Aim-ing for growth in 2019

By Harriet Clarfelt

The Alternative Investment Market (Aim) was launched in 1995 as an incubator for smaller
businesses, providing these with access to the external funds needed for rapid growth. And in
a glowing demonstration of its ability to foster such expansion, at the time of our last
Christmas review, the Aim All-Share Index was up more than a fifth on 2017’s opening price.

But as we write, that very same index has fallen 15 per cent since the start of 2018 –
dampened by a particularly downhill October and November. This might well raise questions
about whether Aim is still, in the London Stock Exchange’s words, “powering the companies
of tomorrow”.

Arguably, Aim’s reversal of fortune this year is an important reminder of its intrinsic
riskiness. Lighter-touch regulation and relatively few listing criteria can render some of the
exchange’s constituents vulnerable to illiquidity, volatility or even collapse – particularly at
the smaller end of the market. A major weakness is that the prospect of high growth can
engender high expectations – which, as we’ve seen in recent weeks, are susceptible to swift
deflation.

That all said, the FTSE All-Share index has also declined by 12 per cent – reflecting the fact
that the past couple of months have been challenging for equity markets in general against a
backdrop of macroeconomic disquiet.
Among various global tensions at play, trade disputes continue between the US and China;
there’s the possibility of interest rate hikes across the pond, which could lift borrowing costs
for businesses; Italy’s budget proposals have rubbed the European Commission up the wrong
way; and the UK’s imminent divorce from the EU looms ever closer. Indeed, to the latter
point, accountancy firm UHY Hacker Young notes that companies have shelved merger and
acquisition plans due to Brexit uncertainty – leading merger and acquisition (M&A) activity
on Aim to drop 28 per cent in 2017-18 versus 2016-17. This uncertainty might also have
quelled initial public offering (IPO) ambitions. As at the end of November, 58 companies had
floated on Aim during the year – down by 10 year on year.

Of course, such events and statistics should inform our analysis of Aim stocks – as they
should any decision around portfolio construction. And yet, as we enter 2019, there are still
many reasons to remain optimistic about the growth credentials of the so-called ‘junior
market’ – especially at a time when such growth could prove elusive elsewhere.

A maturing market

True, the number of companies on Aim has fallen since the pre-financial crisis days, and even
since last year. But – exploring a different interpretation of growth – Aim has, in some
regards, become more mature since its inception.
For starters, the market today plays host to behemoths including online retailer Asos (ASC),
drinks group Fevertree Drinks (FEVR) and litigation financing company Burford Capital
(BURF) – all of which are valued in the billions. And while the presence of such giants does
suggest that Aim is no longer a dedicated small-cap haven, these organisations can also offer
excellent examples for minnow peers to follow, in the hope of achieving similar scale.

Second, according to financial services provider Link Asset Services, Aim companies are
increasingly paying out an income to their shareholders – helped by the progressing maturity
of many companies, the larger size of new listings, and new companies paying dividends at
an earlier stage. Indeed, Link’s Aim Dividend Monitor expects dividends paid by Aim-traded
UK companies to bypass £1bn for the first time this year.

Justin Cooper, Link Market Services’ chief executive, says: “We rightly associate Aim with
young companies, hungry for capital to grow... [and the] value of capital being returned to
investors via dividends is still much smaller than the amount being raised for investment”.
But the rate at which dividends are growing suggests that more companies are “reaching that
important milestone where they generate more cash than they absorb”.

Moreover, the report, published in September 2018, finds that Aim dividends are less
concentrated and more diversified than the main market. Thus, perhaps counterintuitively,
Aim could help income-seekers to hedge their bets.

New rules
In a third sign of heightened maturity on Aim, the rules changed in 2018 for both companies
and their nominated advisers (Nomads). Nomads are now formally required to notify the
London Stock Exchange (LSE) of key information about an Aim applicant early in its listing
process, and the LSE has also introduced non-exhaustive examples of matters that could
affect the appropriateness of an Aim applicant. Aim companies must now publish details of
the recognised corporate governance code that they have chosen to apply, how they comply
with that code and where/why they have departed from the code.

Meanwhile, the Financial Reporting Council (FRC) reviewed aspects of the annual reports of
40 smaller listed and Aim-traded companies this year – in an indication that the accuracy and
transparency of reporting will come under closer scrutiny in future.

Stricter statutes should help improve investors’ trust in Aim, and specifically smaller
companies – although regulators are likely to seek to strike a balance between law and
leeway. And speaking of law, this is one of various mini-sectors that have recently emerged
on Aim – with each such sector comprising small but growing businesses in large,
fragmented markets.

Law and order

In last year’s review, we counted three Aim-traded law firms: Gateley (GTLY), Gordon
Dadds (GOR) and Keystone Law (KEYS). The former went public in 2015, and the latter
two in 2017. Such IPOs seem a clever move, against a highly saturated legal milieu where the
elite ‘Magic Circle’ and ‘Silver Circle’ garner the best lawyers and biggest clients, and where
it can be difficult to raise one’s head above the crowd – particularly as a mid-market firm.

We had thus envisaged more IPOs in 2018. Accordingly, Rosenblatt (RBGP), a City law firm
specialising in dispute resolution, listed in May. It has a market cap of £62m today. In June,
legal services group Knights Group Holdings (KGH) floated. It now has a market cap of
£145m. And in the same month, Anexo (ANX) – a provider of credit hire and legal services –
also went public. It is currently valued at £136m.

True, these flotations occurred in the first half of the year. Some would-be peers perhaps
preferred to avoid the choppy pre-Brexit waters in the second half. That said, a quasi-peer did
publish its intention to float in November: Manolete Partners, a UK insolvency litigation
financing business. It expects to join Aim on 14 December, with a market cap on admission
of £76.3m.

It may be a while before we see other law firm flotations, as companies generally await
clarity on what post-Brexit life will hold. But, reflecting our optimism in this sector, we
tipped Keystone Law, Gordon Dadds and Gateley over the course of 2018. And reflecting
some transactional activity, Gordon Dadds’ shares are currently suspended from trading, as it
has agreed terms of the reverse takeover of international law firm Ince & Co. Were this deal
to complete, Gordon Dadds would become the UK’s largest listed law firm. It is currently
valued at £52m, signalling the scale of this hypothetical combination.
Video games

During 2018, two video games companies joined Aim: Team17 (TM17) in May, and
Codemasters(CDM) in June. Both businesses are still reasonably small – valued at under
£300m at the time of writing, in keeping with Aim predecessor and IC buy tip Sumo Group
(SUMO). But all three operate in a pool with bigger fish, including Frontier Developments
(FDEV) and larger IC tip Keywords Studios (KWS) – suggesting there could be room for
expansion.

That said, Keywords’ shares have fallen in recent months. And industry expert Newzoo has
cut its global games forecast for 2018 from $138bn to $135bn, due to regulatory changes in
China and the absence of new global blockbusters. Still, it says the industry is growing at a
healthy pace, at 10.9 per cent from 2018, or $13.2bn. A trend worth keeping an eye on.

Again, it’s possible that IPO activity will slow, as companies monitor broader economic
influences. Green Man Gaming had released its intention to float on Aim in September, but
we understand this has since been delayed due to tough market conditions.

Broader trends

It can also prove fruitful to consider shifting behavioural patterns. For example, the rise of
digital payments could engender opportunities for specialist payments businesses on Aim,
such as buy tip Eckoh (ECK). The increasingly flexible workplace might drive demand for
conference-call technology, such as that supplied by LoopUp (LOOP), or for other software
that can facilitate remote communications.

Shocks and scandals

Aim has seen its share of high-profile scandals this year – although, arguably, these could
have occurred on any market. A reminder, perhaps, that equity investment always entails
some risk.

Conviviality sold its wholesale business to C&C (CCR) and its retail business to grocery
retailer Bestway Direct Limited in April after the drinks company called in administrators.
This followed a profit warning from the drinks company, the discovery of a £30m payment
due to HMRC, and its subsequent failure to raise sufficient rescue funds to keep going.

Cake purveyor Patisserie Holdings (CAKE) hit the headlines in October, and thereafter,
following an initial announcement that the board had been notified of “significant, and
potentially fraudulent, accounting irregularities and therefore a potential material mis-
statement of the Company’s accounts”. The company’s shares on Aim remain suspended.

Long-term view

It seems wise to anticipate more general market turbulence in the new year, but that shouldn’t
prevent long-term investors from taking a punt on Aim. Judicious calls on smaller companies
could ultimately prove to be bargain buys – although large hypothetical rewards do often sit
beneath a ‘hazard’ sign.
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