Intelligent IR: Research-Driven Investor Relations for Small and Microcap Companies [Guest Post]
Guest Post By: Joshua Levine & Robert FerriOn January 3, the European Union’s ambitious regulatory reforms, known as MiFID II, took effect. While the aim is to create unprecedented transparency and curb conflicts of interest, the regulation is upending security markets.
Central to MiFID II is bringing accountability to the market for investment research. Under the new framework, asset managers and other institutional investors will have to make discrete payments for research. In essence, regulators are trying to unbundle research costs from trade allocations to the greatest possible extent.
In the United States, fund managers are beginning to embrace MiFID, arguing that Europe’s rules would likely trim costs and pierce the opacity of Wall Street billing practices if applied in the United States.
If this regulation is adopted by American investment banks, it could cost companies with market caps below $1 billion access to institutional investors—in the form of non-deal roadshows—and make securing research coverage even more difficult than it is today.
“The impact of MiFID II on listed small- and medium-sized companies has the potential to be devastating if independent research coverage ceases or is significantly diminished,” according to the London-based Toscafund Asset Management, a $3.5 billion asset manager.
Small- and micro-cap companies in the United States have long suffered from a dearth of analyst coverage. As far back as 2012, a published study reported that 55 percent of companies with market caps below $250 million have little coverage or have been completely orphaned by Wall Street. By most accounts that figure is higher today, and MiFID’s influence will make the situation worse.
These orphans pay a price in numerous ways, but it is most directly manifested in valuation. In the United States, a 2017 study of small-caps by Jefferies found those with no analyst coverage tend to underperform the overall stock universe by 4.2 percent annually.
More troubling is the high number of corporate management resigned to status quo. Outreach to Wall Street has largely become a paint-by-numbers exercise where smaller firms go through routine efforts without injecting the least bit of creativity or strategic analysis into the process.
Traditional investor relations programs do little to raise a company’s profile among institutional investors and analysts, affect share liquidity and price, or improve prospects for attracting capital. These programs are often ill-suited for small companies struggling to raise money from one financing to the next.
Publicly-Traded Companies Should Act Like One
It has become commonplace. Corporate executives of micro- and small-cap firms complain about the expense—roughly $2 million annually—of being a public company. Citing everything from regulations and filings to legal and accounting costs, the burden of maintaining the infrastructure to support a public vehicle erodes their bottom line.
But consider this: If you cannot achieve a return on investment of that $2 million, it’s likely you should be not public. What might just as easily be said is, if the management cannot achieve that return, it shouldn’t be overseeing a public company. Once you are a public company, it’s too late to complain about the burdens of being public.
Corporate insiders go through the exercise of weighing the pros and cons to determine whether becoming publicly traded is advantageous. But let’s take a quick review.
By being public, your company gains prestige and visibility, while the market provides a valuation of the company daily. Other advantages are access to funding that does not have to be repaid, and the ability to use shares to finance acquisitions and incentivize employees.
There’s more. Shareholders benefit from holding shares that, subject to certain restrictions, provide liquidity, and are usable as collateral for loans. Shares that are publicly traded command higher prices than shares in private firms, and public company management tends to be compensated better than their private counterparts. Overall, the positives help support a strong case for being public.
Still, there is another side beyond the costs related to maintaining a public company and the time dedicated to ongoing reporting requirements of regulatory agencies. Public companies must answer to far more people compared to private companies.
Important management decisions often require board approval, and sometimes the approval from a majority of the shareholders. Then there’s the Securities and Exchange Commission, which may require firms to reveal sensitive information, including business strategies, financial results, and executive salaries and compensation arrangements. Let’s not forget requirements to have financial statements audited on a regular basis.
Shareholders’ tendency to judge management in terms of profits, dividends, and stock prices may be the most stressful part of the job. This can cause management to emphasize short-term strategies at the expense of long-term goals and growth opportunities.
Short sellers are known to derail a company’s messaging and investor relations’ strategy, while activist investors may enter the picture and provide new sources of pressure, which happens in smaller companies more frequently than people realize. Some 71 percent of companies targeted by activists in proxy fight had a market cap of less than $2 billion, according to FTI Consulting.
To successfully manage all of the challenges of running a public company, management needs to learn from its supporters and critics alike, forging the skills to exploit the wide-ranging benefits of being public.
Embedding Fundamental Research and Market Intelligence in the IR Process
Decades of collective experience in researching, analyzing, and advising technology and life sciences companies has taught us that traditional investor relations programs are insufficient for companies off of Wall Street’s radar for them to win recognition of the value they deserve.
Deepening your knowledge of the competitive terrain and workings of capital markets, taking control of your communications to investors and other constituents, and executing an investor relations’ strategy driven by fundamental research and market intelligence will enable you to expand the investor base and improve Wall Street’s perception of your company.
One the most effective steps for Intelligent IR is preparation of the first tier of due diligence, serving as an on-ramp for analysts, bankers, institutional investors, and partners to engage. The goal of this continuous practice is to reduce uncertainty and build confidence in management’s abilities to meet and exceed expectations.
Also critical is identifying value drivers and creating situations and conditions in which the company’s valuation is optimized in the market. With an analyst’s perspective and Street savvy, Intelligent IR incorporates feedback from leading investors and prospects with insights into corporate fundamentals to position a company for attracting new and higher quality investors.
Together, these ongoing efforts are bound to yield positive results, leading to a better performing stock and ultimately to a valuation reflective of the company’s intrinsic value.
For Marc Andreessen of venture firm Andreesen Horowitz, valuation is ultimately connected to all aspects of startup and emerging companies’ shares, including employee morale, ability to recruit new employees, ability to retain employees, ability to sign customer contracts, ability to raise debt financing, ability to deal with regulators. “Every single part of your business ends up being connected and it ends up being tied back to your stock price,” he said.
Intelligent IR can help companies achieve a valuation reflecting a full understanding of their vision, diverse intangibles, and comparative standing relative to peers. By crafting strategies driven by research and attuned to analysts and institutional investors, small- and micro-cap companies can raise their valuations in a market that frequently overlooks them.
About Joshua Levine:
Joshua Levine is principal of Third Stream Research, which synthesizes macroeconomics, technology innovations, and research on companies at the intersection of the most powerful trends impacting valuations. Third Stream provides custom research, analyst expertise and actionable research ideas for the buy-side and sell-side. Levine also has a long-term affiliation with global research and advisory firm 451 Research as an advisor and editor for the flagship publication of the 451 ChangeWave Alliance, a 25,000-member research network whose industry-leading surveys provide insights on trends in consumer and business technology buying plans, and the direction of the overall economy.
About Robert Ferri:
Robert Ferri is founder and CEO of Robert Ferri Partners, a strategic advisory group that provides investor relations, reputation management, corporate transition and research services to selected public and private companies. Since 1997, Ferri has been co-founder, director or shareholder-advisor of two-dozen private companies and served as strategic counsel to 75 publicly traded companies. Ferri has managed initiatives to enable approximately 50 significant public-market transactions, including initial and follow-on public offerings; mergers & acquisitions; and fundraisings.
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