With brokers cutting back, it’s getting harder to secure new followers - but there are tactics for boosting coverage
The sell side is a vital constituency in any IRO’s bid to win over his or her investment community. But when it comes to small-cap companies, for which it is always hard to stand out from a competitive – and loud – group of neighbors, analysts and the research they produce can be the difference between a stock being traded and one that is simply ignored.
Over the last few years, however, pressure on balance sheets has resulted in a number of banks paring down their research teams, particularly in the wake of the financial crisis. In addition, recent rule changes by UK financial regulator the Financial Conduct Authority (FCA) mean asset managers must now be more transparent about how client money is used to pay for research, while incoming regulation for the whole of Europe is predicted to put even greater strain on an already embattled research industry (see MiFID II: what IROs need to know).
Frost Consulting, a broker consultancy, estimates that global equity-related commission payments declined by 43 percent between 2007 and 2012 to reach $23.5 bn annually; Edison Investment Research, an equity research provider, suggests this also led to the halving of analyst numbers – to 9,000 – over the same period.
For small-cap IROs, this is far from good news: IR Magazine research published in July 2013 finds that, while the majority of companies are happy with the number of sell-siders following them, most small-cap companies report that they do not have enough analyst coverage (see Playing by the numbers, below). Larger companies, which tend to have more analysts following them, also say they are more satisfied with the quality of their coverage than their smaller peers.
With brokers cutting down, and companies being left behind, what can be done to boost a corporate’s analyst coverage?
Playing by the numbers The message from research carried out in July 2013 by IR Magazine is clear: small-cap respondents are not as happy with their sell-side coverage as their bigger counterparts. As part of a global IRO survey, we polled more than 700 respondents on a range of issues, including what they thought about their analyst coverage. As might be expected, as cap size increases, so does the number of analysts following a firm. On average, IROs seem relatively content with the number of sell-siders following them: overall, just over half (51 percent) say the number of analysts following their firm is about right (see below left). Look at these results by cap size, however, and it becomes apparent that some companies believe they have too many and others too few. Only 34 percent of small-cap firms say they currently have the right number of sell-siders covering them, while 58 percent would like to increase their coverage (see below right). Just 8 percent of small-cap respondents say they have too many analysts covering their company. By contrast, no mega-cap company complains of having too few analysts. ‘You reach critical mass in the mid-teens,’ comments one US-based respondent. ‘After that, there is little or no value being added.’ IROs in certain sectors feel more strongly about their coverage. In the consumer goods & services market, for example, only 38 percent of respondents feel they have right level of analyst attention, with 23 percent looking for more and 29 percent saying they have too many. Those working in pharmaceuticals, biotech & healthcare, meanwhile, are the most likely to feel underfollowed, with 32 percent of IROs in the sector saying they have too few sell-siders covering their activities. Source: IR Magazine survey. Click for larger version. |
Do your homework
First, you need to know your analysts inside and out, recommends Mary Turnbull, senior vice president of corporate access at financial services company Raymond James. ‘The most important thing – particularly for small caps but also mid-caps – is for IROs to do research about which analysts they want to target,’ she suggests. Checking who covers your industry and market cap peers can yield a ready-made list of appropriate analyst targets, information that is usually available on IR websites.
Jordan Darrow, a consultant at Darrow Associates who specializes in serving the needs of micro-cap and small-cap companies, says such targeting can then be further refined. ‘The next step is to determine what other factors make a firm or its analysts a solid target, which may require an assessment of banking relationships, peer group coverage, trading restrictions, an analyst’s appreciation for a company’s business strategy, or overlaps or commonalities between the analyst and the management team of the company, to name a few factors,’ he explains.
From there, you can write up a ‘to target’ list, establish a first point of contact and start building a working relationship to ‘build credibility’, he adds.
Proper positioning and a refinement of your investment story are also paramount for attracting sell-side attention, Darrow points out. ‘Create a framework around what makes the company unique and how it is positioned to take market share, grow revenues and increase profits,’ he says. ‘Additionally, develop an investment thesis that suggests why the stock would be attractive to investors and provide valuation metrics that make the company seem a compelling investment.’
Turnbull points out that some brokers have dedicated corporate access personnel who will reach out to non-covered companies to include them on roadshows and other events. ‘It’s their specific job to look for companies they don’t have access to,’ she says. ‘But the more research IROs can do, the more they can help an analyst [to initiate coverage].’
Message analysis
Other documentation can help in this regard. Though analysts will be looking for the same attractive information your investment community is after, they are more likely to need it in a quick, set format that can be easily appraised. ‘One thing I’ve heard a lot is that the most important thing IR practitioners can do is have their updated investor presentation available,’ Turnbull says. ‘It’s also good to have a factsheet about the company that gives a quick overview without the need to read every page of your website or financial documents.’
She adds that at a recent buy-side panel, several attendees agreed that these two documents are the most important to have easily accessible and regularly updated – despite several companies not even having them on their website. ‘The more information you have and the easier it is to access, the easier it is for an analyst to notice you,’ summarizes Turnbull.
Stephen Burrows, head of financial reporting and IR at Great Portland Estates, is also a believer in focused interaction with the sell side. The UK real estate firm, which has a large market cap and operates in a sector that is already under the careful eye of the sell side, has 21 analysts following its activities. Burrows notes, however, that whatever stage your firm may be at with the sell side, the key is consistency.
‘Our goal with the sell side is to be as transparent as possible and ensure the dialogue we have with it is open and frequent,’ he explains. ‘In terms of messaging we will typically put out a press release only when a deal has closed and we have something meaningful to disclose. We will then contact all the analysts at 7.00 am just as a press release hits the wires to ensure they all properly understand our rationale for a transaction and to give them an opportunity to ask questions before they put out their daily bulletins.‘
Ahead of a closed period, Burrows and his colleagues will also call analysts to ‘run through their numbers and give them an opportunity to ask questions before it becomes more difficult for us to provide information.’ Such measures ensure not only that Great Portland Estates’ messages are clear and consistent, but also that a strong, communicative relationship is both established and maintained.
Off the beaten track
Analysts are also creatures of comfort, and may not be immediately attracted to your firm for other reasons. ‘Companies can be too small or not the right fit – and an analyst only has so much bandwidth to pick up firms,’ says Turnbull. ‘Sometimes companies also fall between the cracks if they have multiple, very different business lines.’ (See Case study: Pentair, below.)
Turnbull describes a company that approached her that had a strong real estate business and a division that managed several cinemas – two wildly different areas for analysts. ‘We have two separate analysts for those two industries who don’t normally interact, but a good relationship with a corporate access person who can connect the dots might mean a company gets brought along on a roadshow as a non-covered firm and gets noticed that way,’ she suggests.
Case study: Pentair At the end of 2012, valve and industrial control system firm Pentair completed an enormous deal to absorb its industry peer, Tyco International, and create a new company worth $7.7 bn. This transformational deal, says Jim Lucas, head of investor relations at Pentair, made all the difference to being picked up by the sell side and placed the company in the S&P 500 for the first time ever. ‘Prior to the event, we had around 12 analysts following us. Over the past two years our coverage has nearly doubled, to reach 23,’ Lucas reveals. ‘We have seen our coverage transition to more multi-industry analysts as the profile of the company has evolved over time.’ He notes, however, that what has made the real difference for Pentair is ‘quality over quantity’. To maintain this, he and his team review and evaluate their analyst coverage on a regular basis. Post-merger, Lucas opened up his outreach to analysts who specialize in companies that straddle multiple industries, rather than just the flow-and-valve space. ‘We attended more of the large-cap conferences and made sure our C-suite got in front of the analysts who were not as focused on us when our market cap was smaller,’ he explains. The quality of disclosure matters, too. ‘We have always been known for our transparency with regards to the information we disclose,’ Lucas says. Such measures appear to be working: analysts and investors alike named Pentair the recipient of the most progress in IR award at the IR Magazine Awards – US 2014. |
Companies that provide services or products that are relatively incomparable, or firms that exist outside of a broader peer group of other listed outfits, might find there is a shortage of analysts and coverage, Darrow adds. Additionally, companies with a higher market cap tend to have more analysts, so smaller and more specialized companies can easily escape their notice.
This is even more likely for smaller issuers given the limitations imposed by compliance departments and brokerage firms, Darrow says. ‘Many firms will not permit or will limit trading in or research coverage of companies that trade below a certain price,’ he explains. ‘Some firms may use a $5 or $1 share price threshold. For these companies, beyond building a market for their shares, IROs may want to address the benefits of a reverse stock split or the time it may take to naturally see an appreciation in share price above the thresholds before research coverage becomes an option.‘
Ultimately, he adds, an IRO should fill in the gaps in coverage by building up a group of analysts that includes those with the best reputation on the Street in terms of industry knowledge. Other targets might include analysts from firms with a range of institutional clients from different parts of the world, those with firms that distribute to retail brokers (in order to diversify your shareholding) and analysts who have the time and space on their books to spend time focusing on your company.
‘[You] may experience an uphill battle in getting research coverage by not understanding conflicts of interest or the limitations of the target analysts or their companies,’ Darrow says. Analysts will assess your company in terms of being easier to cover, reliable in forecasting and dependable in executing plans.
‘Much of this assessment can be tied into management credibility,’ Darrow points out. ‘On the other hand, any setbacks with respect to credibility – or other developments that derail progress pursuant to a company’s growth plan – will likely result in a delay to or elimination of research being initiated.’
Relationship building
An innate part of remaining credible – and approachable – is to strengthen your direct relationship with analysts. ‘Sometimes it’s a bit tricky when you’re newly public: you don’t have the lay of the land or as much of an idea about what the norms are,’ notes Turnbull. ‘The one thing I would recommend – even if you’re already covered – is to lean on the broker a bit more.’
This can be as simple as sharing information with said broker, she adds, or going so far as to take its feedback and retool your investor presentation and supporting documents accordingly, so they tell your story as strongly as possible.
‘The best relationships between companies and the Street are partnerships,’ Turnbull says. ‘Both sides have important information and insight, and the more you can share that information and leverage it, the better results you will achieve.’
She suggests that another untapped human resource might be institutional investors. ‘Even if you don’t have coverage, institutional investors will be spending a lot of time with analysts at brokerage firms,’ she points out. ‘Talking to them and getting their insight about which analysts are best in your space is really useful, and they can be really helpful in developing your targeting.’
Once you’ve established a connection and shared information, analysts may well want a yet more detailed view of your company. ‘Over time [you can] expose the analyst to senior management through meetings, conference calls and investor conference appearances,’ says Darrow. This ultimately gives analysts a perspective of a company’s strategy and ensures they are aware of progress and developments that show the strategy working.
‘In doing so, you are creating a case for the company’s ability to continue to make progress, which will reflect favorably on the analyst given the need to determine present day investment decisions based on forecasts of future performance – should research coverage be initiated,’ Darrow says.
For companies, inviting analysts for site visits and more specialist meetings is usually of value. ‘We often try to get the analysts away from their desks on site visits to view specific assets and give them access to the management team for a deeper dive on individual projects,’ says Burrows. At Great Portland Estates, for example, the IR team tries to get in front of banks’ equity sales teams – along with the analyst – on at least an annual basis, and more interesting meetings are more likely to stick in their memory. ‘More recently, we held one of these sessions on-site at one of our projects to give them a sense of the scale of our redevelopment activities at the east end of Oxford Street in London, and the feedback we received from this session was very positive,’ he reveals.
Paying for coverage
If analyst contacts are still not forthcoming, the practice of paying for equity research remains an option for some teams. Used by issuers such as power systems manufacturer Rolls-Royce and UK bakery chain Greggs, paying for coverage is more common in Europe than North America, where it is sometimes viewed with skepticism. Not only can it boost your analyst numbers, but it can also put your research in front of investors in regions it might not normally reach, or provide wider coverage of business areas that might be under-represented.
Rating the researchers Where companies are covered by analysts, just how happy are they with the service they receive? In research carried out by IR Magazine in July 2013, IR professionals were asked to assess how satisfied they are with the quality of their sell-side analyst coverage on a scale from zero to 10 (10 being completely satisfied, zero completely dissatisfied and five being neither satisfied nor dissatisfied). On average, respondents rate their satisfaction at 6.4, with most (44 percent) saying they are ‘fairly satisfied’ and rating the service between six and seven. When it comes to market cap size, bigger companies, which have more analysts following them, express a higher level of satisfaction with the quality of coverage. Mega-cap companies, which have an average of 29 sell-siders covering them, are the happiest, scoring their sell-side satisfaction at an average of 6.8 out of 10. Small-cap companies, however, rate it at only 6.1 out of 10 on average. The trend collapses when you consider the results by region, however: European small-cap companies are among the happiest with the quality of their sell-side coverage, rating it at 6.5 out of 10. Asian small-cap firms, by contrast, rate their satisfaction of research quality at just 5.5 out of 10 – the least satisfied group across all cap sizes and regions covered by the research. |
There are a number of firms that will happily write regular updates and distribute them to the market for a flat fee, though not all providers offer an equal service. Deciding whether to pursue issuer-sponsored research – and from there deciding which service provider to use – is a ‘multidimensional issue’ with a number of implications, says Darrow. ‘Various factors to consider include the IR program budget, the reputation of the authoring firm or analyst, the complexity of the company’s business and the ability of an analyst to accurately assess the market, among other areas of importance,’ he says.
‘It is important to know the analyst’s track record and mastery of market subject matter. A company’s ability to meet projections may materially affect its share price, and managing an analyst to provide accurate estimates that are not damaging may be more work than the coverage is worth. This scenario may be further negatively compounded if you are using a ‘paid’ research firm.’
Darrow adds that, as with finding an analyst directly, among the most important considerations is to find the best company not only to produce the research, but also to distribute it widely and efficiently.
Academic research backs up the value of paid-for reports. In 2006 the SEC’s advisory committee on smaller public companies officially endorsed the practice, noting that it was ‘critical to the success’ of smaller issuers. Following that, Marcus Kirk at Emory University’s Goizueta Business School investigated the issue using a sample of more than 500 US companies and 6,000 reports.
According to the paper, entitled ‘Can companies buy credible analyst research?, company-paid research is a ‘viable’ option for firms that lack analyst coverage because reports tend to include vital ‘information content’ for investors. The paper also notes that such reports help capture liquidity, institutional investment and additional analyst coverage. Reports put together by ‘high-credibility’ companies – defined as pure research companies where analysts are not allowed to hold or trade stock – have a much greater impact on stock performance, turnover, institutional ownership and sell-side coverage, Kirk reports.
That said, the perception still exists among some companies that if an issuer is paying to be covered, there is potential for bias. Yet as Darrow points out: ‘All research is in some way being paid for. Brokerage firms often initiate research coverage on companies they provide with investment banking services where the fees have been substantial.’
More significant, he suggests, is a consideration for the ‘traction’ the analyst or company has with the buy side, and whether or not research is carried by consensus information service providers. ‘Buy-side traction likely is, for most practical IR purposes, the highest priority when pursuing any type of research coverage, particularly if a company is directly paying for it,’ he concludes.
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