SMALL CAP IDEAS: FinnCap and Cenkos merger

If there was ever an indication of the dire state of funding for UK small caps, it was the recent news that two of London’s stalwart small-cap brokerages, finnCap and Cenkos, have agreed to join forces through a £42million all-share merger.

Consolidation among small-cap corporate brokers, whose primary mandate is raising cash for the lower echelons of the junior market, is hardly a surprise, and there could definitely be more to come as struggling firms compete for fewer available commissions.

London Stock Exchange data shows the number of constituents listed on the junior AIM market, which was established in the mid-90s to help young businesses achieve their growth targets, has fallen around 5 per cent in the past two years.

AIM peaked at 1,700 constituents in 2007 – that’s more than double what there are today

The numbers get worse the further you dig. AIM peaked at 1,700 constituents in 2007; that’s more than double what there are today.

Cenkos raised only £524million in 2022 compared to over £1.2billion in 2021 as a consequence of this dearth of mandates.

Meanwhile, finnCap’s latest interim report disclosed just £240million in funds raised compared to £500million the year before.

Clearly, the relatively small number involved in the merger belies the fact that these brokerages are integral cogs in the small-cap funding machine.

So their combination, seemingly made out of necessity rather than desire, should be met with a degree of apprehension.

Throw in the steepest run of interest rate hikes since the late 80s and turmoil in the banking sector with Silicon Valley Bank’s collapse and Credit Suisse’s takeover by UBS, and you get a sense that the prolonged small-cap funding drought for British PLCs might be around for another season or two.

In an era when high rates are squeezing bottom lines, traditional lenders are simply less willing to take their chances on default risk unless your fundamentals are rock solid.

The cost of listing on AIM, plus the bureaucracy that goes with what was supposed to be a lightly regulated market, surely hasn’t helped either.

How long do the experts expect this tough funding environment to last?

‘We’re probably sort of at the edge of the woods at the moment,’ said Julie Palmer, regional managing partner at Begbies Traynor Group. ‘Things are beginning to look better on the horizon as we go through 2023 and certainly into 2024.’

Joachim Klement, equity researcher at Liberum, said: ‘We think financing conditions are unlikely to change soon, as we expect the Bank of England, Fed and European Central Bank to not cut interest rates this year and the recession to last until the end of 2023.’

Sector-wise, Klement reckons the retail sector has borne the brunt of the funding drought, reflecting the compounding issues of the cost-of-living crisis.

‘We have seen quite a few companies go into administration, so banks are very reluctant to lend in this sector for fears their borrower may be the next one to fall,’ said Klement.

In The Style, a once-promising women’s fashion online retailer, embodies this trend; the AIM-quoted group was valued at £105million in 2021, but is now being offloaded to private equity group Baaj Capital for just £1.2million.

Firms are finding success with discounted share offers, like gold producer Caledonian Mining

Firms are finding success with discounted share offers, like gold producer Caledonian Mining 

High-street fashion group Superdry had its own take-private rumours swirling about at the tail end of last year until chief executive and controlling shareholder Julian Dunkerton nixed the rumours last month.

Conversely, Superdry managed to seal an £80million loan facility with specialist lender Bantry Bay Capital, albeit at a 7.5 per cent premium to the bank rate – it goes to show that funding is out there if you’re happy to pay the price.

For firms deciding to test the market, they’re finding success with discounted share offers.

Caledonia Mining, for instance, announced last week plans to raise around £8million through a share placing on AIM at a 3 per cent weighted discount to the trailing 30-day trading period.

Caledonia has the advantage of being a gold-producing group that actually increased its resource base in recent months, making an investment in it less speculative than an exploration-stage entity.

Existing shareholders may baulk at a discounted fundraise, but raising funds in this environment requires pragmatism and a bit of sacrifice.

Palmer recommends maintaining an open dialogue among stakeholders. ‘The key word is patience right now,’ said Palmer. ‘Look forward, manage your position and keep open communication.’

Companies that leave their small-cap funding needs till they’re in an urgent position are putting themselves at a disservice, ‘because you’re just not going to get an urgent solution right now’, warned Palmer.

And finally, for the retail investors doing their due diligence, the obvious thing to look out for is a strong cash-generating business with a sufficient runway to make it through the storm.

It sounds boring, but right now, patience is a virtue.

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