Investment bank Peel Hunt has published a note warning that London’s stock market could shrink further in 2024 amid takeovers by foreign buyers and because “the pace of de-equitisation is relentless.”

The broker said the de-equitisation of the London stock market “will likely continue unless action is taken and impacts quickly.”

Bloomberg has reported that new London share listings barely reached $1 billion last year — the lowest annual tally since the 2008 financial crisis.

Meanwhile $25 billion worth of takeover deals involving London-listed companies were announced in 2023.

Peel Hunt’s head of research Charles Hall said there were 40 M&A transactions of more than £100 million announced for London-listed firms in 2023, with the pace increasing through the year.

The note said there was greater activity from acquirors based outside the UK — 55% by number and 64% by value.

Hall wrote that the M&A activity was predominately among smaller companies.

“There has been minimal IPO activity for the last two years,” warned the note. “We believe this needs to be actively addressed.”

Hall wrote: “This note looks at the key trends during 2023, including sector activity, scale of premia and type of buyer.

“The key takeaway is that the pace of de-equitisation is relentless and will likely continue unless action is taken and impacts quickly.

“This is driven by the low UK valuations, which makes it an attractive hunting ground for acquirors and is a key factor behind the dearth of IPO activity …”

The note said the average takeover price premium was 50% “which reflects the depressed valuations of so many UK smaller companies.”

It noted an increase in the pace of takeovers. Three offers were announced in Q1 — while Q4 was the busiest quarter, with 18 announced offers.

About 58% of offers were from financial buyers, as well as the majority by value (71%) — but corporate buyers were particularly active in Q4 as the rate environment and economic outlook became clearer.

Hall said that currently there are willing buyers of UK listed firms, attracted by the valuations available and the probability of a successful conclusion, and willing sellers due to fund outflows and scale of premia.

“The key driver behind this has been fund flows,” wrote Hall.

“There have been 30 consecutive months of outflows from UK funds, which inevitably drives selling pressure and impacts on valuation.”

The note argued that there are many reasons for the fund outflows, including:

• The higher rate environment, resulting in changes to portfolio allocation.
• Pressure from the higher cost of living impacting ability to fund investments (eg SIPPs and ISAs) or encouraging withdrawals.
• Increase in tax on dividends and capital gains.
• Long-term withdrawal from equities by pensions and insurers.
• Internationalisation of portfolios.
• Limited interest from overseas investors.

“The negative trend is self-fuelling, as the poor performance of UK equities makes them appear less attractive to fund managers and retail investors, the reduction in liquidity reduces appetite from overseas investors, and reduced capitalisation impacts on index weightings,” wrote Hall.

“This all sounds very negative – but the reverse scenario can happen, and can happen quickly.

“It really needs a trigger to break the cycle. Increased fund flow would be the key driver …”

Hall said increased fund flow could come from:

• Increased appetite by retail investors (eg a British ISA, changes to CGT or dividend tax on UK shares).
• Allocation by pension funds and insurance companies, through government incentivisation and regulatory change to enable a greater focus on performance rather than risk.
• Increase in share buybacks, reflecting the low valuations and tax differential between capital gain and dividends.
• Appetite from overseas investors, if they perceived a material change in UK fund flows.
• Reduced cost of ownership and benefit of higher liquidity, through addressing the UK’s penal level of stamp duty vs other markets.

“This could all be achieved without a change in the economic outlook, which would be the icing on the cake, with reducing inflation driving the prospect of lower rates and an improvement in economic activity,” concluded Hall.

“If we do see increased demand for UK equities, then valuations should improve materially, which would make an IPO a more attractive option.

“However, there are some deep-rooted issues in the UK regarding IPOs and the health of equity capital markets, which have material consequences for long-term economic growth.

“The fact that more UK companies of material size listed in the US rather than the UK in 2023 shows the extent of the issue.”