Delisting trends and their Impact on the JSE.

Written by Vikash Shiba, Investment Analyst at RISE

Following the discovery of gold in 1886, the Johannesburg Stock Exchange (JSE) was founded to facilitate the access of investment capital by newly formed financial and mining companies.[i] The success and longevity of the JSE can be attributed to its diverse and inclusive offerings that have, historically, been able to meet the changing demands of the market – making it a (if not the most) suitable platform to raise capital in South Africa.[ii] As a result, based on market capitalization of listed companies, the JSE is currently the largest stock exchange in Africa[iii] and is ranked as the eighteenth largest in the world.[iv]

However, despite the JSE being able to maintain a sizeable market cap, serious concerns are being raised regarding the number of listed companies which have delisted in recent years, causing the JSE to effectively ‘shrink’. Delisting describes the removal of listed securities from a stock exchange, either through voluntary or involuntary means.[v]

This article will briefly examine the market statistics of the JSE and proceed to unpack some reasons behind the recent trend(s) witnessed in relation to delisting. This will demonstrate the changes in the market and determine the subsequent effect on public equity structures in South Africa.

Market Statistics of the JSE

Table 1 below shows that between 2012 and April 2022, the number of JSE listings has declined by 28%, from 402 to 315;[vi] this is less than half of the 850 companies that were listed on the local stock exchange during the 1990s.[vii] The steady downward trend in JSE Market Statistics’ data (from 2012 to 2022) was interrupted by an unexpected growth spurt between 2014 and 2015. According to Financial Mail journalist, Stephen Cranston, this was however due to new foreign company listings in those years.

Although this is problematic for the JSE, and therefore, the South African market, this phenomenon (where delistings outnumber new listings) can be seen quite vividly in larger international stock exchanges as well. Cranston emphasises that the JSE's 28% decline in company value actually compares favourably against Luxembourg's 52% and Frankfurt's 35%. The world’s largest exchange, the New York Stock Exchange, and the London Stock Exchange have also struggled (albeit not as much), losing 15% and 19% of their value, respectively.

As stated above, despite market volatility, the trend in the market capitalization of companies listed on the JSE has risen notwithstanding the JSE now listing fewer businesses. The companies listed on the exchange now tend to be older and larger corporations that continue to build their market capitalization while smaller and new firms prefer alternate means of acquiring capital.[viii]

‘The JSE’s latest financial results revealed 24 companies delisted from the JSE in 2021 [with only 9 concurrent new listings].[ix] It follows 20 delistings in 2020 and 24 delistings in 2019.’[x] Further, from January 2021 to date, 35 companies have delisted from the JSE; 11 of which delisted this year, alone.[xi] This means that in the last sixteen months, the JSE has lost at least 8% of its listings. In addition, and quite disconcertingly, data provided by JSE Market Statistics illustrates that by 2021, the JSE had experienced net delistings for the sixth year in a row.[xii]

Table 1: Total number of companies listed on the JSE from 2012 to April 2022

Source: JSE Market Statistics

Table 2: New listings and delistings between 2012 and April 2022

Source: JSE Market Statistics?

Table 2 above shows that, from 2012 to April 2022, delistings outnumbered new listings in most years, with the lowest net listings taking place in 2019. Nikani & Holland have found that the companies most affected by the delisting trends (which will be discussed below) have a small to medium market capitalization, which is estimated to be less than R10 billion[i] as the market structure and equity markets in South Africa change, and preference is given to the top 200 companies[ii] listed on the exchange.[iii] As it was stated above, the companies listed on the JSE tend to be larger companies, and these ‘large caps’ are seen to be dual-listing in order to access cheaper financing globally. The effect of this is that it reduces the free float on the JSE and impacts the ability of small and medium caps to operate effectively within this market structure.

Having seen the data on listings and delistings over the past decade, the focus now shifts to the market trends which have resulted in the ‘shrinking’ of the JSE, as it were. The following discussion traverses Nikani & Holland’s most emphasised ‘potential causes for delisting’. Insufficient financial visibility (and research coverage), exorbitant transaction costs, and changing macroeconomic factors will be considered below in an attempt to illustrate the impact they each currently have on the public equity market in South Africa.

1.????Insufficient financial visibility and/or research coverage

Nikani & Holland define financial visibility as ‘the cost of capital and lower valuation of a company arising from a lack of interest by investors, particularly by financial institutions, reflected in a lack of market liquidity in the company’s shares’.[iv] Marius Strydom, the CEO of?ALG, the SA partner to?Edison, writes that ‘[g]ood research coverage can improve liquidity through increased awareness, increased information flow, …’.[v] And, in a subsequent interview, he brings awareness to the fact that,

‘… coverage is certainly an issue, especially for the small and mid-cap stocks. They are not seeing the benefits of being listed if they are not being talked about. They don’t have sufficient consensus numbers and don’t appear on the radar screens of investors out there.’[vi] (emphasis added)

The lack of coverage and financial visibility has resulted in almost no information on small cap companies. This unfortunately translates into a lack of investor interest and a wanting for market liquidity in the companies’ shares.

Similarly, with the rise in passive funds, the lack of research coverage presents a challenge for investors that have to conduct their own research and analyses to determine the value of the respective fund. The concern is that they may not find that conducting this research (themselves) is an appropriate use of their time, effort, and resources.[vii] Unlike larger companies, and those with a proven track record, small businesses may lack the awareness and visibility required to attract public investors. As a result, a company's capacity to seek a public life is adversely affected. What this means is that smaller businesses have become ever more reliant on active investing and private equity.

Unsurprisingly, this does not apply to large cap companies, as their value is more evident – even in the absence of readily available and comprehensive research. According to Strydom, there has been (and presumably will be) an increase in external, sponsored research paid for by interested global and institutional investors.[viii] Institutional investors contribute for 80% to 90% of monthly trading on the JSE, making them significant participants in the South African capital markets.[ix]

The JSE's ‘investable companies’ are the focus of these fund managers. However, ‘investable companies’ typically only encompass the top 200 listed companies on the JSE and exclude companies that have a small to medium market capitalisation. This is because the most effective?investors on the JSE are constrained by their investment strategies, mandates, and practical realities such as available liquidity;[x] the lack of financial visibility, a proven track record, and/or any competitive advantage count against consideration of – and investment in – smaller firms.

2.????Transaction costs: Why are small and medium cap companies choosing to go private?

In addition to the reasons mentioned throughout this article, the cost of going public is also a prominent concern (if not the most important concern) for small and medium cap companies; it is cumulatively exorbitant. Small and medium cap companies must account for auditing charges, listing fees, and the cost of compliance requirements for public and listed firms[xi] among others. Similarly, the current regulatory burden also acts as a deterrent to listing (and a cause of delistings), especially for smaller players as the cost of compliance and regulation run high. This process of ‘going public’ therefore has a significant impact on the company itself, as well as on its potential to sustain itself once it crosses that threshold.

Moreover, the majority of listing expenses do not take the size of the company into account, meaning that smaller businesses bear disproportionately enormous costs, which they are often unable to carry or recoup. Thus, small and medium cap companies prefer private equity and investments as they are less onerous and are easier to attain in our transforming market economy.

The private equity sector in South Africa is still in early development, but arguably provides the greatest opportunities for the development of small and medium cap companies. Primary contributions of large-scale funding, in the absence of public equity and investment, come from the private equity market.[xii]

Overall, it is thus perceived to be more beneficial for smaller firms to choose to ‘go private’ rather than public as it allows them to cut through a significant amount of red tape and avoid the crippling transaction costs involved.

3.????Macroeconomic factors affecting potential and current investors

Factors such as tax benefits for private equity companies and economic growth, which affect the number of delistings, are formative macroeconomic considerations. With the depressed rate of growth of the global and local economy in South Africa over the past two decades, interest rates have fallen and consequently led to two fundamental shifts. First, the prominent allure of debt financing, and secondly, the lack of access to the advantages of raising equity capital on the JSE; it has become more economical for small to medium cap companies to go private[xiii] (evidenced above).

The nature and extent of tax benefits has the power to impact delistings in the market. Nikani & Holland note that the view of the UK APPCGG[xiv] is that,

‘[p]rivate equity funds appear to benefit from preferential tax treatment because … [f]unds can finance their purchases through debt, and this provides them with a tax shield because, unlike dividends, interest is tax-deductible. … [therefore] the proportion of taxable profit is less … .’[xv] (emphasis added)

But, the extent to which private equity firms are able to benefit from these deductibles will vary based on other economic and macroeconomic factors, including a country’s economic growth.[xvi]

Despite the decline in economic growth, a RMB Corporate Finance trio find

‘[m]any great SA businesses were and still are trading at attractive valuations — not just when compared to developed markets but also to their history and emerging market peers, hence the sharp rise in foreign direct investment (FDI) in SA across various sectors’.[xvii]

This trend can arguably be attributed to merger and acquisition (M&A) activity. CEO of Translink Corporate Finance in South Africa, John Blake writes that across Europe and the US M&A activity is at an all-time high, and he expects the same to be seen locally in due course.

Considering the unique value proposition that certain South African companies offer, about 40% of invested funds come from foreign investors;[xviii] the years 2020 and 2021 saw a substantial number of popular South African companies being acquired by foreign investors (Heineken offered to acquired Distell; Ardagh agreed to acquire Consol; PepsiCo acquired Pioneer Foods).[xix] This is extremely beneficial to the country's economic recovery prospects as the valuations of South African companies become more attractive and investor confidence heightens.[xx]

Blake acknowledges that ‘local companies are ‘typically subject to a risk premium’ premised on combatting the inherent risk which is understood to underlie dealings with South Africa and South African listed companies. South Africa’s overarching poor economic (and other) development, and prohibitive borrowing costs[xxi] which are typically (and more specifically) associated with our public equity capital markets. The risk premium discounts their value and makes them less expensive than sufficiently similar companies internationally. This means profitable and globally competitive local businesses are regrettably being undervalued and sold at a bargain to compensate for the risk involved in their acquisition;[xxii] South African listed companies are effectively becoming attractive as ‘takeout targets’ to both foreign companies and management.

Conclusion

Small to medium cap companies which are less profitable and provide lower returns on the exchange have fewer opportunities to raise capital using the current public equity market structure; private equity markets have outperformed public markets in relation to these companies – globally.[xxiii] ?Consequently, these companies have lower financial visibility and research coverage disincentivising institutional investors and adversely affecting their market liquidity and ‘free float’. Ultimately, these interrelated factors prompt decisions to delist and go private, preventing South African investors from building diverse public portfolios.

However, there is light at the end of the tunnel. Analysts predict that there will be a reverse trend and a decrease in the number of delistings. First, because low coverage, sponsored research, and international interest together create a promising (and strong) foundation for stock pickers to actively work to find hidden gems – albeit within this category of listed companies who would otherwise be likely to delist. Further, with the recently approved amendments to the JSE listing requirements (in respect of the ‘cutting the red tape’ project),[xxiv] onerous requirements and factors are reconstructed, and thus, mitigated. RISE recognises this opportunity in the Small and Mid-Cap space and has set up a RISE Mid/Small Cap fund to take advantage of it.

Notwithstanding the blatant downward trend, with amendments to the public equity market structure and organisation, public equity capital in the JSE may once again RISE up and take prominence as the leading platform to raise capital in South Africa.

Disclaimer:

This article is intended as a general guide and should not be construed as legal or other professional advice. No responsibility can be taken for any mistakes or omissions, as well as any loss or damage resulting from the use of this material. For precise and thorough legal advice, always consult your legal advisor. Errors and omissions are not included (E&OE)?

[i] Nikani, A. & Holland, M. (2021) at p 7.

[ii] Nikani, A. & Holland, M. (2021) at p 42.

[iii] BusinessLIVE. (2021).?Behind the great JSE exodus. [online] Available at: https://www.businesslive.co.za/fm/money-and-investing/2021-11-04-behind-the-great-jse-exodus/ [Accessed 3 May 2022].

[iv] Nikani, A. & Holland, M. (2021) at p 6.

[v] Strydom, M. (2021).?OPINION | SA listed companies face alarming decline in research coverage. [online] Fin24. Available at: https://www.news24.com/fin24/opinion/opinion-sa-listed-companies-face-alarming-decline-in-research-coverage-20210814 [Accessed 3 May 2022].

[vi] BizNews, E. (2022).?The key drivers behind the JSE delisting trend – Marius Strydom. [online] BizNews.com. Available at: https://www.biznews.com/news/2022/01/14/jse-marius-strydom [Accessed 3 May 2022].

[vii] BizNews, E. (2022).?The key drivers behind the JSE delisting trend – Marius Strydom.

[viii] Strydom, M. (2021).?OPINION | SA listed companies face alarming decline in research coverage.

[ix] ?Nikani, A. & Holland, M. (2021) at pp 37, 41, and 45.

[x] ?Nikani, A. & Holland, M. (2021) at pp 23, 32, and 45-6.

[xi] Nikani, A. & Holland, M. (2021).

[xii] White & Case LLP (2021).?Private equity in Africa: Trends and opportunities in 2021 | White & Case LLP. [online] Available at: https://www.whitecase.com/publications/insight/africa-focus-spring-2021/private-equity-africa-trends-and-opportunities-2021.

[xiii] Nikani, A. & Holland, M. (2021) at pp 26-7.

[xiv] All Party Parliamentary Corporate Governance Group.

[xv] All Party Parliamentary Corporate Governance Group (APPCGG) (2020). Factors influencing the decline in the number of public companies in the UK, London, as cited in Nikani, A. & Holland, M. (2021) at p 26

[xvi] Nikani, A. & Holland, M. (2021) at pp 26.

[xvii] Nagar, K., Thobejane, M., & Parbhoo, D. (2022).?Deal-making activity will remain strong in 2022. [online] Available at: https://www.businesslive.co.za/bd/opinion/2022-02-07-deal-making-activity-will-remain-strong-in-2022/ [Accessed 3 May 2022].

[xviii] Nikani, A. & Holland, M. (2021) at p 37.

[xix] Blake, J. (2021).?OPINION | Why SA may be the next hot spot for takeover deals. [online] Fin24. Available at: https://www.news24.com/fin24/opinion/opinion-why-sa-may-be-the-next-hot-spot-for-takeover-deals-20211127 [Accessed 4 May 2022].

[xx] Nagar, K., Thobejane, M., & Parbhoo, D. (2022).?Deal-making activity will remain strong in 2022.

[xxi] Blake, J. (2021).?OPINION | Why SA may be the next hot spot for takeover deals.

[xxii] Blake, J. (2021).?OPINION | Why SA may be the next hot spot for takeover deals.

[xxiii] Nikani, A. & Holland, M. (2021) at p 38.

[xxiv] www.jse.co.za. (2022).?JSE amends listings requirements to cut red tape and create an enabling environment | Johannesburg Stock Exchange. [online] Available at: https://www.jse.co.za/news/news/jse-amends-listings-requirements-cut-red-tape-and-create-enabling-environment [Accessed 6 May 2022].