Size and the City

Part of the journey for a CEO intent on scaling a company is realising that errors occur along the way. No one, after all, is perfect and everyone is entitled to make mistakes – unless, that is, you’re in charge of a listed entity, when you’re expected to be flawless.

Ken Scott is the CEO of training group ILX, which listed on the market in 2000. Earlier this year, it missed its forecasted numbers and issued a profit warning, which saw the share price drop from a high of 95p at the beginning of the year to 57.5p.

Since Scott took over in 2003, ILX has gone from making losses of over £2 million to being profitable, and has made six acquisitions. However, it was one of these companies that caused this year’s disappointing financial results: ‘We had a difficult year in the best-practice division. We’d bought a business in November 2005 and it performed incredibly badly, making losses when it was supposed to post nearly £1 million profits,’ he says.

In effect, the reasons for this were beyond Scott’s control: ‘It was a small team of six people and the commercial director, who was essentially our route to market, left after a falling out with the managing director. It took a long time to find a suitable replacement.’

Although ILX missed its numbers, the financials it released for the year to March were the envy of many CEOs, with turnover surging 50 per cent to £10.3 million and pre-tax profits of £1.46 million. ‘It’s the way the market operates,’ comments Scott, stoically.

Gary Carter, CEO of software simulation specialist Flomerics, tells a similar tale. In July 2006 Flomerics acquired German software company Nika for an initial consideration of £8.8 million. The plan was to repeat that company’s domestic success in other markets, notably the US.

Interim results this year showed that turnover had grown by 23 per cent to £7 million, and a pre-tax loss of £805,000 was posted, compared to a profit for the comparable period in 2006 of £138,000. That’s seen the share price head south, falling from a year high of 110p down to 43.5p.

Carter is fully aware of how the market functions, but concedes that it’s tough to build on a strategy when the slightest error can result in millions wiped off your market cap. ‘The problem when you’re a small company is trying to grow while investing for the long term,’ he says. ‘Shareholders say they’re interested in the long term, but they want it both ways.’

Reason versus instinct

In a rational universe, the reasons for a company missing its forecasted performance should be important or, at the very least, worth hearing. Unfortunately, the public markets are not necessarily the right place for enlightened, logical assessments.

It’s a truth all too familiar to Chris Moe, the earnest CFO of Vectrix. During the previous two years the US company, which makes environmentally friendly scooters, raised over $100 million (£48.9 million) in private equity. After assessing various markets, Vetrix and its investors decided AIM was the natural choice, and the company raised £33.7 million through an institutional placing at 52p, achieving a market value of £135 million.

Less than six months later, this pre-profit company’s share price toppled from 49p to 12.7p. Moe comments: ‘The thing about stock prices that are trading on a story or theme – as opposed to revenue or a price-to-earnings multiple – is that, for a while, they tend to have strong momentum. If things go up, they generally keep going in that direction, but the reverse is also true. It’s even stronger on the downside.’

Loss of control

According to the former US Marine captain, there are two main reasons for the fall in share price. Firstly, pre-IPO, there were 320 shareholders, making it impractical for Vectrix’s nominated adviser and broker, HSBC, to arrange lock-in agreements. ‘Fifteen per cent signed an orderly market agreement, which isn’t a lock-in but it’s close enough,’ says Moe.

Inevitably, a significant number of stakeholders who had bought shares at half the IPO price decided to cash in. However, the selling continued apace after a warning was issued following a mistake discovered in the assembly line. ‘We had early-stage production issues in July which were fully disclosed and swiftly resolved,’ states Moe. The spiralling share price meant that some funds had to sell, as they weren’t allowed to hold investments below a certain size. A month later, the full scale of the sub-prime crisis emerged and that, suggests Moe, led to several hedge funds having mortgage-backed assets to offload.

At present, 2,000 bikes have rolled off Vetrix’s production line and agreements have been struck with 35 dealers around the world. ‘We’re not completely beyond the inspiration phase, but we’re definitely deep into the perspiration phase,’ says Moe, who attributes the assembly line blip to exuberance. ‘We should’ve expected a hitch but we were a little overconfident. We were honest, but naïve.’

Moe, Scott and Carter head companies with market caps under or around £30 million. There’s a feeling that AIM is less forgiving than ever before for businesses operating in this area. ILX’s Scott suggests that the investment institutions and advisers aren’t interested in anything below that level: ‘The AIM market at the moment is in an awful state. I’ve spoken to some of our institutional investors – across the board, they say that the good, the bad and the ugly are being put in the same pot, so a lot of institutions aren’t investing.’

Hidden gems

If this is true, companies with genuine growth prospects are getting lost amidst those which, in all likelihood, should never have gone to market in the first place. For those CEOs at the more aspirational end of the market, the best course of action may be to concentrate on higher turnover and profits, and assume justice will eventually be done with an appropriate market cap.

Scott says: ‘My problem is that if I focus on the share price, I’m not focusing on the business. All I can really control is the fundamentals, so presently we’re in a good position. We generate a huge amount of cash, and as the year progresses we’ll hit our numbers and people will see this coming through.’

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.