David Kuo talks to Gavin Oldham from the Share Centre and David O'Hara from Blackthorn Focus.
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David:
This is MoneyTalk, the weekly investing podcast from the Motley Fool. I'm David Kuo, and today we'll be looking at elephants and fleas, and deciding whether or not elephants can gallop, and whether fleas can jump 200 times their own height. My guests today are David O'Hara from Blackthorn Focus, and Gavin Oldham, Chief Executive Officer of Share plc. David, a lot of people probably know you as a contributor here at the Motley Fool, you're on the discussion boards, but you're also involved in something called Blackthorn Focus, now can you explain to our listeners what Blackthorn Focus is, and what it actually does?
David O'H:
Blackthorn Focus is a publications and events organisation that I set up in 2009, with the aim of focusing on issues in the financial services industry. The idea is to put together forums where companies come together and have discussions, and hopefully come towards some conclusions towards change and improvements.
David:
OK, over to you Gavin – you're the Chief Executive Officer of Share plc, probably better known to a lot of people as The Share Centre.
Gavin:
Yes, the Share Centre has been running now for 19 years, and I set it up in April 1991.
David:
And it recently floated on the stock market?
Gavin:
Yes, in 2008 we became an AIM company.
David:
The thing about Share plc is that you have something in there called Sharemark, which is a trading platform – can you tell us a little bit about Sharemark itself?
Gavin:
Yes indeed, in 2000 we decided that we would give free shares to our customers, the company became profitable in 1996 and we'd always said that there'd be a chance to share in our success, and we felt the right way to carry that out was by taking a bit of the capital, and giving it to our customers, which we did then, and all of a sudden we had 90,000 shareholders, the company was making good progress, but we felt it was premature at that stage to take it onto AIM, or one of the more traditional markets, and so we felt we had the opportunity to set up a trading platform ourselves, and we did that, and we called it Sharemark.
It operates a completely different way from the main London Stock Exchange markets, or PLUS market and so on, it doesn't have market makers, people put in their orders on a limit basis, they put a price limit either to buy or to sell, and they trade directly with one another at a single price, and we traded Share plc on Sharemark, just on Sharemark, right up until 2008, so that's eight years of trading, just about, and it's really worked very well indeed for us, and some part of the way through that, about 2002/2003, we started opening up Sharemark for other companies, and quite a large number of companies use us now, and in many cases they only trade on Sharemark, but in some cases they're what we call "dual traded companies", where they're also traded in AIM or PLUS or some other market, generally a market-maker market.
So it's a very efficient market for smaller companies, it trades periodically, not all the time, and they're on set published purely at auctions, which may be once a week, it may be once a month, or in some cases it may even be once a quarter, and what it means is it can gather limit orders, and people can see those orders coming in, and the price firms around those orders, and when the auction goes through, it's a good deal which pulls together both buyers and sellers at a single price.
David:
But aren't you trying to, in some ways, re-invent the wheel? – because we already have AIM, we have something called PLUS, which was formerly OFEX, and now you have Sharemark?
Gavin:
No, the big difference is that, when you trade on AIM or PLUS or on the main list of the Stock Exchange, those are market-maker driven markets, where the market-maker is making a bid off a price which gives you immediate trading, and in a smaller company, there is a premium to be paid for trading on an immediate basis, and that premium is really because the market-maker who takes your trade will have to hold it either for longer, or in a larger size than he would really want to, but he can't trade it on straight away, and so you get these really quite big spreads building up between bid and offer price. Well in Sharemark, we work a completely different way, because we don't give instant trading, and by the investors being patient to take their orders through for trading at a single point, they can trade directly with one another, and so it's a much more efficient way of trading for smaller companies, completely different business model.
David:
But isn't part of the fun of trading in small shares that you can trade instantly? – but if you're going to ask people to submit an order, and then sit on their hands for a while, that takes some of the fun out of it?
Gavin:
Well, of course, many people do like to trade instantly, that's absolutely true, but there is a price to be paid for that, simply because the job of a market-maker will actually expect that premium for actually providing that service to them in that way, and really it's often much better to handle your business quite carefully, I mean, for example, if you say to your broker, even if they're not traded on Sharemark, you say to them, look, I know the price at the moment is 95 to 105, but I'm a buyer at 98 or 99, I don't want to pay 105, and the broker can actually phone the market-maker and say, look, I've got business to do at 98 and 99 – any chance you could actually give me that price? And actually many dealers enjoy working that order, that's what you call, working the order in that way, it's an old term, it comes back right from the old Stock Exchange, back in the 1970s and 1980s, and that's what that means, and if your limit order can be worked in that way, you might get quite a keen price.
David:
OK, now we touched on small caps, we touched on the attraction of small caps. Now David, what in your mind is a small cap?
David O'H:
Well, everyone's got a different definition really.
David:
I know there is no "one size fits all" small cap, is there?
David O'H:
I think, when people talk about small caps, and why there were difficulties in the small cap market, or why things were different in the small cap markets, then I think you have to look at a retail fund manager, so if you imagine the sorts of funds that advertise on the Motley Fool or on lots of other websites, then think of the manager running that fund, and then think to yourself, which other companies below that are too small for that fund manager to invest in, and to that fund manager, those are the too small caps, he can't invest in them in any size, can't make a good return, they won't make a very good contribution to the fund's returns to investors. But I think really, to a professional fund manager, we'd probably give them about a £250 million market cap.
Now, as we've seen over the last two years, some mid caps have ended up becoming small caps, they've not changed as companies, but the share price has, and the risk there, and then the opportunity it presents, is that some companies have become too small for institutional investors to invest in, they're there for private investors to come along and snap them up, and when the share price appreciates, it will come on more investment managers' radars, and hopefully that share price will continue to accelerate upwards.
David:
So by that definition, Gavin, your company would be a small cap company?
Gavin:
Well, I mean, a small cap company is really talking about the market capitalisation, and indeed a lot of people have different definitions for that, in fact the largest AIM company, although it would technically be called small caps, actually reaches up into the billions, but of course that's not really a small cap, I think I'd be really talking about something certainly sort of below £100 million really, to be talking about small cap.
David:
OK, so what kind of specific problems do small cap companies face then, Gavin?
Gavin:
They generally have real problems about the liquidity of their shares in the marketplace, this very wide bid offer spread, which is absolutely typical in the small cap markets, there are a huge number of companies which have spreads which are over 10%, which is really very wide indeed, and that's caused by a whole range of problems, partly it's caused by lack of research, because small companies are not adequately researched, and very often have to sponsor, actually have to pay to have somebody to come and provide the research for them. It's still pretty objective, I have to say, even though it's paid for in that way, because obviously the research companies only keep their reputation by giving objective research, but it's an indication about what small cap companies have to do in order to make sure that they are covered.
David:
So how popular are small cap companies with private investors?
Gavin:
Well, they are generally quite popular, because it's an area which is insufficiently researched, as I was saying, by institutional brokers, and so the opportunities, and a certain lack of efficiency in that market, which gives people more of a chance to do their own research and find out a little bit about them, and to take it forward from there. So the thing is that this issue about bid offer spreads actually goes a little bit deeper than purely the research, it's a problem also of when the shares are brought to the market in the first place, they're often placed with an inadequate number of shareholders, and so we don't have a spread of capital base, and we don't have a natural constituency of demand and supply for the trading to take place from. Stamp duty is another thing which has significantly impeded smaller cap shares, because now we have spread betting and CFDs going on, a lot of the active traders have said, well, all these spread betters, they advertise their services as being without stamp duty, and without having tax on them, and so what they've tended to do, to transfer their business to that type of business model, which then is based on much larger companies, and so the smaller cap companies have lost that liquidity out of the marketplace.
David:
So how are you going to overcome that problem then? – I mean, if you only have a few million shares in circulation, and you only have a market cap of a few million pounds, how are you going to get that spread of private investors, or the spread of investors in general, to give you that liquidity?
Gavin:
Well, I think there's a lot of things that companies can do to help that process, one of the things that they can do is to look at employee share ownership – it's a very good way of getting regular demand into the shares in the secondary market, I mean people who do share options and share incentive plans frequently cover those requirements from issuing new shares, but what they could do is to go into the secondary market and buy them, and that all helps create demand. Customary share ownership is another thing, a retail company, ASOS, for example, will actually have a huge amount of retail interest in its activities, and so investors tend to collect around them, and there's a lot that a company can to do encourage that process, and those are things which can happen all the way through the trading in the shares, when a company first comes to the market, I will always say, don't just take the corporate brokers' guidance of just doing a placing, because it's simple and easy to do at that stage, always say to the broker, look, I really want a good secondary market to take place – am I going to get a good secondary market by doing this issue the way that you're suggesting?
David:
So David, as a private investor yourself, how do you go about researching small companies?
David O'H:
The Motley Fool's a good place to start actually.
David:
Oh, thank you very much, yes!
David O'H:
The quality of research on some small cap companies, and I'll spare your blushes, David, it is second-to-none, there's some research on small cap companies that is not bettered anywhere on certain companies. When I look at a company like Indigo Vision, that' s been a success for a lot of posters on the Motley Fool. Back in 2004, the shares were 30 pence and Paul Scott, former Finance Director of Pilot, the national retailer, was saying how he treated it as a punt at the time, however as the company continued to be successful, he began to reconsider it as a more serious investment, and the share price accelerated, it was as high as £9, £10.
David:
So what does Indigo Vision actually do?
David O'H:
They do, it's called "IP over CCTV", that's too many acronyms there! Imagine you've got CCTV cameras, now they typically will record onto a film, onto a reel, however how would you then go and search that, and also you have all archive difficulties. If you can record to a hard disk, then you are able to do more with that information, and also if the information is relayed over IP, the same internet protocol that is used on the internet, then you can do things like, clever things like, do error checking in that data, but if you've just got a bit of wire in the warehouse up to the head office, that's actually very vulnerable. If you've seen the movie "Speed", they can cut that wire, and start filming somewhere else, or passing a signal from a different location back through the CCTV system, whereas if you have IP over CCTV, you can just do lots of clever things, companies have realised that, and Indigo Vision has been a great success story.
David:
As a man whose idea of technology is the abacus, I'm sure that sort of comes in handy for some people. Gavin – over to you, what do you think private investors find interesting, or more to the point, how are they going to actually do the research? David has already pointed out that you can do some research yourself by having a look at websites, but is there an easier way for people to do that?
Gavin:
Well, there's no doubt these days that, through the internet, you can get access to the same, much the same quality of market information about companies as an institution can, and this is what has led to such a huge development and growth in the interests of personal investors within the small cap companies, and in fact in the stock market generally, and it is really quite remarkable, over the last year, there's been a lot of activity from that point of view, and of course, if you can find the right companies, the growth is certainly there, it's often said that the growth of a company, it's of the country in the future, will come out of smaller and medium sized businesses – that's employment, that's in terms of revenue growth, building up exports, because they are the people who really can move and can really develop, and really the Government ought to be doing a lot more to encourage SMEs, I mean we have a situation where capital gains tax has been adjusted now, and of course people may like to see an 18% flat rate, it's simpler, but in fact there is now no difference between taking a very short term position, perhaps in something which is quite leveraged, in order to get your gain and then pay your 18%, or actually taking the additional risk in a smaller company, and actually really being a long-term investor within that and getting the growth over a period of time, the tax rate would be the same. Stamp duty is another significant drag on smaller companies' marketability, and therefore it tends to affect its valuations, and so as a result it's more difficult for smaller companies to raise the money through equity issues.
David:
So are you calling for an abolition of stamp duty?
Gavin:
I would certainly like to see, certainly for smaller companies, a situation where we could see stamp duty removed, and it doesn't raise an awful lot for AIM companies, for example, for the Government. It would be possible to see some limitations on the deductibility of corporate debt against corporate profits so that we could actually take the burden off stamp duty, and improve the prospects for raising money through equity.
David:
But you know that's not going to happen now, don't you?
Gavin:
I think it's very difficult, because as soon as you ....
David:
The Government needs every penny it can get its hands on.
Gavin:
Look, as soon as you produce an idea which will generate more tax, so that tax can be taken off somewhere else, the Government will say, thank you very much, I'll have the one which actually takes more tax, you can actually forget about the other one, because we're in such a desperate public sector deficit position.
David:
Well, quite right, it has a budget deficit of somewhere round about £170 billion pounds.
Gavin:
It's a very serious position, and nobody knows that, I can assure you, well more than I do.
David:
It isn't going to happen, is it? – especially when the national debt is climbing towards one trillion pounds – they are not going to do that.
Gavin:
I know there are some big challenges.
David:
I think "big" is a slight understatement! But going back to small caps in general, at the beginning of this podcast I said that elephants don't gallop, and fleas can jump 200 times their normal height. Now, the problem with fleas is they also get squashed, David, and isn't the problem there that it is a huge risk for private investors – you put a few thousand pounds in a small cap company, and it gets squashed.
David O'H:
Sure, that's a risk, but if you've been through what we've just been through, you can see that happening to some large caps too – Woolworths has gone bust, RBS was on the brink, the shareholders in HBOS didn't end up with much, Bradford & Bingley went as well. So there are risks still in large cap companies, but in the small caps, that's where the biggest returns can be, so sure, you have to then balance the risks with the returns, and the returns can be much much greater amongst small cap companies. And also, I reckon, David, that fleas have probably been around a bit longer than elephants.
David:
I don't know! – I think the woolly mammoth has been around for a while.
David O'H:
I bet the woolly mammoth had fleas on it.
David:
I'm sure it had a few fleas on it. Now, you mentioned a couple of bugbears that private investors have with regards to research, and how they can overcome that. Now, I think one of the biggest bugbears for anyone who is investing in small caps, particularly AIM-listed shares, is that they cannot put it in an ISA.
Gavin:
It's extraordinary, isn't it?
David:
So why is that? – can you explain to me why that is the case?
Gavin:
Well, I know what the Treasury's reasoning is for it, I still think it's most bizarre.
David O'H:
It's inertia.
Gavin:
Well, I don't think it is complete inertia, I mean the thing is that they say that AIM shares benefit from being business assets, and therefore having certain inheritance tax advantages, which they think present some sort of quid-pro-quo for the fact that they're not a live name, but you can put AIM shares inside a personal pension.
David:
Correct, yes.
Gavin:
And yet you can't put them into a share ISA, it's an extraordinary situation, and I have to say that it seems to be completely irrelevant, to draw some comparison with the inheritance tax position, which actually affects entrepreneurs much more than the ISA situation, which basically is open to everyone. So it certainly seems to me that AIM shares should be like that.
David:
It is a red herring, isn't it? – as far as the Inland Revenue's concerned, I mean you said, David, that it was inertia – what did you mean by that?
David O'H:
Well, I was suggesting that, why change something?
David:
You're trying to cause trouble?
David O'H:
If you want to get people to change something, it's very difficult isn't it? And it would have to be explained, someone would have to come out and justify it, and lots of paperwork would have to be produced, so we're only talking about small cap companies here, so maybe they're just hunkering down and hoping we'll go away.
Gavin:
I think actually it's going to become more and more important, because ISAs are increasingly going to be many people's first choice of retirement savings, as pensions become more and more under pressure, we know already that the front end tax relief is now under threat, I mean anyone earning higher rates of pay will realise that they don't any longer get higher rate tax relief on it, so putting that into their pension, so more people will look at ISAs in the future, and I think they need, therefore, to have this sort of investment flexibility within ISAs that they can have within pensions.
David:
OK, now my final question to the two of you is this: you've mentioned Indigo Vision, and Gavin, you've mentioned ASOS as companies that have done reasonably well in the small cap arena. Now, people are saying, don't let these two gentlemen go until they tell us what they know about small caps, and which are the sectors that they should be focusing on at the moment? A name would be good, but a sector is acceptable.
Gavin:
I think I'd prefer to focus on the sectors really. Within the retailers, you've got to be very very careful at the moment, and I think what I've said about ASOS actually illustrates the strength of the internet proposition there, those who have positions on the high street will be under considerably more pressure really over the months ahead. I think that really overseas earnings are something well worth looking for, and of course a lot of the London market does have overseas earnings, they also have some strong exporters within the small caps. So those are the sort of companies, I think, that one should be looking for.
David:
I can't think which one in particular you're actually referring to. David, you were going to say something?
David O'H:
Datong Electronics, I believe, fits the bill there.
David:
Which one is that?
David O'H:
They're called Datong Electronics.
David:
OK, and what do they do? – it's another one of these techie companies, yeah?
David O'H:
It's a techie company, yes.
David:
More complicated than an abacus?
David O'H:
Look, they can't tell you what they do, David, they can't tell me either, and they can't show you, because their products are so secret that they aren't allowed to show them to plebs like you and I.
David:
My goodness!
David O'H:
Yes, they're at the James Bond end of the manufacturing.
David:
A bit like Kinetic then?
David O'H:
Yes, similar to QinetiQ. What they do say is that they manufacture and design beacons, so if you are in a person, and the term they use is, "an asset", behind enemy lines, they would like to know where you are from one time to another, and if you can imagine, you could put a beacon onto a vehicle, they could then track where that vehicle is in the world.
David:
So are they in the defence sector then?
David O'H:
Yes.
David:
You see, defence sector is one that I'm actually quite interested in for 2010 and beyond, because in earlier podcasts we've had Justin Urquhart-Stewart and a number of other people here, and I think one of the things they were talking about was governments trying to protect their sovereign borders, and he's not actually saying that people are going to start wars with other countries, but people are just very careful about protecting what they have, and we've already seen that with countries, embattled countries like Iceland saying, I know I owe you money, but I can't afford to pay it to you, so what are you going to do?
David O'H:
Well, we're not going to have trench warfare any more, but in the last ten years we have seen an increase in the number of what I'd call skirmishes around the world, and I think we're going to see more of those, perhaps in Africa and in some parts of the Middle East, where special forces, representatives from the UK or the US, will be operating, and they're going to need kit, and that's where Datong comes in.
David:
So thank you very much, the two of you, for coming in today. Have you got any final words for our listeners? – Gavin?
Gavin:
Well I would say, steer very clear of gilts during this year, I think it's going to become really quite a volatile area, and actually there's an awful lot to go for in equities, particularly well covered dividends, so you do get some return which you can't get from the money in the bank. So I think that the market will actually, in a fairly subdued way this year compared with last year, but continue to produce results.
David:
OK, thank you very much – and you, David?
David O'H:
Yes, my advice was, any small cap company that has seen their share price hit a low and a lack of liquidity in their shares, is this: be successful. If you're a successful company, it's amazing how your share price will catch up, particularly if you're paying a good dividend.
David:
Wonderful. So thank you very much to the two of you for coming in today. Now, you may not know this, but I end each podcast with a quote, and I found a quote that I think sums up what this podcast is all about, and today's quote comes from Dwight Eisenhower. Now, he said, "It's not the size of the dog in a fight that counts, but the size of the fight in the dog".
Gavin:
Hmm, an interesting one.
David:
So you were talking about small caps, and let's hope that none of our small caps turn into dogs.
Gavin:
And if I could add just one other brief comment.
David:
Go on.
Gavin:
Time spent in reconnaissance is rarely wasted.
David:
Thank you very much. This has been Money Talk, I have been David Kuo, and my guests have been David O'Hara of Blackthorn Focus, and Gavin Oldham of The Share Centre. If you have a comment about today's show, you can post it on the Money Talk web page, which you can find at www.fool.co.uk/podcast, and if you have a suggestion for future shows, you can email me at moneytalk@fool.co.uk. Until next time everybody, have a great week.
