The term ‘de-equitisation’ does not exactly roll off the tongue, but it is a challenge that has faced global equity markets in recent years, becoming particularly problematic in the UK. The term is used to describe the shrinking pool of shares available on public equity markets and it occurs when companies buy back their own shares or are taken off market at a faster rate than new shares or companies are being listed.
While this is normally considered an unsettling dynamic, we have to note that, for short-term investors, de-equitisation presents an interesting opportunity. In 2023, we saw a total of 39 bids for UK companies[1], across a range of different size companies, and this trend has continued into 2024. When a company is bid for, the prospective buyer will typically pay a premium to gain shareholder support and the initial surge in share price on a takeover announcements can provide a short term boost to returns. However, reality soon dawns that in selling the company, you are forgoing future returns and must find another attractive investment opportunity as a replacement within your portfolio.
Share buybacks on the other hand provide a more slow and controlled system of reward for investors. This method of return involves companies typically using excess profits to buy up their own shares, often because management feel they are undervalued. Similar to dividends, this provides a return to investors. Future profits are spread across fewer shares, making those remaining more valuable. With UK equity valuations well below both peers and long-term averages, the desire to buy back shares is understandable.
While the impact of takeovers is more explosive, the erosive effect of buybacks on share counts is often underestimated. Indeed, if analyst estimates are met, then BP will reduce its share count by 25% over the next three years. Similarly, Barclays is predicted to reduce its share count by 20%[2].
While bids and buybacks should be supportive of the market over the short-to-medium term, we are long-term investors in UK equities. On that basis, de-equitisation creates issues, as we want to see a burgeoning and healthy market eco-system, with plenty of new ideas and growth capital coming to market.
We are pleased to note that, after a fallow period, we are finally starting to see green shoots emerging. Over recent weeks, we have seen several firms raise capital by issuing shares. Most notably, National Grid set out its desire to grow its electricity network in the UK and US, backed by a £7 billion equity raise, marking the largest equity raise since Lloyd’s Bank in the depths of the Global Financial Crisis. London property company, Great Portland Estates, also cited growth plans as the rationale behind its £350 million capital raise.
More pleasingly, we are seeing increased momentum around initial public offerings (IPOs), the process whereby companies list on a stock exchange. For fast fashion giant Shein, London appears to be a likely destination, with a valuation touted to be in the region of £50 billion, potentially making it the twelfth largest name on the UK market.
Having been shunned by several home-grown technology companies over the years, it is pleasing to see low-cost computer maker, Raspberry Pi, choosing to make the London market its home. The business was valued at £541.6m and shares have made a strong start to life as a listed entity, which will hopefully encourage others to make the move to public equity markets.
We believe that a more positive environment for raising capital signals a turning point for UK equities, after a period of underperformance relative to peers. Interestingly, we have seen several large investment banks turn more positive on UK equities and this was also reflected in the Bank of America global fund manager survey[3], which polls over 200 asset managers, pointing to a rotation into UK stocks.
Improved sentiment is evident in the performance of UK equities over the past quarter, with domestic shares materially outperforming broader global equities. Importantly, UK equities remain on steep discounts to peers while offering attractive shareholder returns through dividends and buybacks.
The Mattioli Woods UK Dynamic Fund aims to uncover exciting opportunities in the UK equity market. Specifically, we are looking for companies that trade at attractive valuations, with the potential for earnings growth, multiple expansion and distributions, either through dividends or buybacks. Indeed, at the time of writing, every company in the fund is paying a dividend and 43% of the companies in the portfolio have bought back stock over the past 12 months. We believe that attractive shareholder distributions, combined with low starting valuations makes the UK equity market well placed to outperform over the coming years.
The value of investments and the income from them can fall as well as rise and investors may not get back the full amount invested. Past performance is not a guide to the future.
This article has been produced for information purposes only and is not intended to be an invitation to buy or act upon the comments made. All investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. Any forward-looking statements and forecasted returns represent the current views of Mattioli Woods plc and may be subject to change. The content is correct at the time of writing (June 2024).
Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority.
[1] – Peel Hunt – UK M&A Feeding Frenzy 03/04/24
[2] – Refinitiv
[3] – Bloomberg (Bank of America's Fund Manager Survey Shows UK Stocks Getting Less Unpopular - Bloomberg)
