Rough diamonds in alternative markets

In recent years, investors have been attracted by the growth potential that European companies offer compared with their US counterparts. While US public markets have outperformed the European markets by a wide margin, as measured by the annual returns over the past 20 years of 7% in the US versus 4% in Europe, the performance of micro and small cap companies, in particular, has been comparable, reflecting the European markets’ potential to offer returns that match that of the US. Historically, these micro and small cap companies have consistently outperformed the benchmarks, returning up to two times (2x) more with comparable volatility.

Long-term capital

For these micro and small cap companies, long-term capital has been a key component of their consistent track record. An analysis of their past performance suggests that year on year these companies tend to outperform large cap companies 60% of the time but if the holding period is increased to five years, micro and small cap companies do better 90% of the time.

In Europe, such companies, with a proven business model, track record of double-digit revenue and profit growth, competitive advantages based on technology and innovation, and high growth potential, are often found on alternative or secondary markets – such as BME Growth (formerly MAB), Euronext Growth, AIM in London or Italy, and even Nasdaq Nordics – which often serves as a prelude to their listing on main markets or large corporate transactions.

These companies are generally still run by their founders and they go to the market to seek alternative funding to, for instance, finance new expansion programmes, as a mechanism for shareholder and employee remuneration, or to finance inorganic growth strategies via acquisitions. These are companies whose dynamics resemble the firms that private equity or leveraged buyout funds often target, but which are off the radar of PE or LBO firms.

Stellar growth

Over the past few years, these alternative markets have developed and increased in depth. Between 2018 and 2021 alone, BME Growth, for example, saw its liquidity surge 4x, even as companies with successful technology models tapped the market in search of funding. However, overall, less capital has flowed into these markets than in the private markets. In 2021, only €960 million in funding was injected into the alternative markets in Spain while, in the private markets, Spanish start-ups raised almost €4.3 billion – 4.5x more. Even considering 2019, the record year for BME Growth when financing operations worth approximately €1.5 billion were executed, the figure falls short when compared with the capital available to private markets.

This excess of capital in private markets vis-à-vis alternative markets creates an attractive investment opportunity for the latter, as evidenced by the returns they offer, which are superior to benchmark indices: the MSCI Europe has returned 4.4% over the past 20 years compared with, for example, the MSCI Europe Small Cap Index, which has seen its market capitalisation grow 6x over the same period, offering an implied return of close to 10%.

Less noise, more substance

Another factor that boosts these companies’ potential for outperformance is the availability of information as, unlike major stocks, many of them are not closely tracked by analysts. For example, the average company on the STOXX Europe 600, which comprises 600 of Europe’s largest companies, has 19 active analyst recommendations while the average company on London’s AIM or Euronext Growth has only 1.4 analyst recommendations, so an active investment approach in the latter allows potential market inefficiencies to be identified and exploited. By way of example, in the US there are six active recommendations for every stock in the index, illustrating the huge opportunity that exists in Europe.

Moreover, these companies – which do not follow the traditional venture capital model where the growth and viability of a company depends on successive capitalisations – generally operate in positive numbers: in 2020 alone, the last year for which full BME Growth figures are available, the total turnover of the listed European companies was more than €2.4 billion with an EBITDA of €250 million, representing a margin of around 10%. Some of them even paid dividends, thus increasing total shareholder return.

Why Axon?

While it is possible to participate in these markets directly, doing so through specialised investment managers with active management models offers additional benefits as they will be able to influence companies’ decisions and participate in key value creation initiatives. Axon Partners Group, through its growth capital strategy, provides access to these investment opportunities by participating in such companies at different stages of their IPO lifecycle – from the pre-IPO and IPO phase to the listing stage, allowing investors to capture the value generated during each of these different phases.

The regulatory mix required by these markets and the higher levels of liquidity observed in recent years, which translate into lower price impacts and are a key differentiator compared with private markets that lack liquidity, provide an ideal platform for institutional investors to better protect their interests. For institutional