Diversified Oil and Gas (LSE:DGOC) confirmed on Monday 18 May that it had made the move from the AIM market to London’s flagship Main Market.
Is this a sound move? Why make the switch at all?
Questions have been raised over DGOC’s model, and digging through the financials we can see that the company is heavily leveraged.
At a time when corporate debt is a major problem, earnings and revenue have been walloped by plants closing in the face of Covid-19 lockdowns and the oil price has collapsed, some may question the viability of such a move.
However, it is one of the fastest-growing energy companies on the market, and it has fared better than the likes of small-cap investor favourites Premier Oil (LSE:PMO) and Tullow Oil (LSE:TLW). Both can boast significant volume but are volatile as all hell and have seen their share price crater over recent months.
These two are also being heavily shorted by hedge funds.
Premier in particular is having a lot of trouble shaking Hong Kong hedgie Asia Research & Capital Management, which says its justification for spending £660 million on three North Sea gas assets from BP (LSE:BP) and Dana Petroleum (LSE:DNX) is weak at best.
The fact that Premier is massively indebted — to the tune of £1.6 billion at the end of 2019 — and its acquisitions are again going to be fuelled by more debt, suggests these buyouts could still blow up in its face.
And the latter of these, the Irish indie Tullow, has had a shocker of a year. Its share price plummeted to two-decade lows in December 2019, with over £2 billion wiped from its market cap in a matter of months. Rumours of a takeover by Total Chief came to nought in February. Total CEO Patrick Pouyanne was brutal. Asked by Reuters whether Total might swoop for Tullow, he said: “Stop dreaming…No.”
But enough about the competition. What about DGOC? It expects to be listed on the FTSE 250 come September when the indices are rejigged.
Its co-founder Rusty Hutson told the Financial Times that the collapse in oil markets “has created a major opportunity for us, as people are having to sell assets they may not normally want to. We’ve seen some bankruptcies and we’re going to see a lot more. Buying assets has always been a better deal for us.”
Distressed assets usually come at knockdown prices. Call it a ‘motivated seller’, call it a fire sale, the effect is the same.
Certainly, the horrorshow facing US shale companies presents significant buying opportunities.
Most are burning cash like it is going out of fashion, and investors are rightly swerving US shale right now.
Focusing on gas over oil has helped the likes of Touchstone Exploration (LSE:TXP), which is a strong contender for buy of the year, and it’s one DGOC intends to follow.
The strategy is to take over existing gas wells, pump up the market price by slashing costs, and keep hold of investors by paying strong dividends.
Committing to an 11% dividend seems ludicrous at a time when 45% of all companies on the FTSE have cut or suspended dividends entirely. And that number includes Royal Dutch Shell, which before Covid had not cut its dividend in 80 years.
But Hutson confirmed in early May that his company’s 3.5c per share payout would continue, based on daily production being held at 94,000 barrels of oil equivalent.
“Navigating unprecedented market volatility and general economic uncertainty validates the business model DGO defined nearly 20 years ago,” he said at the time, revealing $78 million in earnings across the quarter.
Its most recent takeover bid comes for Appalachian upstream and midstream assets from Carbon Energy Corporation, for a deal in the region of $110 million.
Why AIM higher?
London’s Alternative Investment Market is a natural breeding ground for growth stocks, but market cap is no barrier. Fast-growth online clothing stocks like Boohoo (LSE:BOO) and ASOS (LSE:ASC), video game pioneers Team17 (LSE:TM17) and premium drinks brand Fevertree (LSE:FEVR) are all AIM-listed. The richest of these have market caps exceeding several billion pounds. Listed on the same market are micro-cap minnows with valuations of just a couple of million pounds.
The number of companies making the switch from the AIM market to the Main Market is very low, and trending downwards.
Research by trade body, the Quoted Companies Alliance, found that, over the last ten years, only 56 companies have graduated from AIM to the Main Market. Since 2009, the annual number has been in single figures, and in 2019 there were just four.
In the same time frame, 65 companies have moved in the opposite direction, downgrading themselves from the Main Market to AIM.
Why does it matter?
There is vastly more liquidity on the Main Market than on AIM. That means many more buyers and sellers, and a much better chance for investors to move in and out of positions with speed and efficiency.
There is also a large profile boost garnered by switching upwards to the Main Market. This is, after all, London’s flagship market.
However, the financial reporting requirements for Main Market companies are much higher than on AIM. All of this comes with significant costs attached. AIM companies are allowed to publish their annual reports within 6 months of the year end. Main Market companies are required to publish half-yearly reports. There are also looser regulatory requirements for AIM-listed company acquisitions.
One of the more recent Main to AIM moves was Manchester engineering company Renold (LSE:RNO). It reported ahead of its June 2019 downgrade that switching to the junior stock market would “provide it with the ability to execute transactions with greater efficiency and certainty”.
So even while moving upwards is presented as a natural progression, companies often find the payoff of moving up to the Main Market does not make financial sense.
It is no marker of sure prosperity to do so. For example, one of 2019’s AIM to Main movers, Thalassa Holdings (LSE:THAL), saw its stock price plummet from 82p to 47p in the 12 months after its switch.
Stepping down to AIM means reduced ongoing costs for a company and can work as a way for businesses to cut expenditure and engage in a turnaround strategy.
As lawyers Stephenson Harwood note, this move worked for model railway brand Hornby (LSE:HRN) in 2016.
“Hornby stated in its shareholder circular that it was unable to raise sufficient funds on the Main Market without publishing a prospectus, which it could not afford to do so. On AIM, it was able to issue placing shares representing 28% of its issued share capital without a prospectus.”
The gargantuan costs of building a prospectus and disseminating it to investors should not be overlooked.
The ‘natural progression’ argument is getting weaker and weaker as the years pass. Certainly, the lack of movement from AIM to Main is an obvious metric that prestige matters little in the face of inability to control costs.