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STOCK EXCHANGE GUIDE – London’s unquoted alternatives

June 1995 witnessed the birth of the Alternative Investment Market, the nursery for wannabe Glaxo Wellcomes of the future. September 1995 saw the start of Ofex, the off-exchange unregulated trading facility offering companies basic marketability in their shares. Though very different in character, both have grown healthily.

By March this year Ofex had attracted 194 companies which now have a combined market capitalisation of #2.5bn. Although the average market cap is just #12.9m, the largest company on Ofex, National Parking Corporation, is valued at #660.6m, followed by Weetabix at #410.4m.

Run by market-maker JP Jenkins, Ofex attracts companies that need basic share marketability, perhaps to provide an exit route for a venture capitalist.

Some may have a share scheme in place and want to get an independent price and market-making facility for those shares. “Companies also see that if their shares are traded on Ofex, the paper has a value and they can use it, rather than cash, for acquisitions,” says Barry Hocken, marketing director of Newstrack, the Ofex’s news service .

Many Ofex companies do seek extra funds. Between 1995 and the end of January 1998 there were 167 share issues raising a total of #120m, a third relating to initial public offerings and the rest to secondary fund-raisings.

On average, companies raise around #719m, and few seek more than #1m. The great advantage is that Ofex is unregulated, though it published a code of best practice last October in recognition that investors need some comfort. Lack of regulation reduces joining costs. The one-off application fee of #500 and an annual #3,500 charge shouldn’t break many banks. However, some companies may be put off by the fairly restricted pool of investors.

You won’t catch big institutions here, but rather private investors who want to make the most of the tax incentives offered by investing in the shares of companies that are technically “unquoted”.

Though many Ofex companies are happy where they are, 14 have moved up to Aim. Though still a market for small companies – the average market cap is just over #18m and around 80% of companies are capitalised at less than #30m – most Aim companies have growth ambitions. Net asset values of companies that joined Aim in its first two months have increased by an average of 40%.

Unlike the main London stockmarket – the Official List – Aim places no restriction on the size of companies that join, nor on the length of trading record or percentage of shares in public hands. “Companies are attracted to Aim by its accessibility,” says Theresa Wallis, Aim’s chief operating officer, referring particularly to IT companies and start-ups. “But the market felt it should cater for a wide range of industry sectors,” she stresses. “It’s also a market for growing companies that aren’t in trendy sectors.”

Companies seeking admission to Aim have to prepare an admission document, similar to an Official List prospectus. But the market authorities have, in effect, cleverly outsourced much of the regulatory burden to nominated advisors (nomads), such as merchant banks, corporate finance boutiques and even accountancy firms. A nomad advises the company during its market application and is responsible for deciding whether a company is suitable to join Aim. The nomad has to be retained to make sure the company is aware of its continuing obligations which centre around the disclosure of information to investors.

Given that many of its target companies are in their early growth stages, regulation for Aim companies was always intended to be lighter than on the Official List. This inevitably led to some questioning of the credibility of some of its companies. A series of Aim company profit warnings seriously dented the market’s image and some advisers privately admit to pushing larger clients towards the main market to appear more credible to potential investors.

Aim responded by updating its admission rules last summer. Even greater emphasis has been placed on the nomad’s responsibility to satisfy itself that a company is appropriate for admission to Aim. Further tightening is unlikely. “In terms of providing a framework to create confidence in the quality of the companies and the ability of management to operate in the public arena, there isn’t much more the Aim rules can do without mirroring the main list rules,” says David Mandell, corporate finance partner at SJ Berwin & Co.

In fact, questioning the reliability of Aim companies may be unjustified.Richard Taffler, professor of accounting and finance at City University Business School, compared the Z-scores, a measure of corporate health, for Aim companies (excluding start-ups) and companies on the main list. He found no material difference. One possible interpretation is that start-ups, obviously the most risky investments, have had too great an influence on the perception of all Aim companies’ stability.

Despite lighter regulation than the main market, joining Aim isn’t particularly cheap, costing perhaps 9% of any amount raised. Most of the expense comes from the inevitable advisers, but there is also a joining fee of #2,500, an increased fee in year two and a #4,000 fee for years three onwards.

Costly or not, interest in joining appears healthy and the market is expected to grow to a total of 400 companies by the end of the year. Companies raising capital at admission generally look for sums ranging from #1m to #10m. Andrew Griffiths, editor of the Aim Newsletter, believes there is plenty of investor interest: “It is a bit of a fallacy that there is a wider spread of institutions willing to invest in you on the main market.

We found that more than 100 big name institutions had invested in one Aim company or another.” Institutional investors own, on average, 22% of Aim companies and have provided 62% of the #1.6bn raised in new capital. Venture capital trusts can invest in Aim companies because, like those on Ofex, they are technically “unquoted”, whereas VCT’s can’t buy shares in fully listed companies.

Aim shares do tend to be illiquid, however, partly due to the fact that many managers own a large number of their company’s shares, reducing those available for institutions. “There may be very little trading because shares are held by families or friends of families. The only reason they are on Aim is to get a price to see what their company is worth,” says Griffiths.

But most companies aren’t this sleepy. “If a company wanted to make lots of acquisitions, that could push it to Aim,” says Ernst & Young corporate finance partner Clive Ward. A fully listed company that makes an acquisition worth over 25% of its own value has to get shareholder approval for the deal. Aim companies only have to get approval where deals are equivalent to 100% of their own size, which reduces the cost significantly.

Overall, things look pretty good for Aim. Andrew Beeson, chief executive of Beeson Gregory, says: “We have just done an issue in which we were only raising #3m. Demand was extraordinary. If you present an interesting opportunity, people will go for it.”

Aim: Gooch & Housego plc

Somerset-based Gooch & Housego, manufacturer of high-quality precision optical components, joined Aim in December 1997. The company achieved a market capitalisation of #17.8m, raising #5.9m. Since then the shares have risen from the placing price of 105p to over 150p, giving the company a market value of over #25m. Price Waterhouse Corporate Finance acted as nominated adviser to the issue.

The #6.7m turnover company had been growing fast, with profit before tax up 35% to #1.43m for the year to 30 September 1997. In 1995 it acquired a Florida-based company, expanding its potential in the US, and some of the funds raised from the placing were intended to finance expansion of facilities in Florida. “We have just built a 25,000 sq ft factory,” says Archie Gooch, the company’s octogenarian founder and current executive chairman. “It’s all about doing a lot more business in America. We are going to build up our market.” Gooch says he would ideally have headed for a main market listing but went for Aim in order to take advantage of retirement relief.

Gooch accepts the cost of joining the market, including advisers’ fees.

“They charge a lot of money, these people, but you have to expect that,” he says. The company was successful in its efforts to stimulate investor interest. “The managing director, finance director and I toured round the institutions,” Gooch says. “We were subscribed twice over.”

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