The plight of the brokers 

It has been well documented that the past couple of years have been particularly difficult for the small-cap broking sector. The FTSE SmallCap index has fallen by 10 per cent over the past 12 months and the AIM 100 index has fallen by 20 per cent. Trading volumes have fallen, with more trading being done electronically alongside lower risk appetite from investors, resulting in the dragging down of commissions, permeating through to the virtual collapse of the IPO market. This has been exacerbated by the valuation mismatch for private companies between those sought by private equity firms and those willing to be paid by institutions.

Over the past few months, redundancies have been announced at a number of brokers as management teams undertake cost-cutting exercises, with one leading European investment bank recently announcing that it is considering the closure of its securities business. Alongside are a number of consolidation plays, including Ambrian/RFC, Arbuthnot Securities/Westhouse, Evolution/Investec and Merchant Securities/Sanlam. 

Against this turbulent backdrop, you could be tempted to believe that the small-cap brokerage business model is broken beyond repair. However, employees continue to pay into their pensions, generating a pool of funds that, if effective portfolio management models are to be believed, will eventually need to be invested into small-cap equities in order to seek capital appreciation return.

Bringing in the money
There are examples of some successful fundraisings, which disappointingly get ‘lost’ in the negative noise. In the year to date, there have been 42 fundraisings, of which 35 were for £20 million or less. Arden has recently raised £8 million for Trifast, a global manufacturer and distributor of industrial fastenings made from carbon steel, high-tensile steel, nylon, titanium and other corrosion-resistant materials. 

The placing formed part of the funding for the £15 million acquisition of Power Steel, a private Malaysian company that manufactures and distributes highly engineered parts to the automotive, motorcycle and compressor industries. Trifast secured the balance of funding from DBS Bank in Singapore at a competitive rate of 3.1 per cent. 

Investors wanted to commit their monies into the acquisition, which demonstrated high operating margins benefiting from both manufacturing and distribution of the products rather than simply being a middle-man. The acquisition can cross-pollinate the existing customer base by offering a wider range of products but, in short, the deal is earnings-enhancing even on a self-managing and stand-alone basis. 

Great Eastern Energy Corporation, the Indian coal-bed methane company with global depositary receipts (GDRs) listed in London, recently announced a rights issue in India to help fund the drilling of additional wells and for the initial investment in a new CBM block. The deal was supported by Arden, with a placing of £9 million of existing GDRs with institutional buyers in London.

And despite the well-publicised demise of the UK IPO market, there are glimmers of life. There have been 60 AIM flotations so far this year, including the recently completed £166 million IPO of Nandan Cleantec, a vertically integrated Jatropha biofuel producer, raising £16 million of new money in order to fund the acquisition and development of land for planting Jatropha and to build further biofuel processing units as further capacity is required. 

At first, it is hard to see the similarities between these LSE deals – the first is a main market global industrial fastenings company, the second is an unlisted Indian company with its shares traded on the UK stock market in GDR form, and the last example is an AIM biofuel producer with assets in India. But all three of these companies are an example of the thriving growth company sector, and the management teams continue to invest in and grow their businesses. Active fund managers can recognise a good deal, and can provide funding for the right opportunity at the right price.  

So, as we end a challenging year, let us focus on the positives – it is not all doom and gloom. And although it is likely that 2012 is going to be equally as challenging, the small-cap market is still active and still energetic enough to add value to good, strong companies that need investment to grow.

Adrian Trimmings, a corporate finance director at Arden Partners, acted as sponsor and led the deal for Trifast. An engineering graduate from the University of Exeter and a chartered accountant, he has been with Arden for five years