Counter revolution

By Ian Fraser

Published: Sunday Herald

Date: October 12th, 2003

The stock market may be set for recovery, so there’s talk of a run of middle-ranking firms gambling on flotation. But, reports Ian Fraser, as the Wolfson Microelectronics float hangs in the balance, it is probably not the right move for all unless they can bring £1bn to the table.

TO FLOAT or not to float: that is the question. Whether it is nobler to suffer the slings and arrows of negligent, over-regulated stockmarkets or go private against a sea of troubles, and by opposing end them?

With apologies to Shakespeare, this is the dilemma facing Scotland’s middle-ranking firms, many of which are pondering the merits or otherwise of being listed on the London stock exchange. The dilemma perhaps has intensified of late as the stockmarket looks like it could be poised for a significant recovery, and because certain leading corporate financiers are talking up “a pipeline of corporate flotations in Scotland”.

Much of the excitement has been fuelled by the speculation over the flotation of Wolfson Microelectronics, the Edinburgh-based computer chip maker.

If this flotation does go ahead – it is hanging in the balance this weekend as rival company Cirrus Logic claims Wolfson has infringed on two of its US patents – some observers will be driven to scratch their heads and wonder whether we have entered a 1999 timewarp when technology firms were flavour of the month and when “old economy” firms were in the dog house.

Spun out of Edinburgh University’s Wolfson Laboratory in 1983, Wolfson designs and manufactures specialist computer chips that can be found inside such gizmos as Microsoft’s Xbox, Apple’s iPod and countless mobile phones and DVD players. Unlike many other technology wannabes, the company has until now tended to hide its light under a bushel.

Market sources suggest US-based institutional buyers are going to grab a “significant” slug of Wolfson’s equity if the chipmaker makes its market debut this Thursday. Sources also add that Wolfson’s support should enable the issue to get off to a healthy start, despite a lack of enthusiasm from some potential UK buyers who are not happy that the firm’s original backers at Scottish Enterprise and Edinburgh City Council are selling out.

One Scottish analyst source said: “The suggested range of 155p to 210p a share represents a full price and we don’t like the idea that shareholders are taking their profits. We can see why they are doing it but it is not exactly a gesture of confidence at a time when the market in technology shares is still well short of recent peaks.”

The source still believes the overseas support means the shares should sell at around 185p each, valuing Wolfson at some £195 million. At that level, Scottish Enterprise would pick up £17.6m after investing just £250,000 in 1994, while Edinburgh City Council should receive about £10.4m.

Other current shareholders – including Braveheart Ventures, WestLB, Enterprise Capital, Sanyo and Texas Instruments – are believed to be intending to retain at least some of their stakes.

But one thing seems certain. Several other Scots firms will now consider following Wolfson’s lead. The Galashiels-based drugs company Strakan and the Dundee dental specialist Innov8ive Detection and Monitoring are the most obvious candidates.

There’s a widely held view that a flotation can transform a business, notably by making it easier to fund acquisitions. Indeed there are countless firms where this new-found ability has been ruthlessly and successfully exploited by entrepreneurial CEOs. Other reasons for seeking a float are that it permits the business’s owners to cash out their personal stakes whenever they choose and raises the company’s media profile at a UK level. The latter has clear marketing and branding benefits though it can also be a danger should corporate performance splutter or go into reverse.

Being a publicly quoted company is not always a bed of roses, as companies that have chosen to remove themselves from the market by going down the public-to-private route (such as Clyde Blowers, Cala and Macdonald Hotels) will gladly testify.

Such firms have opted either to chase private-equity funding or to opt for major indebtedness to their banks just so they can escape the ruthlessly detached master that the stockmarket can become.

There is also the small issue of the vast amounts of management time consumed by placating City-based investors. Chris Masters, the former chairman of Aggreko, has estimated that when carrying out that role he was spending 80% of his time talking to analysts and fund managers.

There is also the rise and rise of regulation, which is likely to become ever tighter in the wake of the US Sarbanes-Oxley Act, and is clearly something that will make being a plc director less attractive and potentially more hazardous.

The Higgs review of corporate governance has already limited plc directors’ freedom of manoeuvre and, only last week, the Financial Services Authority (FSA) published proposals for listing rules, which are likely to mean that firms wanting to delist will have to secure the consent of at least 75% of their shareholders. The FSA is also seeking views on whether it should be able to disqualify directors for serious breaches of listing rules.

Jim McColl, the entrepreneur who took Clyde Blowers private in 1999 with the backing of venture capitalists 3i, believes being publicly quoted is losing its lustre for all but the largest companies.

He says this is partly due to the increased cost of regulation, such as that arising from Sarbanes-Oxley and “all this whinging about [remuneration] packages.” He now believes there is little point in a company being listed at all unless it has a market capitalisation of at least £1 billion. “In my view there is no need for it [a listing] unless you reach that size. The big money is in private equity.”

McColl adds: “I believe there is plenty of money available from private equity houses until you get to a market value of around £1 billion. There are lots of opportunities in the private equity market.”

If Scottish firms adhered to McColl’s formula, there would be just seven or eight plcs in Scotland, including the two banks, the leading utilities, Scottish & Newcastle, Johnson Press and FirstGroup.

Well-known names including Cairn Energy, Thus, Isis Asset Management, SMG and John Menzies would either be privately held, venture capital-backed or subsidiaries of larger groups.

That would be a body blow for the many professional, advisory and services firms in Scotland, which tend to derive their fattest fees from advising plcs on both sides of the Border. Organisations that would suffer include law firms, accountancy firms, investment banks and corporate financiers. But it would clearly be a boon for such local private equity specialists as 3i, Dunedin Capital Partners and Penta and Scottish Equity Partners.

“In my view the idea of [a £1bn threshold] is just rubbish,” says Ben Thomson, chief executive of Edinburgh-based investment bank Noble Group. “Yes there are additional costs [involved in being a listed company], but it does bring real benefits.

“The biggest is that it enables a company, at the right time, to raise capital and make acquisitions. It also provides greater liquidity for shareholders and helps build up a company’s reputation. Being listed also forces you to have high standards of corporate governance. That is not to say many firms do not have those anyway but it provides a discipline and a framework against which to work. That can only be in shareholders’ interests,” he adds.

Thorold Mackie, founder and managing director of Research & Analysis Ltd – and formerly a broker at Bell Lawrie White and ING – was no less critical of McColl’s thesis. “That [£1bn] is far too high a threshold. His views are perhaps coloured by the fact that his own experience of the market was not particularly successful.”

But McColl insists far too many Scottish-based plcs are “going nowhere” and that many are going to find it even more difficult to justify the costs of maintaining a stockmarket listing, as regulations become more stringent. He said: “Some of the Scottish plcs haven’t moved their market capitalisation for years. You do wonder why they are on the market at all. The only reason for being listed is to give the company access to the capital markets, but many of the smaller listed companies in Scotland are plainly not using it for this.”

The Scottish corporate landscape has already changed considerably since the late 1990s. Many Scottish-based companies have disappeared from the market in that time, including Kwik-Fit, Stakis, Cala, Morrison, Atlantic Telecom, Alexander Russell, Orbital Software, Clydeport, Burn Stewart, Bett Brothers and Macdonald Hotels.

In total, 19 Scottish-based plcs have left the stockmarket since 1999, with only eight joining.

Noble’s Ben Thomson is relatively pessimistic about the near-term future for Scottish flotations, despite all the hyperbole surrounding Wolfson. He says: “There is not nearly the same appetite for it as in England. I would like to think more Scottish firms are considering flotations at the moment.”

According to “big four” accountancy firm KPMG, the pipeline of forthcoming flotations looks healthier than it has for months. KPMG believes the flotation of former Yellow Pages directory business Yell in July, which raised £1.22bn proves investors are rediscovering a taste for new issues. KPMG’s head of corporate finance in Scotland, Jeff Corray, said: “The market is open for business, there is an appetite for quality stocks at the right price and more companies are waiting in the wings than we have seen for some time. The signs of life in the US also send a positive signal.”

He added: “Conditions are better now than a year ago and institutions have more confidence in putting their money into equities.”

At a UK level, firms such as Burren Energy, Inpharmatica, Strakan, Xchanging are set to float this year with Tussauds and Wellington Re said to be planning to list early next year.

Corray believes the pipeline is likely to be driven in future by private equity exits. He adds: “Twelve months ago embarking on listing preparations was not considered worth the effort. Now companies with an IPO [flotation] on the agenda should feel much more confident about starting the process.

“For companies with capital requirements and acquisition plans, now is a better time to consider making use of the public markets. We are not likely to see a great flood of activity due to supply problems but a pick up in deal numbers is expected as we enter 2004.”

But 3i’s Scottish director Robin Marshall ridicules the notion that there is about to be a sudden rash of flotations. He says: “The capital market is still very tough. There have been 10 across the UK including Yell and Benfield. But is there a pipeline of IPOs in Scotland? No. Is there a pipeline of IPOs in the UK? No. It’s far too early to say that people are queuing up to float their businesses.”

Nor does Marshall regard IPOs as a particularly attractive exit route for venture capitalists such as himself. He says: “A trade sale is the preferred exit for most mid-market deals.”

“With IPOs, it is difficult for private equity houses to exit their full share. Institutions like other institutions to stay in for a period of time, as we are doing with Wood Group. It is much easier to realise all of the proceeds from day one in cash with a trade sale.” Marshall cited recent trade sale exits made by 3i, which included the £17.25m sale of nursery chain Careshare to Just Learning, as well as the £85m sale of Stiell Group to Alfred McAlpine.

MANY fledgling Scottish companies are complaining about a lack of venture capital activity, especially in the technology and research areas. Their views have been underlined by officials at the Scottish Institute for Enterprise (SIE) which helps spin-out businesses from the country’s 11 universities.

Graham Wheeler, incubator manager at the Edinburgh Technology Centre, says: “The businesses are frequently able to raise initial finance from government grants or from business angels such as Braveheart in Perth, but the real problems begin when the angels want to realise the cash and the companies require more funds for development.

“The venture capital firms still appear to be suffering from the poor investments they made two or three years ago and appear to have little appetite, although the current crop of potentials is much more prepared for the marketplace and more robust than those which swallowed their cash.”

Sharon Bamford, SIE’s chief executive, echoes his view. “The misalignment of expectations between the two sides is something we are trying to address,” she says.

“The VC firms are looking for an income stream and an early move to the stockmarket while the academics want the money to spend on more research. We have to bridge that gap but we seem to have a little way to go at present.”

The major venture capital firms maintain conditions are improving.

Neil Crabb, joint managing director of Edinburgh-based Sigma, formed to invest in Scottish technology firms, says: “The current climate in Scotland is very encouraging. Activity has picked up quite aggressively.”

Even when funds are available not all find the terms acceptable, many suggesting the private equity houses are too greedy. “They have had their fingers burnt in the past and wanted us to pay for their mistakes by offering miserly terms,” said the head of one firm. “They may facilitate our flotation but it would come at a heavy price.”

But Jim McColl, chief executive of Clyde Blowers, claims companies which enter the private equity markets “green” can get their fingers burnt. “You have to have a lot of expertise in handling venture capital to get a good deal,” he says.

“There are so many ways of structuring deals on the private equity market, but it is essential to get to know it first.”

STOCK MARKET LEAVERS

Company / Date left market / Reason for leaving

Morrison 2000 acquired by AWG

Highland Distillers 2000 acquired by Edrington

James Finlay 2000 acquired by Swire Group

Scottish Metropolitan 2000 acquired by Rodamco

Hewden Stewart 2000 acquired by Finning International

Atlantic Telecom 2001 went bankrupt

Orbital Software 2001 acquired by Sopheon

Clydeport 2002 acquired by Peel Holdings

Burn Stewart Distillers 2003 acquired by CL Financial

Edinburgh Fund Man. 2003 acquired by AAM

Bett Brothers 2003 acquired by Gladedale

Macdonald Hotels 2003 public-to-private/MBO

STOCK MARKET JOINERS

Company /date of IPO / sector

IndigoVision 2000 Information Technology

Orbital Software 2000 Information Technology

Murgitroyd 2001 Patent Attorneys

Halladale 2001 Property

Venture Production 2002 Oil and Gas

Wood Group 2002 Oil and Gas

Vebnet 2003 Information Technology

Faroe Petroleum 2003 Oil and Gas

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Posted by Ian Fraser on Oct 12 2003. Filed under Article Library. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry