IPO at AIM London or at Entry Standard in Frankfurt

Is the AIM segment of the London Stock Exchange an attractive alternative stock exchange for German small and medium sized companies which are seeking an IPO?  Is the Entry Standard at the Frankfurt Stock Exchange an equal competitor?

The initial success of Europe’s former exchange segments targeted at fast growing small and medium sized companies (e.g., Neuer Markt, EASDAQ, Nuevo Mercado, Nouveau Marché) between 1997 and 2000 confirms the strong demand both from the perspective of SMEs and public market investors – for specialised stock exchange segments which satisfy the specific needs of small and medium sized companies. Germany’s former Neuer Markt, which counted over 300 listed companies with a total market capitalisation of over €230 billion in 2000, was the most successful former alternative market segment for SMEs. However, when the global market sentiment towards technology companies reversed in the awakening of the dotcom bubble, the Neuer Markt also suffered one of the most devastating stock market crashes experienced worldwide. The reputation of Germany’s stock markets, and in particular the Neuer Markt, was damaged by the emergence of numerous cases of fraud and insider trading, as the structure of the Neuer Markt did not have sufficient regulatory controls to protect the interest of investors. This also significantly weakened investor confidence with regard to small and medium sized companies in Germany.

However, despite the disappointing development of Germany’s Neuer Markt, one must consider that small and medium sized enterprises (SMEs) are a key driver of the economy, as they are a key source of innovation and growth in many countries. SMEs are a major source for jobs in Europe and account for 99% of companies in the European Union. This is particularly true in Germany with its long tradition of “Mittelstand” companies, which account for the largest share (28%) of SMEs in the European Union. SMEs are in need of alternative sources of funding in order to grow, as the current main source of funding continues to be the risk adverse and expensive lending banks which are also becoming increasingly restrictive in terms of their lending abilities after the introduction of Basel II, the need for value increasing transactions also with loan products and the recent liquidity crises resulting from the problems in the US mortgage loan market. However, the major obstacle with regards to an IPO for many SMEs is the size of their companies, as the majority of managers regard their companies as too small to qualify for a listing on available stock exchanges in their home market. A number of shareholders of small and medium sized companies in Germany, including the venture capital community, have also confirmed that they are unsatisfied with the currently existing stock market segments available for SMEs in Germany.

Global IPO activity has picked up significantly in recent years. Quarterly IPO activity has been very strong, increasing almost quarter on quarter from 2003 to 2006. The levels experienced during the bubble period in 2000 have been approached. However, unlike in 2000, recent IPO activity has been strong across a variety of industry sectors and countries, suggesting that recent IPO markets have been driven by an overall improvement in the economic and business environment, and that the IPO markets will not be as volatile as they were during the dotcom awakening. Nevertheless, the Frankfurt Stock Exchange has had a very slow start during this recovery phase reporting only few IPOs compared with the AIM at the London Stock Exchange.

Recent trends in 2006 and 2007 observed in IPO markets point towards increased interest in growth stories and smaller sized companies, as investors have regained confidence in capital markets and are seeking higher returns for their investments. In addition, stock markets are becoming increasingly global with a number of companies listing on exchanges outside of their home market as they seek to capture certain advantages which may not be available in their home markets. A number of exchanges such as the AIM segment, which has been very successful in attracting foreign companies, are also actively marketing their listing platforms to companies and intermediaries internationally. In addition to domicile, key criteria for determining the appropriate exchange for a listing include branding, liquidity, costs and the availability of listed peers.

The regulatory analysis of the AIM segment of the London Stock Exchange and the established regulated segments of the Frankfurt Stock Exchange points to significant differences. Companies which list on AIM benefit from lower listing costs, flexible entry criteria, faster and more efficient listing procedures and significant tax advantages, which do not appear to be compensated by a significantly lower degree of regulation and transparency. In addition, the AIM segment currently benefits from its strong brand and its reputation as an established and successful international exchange for small and medium sized companies. In contrast, the regulated segments of the Frankfurt Stock Exchange did not cater for the specific needs of small and medium sized companies only until the introduction of the Entry Standard segment of the Open Market in October 2005.

The AIM market of the London Stock Exchange has experienced a huge success in recent years counting for more than half of all IPOs in Europe. The average offering size of IPOs on the regulated segments of the Frankfurt Stock Exchange has been significantly higher than on AIM, as the majority of companies which have recently listed in Germany are larger sized companies.

The analysis of the share price performance of recent IPOs on AIM and the FSE in 2005 illustrates that on average, returns have been higher for companies which listed in Germany. However, returns for AIM listed companies have been more volatile and have varied significantly, reflecting the higher risks (and possible higher returns) which are associated with investing in smaller sized companies. The liquidity of AIM listed companies also appears to be lower than for recent issues on the FSE, however, this also varies significantly by company. The strong level of liquidity on the FSE also suggests that there is enough demand and trading of public securities in Germany to cater more effectively for SMEs.

Further Analysis from the perspective of the issuer (SME), shareholder (typically venture capitalists), of the market, the regulations and the investment success have had enlightening results. The AIM segment clearly offers significant benefits to German small and mid-sized companies, relative to a main market listing on the FSE. However, the AIM segment is more appropriate for companies which have a domicile in the UK or those which do not have access to established capital markets with sufficient liquidity in their home market countries.

Germany benefits from the enormous number of SMEs in Europe and its highly liquid and strong stock exchange. The FSE does not appear to have effectively worked on the potential in SMEs in recent years compared with the FSE. In fact it could do much better. However, while a foreign company listing on AIM may also have several advantages, the limited visibility may result in a weak liquidity and possible weak performance of the shares following the IPO. Mid and small-sized companies will continue to be a key driver of growth and IPO activity in Germany and the FSE should react to this.

The FSE needs to ensure that it will actively participate in this development by offering a platform which meets all of the requirements of its small and medium sized companies. While the AIM certainly appears to be an attractive alternative to existing established segments in Germany, a similar segment on the FSE may offer considerable advantages relative to a foreign AIM segment listing. The introduction of the Entry Standard by the Frankfurt Stock Exchange in October 2005 was a major step in this direction.