The exit of another tech darling signals a desperate moment for UK equity markets.
Darktrace, the only cyber security company listed on the London Stock Exchange, has accepted a £4.2 billion offer from a US private equity firm.
So what? The exit of another tech darling signals a desperate moment for UK equity markets. Companies across the FTSE increasingly see buyouts or moving their listing as go-to routes to achieving fair value.
Some of Darktrace’s reasons for leaving are particular: its three-year stint as a public company has been plagued by accounting concerns and its association with Mike Lynch, Darktrace’s co-founder who is currently facing a fraud trial in the US. But the real sore point is its valuation. Compared with US peers in the cyber sector, Darktrace trades at a significant discount.
Mind the gap. According to analysis by Goldman Sachs, over the last eight years a valuation gap of between 35 and 40 per cent has opened up between European (including UK) stocks and the US. Strip out the exceptional performance of Magnificent Seven stocks like Microsoft, and it’s still 25 per cent.
Tech firms like Darktrace are inevitably drawn to Silicon Valley’s siren call. More concerning are the noises coming from the LSE’s legacy commodity sector.
Last month Ben van Beurden, the former boss of Shell, said the company was “massively undervalued” and might benefit from switching its listing to the US. Meanwhile, BHP’s recent £31 billion bid for fellow miner Anglo American has deepened concerns that “London is no longer the home of mining”. One expert said there was a “sad and serious likelihood that both those companies won’t be in the FTSE by the end of the year”.
Estimates from AJ Bell may indicate why:
- 56 per cent – British American Tobacco’s discount to US peer Philip Morris, in terms of price-to-earnings ratio.
- 32 per cent – Shell’s discount to Exxon Mobil.
- 25 per cent – Diageo’s discount to Brown Forman.
Switching a stock listing to the US won’t magically swell a company’s valuation. AJ Bell’s analysis shows some UK firms, like Ashtead and Entain, actually trade at a premium to US counterparts in construction and gambling. Often, moving only makes sense if a company already has an American sales footprint or there’s a solid ecosystem of similar firms.
Making cents. Critics point to pay disparity as another reason for London’s dimming reputation. According to Spencer Stuart, the executive search firm, non-executive director fees differ hugely between the US and UK:
- $321,200 – average fees paid by S&P 500 companies;
- £76,800 – average fees paid by the top 150 FTSE companies.
Concerns about pay and valuations are interlinked. Most CEO rewards are equity-heavy and linked to share price targets. Weak valuations mean weaker pay, and that creates another, more personal, incentive to switch listings.
Exchange extinction? Hold your horses. Markets are, by nature, cyclical. The FTSE 100 hit a record high last week, fuelled by worries about delayed Fed rate cuts and a surge in commodity prices.
“The London market is a long established one with good analyst coverage, excellent property rights and a reasonable liquidity – all those things are still in its favour,” says Sharon Bell, Senior Equity Strategist at Goldman Sachs. Fully closing the valuation gap is near impossible given America’s growth prospects, but narrowing it is both possible and necessary. Firms can achieve this via
- Buybacks and buyouts. There’s a stigma attached to both. But buybacks communicate a faith in a company’s own share price and the extra capital and expertise brought in by private equity firms can be a useful short-term solution for companies worried about their valuation. The harder task will be to get them to IPO in the UK once they’ve been turned around.
- Pushing structural reform. Regulators and government need to be clear-eyed about the challenge facing the UK equity market. One untapped resource is retail investors: British households invest only 11 per cent of their financial assets in stocks, compared with 23 per cent in France and 36 per cent in America.
The chicken and egg problem. Companies like Darktrace feel that UK investors aren’t bullish enough about their prospects as high-growth tech stocks. Meanwhile, UK investors, especially institutional ones, are accused of being too risk-averse or too flighty.
The elephant in the room. The root of London’s big discount is uncertainty over whether companies can access capital and labour at scale. Europe seems like an obvious source.
