AIM will probably see its first corpses in the next few months, but failures will always be part of what is becoming a junior market success story.
Back in 1992, the small company sector looked pretty gruesome. The Unlisted Securities Market (USM), host to over 850 company flotations in the 1980s, appeared to have outlived its usefulness. No one wanted to invest in it and no one wanted to float on it. The Stock Exchange therefore proposed a decent burial. Warburg, UBS and Nat-West all withdrew from small company market-making and their asset management arms dumped small company investments wholesale. Small company chairmen thought they were being thrown to the wolves.
Reel forward four years to the point where 'Hasn't it done well?' was the almost universal acknowledgement of the first anniversary of AIM, the Alternative Investment Market: 185 companies, £500 million of new capital raised and a market capitalisation of nearly £4 billion all say it has. The AIM Index is ahead of all comers, and small investors are keeping at least three AIM newsletters in business. Hoping to raise £25 million for a dedicated AIM trust last autumn, fund manager Ivory & Sime pulled in £43 million.
The AIM brand is certainly being sprayed around the personal finance marketplace as if there were no tomorrow. Who wants a FTSE PEP when they can have an AIM PEP?
Well, a majority, in fact. AIM is never going to be the place for widows and orphans and it was never designed as such. Some AIM recruits have already shown themselves to be pretty flaky. Investors in last year's issue by Satellite Communications Systems are already sitting on a 75% loss (see box p55) and such a performance is far from unique. Firecrest, an advertising and promotions company, is another example: it promoted itself into a liquidity crisis even while it hyped its share price with endless announcements about its new Internet division. But AIM hasn't seen a full-blown scandal yet and nothing has gone into receivership.
And there are some meaty companies on AIM. That doesn't mean investing in them is without risk, rather that the risk arises from challenging but credible ambitions. Pet City, for one, is a chain of sheds which hopes to do for the high street pet trade what supermarkets did for independent grocers. Controlled by the founders of Dodge City (a DIY chain acquired in the early '80s by B&Q) and Majestic Wine, Pet City aims for 300 outlets by 2003, a stretching target, but believable in the light of the 50 opened to date. It is making losses, but these seem to be explained by opening costs. The company raised £20 million to fund expansion when it arrived on AIM. 'Going onto AIM was a straightforward exercise which we completed in eight weeks,' says chairman Richard Northcott. 'We could have gone for a full listing, but we couldn't see the advantages.' With its share price up 35% from the placing price last December, Pet City is now capitalised at £100 million.
The speed of Pet City's listing is fairly typical of AIM. When the rules surrounding its creation were drawn up, the Stock Exchange acknowledged that some cherished traditions would have to be dropped if a junior market were to flourish. Out went the Exchange's ability to veto a prospectus and therefore a flotation, and out went the need for a sponsor to bring to the Exchange's attention 'all relevant matters regarding suitability for admission'. For AIM wannabes, the sponsor is replaced by a nominated adviser, or Nomad as the breed is known, whose duty is merely to confirm that the company in question has met all the stated criteria. A corollary of an AIM flotation being faster and less rigorous is, of course, a significant reduction in the fees involved.
In addition to dynamic firms such as Pet City, AIM also boasts plenty of stodgy companies such as Jennings Brothers, a Lake District brewer with measured expansion plans. It transferred to AIM from the old matched bargains market which had been its home since time immemorial. 'You could say we're stodgy,' comments managing director Trevor Green, 'but we would say we add some much-appreciated gravitas to AIM. We considered a full listing, but only briefly. AIM was cheap, straightforward and met all our present needs. We do, however, plan to raise new capital at some point, and although we could do that on AIM, we will probably use the opportunity to move to a full listing.' Others in the stodge category include Guiton, which owns the Jersey Evening Post and a chain of newsagents, and NWF, an ex-farmers' co-operative, which makes animal feed and distributes petrol and groceries. All of them have respectable profit records.
So much for the companies then, what about the investors? Who's buying and who's selling? While there are no clear statistics, it is clear that AIM becomes more popular with institutional investors every day. This interest is not limited to specialist funds such as Ivory & Sime's, as corporate finance director Ken Ford at small issuing house Teather & Greenwood explains. Ford has participated in 15 AIM flotations since the market opened and put seven small companies onto the main market in the same time. 'We see £1 million of pre-tax profits as the break point between the two markets,' he says. 'At first, there was a significant difference in terms of the institutional interest you would generate, but it's much less of an issue now. I would say that currently, out of five institutions who are interested in small companies, four are looking at the AIM market.' Ford says the extra one in five should not be ignored, however, which is one reason he directs bigger clients towards a full listing. But he also points to tax advantages in sticking to AIM even where companies are in a position to achieve a full listing. 'There are useful tax breaks for AIM shareholders,' he explains, 'although sometimes you have your work cut out to extract these from the Inland Revenue.'
Professional interest in AIM is also confirmed by the swelling flow of flotations which include a placing, a step which involves brokers and institutional investors buying into the company at its flotation. While some of the brokers participating in a placing will be allocating the shares to private clients, it's a fair bet that much the greater part of the £500 million raised to date has come from institutions.
Important as professional interest is becoming, the private investor still makes a big impression on the market, especially on its racier stocks.
Julian Palfreyman, who runs the AIM book at the leading small company market-maker Winterflood, describes how overwhelming demand - and giddying price gyrations - can be unleashed by the effect on small shareholders of a favourable comment on an AIM company in one of the share-tipping columns in the press. 'A few snippets of favourable publicity, especially if they use vogue terms such as "the Internet", "search engine" or "multimedia" will result in dozens of orders for 500, 1,000, or even 2,000 shares - this is private investor buying.
To shake out stock to satisfy these buyers, the price rises in a way which has nothing to do with the intrinsic value of the company. As the buyers soon find out, once the publicity tails off.'
As to who is selling the shares, rarely is it the management of the companies in question. Where money has changed hands as part of the flotation, it has mostly been in exchange for new shares issued by the company. This is not a restriction of AIM as such: it's just a simple fact of life that if you want to raise money for a newish venture - the category which embraces most of AIM's cash-raising flotations - you won't get very far if you want to take some money out of it yourself (suggestion: instead, put yourself down for the biggest salary you can think of without laughing - it's amazing how directors' pay goes smartly upwards as soon as outsiders' money comes in). That does not stop sponsors trying to slip through an occasional nugget of director selling, however. Alongside £3 million to be raised for the company, the prospectus of Israeli drinks dispenser manufacturer Selector, for instance, said its directors would be cashing in £400,000 of shares - or two-thirds of Selector's total pre-tax profits over the previous three years. Answering an enquiry about how this aspect of the issue was received, a spokesman says, 'We decided, at a late stage, not to go forward with the director sales'. While Pet City's directors could arguably have sold some of their shares, had they been so minded, the move would surely have had a deleterious effect on the pricing of their issue. As a general rule, directors lightening their own stakes when arriving on AIM need to be armed with both a halfway decent profits record and a damned good reason.
These restrictions don't necessarily apply to non-director shareholders, however. In the July 1996 £15 million flotation of Intelligent Environments, which supplies software development tools to a classy customer list, many of the first round of venture capital investors sold up to a battery of incoming heavyweight institutions. Where existing shareholders don't sell at the flotation, however, they will usually be asked to commit themselves not to sell their holdings for at least the next year. The sponsoring broker will normally wrap this undertaking around all directors (standard practice on the Official List too) and as many shareholders as it can.
This serves to curb some of the worst abuses seen in certain other junior markets across the world which have lost credibility and faded away.With care, AIM should avoid such a fate. True, the next few months will probably see the first AIM corpses but these will probably not cause more than a modest slowdown in the market's growth, not least because flotations which quickly turn into sob stories are part and parcel of any new issues market. AIM has genuinely allowed the private investor - and indeed the conventional fund manager - into the venture capital market and while that enables some to play the greater fool when offered the chance, it also creates warm feelings about the few dazzling investments opened up, which would never have got onto the Official List. And, although some of the first Nomads have arguably abused the freedoms of the new market, the rumour is that at least one will be shut down by the review the Exchange is currently carrying out.
But what happens if a bear market strikes, when liquidity in smaller company shares traditionally dries up? Or when tougher economic conditions emphasise how erratic the performance of small companies can be? The USM failed these tests. There is, however, a key difference between the USM and AIM. The USM's problems were exacerbated by an EC Directive reducing the entry requirements for the Official List, which left the junior market looking not junior enough. AIM doesn't suffer from such an identity crisis. A listing on AIM is very different beast from a listing on the full market. The key to its long-term success may lie in the very rough-and-readiness that its critics decry.
The Flakier Side of AIM: A Case History
SCS's bright future prospects turn sour in double-quick time
When the Stock Exchange set up AIM, it knocked down many of the hurdles to old-fashioned enthusiastic promotion, including a ban on unaudited financial projections. It might as well have handed out rose-tinted spectacles.
Last August Satellite Communications Systems (SCS) came to AIM, courtesy of City brokers, Williams de Broe (who also launched Pet City on AIM).
SCS proposed to offer European supermarkets the opportunity of having dedicated broadcasts of advertising and music, and had already landed its first customer, the Tengelmann store chain in Germany.
A single column in the prospectus set out SCS's three-year financial history to December 1994, revealing that it had by that stage gobbled up £1.5 million. Nothing was said about what had been spent subsequently.
The profits in prospect
SCS was more expansive about the future. Here were five detailed columns, extending out to the millennium, revealing how 1995's losses of £927,000 were projected to reverse to £7 million of profits in 1996, and rise to £18 million by 1999.
The accountants were frank about SCS's pressing need for the new money: 'The Group is dependent on the successful raising of finance ... we consider that these disclosures should be brought to your attention,' said Binder Hamlyn, part of Arthur Andersen. Most investors would consider that a company which had run out of money, however promising its prospects, was one that would find it difficult to extract good terms from new investors.
The directors and others had subscribed £1.1 million into SCS up to the date it came to the market, at prices of 20p and 30p per share. They must therefore have been pleased to find these shares had multiplied in value to 125p each by the time outside investors trooped in to put £6 million at the company's disposal. At this valuation, the founders' £1.1 million was worth £7.1 million.
No receivers, no revenue
The first note of trouble came in February, by which time, according to its prospectus, SCS was to have installed its receivers in 1,500 Tengelmann stores. This programme, it emerged, was only two-thirds complete which meant SCS had secured no advertising revenue in 1995 and that the losses would be higher than projected.
Moreover, the knock-on into 1996 would be severe too. More details were to follow in March along with the December 1995 figures, promised the board. March passed, and April. Then came, not results, but the advice that SCS was negotiating to buy its German equipment supplier. The shares were suspended at 31p.
More alarming still, later in May came the news that SCS was suing five of its employees including its founder for £750,000 in a case involving improper payments.