirr, chief executive of St Helen’s Capital believes that specialist situation funds will be set up to look at stocks trading on cheap PEs: ‘This will help people get the courage back up to invest in Aim. We’re just not there yet,’ he says.

Plus point

With companies at the lower end of the market struggling to raise money, particularly those without secured or near-term revenue generation, the current weak market climate could flush out the minnows of Aim. One organisation waiting to gobble these up is Plus Markets, which is still trying to shrug off the patchy reputation of its former identity, Ofex.

Aim might be facing increased competition for international company listings, but it won’t be losing too much sleep over Plus threatening to take market share for UK business. The average market valuation of a company quoted on Plus is a mere £10 million - £20 million. It has Arsenal football club and the brewer Shepherd Neame, but these are exceptions to Plus, which only has four companies valued over £100 million.

Business development director Nemone Wynn-Evans balks at the suggestion that Plus is a place for tiddlers. ‘Do not call us a junior market. We are a full stock exchange,’ she insists. Plus sells itself on the ability to trade any main market company. The rules aren’t the same for Aim companies as Plus needs their permission to trade shares. Only around 80 firms have agreed so far, but a review of the listing regime by the Financial Services Authority could see Plus win its fight for full trading capabilities across both the main board and Aim without permissions.

It claims that of the 80 or so Aim stocks it is able to handle, three quarters see more than 50% of their daily trading activity on the Plus platform. Wynn-Evans believes that Aim is ‘too busy’ and quoted stocks get lost in the crowd. ‘Of the Plus- quoted companies that have moved to Aim, many found their profile dropped dramatically. If Aim stocks see half of their trading on our platform, there’s a good argument for them to be quoted on Plus too. We’re cheaper, which is a key benefit to small companies.’

You may not be surprised to see that the LSE and Plus aren’t exactly friends. ‘Plus says that it can offer small cap firms liquidity and access to capital, but the companies that pay to have a quote on Plus don’t seem to be benefiting from this,’ says Marcus Stuttard of Aim. ‘They trade, on average, less than once a week and during 2007 raised £66 million compared with the £16 billion that was raised by Aim companies during the same period.’

Counting the cost

Cost is certainly a factor influencing the decision for some to move down from Aim to Plus. John Bridges at Orange Corporate Finance reckons it costs £100,000 to maintain an Aim listing. The broker and nomad get £30,000 each and the rest goes on corporate governance and a non-exec director. He estimates Plus costs just £15,000-£20,000 for a corporate adviser, helped by not requiring a non-exec director, even though that is bad corporate governance. List a company on Aim and you’d be set back around £500,000 – or £830,000 in the case of stockbroker Share Centre, which floated last week. With Plus, fees come to around £160,000-£180,000, claims Bridges.

While Aim is certainly cheaper than being on the main board of the LSE, its costs can be a burden to the bottom end of the market, where companies may struggle to afford a listing. With that in mind, imagine this scenario – what if Aim imposed a minimum market cap in line with many other junior exchanges? Let’s say £50 million. Any company under that size already on Aim would automatically be transferred to Plus. Could this work?

‘Many small companies are stuck on Aim,’ says Adam Pollock, joint CEO of Dawnay Day Investment Banking. ‘If the economy is booming, then £10 million to £20 million companies could become £60 million or £70 million companies. In this market, that won’t happen. But if there was a mechanism to clean out the lower end from Aim to a more suitable exchange, that would be a plus.’ A pun indeed, as the suggestion of offloading the small fish to Plus doesn’t sound too far fetched.

There are technicalities to consider, such as what happens if larger companies on Aim slip below the minimum market cap threshold – do they automatically get expelled? ‘It would be possible,’ says Wynn-Evans at Plus. ‘Many market commentators have previously said this. As Aim has attracted international business, it is no longer catering for smaller companies.’

The LSE firmly disagrees with the proposition of shifting the tiny feet from Aim to Plus. ‘This is a terrible suggestion,’ says Stuttard. The exchange says there has never been consideration given to enforcing a minimum market size for Aim. Stuttard explains: ‘We aim to provide companies and investors with the greatest level of choice. For that reason we do not set a minimum market value for companies seeking admission to the market. The core mission of Aim is to ensure that it remains what it has been from the start – a market for small and medium-sized companies which are ambitious to grow and need capital for their future expansion.’

Local competition

Aim remains the largest growth market, and probably the best known, but it cannot afford to be complacent. The rapid growth of junior markets around the world means companies can choose an appropriate exchange locally. Catalist is fully aware of this fact and plans to use a position in Singapore to its advantage, as Lawrence Wong, head of listings at SGX explains: ‘Catalist has the key advantage of being situated in Asia, offering a listing platform within the same time zone as Asian companies. This means immediacy of information and access to trading activity.’

Sometimes it is not possible to find an appropriate local exchange, as securities services group Mortice discovered when it began preparations for a stock market listing last year. The company is seeking to be a pan-Indian facilities management group but was too small to join the Bombay exchange. It is incorporated in Singapore so could have chosen Catalist or its predecessor Sesdaq, but felt Aim was a more appropriate exchange to reach international investors. The £5 million it raised for last week’s IPO came from Singapore, Switzerland and Hong Kong. ‘We thought Aim would be the most economic and better valuation for our needs,’ says executive chairman Manjit Rajain.

Floats are picking up again on Aim, having been through a lean period in the early part of this year. There are reports of numerous companies waiting to list on the UK junior market once conditions show signs of sustainable improvement, so the outlook is still rosy.

Aim simply needs to accept that its dominant position is now being challenged from all corners of the globe. ‘Aim continues to go from strength to strength. It’s the only truly internationally focused growth market in the world and will continue to develop in line with the changing demands of issuers and investors,’ says Studdart. ‘We are confident that Aim’s future development is based on solid foundations.’

So it will probably be given a good kick up the rear from rival markets, but with 13 years’ experience under its belt, Aim should have the confidence and expertise to successfully fight its corner and continue as the market of choice for fast growing small companies with big ambitions.

Aim in 30-seconds

• Launched by the London Stock Exchange in 1995, Aim is now worth around £91 billion and claims to be the most successful growth market in the world.

• 2007 was the first time in ten years that the secondary market accounted for greater fund raising than new money: £9.6bn against £6.5bn. In the first four months of 2008, more than 3.5 times as much money was raised on the secondary market as new money.

• The average daily value of trades for the first four months of 2008 was £248.5 million.

Catalist

• Using the basis of its junior board Sesdaq, Singapore's Exchange launched Catalist in late 2007 as a market for small growing companies in Asia

• There isn't a minimum market cap requirement for IPO, but there must be at least 200 shareholders at listing

• Initial listing fees are capped at S$100,000 (roughly £37,000), with the annual fee set having an upper limit of S$50,000 (£18,500)

• There are 160 companies on Catalist although this is somewhat misleading. These have been transferred from Sesdaq and have yet to find a sponsor. The first batch of sponsors, approved in February, are currently preparing new listings. The first IPO on Catalist has still to happen.

Alternext

• Small and mid cap market with strong focus on the Eurozone, launched by Euronext in May 2005

• To IPO, companies must have a minimum float of ?2.5 million

• In its first two years, Alternext attracted over 90 companies at an average size of ?52 million with a combined market cap of ?4.8 billion. Today there are 121 companies

• Similar to Aim, the performance of small and mid cap stocks on Alternext hasn't been great as markets cool off. The Alternext All-Share index has fallen by 25% in the past 12 months. In March, Alternext announced plans to raise the visibility of its listed companies including a new emblem to flag up Alternext participation and a website called 'MyListing'. The latter is an interface for listed companies to access market data on their stock including analysis tools

• Alternext recently secured its first Chinese company listings with China Corn Oil and Huacheng Real Estate

• Steam cleaning technology group Proventec this week becomes the first Aim-quoted company to have a dual listing on Alternext.