Henderson’s Hermon dismisses ‘poor quality’ UK flotations

Henderson Smaller Companies fund manager Neil Hermon unimpressed by recent crop of companies listing in the UK, following roof tiler Marley's cancellation of its flotation.

This year may be a bumper year for initial public offerings (IPO) but Henderson UK small cap manager Neil Hermon has criticised the quality of the companies floating on the stock market, saying many are overvalued.

After a quiet 2020 when the new issues market stalled in the coronavirus pandemic, UK investors were spoilt for choice in the first half of 2021 as 45 companies came to market, more than the total number of new last year. Out of this bumper crop, Hermon cherry-picked five for his £895m Henderson Smaller Companies (HSL ) investment trust.

He added Alphawave (AWE), which licences out its high-speed data transmission technology, Auction Technology Group (ATG), private asset growth investor Bridgepoint (BPT), infrastructure and private equity investment manager Foresight Group (FSG), and online card and gift platform Moonpig (MOON).

Hermon said he was ‘reasonably open to the IPO market’ and has invested in successful flotations in the past, highlighting Watches of Switzerland (WOSG) and game developer Team17 (TM17) as ones that have ‘performed exceptionally well’.

However, he said ‘the current crop [of IPOs] doesn’t really excite us’.

‘The quality of the IPO is relatively poor and the expectations of the valuations does not reflect what we think they are worth,’ he said.

The fund manager’s comments come in a week in which e-commerce group THG (THG) has slumped after failing to convince investors about the prospects for its website services division Ingenuity. The company has shed more than £1bn in market value since floating at over £4bn a year ago.

Hermon flagged this week’s decision by roof tile manufacturer Marley to scrap its £500m due to market volatility.

‘There is a decent management team and it’s a good story, there are good margins, and it stacked up well. The only thing that didn’t was the valuation,’ said Hermon.

‘Private equity vendors were looking for a valuation we didn’t think was justified against other quoted players. It was priced too highly. It’s a reminder that [companies] have to price IPOs correctly.’

Hermon said IPOs continue to be a ‘rich source of investment opportunities’ but he has to be ‘disciplined and discerning’ when picking companies.

‘Looking forward at the pipeline, we will be less active in the next few months than we have been in the past few months because there is not the quality in the current crop as there was in the previous, you find the better quality comes first,’ he said.

The ‘flipside’ of the strong IPO market is the high level of takeover activity being seen in the mid-cap and small-cap section of the UK market, and Hermon (pictured) has seen six bids for companies he owned.

Video game developer Codemasters (CDM) was bought by gaming giant Electronic Arts (EA) for $1.2bn; infrastructure group John Laing (JLG) was taken over by private equity group KKR; Apex Group snapped up fund administrator Sanne (SNN) for £1.5bn; housebuilder St Modwen was bought by US private equity firm Blackstone for £1.3bn; defence firm Ultra Electronics (ULE) also succumbed to a £2.6bn private equity bid from Cobham; and inhaler maker Vectura (VEC) became the target of an unlikely bidder in tobacco giant Philip Morris, which paid £1bn for the group.

The takeovers have all helped Hermon to outperform over the past year, with the net asset value (NAV) soaring 47.1% and the share price enjoying a 50% rise, with the trust underperforming in just two of its 18 previous financial years.

Since Hermon took over the running of the fund in 2002 it has delivered a 1,798% total return to the end of December 2020, versus an 837% return from the Numis Smaller Companies index.

Despite the strong performance, the shares trade 10% below their net asset value, compared to their average discount of 6% in the past year. UK small-cap trusts have seen their discounts widen recently as investors worry about inflation and the slowdown in the economic rebound from Covid-19.

Hermon said the number of ‘high-profile bids in the UK market’ reflects the cheapness of the market companies to international markets.

He said there is a ‘preponderance’ of overseas buyers, mostly from the US, and ‘a lot of private equity money looking at UK assets’.

‘Nothing has changed in the market to stop that. As we get to the end of the year we will see a heightened pick up in M&A, reflecting the fact that the UK is cheap,’ he said.

‘That is good for the small-caps and mid-caps because we are the companies that get those transactions, and typically at a premium to the share price.’

Hermon said he was ‘not really’ concerned about the market being hollowed out by overseas buyers because ‘the other side of it is the IPO market and for every takeover, we are getting two or three companies coming to market’.


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