T h e ' I n s t i t u t i o n o f P r o d u c t i o n E n g i n e e r s J o u r n a l

V O L . 3 7 N o . 7 ' J U L Y , 1 9 5 8

Business Financingand

The Stock Exchangeby GORDON CUMMINGS

IN recent years, large and increasing sums have been invested in a great deal ofcapital development ranging from housing to new factories, modernisation ofexisting plants and retail distribution outlets. Taking the latest National Income

and Expenditure estimates, the total gross amount of such investment in the six years1952 to 1957 was £18,704 million. Annual outlay at current prices rose year by yearfrom £2,411 million in 1952 to £4,050 million last year, to be compared with theaverage of £3,117 million.

three main groups

Capital investment falls into three main groups — gross fixed capital formationat home; the value of physical increases in stocks and work in progress; and UnitedKingdom net investment abroad. The most interesting and significant figures arethose of the first and third groups, and the break-down of the first group.

Gross fixed capital formation at home during the past six years totalled no lessthan £16,380 million, of which, according to the official analysis, £11,665 millionwas attributable to persons, companies and public corporations; £1,290 million tothe Central Government; and £3,425 million to local authorities. Whereas, however,annual outlay by the Government and local authorities varied not very widely fromthe averages of £215 million and £571 million, respectively, the average of £1,944million for the first sector went against a fairly steady rise from £1,358 million in1952 to £2,558 million in 1957.

In its particular way, the third group has shown a more remarkable trend.Despite balance of payments problems, which have called for strong action at timesto stop heavy drains on the gold and dollar reserves, this country has continuedher traditional role of a major overseas investor. In various ways, directly andindirectly, Britain has been investing abroad at the rate of some £200 million ayear. Per head of the population, she is in fact the largest overseas investor in theworld, with over half the money representing private investment — a higherproportion than in the U.S.A.

the sources of capitalWhat are the sources of all these vast sums of capital ? First, limited companies

and public corporations provide a very large proportion themselves, from theamounts set aside out of trading profits for depreciation and obsolescene and netprofits put to reserves after payment of taxation and dividends or interest on capital.

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Second, the Central Government and local authorities also meet part of theircapital needs out of surplus taxation, rating»and other revenue in the case of tradingactivities; further sums are provided out of depreciation or sinking funds. In otherwords, part of their tax revenue is diverted to capital projects such as housing, publicworks and, in the case of the Government, to loans for the expansion andmodernisation of the nationalised industries.

Third, the savings of individuals, including the depreciation and profitretentions of unincorporated businesses. To a substantial, and growing, extent agreat deal of the savings of individuals finds its way indirectly into capital investmentthrough contributions to pension funds, life assurance premiums, deposits in savingsbanks, building societies, co-operative societies and other friendly or mutualassociations, and trades unions — the surpluses of these bodies are invested invarious forms, to a large extent in Government and similar securities; and, in manycases, in the stocks and shares of limited companies.

Although the companies, corporations and Government — national and local— finance much of their capital development from their own " savings ", they haveto look elsewhere for the balance of their investment funds. This they do largelyby tapping the surplus of personal savings, which today represent some 40% of allsaving.

Naturally, in our complex society, as this often involves much more than therelatively simple " one-man " operation of borrowing from a bank or individual, orraising a mortgage, there has to be efficient machinery for channelling funds from amultiplicity of sources to the points where it is needed. As with the distribution ofmost commodities, there has to be a market place where everyone can be broughttogether speedily and efficiently.

an essential task

The Capital, or New Issue, market centred in the City of London does thisessential task. Although called a " market", this vital part of Britain's financialmachinery has no market place as such. With many generations of experience onwhich to draw and unrivalled anywhere for skill, knowledge and initiative, itsmake-up is diverse and widespread. Participants, each with their essential role andsome of them with headquarters in the provincial cities, include finance houses, themerchant banks, insurance companies, trust companies, pension funds, British andCommonwealth banks, the Bank of England and, last but not least, the StockExchange.

The nature of a capital issue has a direct bearing on the method of operation.For instance, a British Government loan or funding operation is carried throughtoday almost entirely by the Bank of England and the Government Broker, withthe Government departments participating as major subscribers — in some instancesthe entire loan is taken by the departments, which then. " let it out" through theStock Exchange to institutional and other investors, often at rising prices. _

Otherwise, although the Bank of England will advise on the terms and timingin the case of local authority, Dominion Government and other gilt-edged issues,the pivotal point is what is called an Issuing House, which may be a financecompany specialising in such business, a merchant bank, one of the mining financehouses, a firm of stockbrokers with a new issue department of their own, or, inthe case of very large issues, a consortium of several " houses ". The Issuing Housecarries through all the negotiations, advises on the terms and timing, and looksafter the routine and sometimes delicate work of setting the machinery in motion.The other participants provide banking, stock market, underwriting and otheressential services.

An Issuing House has considerable responsibilities. While its main work in thecase of a gilt-edged issue is to arrange underwriting and contribute its experience tothe settlement of terms, an issue by a limited company can be a much more complexbusiness. The latter may be an established public company wishing to raiseadditional capital or to convert an existing issue of loan or preference capital; itmay be the issue of capital by one company in exchange for the capital of another

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which it is taking over or with which it is amalgamating; or it may be an offer tothe public or a marketing of the share or loan capital of a new Company or acompany whose capital has not previously had a stock market quotation.

Established issuing houses are very proud of their reputations and before theywill become associated with any issue they want to be assured of its soundness. If itis a company with which they have already been associated, the preliminaries maynot go further than bringing up-to-date the relevant information about thecompany's profits, assets, prospects and management; the reason for wanting newcapital; and deciding the size, form, terms and best time for the operation.

When, however, the proposition concerns a private business about whichlittle, or only general, information is available, much more enquiry and investigationare demanded. As a preliminary, the issuing house will want to know how long thebusiness has been established, its ramifications, whether it is soundly managed, whocontrols its affairs, if it has a reasonably sure and expanding future, the reasonsfor turning it into a public company or raising new capital, and that its profitsand assets are large enough to make a public issue feasible.

Officially supplied information will be supplemented by enquiries amongstoutside sources as to the reputation, trade standing, competitive position andmanagement of the business. Next, experts and principals of the issuing house willget the " feel" of the business and its management by personal examination.Independent accountants then report on the profits over a lengthy period of years,recent balance sheets, the basis of valuing the assets and the adequacy of financial,stock, costing and other controls.

When all this information has been digested, the issuing house can then makeits proposals as to the form and terms on which a successful issue might be made.Economic and stock market conditions at the time have a direct bearing here.For instance, apart from factors such as the size and nature of the operation andthe type of business, current conditions and public appetite for particular types ofsecurities play a vital part in deciding whether the offer should be ordinary shares,preference shares, debentures or, a growing popular form, loan stock which can beconverted into ordinary shares on defined terms.

Apart from " rights" or other offers made only to shareholders of publiccompanies, the mode of the operation has next to be settled. It can be a publicissue on stated terms, with the issuing house making all the arrangements andunderwriting it. Alternatively, it may be an " Offer for Sale", with the issuinghouse or some other party buying the securities offered at stated prices and resellingto the public at higher prices, the difference covering expenses and profit.

A third method, usually adopted where the amount involved is relativelysmall, is a " placing ". The issuing house " places" blocks of stock at fixed priceswith finance houses, insurance companies, pension funds, trust companies, brokersand other connections. Unless there is some reason to the contrary, permission todeal in the stock is sought from the Council of the Stock Exchange and a marketmade. A fourth method, generally limited to comparatively small companies orcases where large holdings have to be dispersed to meet death duties or for familyreasons, is the " introduction " to the stock market of part of the company's capital.

publishing the prospectus

With the exception of issues limited to existing shareholders, where a lettersetting out the reasons for the operation and giving information as to underwriting,relevant contracts and so on is generally adequate to meet legal and other require-ments, a prospectus or similar statement has to be published. As the " shop window ",this is a most important document and, rightly, the issuing house pays particularand careful attention to its drafting.

Before looking at this side of the operation, it should be pointed out that whatcan be a very• difficult and shifting hurdle has to be surmounted first. Today acompany which seeks to raise new capital exceeding £10,000 must first obtainTreasury permission. It must supply to the Capital Issues Committee — who actas the Treasury's advisor — a great deal of information about the nature of thecompany's business and the terms and reasons for wanting to raise new money.

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Though it may be difficult for the outsider to understand the bases on which theC.I.G. formulates its opinions, the qualifying requirement is that the issue shouldbe in the national interests.

The Companies Act, 1948, lays down the information which must be givenin a prospectus. It is extensive and thorough. Details of the company's capitaland the rights attaching to various issues . . . the extent and terms of the offer . . .the names and addresses of the directors and other officials, the auditors, bankers,brokers and the issuing house . . . the nature of the business and its history . . .recent profits and the basis of calculation . . . the assets and liabilities . . . thereasons for the issue . . . the directors' view of prospects . . . the net proceeds ofthe issue . . . underwriting and other contracts . . . relevant articles of associationsuch as directors' qualifying shareholding . . . professional valuations and reports. . . these are some of the facts which must be given.

While the prospectus — or in the case of a placing or introduction, the" statement", which is its equivalent — is in the draft stage, the Stock Exchangecomes well into the picture. First, the brokers to the issue are advising on importantmatters such as market conditions and terms. Second, the Council of the LondonStock Exchange has to have its own information requirements satisfactorily met,and these are even more searching than those laid down by the law.

In addition to requiring copies of all relevant reports and contracts, the StockExchange, which delegates this valuable work to its Share and Loan Department,wants to know a great deal about the directors, officials and others associated withthe company and the issuing house. With nothing taken for granted, it has its ownrecords and sources of information from which to check the standing andqualifications of all the people concerned. Close liaison also is maintained withScotland Yard's Fraud Squad and with the various provincial stock exchanges.

Through the brokers to the issue, the Share and Loan Department may askfor further information or suggest changes designed to give clearer or fuller informa-tion to intending investors. While not directly concerned with the prospectus, thedirectors of the company must also undertake, after a quotation has been granted,to notify the Stock Exchange of future dividend and profit figures and otherinformation as it becomes available.

underwritingAnother important part of the operation often handled by the brokers is the

underwriting of the issue. As underwriting is the guarantee which ensures thatwhatever the public response the offer will be fully subscribed, it must be placedin financially responsible quarters such as with insurance companies, pension funds,investment trusts, finance houses, merchant bankers, members of the Stock Exchangeand carefully selected individuals.

Underwriters, or sub-underwriters as they are often called, are paid commissionfor their " guarantee". Depending on the nature of the issue, commission mayrange from as little as £% on a first-class debenture stock to 2£% or more on theprice of a share offer. Although underwriting may appear to be " money for jam "when an issue is over-subscribed and there is no liability, it can be the very reversewhen it is under-subscribed. A political, international or economic crisis, or otheradverse development flaring up unexpectedly between completion of the finalarrangements and the opening of the subscription lists, can turn a certainty into aserious failure.

The company still gets its money; but the underwriters shoulder the burden.And as some recent very large issues have shown, the burden can be substantialand call for long, careful " nursing " before the underwriters get back the capitalthey have to lock up — sometimes at a heavy loss. For instance, not so long agothey were left with a very large proportion of a £29,000,000 issue of ordinaryshares and loan stocks by Vickers, the large shipbuilding, aircraft and engineeringgroup, while in April they had to take up 68% of a £20,000,000 New ZealandGovernment loan.

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After an issue is completed and the Council has granted the quotation whichis the prequisite of dealings, the Stock Exchange carries on a further major andcontinuing part of the process. It provides the market where buyers and sellersare swiftly brought together at fair prices. Equally, its broker members advisetheir client on investment and look after the intricate routine work of transferringthe ownership of securities.

A few facts show the measure of the service to national and internationaldevelopment provided by the London Stock Exchange, which, despite the hamperinglimitations imposed by the War and its aftermath, is still the world's greatestinternational security market.

The nominal amount of almost 10,000 different securities officially quotedis upwards of £30,000 million; and the market value is substantially higher. Varyingin amount from a few thousand pounds to many hundreds of millions of pounds,the individual issues cover a kaleidoscopic field from Government, local authority,nationalised industry and other gilt-edged stocks, accounting for more than two-thirds of the nominal total, to the stocks and shares of a great variety of industrial,trading and other companies; giant international oil concerns; bank, insurance,financial and shipping companies; breweries and distilleries; tea and rubberplantations; gold, copper, tin and other mines; and other enterprise in Britain orspread over the free world.

The list is constantly changing as new securities are issued or old stocks areredeemed or converted. Again, the changes are varied. Some of the newcomersrepresent the raising of new money in ways already described. Others are securitiesissued for assets taken over by one company from another, or an amalgamation.And others cover the capitalisation of reserve funds by the distribution of additionalshares to shareholders.

The extent of the annual additions, together with the amounts of " newmoney " subscribed through the medium of the Stock Exchange, is shown by thefollowing table which summarises the totals under the two general headings ofgilt-edged and foreign Government loans; and securities issued by the companies.

QUOTATIONS GRANTED BY THE LONDON STOCK EXCHANGE

Year toMarch 24

1950

1951

1952

1953

1954

1955

1956

1957

NationalTotal

£'000

1,321,927

1,723,607

1,534,027

1,922,423

2,717,148

2,850,930

2,087,712

2,054,381

Amount — AllGilt-edged, etc.

£'000

1,068,948

1,439,907

1,193,456

1,542,961

2,189,656

1,914,868

1,388,831

1,317,067

ApplicationsCompanies

£'000

252,979

283,700

340,571

379,462

527,492

936,062

699,831

737,314

Total

£'000

194,536

730,310

1,298,007

792,441

1,035,631

766,137

1,257,407

824,470

Cash SubscriptionsGilt-edged, etc.

£'000

77.1426

549,968

1,108,445

677,874 *

834,235

493,463

925,634

539,714

Companies

£'000

117,394

180,342

189,562

114,567

201,396

272,674

331,773

284,756

Visits to the Stock Exchange, including a lecture of about an hour's duration, can bearranged to take place from Mondays to Fridays. Members of the Institution who wouldbe interested in making up a party for this purpose are invited to communicate with:

THE SECRETARY, 10 CHESTERFIELD STREET, LONDON, W.I.

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