European stock market will dwarf Irish firms

From next year, avid FTSE, DAX or even ISEQ watchers will have to face the fact their favourite stock market indices will no longer be quite as important as they once were. The introduction of a single currency is likely to usher in a pan-European stock market in which Irish shares will play a very small part.

The jury is still out on which of the emerging European share indices will become the new benchmark for investors, quoted alongside the Dow and Nikkei on television news bulletins. But whether the FTSE Eurotop 300, the DJ Stoxx 50 or the MSCI Europe index prevails, only a handful of Irish stocks is likely to merit inclusion in any index of European blue-chips alongside heavyweights like Deutsche Bank, France Telecom and Unilever. This poses serious challenges for the large number of small to medium-sized companies in the Dublin market.

Those most likely to make the grade in a single European index, allowing them to command automatic attention from overseas investors, are the bigger and more liquid stocks or those which are European leaders in their sector.

"It will be easier to appear on investors' radar screens if you are a large stock," says Mr John Conroy, head of equity research at NCB Stockbrokers. He believes that to be marketable to the broadest range of institutions companies will need a market capitalisation of around £1 billion. Just seven Irish companies currently make the cut while only two or three, including the two big banks, are likely to show up in a list of Europe's top companies.

However, firms like CRH and Ryanair, leading players in the building materials and low-cost airlines sector respectively, should find it easy to attract the attention of overseas fund managers as investor interest switches from country-based investment to a concentration on sectors.

Other Irish firms which are serious sector players include Elan, Irish Life if it is judged against other life assurance companies, Kerry and Smurfit although its sector finds itself out of favour at the moment.

But what fate awaits the small and medium-sized companies that account for some 20 per cent of the Irish market? Most analysts are quick to stress that companies offering value will always find buyers. "If you have a gem that is growing quickly, people will invest in it," says Mr Chris O'Connell, director of IBI Corporate Finance.

But the wide range of choice available across the euro zone will allow investors to be more discriminating and should separate the wheat from the chaff. Those firms which have been poor performers for Irish investors will find it very difficult to attract the interest of overseas fund managers and even the more solid small firms will have to step up their marketing and investor relations efforts while focusing on expansion.

Consequently, market-watchers expect an increase in corporate activity in the second-line sector with takeovers, mergers, management buyouts (MBOs) and share buy-backs becoming more common, all of which is likely to be good news for shareholders.

Many analysts now believe that companies will need to aim for a market capitalisation of at least £300 million if they are to prosper in an enlarged market. As a result they expect an increase in venture capital activity as private equity funds target troubled companies, or those for whom the costs of being public outweigh the benefits with a view to taking them private.

Market sources already suggest that slide rules are being run over companies like Crean, Jones and Powerscreen, all of which have had problems of one sort or another in the recent past. Management buyouts and institutional buyouts, (IBOs), where the venture capital company with the agreement of management puts up the funds to buy the company, are the main form in which publicly-quoted companies can be withdrawn from the stock market and taken private.

However, IBOs are more a feature of the British scene and more likely to be undertaken by British venture capital companies.

"It is unlikely any Irish company would have the appetite or depth of pocket for that," says Mr David Fassbender, managing director of ICC Venture Capital. "More typical of the Irish scene is that management, with support from a venture capital company, makes an offer for the business."

For those companies determined to remain public, achieving a certain size or scale will becoming increasingly important. As a result, a pick-up in merger and takeover activity is expected. Jurys' proposed bid for the Doyle Hotel Group, the merger talks taking place between Irish Life and Irish Permanent and the rumours surrounding Greencore and IAWS suggest that some Irish companies are already attempting to take control of their own future by looking around for local link-ups rather than waiting to be snapped up by overseas bidders.

However, observers of the Irish scene say there are few really obvious mergers which would deliver real synergies while link-ups between firms in the same business in the Irish market could run into competition problems. Those who do not conclude mergers could find themselves the subject of takeover interest by overseas firms keen to gain exposure to the booming Irish economy, particularly given the low ratings among second-line Irish stocks at present. CGU, which already owns 28 per cent of Hibernian, is expected to make a bid for the Irish insurer while firms like Tullow are also considered attractive takeover targets.

"Given the strong growth prospects in Ireland, rating disparities will leave good quality smaller Irish stocks vulnerable to takeovers by larger European companies," says NCB's Mr Conroy.

Meanwhile, management may decide to respond to low multiples with share buy-backs in a bid to enhance shareholder value, he says.

However, all is not doom and gloom for the smaller quoted sector and most analysts believe a streamlining of the sector rather than a mass exodus of smaller firms from the market is the most likely outcome of the move to a larger euro market.

The development of specialist funds which invest only in small or medium stocks will lend support to those with a good and growing business.

"There will always be some institutions with a particular interest in and appetite for small companies," says Mr John Lawrie, Irish investment manager at Aberdeen Asset Managers.

Meanwhile, smaller companies will increasingly be used to provide exposure to national economies. Overseas investors who would like to buy a chunk of the Irish economy may be inclined to do it through small and soundly managed firms whose businesses are primarily domestic as the big firms become more internationally focused.