The Gloom About the London Market is Overdone

The London Stock Exchange (LSE) has been navigating a challenging landscape, marked by high-profile delistings and stiff competition from US exchanges. Just Eat Takeaway's decision to remove its secondary London listing is the latest in a series of setbacks, raising questions about the city’s competitiveness. However, while these challenges are real, the pessimism surrounding the London market appears overblown.

Signs of Resilience

Despite the headwinds, the IPO pipeline offers a glimmer of hope. So far in 2023, 14 IPOs have raised £750 million, and the pipeline for 2024 looks promising. French media conglomerate Vivendi's €6 billion to €8 billion planned IPO of its TV business Canal+ could be London’s largest listing since 2022. Similarly, Chinese fast-fashion giant Shein is exploring a potential London listing, which would be a massive vote of confidence in the market. These deals could help restore investor confidence and attract more listings in the near term.

The LSE has also introduced reforms aimed at boosting its competitiveness. These include easing shareholder voting requirements and enabling dual-class share structures, making London more attractive to tech and growth companies. Such measures are designed to counter the appeal of US markets, where management has more freedom to make strategic decisions without shareholder intervention.

The Liquidity and Valuation Puzzle

One of the most cited criticisms of the London market is its relative lack of liquidity compared to New York. However, this gap is not as wide as it seems. Excluding the 79 US megacap stocks that dominate over half of US market turnover, the average large-cap daily trading value in the US is only 1.3 times that of London and other European markets. This suggests that the liquidity disadvantage is exaggerated and primarily skewed by outliers like the US tech giants.

What’s more concerning is the valuation disparity. The FTSE 100’s forward price-to-earnings (P/E) ratio is just 12x, roughly half that of the S&P 500. Although much of this gap disappears when excluding highly valued US tech stocks, the undervaluation of the London market persists. Analysts, including Charles Hall from Peel Hunt, estimate the market is undervalued by about 20%. For value investors, this presents a compelling opportunity to capitalise on mispriced assets.

MY ANALYSIS

The challenges facing the London Stock Exchange (LSE) are undeniable, with high-profile delistings like Just Eat Takeaway highlighting the competitive edge of US markets. However, the narrative of inevitable decline seems overstated. The IPO pipeline's resurgence, led by Vivendi’s Canal+ and a potential Shein listing, demonstrates that London remains a viable destination for major firms, particularly those seeking alternative markets to New York.

Liquidity, often cited as a disadvantage for London, narrows significantly when US megacap tech stocks are excluded. This suggests that the perceived gap between the LSE and US exchanges is partly a narrative shaped by outlier giants. Additionally, the new listing rules, which offer greater flexibility for management and accommodate dual-class structures, align London with the needs of growth-focused companies, particularly in fintech and tech.

The valuation disparity between the FTSE 100 and the S&P 500 — half in forward P/E terms — further underscores the UK market's relative undervaluation. This creates opportunities for value-driven investors who can capitalise on an underappreciated market. The 20% undervaluation estimate by Peel Hunt's Charles Hall supports this notion and highlights the need for more institutional support.

A pressing concern is the dismal domestic equity allocation by UK pension funds, which has plummeted to 4.4% of assets. Government measures to encourage more domestic investment — while contentious — may be a necessary intervention to support capital formation for UK companies. Nonetheless, the solution lies in building a robust pipeline of new firms to replace those leaving the market, alongside incentives for homegrown capital to back these ventures.

In my opinion, the London market’s revival depends on sustaining momentum in IPOs, leveraging its regulatory flexibility, and addressing the systemic undervaluation through strategic domestic and foreign investment. The gloom surrounding the LSE is overstated, and the long-term prospects are brighter with the right structural and capital reforms.

Conclusion

While challenges persist, the London Stock Exchange is far from obsolete. Structural reforms, strategic IPOs, and addressing the undervaluation of UK equities can turn the tide. Domestic and international investors alike should see this as an opportunity to engage with a market that has significant potential for long-term growth. With the right measures, London can reassert itself as a leading global financial hub.