The Oasis Reporters
October 8, 2021
South Africa is home to the largest stock exchange in Africa and the 20th in the word by market capitalisation. The Johannesburg Stock Exchange (JSE) was established in 1887, during the country’s gold rush.
Well functioning markets are considered preconditions for the financial development of economies. While many African stock markets remain small in terms of market capitalisation, traded value and and turnover, the JSE is an exception. That’s not to say it hasn’t had its fair share of scandals over the years that have dented its credibility.
In 2003, the JSE established the JSE AltX, a division for small and medium-sized enterprisess (SMEs) with high growth potential. The aim was to provide them with a platform to access public funding with less stringent criteria than banks and the JSE main board. It was envisaged as helping SMEs improve liquidity and get access to capital markets
However, in my research, much of these promises aren’t fulfilled.
I looked at three categories of companies: those that had delisted, those currently listed and those that have migrated to the main board from 2008 until 2018.
The results paint a not-so convincing picture for growth and sustainability on the alternative stock exchange.
For example, analysis of various ratios that measure growth and sustainability in listed companies show a weak relationship with improved market capitalisation and liquidity. For many delisted, listed and migrated companies, improvement in liquidity, growth, profitability, improved leverage, and sustainability was minimal.
I used these measures because they enabled us to evaluate whether the JSE AltX platform is a catalyst for growth. I found that there was only a 50/50 probability of the JSE AltX playing this role.
For sustainability, the results present a dim picture of participating on the stock exchange. The JSE AltX provides different benefits for various groups of companies. But it should not be thought of as a magic wand.
The insights should be helpful to investors evaluating their investment decisions. And to policy-makers trying to find ways to support initiatives beneficial to high growth potential SMEs. Lastly, it might help the JSE AltX think about how to resuscitate the stock exchange.
Stock exchanges and SMEs
The common themes around SMEs – job creation, innovation, economic growth – have attracted a great deal of research. The role of stock exchanges in the performance of SMEs has been less explored.
Stock exchanges ideally provide continuous trading markets, thereby creating liquidity for investments and opportunities for growth. Such a platform could potentially improve SME performance and sustainability, as liquidity is considered a prominent factor in business failure.
The JSE AltX is based on the model used for the UK’s London Alternative Investment Market (AIM). It’s considered the most successful alternative exchange in the world. Its listing requirements are less onerous than the main exchange. And no minimum number of shares to be in public hands is required. Nor is a trading record.
To list on the JSE companies have to have at least R25 million share capital, three-year profit history and a minimum pre-tax profit of R15 million. For JSE AltX listings, companies simply require R2 million share capital, no profit history and have no pre-tax limits. These requirements have been eased even further during COVID-19.
Since its inception, the JSE AltX has had its fair share of successes, as well as failures.
It’s weaknesses include the fact that 40% of companies that had migrated to the main board in 2019 were trading in the red.
In addition, the exchange is characterised by an inability to convert securities into “cash” without affecting its market price – and is perceived as high risk by investors.
Importance of SMEs
But research suggests that not all SMEs contribute equally to job creation and economic growth. And that, specifically the SMEs with the highest potential for macroeconomic benefit, including job creation, are those that would list on a stock exchange. For example, high-growth SMEs created close to 86% of new jobs through businesses less than four years old.
Nevertheless, 75% of SMEs still fail. This can be attributed to various reasons from talent, skills, and inability to secure funds needed for growth.
It is, therefore, important to understand what makes SMEs achieve sustainable growth. And then the necessary conducive conditions that allow high-potential SMEs to realise their potential need to be created.
While various efforts are made to encourage the establishment of SMEs, sustainability and growth are often constrained by financing. This still remains a major constraint for survival. Factors affecting financing needs may include where in the life cycle an SME finds itself as well as the pace at which the business grows.
High-growth SMEs are likely to have greater requirements for expansion capital and may source funding in the form of equity or loans. But, funding is often biased against SMEs. Ideally, capital should flow from investors to SMEs.
This is where a platform like the AltX can play a role.
So why hasn’t it worked?
For many investors, the less onerous listing requirements of the JSE AltX have created a perception of risk. This has deterred potential investors.
Secondly, many of the JSE AltX’s top performers have migrated to the main board. This has left the platform struggling with companies that don’t perform well.
Thirdly, relaxed listing requirements don’t adequately prepare SMEs for the challenges of a stock market environment. They may also not be considered transparent enough for investors.
To improve its appeal, it could be helpful for the bourse to focus on areas such as listing requirements and efforts to improve the reputation of the JSE AltX.
In future, evaluation of the JSE AltX could benefit from insights from the executive directors of the listed entities. These would provide insider perspectives related to their experience of the stock exchange. This would allow researchers, companies, the JSE AltX and other relevant stakeholders to achieve a better understanding of the performance of the JSE AltX and the expectations for performance, as well as assist in making decisions about listing on the platform.
What we do know so far is that numbers don’t lie.