Six years ago, Softbank bought Cambridge, UK-based Arm and took it private, removing one of the most successful tech companies from the FTSE 100 index. Although Softbank said that Arm would remain a UK based company the sale of a British semiconductor and software design company to a foreign owner, and the loss of such a company from the UK’s main index caused concern.
The UK government could have intervened, citing the company as strategically significant. Or they could have argued that Arm was integral to developing the Cambridge-Milton Keynes-Oxford corridor as some sort of rival to Silicon Valley. This was a goal at the time but may have since fallen by the wayside in favour of levelling up the North of England. Anyway, the government did not intervene, and despite opposition from the likes of Hermann Hauser, Arm shareholders approved the takeover.
What might irk those that opposed the deal further was the supposed long-term investor Softbank trying to sell Arm to Nvidia in September 2020 for a quick $10bn profit. That deal collapsed after competition watchdogs weighed in. No matter, as Softbank CEO Masayoshi Son said in June 2022 that he was seeking to get rid of the company by listing it on NASDAQ.
ARM is a UK company. Not listing it back on its own turf could be seen as a vote of no confidence in London as a financial centre. Indeed, the UK government is displeased with these plans and doing all it can to persuade Softbank to reconsider. Perhaps, they will succeed. But maybe they won’t. Arm might end up with a secondary listing on the London Stock Exchange as it had on the NASDAQ when it was a FTSE 100 member. Perhaps the real issue is why the fight to get Arm back was not matched in intensity with the fight to keep it from being sold to Softbank in the first place: Oh yes, because back then, it was seen as a sign of Britain’s global attractiveness, and not at all because UK assets looked very cheap to foreign parties due to a relatively weak pound.
London Stock Exchange losing ground
Here is why there might be concerns about London waning as a financial centre. It trails behind New York, Shanghai, Hong Kong, and Shenzhen in terms of billions raised in new listings for 2021. That’s despite raising £16.9bn in IPOs in 2021, which was its best year since 2007. US exchanges raised 14 times that amount, and the Chinese and Hong Kong financial centres raised about four times as much.
Tech IPOs are the current hot listings. Some commentators have called the UK markets out as outright hostile to tech and more broadly, growth stocks. That’s a problem if true because according to Dealroom, 116 tech unicorns (private companies worth north of $1bn) call the UK home. The UK is emerging as a global hub for fintech. It would be a pity if a swathe of these tech companies decided against listing in the UK. That would certainly increase the gap between the amounts raised in new listings elsewhere and those in London in the future.
London hostile to tech?
Back to Softbank and Arm. Why is Softbank considering listing on the NASDAQ over London? Softbank’s CEO has given various reasons. Recently, Mr Son has said he wants to avoid London because of the political turmoil in the UK government. But before that, he said he wanted to list in the US because most of the Arm’s customers are there. What he might have meant was most of the potential investors are there. A dual listing in both the US and the UK has also been floated, like before, but with the primary listing being in the US. Now, it looks as if Mr Son might be trying to sell the company to Samsung Electronics after saying he was seeking a “strategic alliance” with the South Korean technology behemoth.
Masayoshi Son is obviously doing the rational thing and trying to get as much money as possible if he disposes of Arm. Preferring the NASDAQ to London if he goes for an IPO can only be seen as a lack of confidence in the success of an IPO there. He won’t get as much money in London compared to the NASDAQ, which, after all, is a tech hub. And who could blame him? Think of recent London tech IPOs and blockbusters are not what come to mind. Much commentary has been devoted to the question of whether indeed London is hostile to growth stocks, which tech ones typically are.
Is the market the problem?
Restrictions on dual-class share structures have been cited as a reason for London not being attractive as elsewhere to list. Having two classes of stock, one for the public and the other for the founders and insiders is common in founder-led companies, and new growth and tech companies are usually of this type. The dual-class structure almost always gives outsized voting rights to the founders after the IPO, giving them control. That’s not something that the city of London has been comfortable with, and dual-class listings were basically outlawed. Founders want to keep control, so they perhaps avoided listing in London.
However, the rules changed in 2021, allowing certain types of dual-class share structured companies to list. But it will take time for the perception of London to change. Another rule was relaxed in 2021 concerning the free float. A stock’s free float is the proportion of shares that are freely available for trading by the public and not held closely by insiders and connected parties. Dual-class shares are not typically included in the free float. London listings now come with a minimum free float requirement of 10%. Again, it will take time for these changes to bed in. The reason London had these rules was that it deemed dual-class shares and low free floats to be prejudicial to investors. It will take time to see if the changes hurt or help investors.
The London Stock Exchange’s premium segment is reserved for companies with market caps of more than £30m (not a problem for Arm) but comes with a bunch of conditions that some consider onerous. For example, takeover and asset disposal discussions, whether buying or selling, must be made public. The limits are quite low in the premium segment, meaning most talks must be made public. That can make the business of acquiring more expensive than if teed up behind closed doors. There is an alternative, the Alternative Investment Market (AIM), but listing there means the UK’s main indexes, the FTSE 350, FTSE 250, and FTSE 100, are off limits.
MiFID II, an EU legislative framework, has been cited as a reason for London being unattractive (but that would also extend to most European exchanges). I’m not convinced as this is relatively recent, and in the case of Arm does not apply. But MiFID II implementation reduced the amount of research done on smaller companies. Basically, fund fees typically included a charge for research, even if that research might not have benefitted the investor paying the fees. Brokerages were forced to split their research fees out. Less money was available for research, so the number of analysts was cut. It was not the big companies that missed out on research but the smaller ones. They suffered from a lack of awareness, and any IPO might flop. MiFID II was probably a good deal for investors. But it also probably put smaller companies off listing. There are plans to ease the impact of MiFID II in this regard, however: further evidence the UK government and the city are attempting an image change.
Then there is the overall characteristic of UK indexes to consider. They tend to have higher average dividend yields, lower P/E ratios and lower EPS growth rates than US-based and other indexes. For example, right about now, the S&P 500 has an average P/E ratio of 19 and a dividend yield of 1.7%, and the NASDAQ’s PE ratio is 24. The highest UK index PE ratio is the FTSE AIM 100’s 13.72. The lowest dividend yield I can find amongst UK indexes is also found in the FTSE AIM 100, and it’s 2.51%.
Higher dividend yields and lower PE ratios. Not very growth or techy. But, then again, market prices are determined by investors. So perhaps it’s not the markets that are the problem, but the people using them.
Are UK investors the problem?
Markets exist to serve their customers. They are going to look like what their customers want. Given the higher dividend yield on UK indexes compared to their US counterparts, I think it’s safe to say that UK investors, both private and institutional—the pension funds in particular—like their dividends. Dividend-paying stocks are usually more mature companies for whom growth has slowed. This naturally leads to a lower average PE ratio, as seen in the UK indexes in comparison to their American counterparts. Lower growth and higher dividends are not the hallmarks of tech stocks.
Loss-making firms cannot afford to pay dividends to shareholders. Many tech companies make losses. Investors in UK markets, if they are hunting for dividends, will probably lose patience with a loss-making firm long before it turns the corner into profitability and can start paying dividends.
I would not say UK investors are short-term thinkers in the broadest sense. If they want a stream of income from their stocks, then they must be thinking long term. Then again UK investors do seem to bite the hand of anyone who offers a decent premium. Arm, SABMiller, Shire, and Sky were all well-known companies that vanished from the UK markets. According to research by Schroders, an asset manager, a third of the major companies on the UK stock market a decade ago were bought out.
It might be that this speaks of the attractiveness of the UK. Sure, but then again, it might be because the companies were cheap because of the pound’s weakness and the knockdown P/E ratios on the UK markets. The willingness of UK investors to sell could also play a role. Who knows for sure, but an investor base willing to cut their losses (or give up potential gains) and run are not to my mind, the best audience for trying to sell a company that, whilst growing revenues, doesn’t pay a dividend and will require a significant amount of time to report an annual profit.
Maybe it’s the companies fault?
What are the chances of a successful tech IPO on the London Stock Exchange? Given, what I have read, I might imagine it is quite low. But failures do seem to get more attention than successes. So, what is the definition of IPO success? A high opening price, which enriches the founders and employees, and a bull run in the price of the stock after it hits the markets, I would say.
I made a brief analysis of the price performance of some well-known tech or tech-like IPOs on the London Stock Exchange. Darktrace—which went public in May 2021—has done well. At one, three- and six-months post-IPO, its stock price was comfortably above its initial price. It was still up at one-year post IPO. Boku, which went public in 2017, was up a year later. THG went public in 2020, during the great bull run post-Covid-19, and managed to hit its anniversary with its stock price underwater.
All the other stocks I looked at were down at the one-year mark. For the 2021 cohort, the global market sell-off might be blamed. And looking at shorter time frames seems to support this, with the majority performing well at the three-month mark. Yet, most of them are underwater now. Even Darktrace, which looked like a success is now trading for less than its IPO price, seemingly another victim of the sell-off.
Whatever the data say, I cannot escape my overall impression that young, non-profitable, cash-burning, techy companies are not well-liked in the UK. Stock price crashes are lauded as proof of these types of companies being found out. High P/E ratio stocks are frightening rather than exciting. High valuations, based on the promise of potential growth, not backed up by tangible results right now, are deemed, I think, as being absurd. I must admit that, on reflection, I am no stranger to these thoughts, and thinking on my biases have a lot to do with why I am now writing this article. Perhaps, these fears are justified. But perhaps growth and tech companies are not doing a good enough job of convincing the UK investing public of their worth.
Be like the big four of tech
In his book The Four, Scott Galloway explains why Amazon, Apple, Google, and Facebook (The Four), all tech titans, have managed to become omnipresent in our daily lives and attain enormous valuations. Mr Galloway introduces the T-Algorithm of factors that the Four share, a kind of rules set for what it takes to be a trillion dollar (or, for now, at least slightly fewer pounds):
- Product differentiation
- Visionary capital
- Global reach
- Likability
- Vertical integration
- Artificial intelligence
- Accelerant
- Geography
The UK and its markets have companies with differentiated products, vertical integration, and that use artificial intelligence. In terms of global reach, comparing UK unicorns to Facebook, a social media company with billions of users, is not fair. But there are many that have customers across the world.
Of the seven factors, I think visionary capital and likability might explain why UK tech stocks do not appear to perform as well as their American counterparts. How many CEOs of UK companies are well known even amongst the investment community? I wager that almost everyone can name the boss of one of The Four. Presenting a bold vision of what the company can achieve is the way to get investors to buy and keep buying a stock even when the realization of that vision is years, perhaps decades away.
Being able to convince investors of the immutable good of the company’s vision and how its services will change the world is how you get investors to part with more and more cheap capital to pay for the growth that is promised.
Perhaps those reading the Economist and the Financial Times will be familiar with the heads of the UK’s hottest tech start-ups. But an interview piece in the trade journals does not come close to achieving the cult status that US bosses enjoy. And how can investors like a company if they barely know who runs it? It’s far easier to like something if you like the person in charge.
The geographic factor is also something worth exploring. Tech startups need access to quality human capital. Being close to prestigious universities and other like-minded enterprises is a boon. The plans for the UK equivalent to Silicon Valley were ambitious and achieved something. But, the UK government could probably do more, and I note that this project seems to have been sidelined to level up the north, a worthy goal, but why not try for both? The best talent from universities will also want to go work someplace that they strongly believe will accelerate their careers. Again, a corridor of business parks and closely associated universities helps spread the message that UK unicorns are that kind of place.
Not hotly hostile
After a bit of thought, I don’t think that the UK markets are hostile to tech stocks. However, I don’t think they are in love with them. A lot of them list in the AIM and currently suffer from a paucity of analyst coverage and are left at the mercy of speculators and chitter chatter on forums. For the ones that do make the premium segment, poor results are swiftly punished, profitability is demanded perhaps too soon, and capital is often hard to come by. When it does come, low appetites for risk drive its cost higher. When times get tough, someone swoops in with an offer, and investors happily acquiesce so long as the offer is at a decent premium to the current share price.
Perhaps a few more visionary leaders might help to assuage investors of their fears if they are unjustified and convince them to have patience. It’s also worth asking if the UK government can do more. Instead of happily letting UK businesses get sold for what are, let’s be honest, usually knock down prices on the global markets they could, instead of praising the loss of our most exciting businesses as evidence of the UK’s desirability for doing business, put up a fight. That would be a signal to investors, who might otherwise be happy to sell up, that it’s worth hanging onto their shares.
Now, this doesn’t mean tech businesses should feel free to tell a good story and simply point to rising revenues as evidence of their greatness. A loss-making, cash-burning company must lay out a path to profit. Investors might be rewarded by rising prices in the face of increasing losses, so long as there is the belief that one day a profit will appear. No business, no matter how visionary the leader, can lose money indefinitely without saying how success (profits) will be achieved. If it does, then I would call the eventual stock price crash evidence that investors have woken up to the truth. And as for smaller growth and tech companies not getting the coverage they deserve, perhaps this site and others like it can help.
The Storied Investor 