The JSE has experienced a net decline in the listings on its main board as companies leave the bourse looking for alternative markets like private equity as sources of long term capital.
Listing activity on the Johannesburg Stock Exchange has been on the decline over the last 3 years. The largest and oldest bourse on the African continent reported in its financial results for 2021 that at least 25 companies de-listed from it during that year. In 2020 there were 20 companies that left the bourse and prior to that there were 24 de-listings. There were only 7 initial public offerings (IPOs) on the JSE in 2021 and only 4 in 2020. The net effect of these developments is that the number of companies listed on the JSE is shrinking. Its current state is a far cry from what it was like at its height in the nineties. At that time there were at least 850 companies listed on the bourse. The JSE is categorized into 2 the main board and what is known as the ALT-X which has concessionary requirements for listing is best suited for small companies seeking to raise relatively small amounts of capital but would not justify a listing on the main board.
Adapt IT and Alaris are reportedly some of the companies that have left the JSE. One of the reasons cited for their departure is that investors focus on the top companies on the JSE like those that make up the top 40. This inevitably means that smaller companies struggle to achieve high trading volumes. This development has resulted in a market where small cap stocks are relatively illiquid. An increase in passive funds or exchange traded funds (ETFs) is another source of the exodus of companies away from the market. If a company is not part of an index, then a that company will seldom haves its shares held by funds or covered extensively by analysts.
Low trading volumes not only result in poor liquidity in stocks but also a discount in their share prices which further negates any benefit of remaining listed.
The Huge Group and Telemasters, small cap JSE listed companies are reported to go days without being traded. This is a shortcoming of the JSE. It is not providing sufficient depth for companies that are not large cap or mainstream businesses as it were. A well performing market should be a source of capital for investors and a source of visibility for the companies listed on it to the investing community. This is a gap that the JSE needs to cover. Many of the companies that have de-listed have opted to raise long term capital from alternative investment markets like private equity.
Private equity is indeed a lucrative investment and funding route. Michael Dell the US technology maven and billionaire has made himself fabulously wealthy and propelled his fortune well above US$ 50 billion by taking his company Dell Technologies private.
To get some perspective and to understand the rationale for Dell taking his giant company private its necessary to examine the context in which that decision was taken. The year was 2013 and PC sales had significantly slowed down and the share price of the company had stagnated according to Forbes. In short, the company’s financing and business models were no longer creating value for the company’s shareholders and that needed to change. What followed the events of 2013 was that Michael Dell who founded the company in his school dorm together with his partner a company called Silver Lake partners arranged a US$ 25 billion leveraged buy-out of the company.
As of April 2021, Dell Technologies had an estimated value of US$ 50 billion which translates to a US$ 50 billion fortune for Michael Dell. There is some merit in going private.
Listed companies must live with the short termism of meeting market expectations for earnings which they pursue at the expense of focus on the long term. Added to this, the lack of coverage and visibility has made the incentive to de-list from stock exchanges more compelling. While private equity has strong financial benefits it also has it challenges. When private equity goes well it goes very well but when things go awry, they go awry exponentially. The best example closest to South African shores of private equity gone wrong is the case of Bain Capital’s takeover of Edgars Consolidated Stores Limited in 2007. The transaction was consummated with ZAR 25 billion in cash and left the company heavily exposed with foreign exchange denominated debt on its balance sheet.
The Bain-Edcon deal was unlike the Dell-Silver Lake transaction. There were no billions that were made with Edcon. The company in 2016 had to be rescued after Bain exited its investment in a debt for equity swap with the company’s creditors some of whom included Franklin Templeton. Even after several attempts at restructuring its capital structure the company was still in the doldrums from its foreign currency debt burden. Most recently the company under a new chief executive was in talks to hold off payments to its landlords where its stores are located. Times are hard for Edcon and they are a far cry from the time it was a listed entity. Back then the company was a darling of the market.
It used to be a momentous affair to list a company on the JSE in times past. It still is somewhat of a rite of passage or coming of age for an entrepreneur and the company. In 2017 when Dischem Pharmaceuticals Limited listed on the JSE in an IPO one of the co-founders Lynette Saltzman got emotional in the process of giving an address and sharing details of the history of the company. The JSE needs to do more for its mid to small cap companies to enhance the liquidity of their shares and to increase their coverage in the investment community. Asked her views on the growing trend of de-listings from the JSE, the CEO of the bourse Dr. Leila Fourie countered by stating that even though number of companies listed on the market declined the market cap of companies on the JSE increased by at least 15% in 2021.
In the long run it is neither sustainable nor appealing for the JSE to be the market that hosts more de-listings than it does listings. It needs addressing. As it stands the South African bourse favors large cap stocks more than it does the smaller caps. Liquidity in the market is essential because it determines the success in secondary markets of public offerings and reduces the risk and cost of underwriters and market makers. Liquidity refers to the depth, breadth, degree of resiliency and trading speed present in a market.
What can be done to improve this situation?
There are ways in which the liquidity of a security can be enhanced according to the National Association of Securities Dealers Automated Quotations (NASDAQ). Its main indicators are a shares turnover. This turnover is expressed a percentage of shares out of the total outstanding that have been traded in a period. A high turnover is commonly the result of low transaction costs and a high interest in both buying and selling a share. The second indicator of liquidity of a share/security is its spread which is the difference between the bid and the ask price. This is significant to investors because it is an indirect transaction cost.
It is the cost of buying and selling at any given time. The tighter the spread the lower the cost for investors. Order depth is the volume of shares or securities available at the bid or ask price and is a measurement of trading intent. This shows how many shares an investor can buy or sell at any given time. It reduces the risk of a negative price movement when buying or selling shares. Therefore, tight spreads and high order depth culminate in lower costs for investors, reduced risk and making a company’s shares more attractive.
The NASDAQ has pioneered a financial innovation which they have called the Liquidity Provider Program. It is the alternative to a scenario where there is an absence of a large pool of investors to create natural liquidity. Under this arrangement a trading member of the NASDAQ and in this case the JSE will take on the responsibility to ensure liquidity in a company’s share by supplementing the existing pool of investors and stepping into the role of the missing desired investor. The Liquidity Provider will provide liquidity as a buyer and seller and provide liquidity in the absence of other trading interests. Analysis by NASDAQ shows that turnover increased by 19% in the months following the introduction of a Liquidity Provider compared to the period before.
Other interventions to enhance market liquidity include increasing investor awareness which encompasses investor communication, analyst coverage, and index inclusion. Share price level which can come from share splits and reverse splits. Shareholder value is another way that liquidity in a security can be enhanced. This depends on the dividend strategy, share buy backs, and spin-offs. Member of the C-Suite at the JSE would be well advised to consider any of these to halt the exodus of companies on its board.