Among the large number of small- and mid-caps, some companies offer enormous growth potential to investors. Still, only few investors are active in those market segments.
Thousands of what are now very successful large-cap companies from across the world spent most of their existence in the middle market with a company value of less than one billion US-Dollar. Almost 50 percent of output in the US originates from small and middle market companies, claims Unigestion based on the Small Business Association, illustrating the importance of small and medium sized businesses for the economy and consumers. Still, market access to this segment is challenging for investors.
Since the 1990s, technology companies remained private for much longer. While companies went public after five years on average between the 1990 and 2005, they had their IPO after ten years in the years between 2010 and 2015, says Unigestion in a press release. During those years in private hands, their revenues grow significantly. This growth cannot be captures by investors limited to listed companies.
Participating through private equity
One solution to this is investing in private equity. Unigestion estimates that 500,000 investable companies in the small and middle sector exist throughout the world. The challenge for private equity investors remains to find those companies that offer the most growth potential.
Moreover, private companies have more attractive valuations than public ones, claims Unigestion. Because fewer companies are going through a competitive sales process, valuation multiples might be 50 percent lower compared to similar public companies. This price arbitrage exists on the one hand because companies might just be unknown and there is less capital on larger market, while on the other, small companies might as well be less efficiently run, have less attractive products and involve higher risks.
Value is often created by exchanging management teams. “When private equity investors take over, they generally will upgrade the management team to effect change, in areas such as improving sales efficiency, finding new markets or launching new products, ultimately seeking to improve the outcomes at the company,” says Unigestion. Most of the added value (64%) is said to be generated by those management improved.
Listed small- and mid-caps
According to a study pursued by La Financière de l’Echiquier (LFDE) and MiddleNext, 78 percent of all publicly listed companies in Europe belong to the small- and mid-cap segment. But those segments account for only three percent of transactions on stock exchanges. Those two market segments are thus remaining a niche for only few investors.
50 percent of the companies now referred to as large-caps where small- or mid-caps in 2000, underlining the opportunities of publicly traded small and mid sized firms. According to Stéphanie Bobtcheff, fund manager of the two funds Echiquier Agenor and Echiquier Entrepreneur, says that small-caps are underestimated within their dynamic of being a driver of European markets. In contrast, this segment includes many high quality companies that are attractive to long-term investors. Many small-caps of today are the large-caps of tomorrow, she claims.