Europe's Small-Cap Fever
By Beth Carney
Europe's small-cap stock markets are booming. Last year, the London Stock Exchange's junior exchange for small companies, the Alternative Investment Market (AIM), attracted 226 initial public offerings, the most in its 10-year history and more than three times the number it drew in the previous year. In April, the Irish Stock Exchange opened the Irish Enterprise Exchange, a junior market for smaller companies. And on May 17, the European stock exchange Euronext is opening a growth market in Paris, called the Alternext, which will focus on listing the one million small-cap companies in the euro zone.
The question now: whether AIM and its emerging rivals can continue to succeed where European exchanges have failed in the past. The Neuer Markt, run by the Deustche Boerse in Frankfurt, which was set up in 1997 for technology companies, collapsed in 2003 after the value of its top 50 companies fell 95% from their peak and several became embroiled in scandals. Other growth markets -- such as an earlier Euronext small-cap market called the Nouveau Marche -- simply never established critical mass and had to be subsumed into existing stock exchanges.
Small-cap exchanges are reemerging as a force in Europe, partly to allow small companies to avoid stricter European Union regulations coming into effect in July that will create new guidelines for reporting and company prospectuses. The new exchanges, like AIM, will be exempt from some of those requirements, because they are classified as self-regulated. Like AIM, the new markets will have simpler listing requirements and regulatory regimes than major European stock exchanges.
The junior markets are also seen as a growth opportunity for major exchanges operating in an increasingly competitive environment. As in the United States, where the New York Stock Exchange and the Nasdaq are attempting to become more competitive by buying electronic trading platforms, stock exchange consolidation looms in Europe, too. British authorities are now reviewing an initial approach by Euronext to buy the London Stock Exchange.
In the meantime, AIM's success in attracting both companies and investors has clearly been a powerful example to its rivals. There are 1,127 companies listed on AIM, including 134 from outside Britain. International listings grew by 15% last year, faster than the 9.7% growth in domestic listings, and AIM's new listings accounted for more than half of all new listings on stock exchanges across Europe, according to statistics complied by the Federation of European Stock Exchanges. Though the average AIM firm has a market capitalization between about $20 million and $40 million, the largest are valued at more than $1 billion.
AIM's performance is another draw: In the 12 months that ended in April, the FTSE AIM index gained 12.6%, outperforming both the FTSE 100 and the FTSE small-cap indexes. A total of $8.8 billion was raised on the exchange in 2004, more than doubling the $4 billion raised in 2003.
The key difference between AIM and earlier growth markets is the exchange's looser regulatory regime, according to Tim Jenkinson, a member of the finance faculty at Oxford University's Said Business School. Under AIM rules, companies can enter the market with no trading record, no minimum market capitalization, and no prospectus. The London Stock Exchange does not review any admission documents.
All the companies need in order to list is for one of several dozen designated nominating advisors -- which include brokers, accounting firms, and investment banks -- to sponsor the company's admission. "It's a very different type of market," said Jenkinson, who attributes its popularity to the relative ease of access.
Of course, the flexible listing process, though cheaper and easier for companies, dramatically increases risks for investors in AIM-listed companies. One concern has been the number of cash shells listing on AIM -- investment companies with no physical business that are formed to raise money for purposes such as mineral exploration or making acquisitions. Last month, the London Stock Exchange tightened AIM's rules regarding such businesses, requiring them to have a $5.7 million market capitalization before listing.
However, the threat of the rule change prompted a rush of cash shells to the market. According to a study by the accountancy and consulting firm Grant Thornton, which advises AIM companies, half the companies that have listed in the first quarter of 2005 are cash shells, which are by definition uncertain propositions. "The types of companies on AIM tend be of a higher risk profile," says Richard Staveley, manager of the SG UK Smaller Companies Fund at SG Asset Management, who limits his fund's investment in AIM to 20% because of the risks.
Adds Crispin Finn, manager of British growth funds at Credit Suisse Asset Management: "There are far more low-quality companies on AIM. In order to find the hidden jewels, you have to sift through a lot more silt."
Both the Irish and Paris exchanges have somewhat stricter listing rules than AIM. The Irish Enterprise Exchange requires companies to have a minimum market capitalization of about $6.4 million, in order to discourage cash shells, and Alternext will demand that companies place at least $3.2 million in public hands. Both exchanges will use sponsoring advisers to help companies list and ensure their compliance.
Whether the new exchanges will replicate AIM's success remains a question. AIM has one big advantage -- a tax break the British government gives to investors in AIM companies to encourage startups. "AIM has such an accepted international reputation, I believe that for some time it will be the first choice," said Simon Boadle, corporate-finance partner at PricewaterhouseCoopers, which advises AIM companies.
For now, AIM is the leader that the others hope to emulate. "AIM is the model that has worked," admits Brian Healy, director of trading at the Irish Stock Exchange. But competition is heating up as rivals aim to emulate AIM's success.
Carney is a correspondent for BusinessWeek Online in London
Edited by Thane Peterson