Q3 2020

8 EU BUSINESS NEWS / Q3 2020 , European rates for new equity capital being raised have fallen by nearly 50%, from 380 annually between 1997 and 2007 to 220 annually between 2008 and 2018. In addition to this, the average number of US IPOs has also halved from 300 IPOs annually 20 years ago to 150. As Edison Group reports. Capital Chasm Set to Spell Economic Disaster Feb20021 Small- and mid-cap stocks (SMIDs) are currently more vulnerable to the COVID shock than markets have already priced in. A capital chasm is set to emerge as the unprecedented conditions have left many businesses in need of re-capitalisation that institutions and other pools of capital have insufficient resources to deliver. This means the Bank of England, other central banks and governments should focus significantly more of their ‘firepower’ on the sector to head- off economic calamity. These are the main findings of Edison Group´s latest report “Racing Covid´s Capital Chasm”. There are two key factors behind the lack of capital supply. First is the 31.5% year-on-year decline in private equity sector activity in Q2 2020, which has significantly reduced the funding available from PE houses. Edison’s analysis suggests that this lull in activity is likely to persist, given the amount of leverage in the private equity industry. Second, the report points to the historic decline in the amount of new equity capital being raised in public markets over the last decade. In Europe, the rates of raising fresh capital have fallen by nearly 50%, from 380 annually between 1997 and 2007 to 220 per year between 2008 and 2018. In the US, the average number of IPOs annually has exactly halved from 300 IPOs 20 years ago to 150 IPOs today. As any further shocks are likely to drive investors towards large-cap stocks and be more severely felt since emergency fiscal measures have already been used, the report stresses that many SMIDs, which deliver up to 33% of revenues and employment, may be unable to recapitalise. This would likely spell economic disaster. Public markets may help avoid this scenario Edison suggests that if the capital chasm does not emerge it will likely be due to government intervention, or a continued upward trend in the use of public equity markets to raise funds. The report indicates that COVID-19 appears to have increased investor appetite for public equities, as £55bn was raised in Europe through IPOs and follow-ons in H120. London accounted for £23.7bn, or 43%, of this total - 15% more than the total raised across the whole of 2019. According to the report, since 1 March, £17.4bn was raised in 249 follow-ons in the London market as companies raced to recapitalise. The report also underlines the sizeable $136bn raised by US public equity markets in H120, which is a $109bn increase on the same period in 2019. Smaller-cap companies need to prepare However, even in a more benign scenario, the report suggests the flow of capital may be restricted to a smaller cohort than usual. Investors are expected to be more exacting when picking smaller cap stocks relative to larger ones. As a result, companies need to prepare to compete for funding and should make themselves as attractive as possible. Edison stresses that strong balance sheets will be fundamental to this. It advises smaller-cap companies to emphasise, where possible, that funds will be used to consolidate and improve pricing power in their markets and that, by being larger and more powerful, their stock liquidity will improve as well. Accessing US investors – Edison Atlantic The report also recommends that companies speak to as wide an investor audience as possible and look further along the long tail in the distribution of capital, especially in the US where investor appetite for foreign stocks is vastly underestimated. While the total US equity market has doubled since 2008, holdings of foreign equities have nearly trebled over the same period. Between 2009 and 2018, net purchases of foreign securities amounted to almost $750bn. Governments need to act The report then makes a number of policy recommendations. One is that governments should further extend QE to buying equities, a measure already being openly discussed in the US, and an approach the Bank of Japan has pioneered. A second is that the Bank of England’s ‘firepower’ - and that of the Federal Reserve and other central banks - be more specifically focused on small- and mid-cap stocks. Edison also supports the Government creating a patient capital fund of significantly more than the £30bn that has been previously suggested - larger starting sums are likely to reduce the fund’s total capital requirements over time by demonstrating complete commitment. This in turn will reduce the risk of under-supply from elsewhere in the capital ecosystem. Other benefits include the possibility of the fund returning