Fool's Eye View

[ February 28, 2000 ]

OFEX, the Road to Ruin?

By Alan Oscroft (TMFAlan)

Liverpool -- Questions about OFEX have been asked a good few times on the Motley Fool message boards. "It's short for 'off-exchange', right?" people will ask, "so is it an exchange or isn't it?" And why do so many people seem to think it is a dark place inhabited by demons, into which we should not tread? Let's have a look at what OFEX really is....

OFEX is not formally recognised as a stock exchange and is not technically a market at all. It is a trading service that enables investors to deal in the shares of a certain number of companies that are not listed on the London Stock Exchange (or anywhere else for that matter). OFEX is run by a single company, J P Jenkins Ltd, which acts as the principal market maker for all OFEX shares (and we have already seen the important role that market makers play in the running of a stock market).

Though J P Jenkins does fulfil the role of market maker, it does not guarantee to maintain liquid levels of shares at the quoted prices in all OFEX companies. OFEX shares are effectively traded on a matched bargain basis, which means that if you hold some shares in an OFEX company and want to sell them, there generally needs to be a willing buyer available at the same time at a mutually agreeable price. Similarly, if you want to buy some shares, there has to be a seller at the price that you want to pay.

For most OFEX companies, J P Jenkins does actually undertake to provide a limited degree of liquidity and can make a market independently of the need to match buyers with sellers directly. For these companies, a firm buy and sell price can be quoted, but the size of the trades that can be guaranteed at the quoted price is likely to be a fair bit smaller than for any sizeable company listed on the London Stock Exchange.

And that doesn't apply to the least liquid shares anyway. For those, the only price that is quoted is a guide price based on previous trades, and J P Jenkins will attempt to find a matching buyer or seller as close to that price as possible. There are no guarantees, though, and it is also worth noting that for some OFEX shares, there may be times of zero liquidity. That is, there might be no shares at all being traded.

So what are the risks of trading in OFEX shares, and is it the kind of thing that Fools should be doing? The most important danger, as we have already seen, is the very low liquidity that accompanies many OFEX companies, and the ensuing difficulty that investors may encounter when they decide they want to sell their shares. If nobody wants to buy them, then that's tough; you're stuck with them.

There are regulatory risks too. OFEX is not covered by the rigorous set of regulations that govern the London Stock Exchange, but instead is guided by J P Jenkins' far less stringent "OFEX Code of Best Practice." This code, if broken, can result in companies being booted out of OFEX, but it won't help a hard done by investor to get any money back. OFEX companies, like all companies, are of course regulated by the relevant laws, and if you feel you are the victim of anything illegal in dealing with an OFEX company, the Financial Services Act of 1986 is there to help. Though what real chance you have of using the Act to your personal satisfaction can only be guessed at.

Another very large danger is the nature of the companies that use OFEX themselves. Now I'm not suggesting anything dodgy by that, I'm just thinking from a Foolish investment point of view. A lot of the companies that use OFEX are very small (market capitalisations of £1 million or so), and many have low penny share prices. Those two concerns, very dear to Foolish hearts, often conspire to make for great volatility and so add what many Fools consider to be an unjustified level of extra risk.

But can we find any examples? Yes, plenty. Let's randomly peruse the current share price quotes on the OFEX website (external link), and see. How about Aerospace Homes, with a market cap of £1.39 million and last traded on 5th November 1999? Remember Guy Fawkes night? That's a long time to go without any shares changing hands. Or African Carnegie Diamonds? With a share price of 1.5p and a market cap of £1.75 million, it probably is something to be sniffed at, for Fools anyway. Oh, and the last trade was back in September. To be fair, some companies "traded" on OFEX don't really have any freely available shares at all and you might never be able to buy them in the first place, so that risk is actually non-existent with them, but I'm sure you get the feel.

It is a very mixed bag though, and one notably non-penny share company that is traded on OFEX is Arsenal FC. With its share price of £2,400 and market capitalisation of £134 million, it's not a company that anyone other than a serious supporter is likely to have very many shares of. But if you don't fancy or can't afford an Arsenal share, you can always go for a few shares in Gillingham FC instead. In fact, at only 20.5p each, you can get quite a handful for the price of a ticket for Highbury. And someone bought some today too.

With so many disadvantages, why do companies use OFEX at all? For startup companies, OFEX can be an effective method of finding initial capital from private investors, when an independent valuation of the company's shares is a very important issue. Other companies use their OFEX price as a way of valuing their shares for use as currency in mergers and acquisitions. Even others use OFEX as a stepping stone to reach the heights of the regulated Alternative Investment Market (AIM) and eventually the main London Stock Exchange Official List. For all of these alternative reasons, OFEX has two underlying advantages over an exchange listing -- there are few messy regulations to comply with, and the whole process is relatively cheap.

But is it a place to be frequented by vast hordes of Fools? I'm sure you can work that out for yourselves.

And one final thought. You know who the latest company to announce its intention to trade on OFEX is? Yes, it's the London Stock Exchange.

Well, we're, getting close to the end of this stock market "mechanics" mini-series now, and there'll be some words on AIM before long. Any thoughts on today's offering (including errors and important omissions), or any suggestions for other areas to cover, are invited, and the Fool's Eye View message board is the place for them.

Related Links
• Fool's Eye View -- What is a Stock Exchange?
• Fool's Eye View -- Market Makers
• Fool's Eye View -- SETS
• OFEX (external link)
• The London Stock Exchange (external link)
• Fool's Eye View message board