The interest of small listed companies
Volatility on the financial markets has rebounded strongly since the beginning of the year against the backdrop of the health and economic crisis. As of end May, the European large and small caps1 were down around 13-14%, with nevertheless a significant improvement in the small caps’ relative performance over recent weeks. More than ever, “cash is king” and investors are paying close attention to the financial solidity of the small caps, whose executives are issuing relatively encouraging statements, with certain even thinking that their companies will come out of this unprecedented crisis even stronger.
The transparency imposed on listed companies effectively often leads to better financial management. As such, even if debt leverage (net debt compared to EBITDA) is estimated at 2.8x for the small caps versus 2x for the large caps, this ratio remains significantly lower than that seen at unlisted companies, notably those controlled by private equity players, with the low interest rates having served as incentives for highly leveraged transactions (often above 4x). It is also not unusual to see listed companies that prefer avoiding the use of debt, thereby maintaining positive cash positions (Barco, Belimo, Diasorin, GTT, Logitech, Moncler, Solutions 30).
Listed companies that are encountering balance sheet difficulties due to current conditions have the option of turning to the market, notably through capital increases, on the condition that investors recognise their capacity to create enterprise value over the medium / long term. This has notably been seen in the UK with groups such as Abcam, Keywords and Auto Trader.
In France, Eurofins, a highly sought out company based on its expertise in testing and diagnostics, has also turned to the market through a capital increase in order to accelerate its debt reduction and finance innovation such as Covid-19 tests, thereby illustrating the role of of the markets, i.e. financing company growth.
In contrast, private companies often must deal exclusively with their creditors in order to attempt to
renegotiate their borrowing conditions, with the temporary (or even longer in case of a slow recovery) loss of EBITDA leading to the exceeding of debt ratios and the triggering of default procedures.
As such, the managements of numerous listed small caps are positive regarding their outlooks for market share gains in the future, both at the expense of less solid competitors and through the possibility of acquisitions at multiples that are becoming more attractive. Additionally, on top of the current economic difficulties, companies are faced with the structural constraints posed by a recovery in line with environmental objectives that only those players able to invest will be able to meet. Once again, access to the financial markets is a key challenge and being the only listed company in its sector constitutes a unique advantage that can create value over the long term.
By the Small & Midcap team, June 2020
Image source : Pixabay
1We use as benchmarks Stoxx Europe 600 and Stoxx Europe Small 200 indices. Source Factset