The impact of
delisting on the JSE
n 1998, there were 669 companies listed on the JSE. By 2004, this number had dropped to 396. This is clearly a significant change, and some commentators have rushed to admonish the JSE, saying that this is evidence of a fundamental malaise in the market. Yet in the same period the total market capitalization of the JSE has almost doubled, rising from R904bn to R1.778 trillion, so it can hardly be fair to say that the market is suffering.
Once you take a moment to look behind the bald statistics, what you will see is evidence of the healthy functioning of a normal market. A market, by its very nature, is a place of speculation, where differing views of the future will lead different investors to different opinions of the intrinsic value of a company. Because the impact of a wave of buying or selling can drive prices in the short term, you will often see trends developing, backed by many market players, which become self-fulfilling prophecies for a period. Thus if everybody in the market decides to pile into small cap stocks, the price of those stocks will rise until the herd decides it has gone too far and starts to take profits and sell out.
Markets tend to work in cycles, and we saw similar listings booms in the late 1980s and the late 1990s. These were not unique to South Africa, and for a period it seemed as though you could list any company in any market in the world and make a fortune. Of course the bubble burst, as bubbles do, ushering in a bear market where investors rushed, licking the wounds they had received from dot coms, back into the safe embrace of large, steady companies whose businesses they could at least understand.
The listings boom was driven primarily by the mindset of investors, who for a time collectively suspended disbelief and placed a far greater value on growth potential than on such stodgy ideas as track record and proven ability to deliver. Their appetite was fed by company promoters and small companies themselves, who realized the enormous paper gains they could make by cobbling together a vehicle for a listing or by listing a company that in hindsight should possibly have been allowed to grow in private for a lot longer before being subjected to the rigours of life as a public company.
Other structural factors pushed the market into what Alan Greenspan famously described as “irrational exuberance.” Retail investors, ever keen to follow a trend rather than set one, saw the remarkable performance coming through from small cap unit trusts and piled in with both feet. This left fund managers with a huge pot of money to spend with a small cap mandate, and a distinct problem. Many of the small caps in their investable universe were so illiquid that they would struggle to get a decent line, and if they tried to buy in the open market they would push prices up even higher. Yet they had to spend all their inflows, and this led to fund managers buying into stocks which, if they had been able to make a rational decision based on the company’s inherent quality alone, they would have been unlikely to touch with a bargepole.
All of this fed the frenzy, encouraging more small companies to list and driving up prices ever further until the inevitable happened, sentiment turned and the bottom fell out of the market. Now fund managers who had found it difficult to spend all their inflows were facing huge outflows as investors scrambled to protect themselves, and if they had struggled to get into these illiquid small caps, they had an even harder time getting out of them.
After the party came the hangover, and once the premium pricing had been flushed out of the market, it soon became apparent that many of these companies lacked the pedigree or the scale to justify maintaining a JSE listing. To prevent a recurrence of some of the wilder excesses of the period, the JSE has significantly tightened up the listings requirements on the main board, and introduced Alt X to provide what should be a more appropriate nursery for smaller companies than the Venture Capital and Development Capital boards. Whereas a company used to be able to list with a pre-tax profit of R1m, the requirement is now for a three year profit history and a profit before tax of R8m. This should ensure that listed companies are of a size and track record to inspire confidence, and should prevent some of the more opportunistic examples of a company cobbled together for the promoters to make a quick buck.
The JSE may have fewer listed companies, but the caliber
of the companies that remain shows that this is a much stronger board,
with much less chance of unwary investors getting burnt. There have
been some losses of quality companies, of which the major example is
De Beers, delisted in June 2001 in one of the largest public to private
transactions the world has ever seen, but this again is the sign of
a healthy market, where companies react to opportunity. There are always
going to be certain sets of circumstances in which it may make sense
for a business to operate as a private company, just as there are many
advantages in being a public company.
Overall, the JSE may have lost a large numbers of names since 1998, but those that remain are a far stronger and more solid group of companies in which to invest. The market as a whole has almost doubled in size, and the listings requirements have been tightened up significantly. With the potential now to go out and sell the benefits of a JSE listing to foreign companies for the first time, the JSE looks poised to see a wide range of quality new listings in the years to come.