International ownership of UK stocks rose to 56% in 2020 from 36% in 2004, according to the latest data from the Office for National Statistics. The shift reflects regulation that strongly incentivized UK pension funds to dump equities.
Shouldn’t the new international holders be equally supportive owners as those they replaced? You’d think so. Yet the shift in ownership has coincided with UK companies becoming less ambitious. London capital raisings were annually worth 2% of the FTSE 100 market capitalization on average from 1990 to 2005, but only 0.9% from 2006 to 2022, according to research by Ondra Partners. And from 1987 to 2004, the value of foreign takeovers by UK companies exceeded inbound M&A, while for most of 2005 to 2022, the inverse was the case, according to the investment banking boutique.
It gets worse. UK companies appear to be paying out too much cash to shareholders, hampering investment in their ability to generate future returns. Ondra suggests one way of capturing this is to calculate the value of FTSE 100 constituents’ cash payouts over the next 10 years and deduct that from the index’s total market capitalization. The residual value should represent the index’s “terminal value,” the estimated worth of its constituents’ longer-term cash flows. Taking this approach, Ondra found that the terminal value of the UK blue-chip index today has fallen sharply since 2006.
Even if you quibble with the crudeness of the math, you can’t ignore the findings when applying the methodology consistently across different markets. The terminal values of the US S&P 500, Germany’s DAX and France’s CAC 40 have all risen over the same period. This implies investors have low expectations for the ability of UK companies to generate long-term value.
The central question is whether corporations’ reluctance to raise money and invest is merely correlated with or is actually caused by withering domestic ownership. There are good reasons to suppose the latter.
Back in the 1990s and early 2000s, UK investment institutions held meaningful stakes in most London stocks. If a chief executive needed funds — say, for a takeover — bankers would make these leading shareholders insiders and run through the pitch. Assuming the idea flew, the local owners would agree to inject cash by buying new shares in proportion to their stakes. They would often also commit to buy spare stock that wasn’t taken up by other shareholders. A handful of key fund managers could make quick decisions.
By the time the fundraising was made public, the cash was in the bag. There were things the old City of London did badly. Getting the natural owners of UK companies to underwrite equity offerings isn’t on the list.
Fast forward to today and passive and international funds dominate UK share registers. Active domestic investors aren’t big enough to offer core support. Everyone is more wary of being made an insider.
How does capital get raised? Clumsily. The need for cash leaks or is announced with a soft underwriting commitment from investment banks. The company’s share price tumbles in anticipation of the glut of new shares coming to market. The eventual stock sale gets priced at a further discount to the depressed share price. Investment banks co-opt hedge funds to sub-underwrite the offering. This crowd in turn may hedge its commitment to be buyer of last resort by short-selling the entire sector. The company at the center of the maelstrom pays a fee for this painful experience.
Small wonder very few UK companies dare do ad hoc share sales for anything remotely ambitious or risky.
Surely, if an investment or M&A transaction is a good idea, fund managers will provide the cash whether they’re in London on Louisiana? The reality is that local investors should know a company best, with easier access to a management and a feel for the firm’s home market. So a domestic “buy” signal for a share sale can set a lead that others will follow. Without it, international investors will — understandably — be cautious.
Downing Street is facing calls to revive a UK equity culture, in particular by consolidating pension plans into vehicles with the scale and time horizon to invest in riskier but higher-returning assets than government bonds. To really understand the problem, policymakers should take a history lesson in the stage management of UK equity deals.
More From Bloomberg Opinion:
Springsteen Shows Private Equity Who’s Boss: Lionel Laurent
Iron Billionaires Are in a Green Energy Race: David Fickling
Oil Megadeals Are Back. The Premiums Are Not: Javier Blas
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.
More stories like this are available on bloomberg.com/opinion
