Sell Side Coverage, Part 2

A couple of weeks ago, I wrote about the relationship between Sell Side Coverage and a company’s ability to generate commissions. The long and the short of the article was that the sell side is paid via commissions and therefore, the more trading volume your stock has, the greater the likelihood a sell side analyst will cover your company. This is bad news if you are a small capitalization company, as the volume of commissions generated by your average daily trading volume will not make you a high probability candidate for coverage.

So if you are a small cap company, the question becomes, can you achieve any meaningful sell side coverage? The answer to this is yes, but like so much in life, in order to achieve your goal, you must be willing to spend a good deal of time and effort in order to get where you want to be.

There are a number of approaches to this, but in the end, they all come down to doing things that make you more attractive to the sell side. First, you can institute a marketing campaign to make your company more known to the sell side. This means reviewing who covers your peers and others in your industry and contacting them regarding your company’s investment thesis. While this alone is unlikely to result in sell side coverage, it does get you on the radar screen and raises your profile with the sell side. It also helps if you can present the sell side with a compelling reason to follow your company, such as a unique market niche, product or approach your company has that will enable the sell side analyst to be more knowledgeable about the industry than his competitors.

Second, you can make yourself more known to the sell side’s clients, the buy side. This involves the somewhat labor-intensive task of segmenting, targeting and positioning the company’s message to the buy side community followed by lots and lots of mostly fruitless phone calls. The result of this can be two things that will get the sell side’s interest: more trading in the stock and more questions about the company from the buy side. In this process it is wise not to ignore the IR officer’s anathema, hedge funds, as that is where a significant portion of today’s stock trading volume resides.

Next, you can make your management more accessible to the sell side. This may help sell side analysts fill in gaps in their knowledge about the industry and your company’s position in it, or may give them more product knowledge. As the sell side is expected to be experts in all aspects of the industry they cover, helping them gain more knowledge will put you on their radar screen. Additionally, doing a sell side analyst’s conference or using them to help arrange non-deal road shows allows them to show the buy side that they have management access, something they do get compensated for by the buy side.

One thing to keep in mind about this process is that it takes time and commitment from company management to raise the profile with the sell side. If a company has a dedicated investor relations officer and that person has a good working knowledge of how the Street operates, and the willingness to spend the time, then it can be done in-house. If, however, like many small cap companies, the CFO is filling the role of principle spokesperson to the Street, then it makes a lot of sense to hire an outside IR advisory firm to do the heavy lifting described above.

(Full and fair disclosure: the author is a consultant for Three Part Advisors, an investor relations strategic communications and consulting firm.)

Proxy Access - Who Benefits?

There is a famous Latin saying, “Cui bono?” that was used in Roman trials to help determine the underlying truth of a matter. The phrase translates into “To whose benefit?” and is meant to suggest the possibility of a hidden motive or that the party responsible may not be who it appears to be at first. And so it is with proxy access, recently adopted by the Securities and Exchange Commission.

The thinking behind proxy access appears pure at first – to promote shareholder democracy by letting shareholders utilize the corporate proxy statement rather than go through the expense of mounting a proxy campaign of their own. But over the years, I’ve come to be suspicious of anything that drapes itself in motherhood and apple pie, whether it comes from the right or left side of the political spectrum, and so I started to think about who really benefits from proxy access.

As I understand the new rule, shareholders who have held at least 3% of a company’s stock for at least 3 years will be able to nominate up to 25% of a company’s board of directors using the company’s own proxy statement. So I guess this is a move to open up corporate boards to shareholders, but I wonder, which shareholders?

Retail? Certainly not retail shareholders; for the most part they don’t reach the 3% threshold.

Hedge Funds? Unlikely, as the turnover in their portfolios means that it is doubtful they will hold stock for 3 years.

What about activist investors – might this new rule inure to their benefit? Possibly, but not to a large extent. A paper entitled “Hedge Fund Activism, Corporate Governance and Firm Performance” suggests that the median holding period for activist hedge funds is 556 days, or 18.5 months. While this might be longer than you thought, it is still only half the time required by the new rule.

Mutual Funds? I suppose mutual funds might be a beneficiary of the new rule, but I’ve never known them to take an interest in nominating directors.

So who’s left? What entities have the financial muscle to hold 3% of a company’s stock for 3 years? What entities have exhibited a desire to use the proxy system to agitate for their own agendas? The answer is: Foundations and Pension Plans. Of these the bulk of the money is represented by pension plans. Add to that the fact that, according to The Wall Street Journal, four out of five for profit corporations have moved away from pension plans, while unionized employees both in the private sector and government, have fought to retain their fixed benefit pensions and the picture of who benefits starts to become clearer.

Least you were in doubt on the issue, consider also that the SEC adopted the rule in a party line vote, 3 democrats for and 2 republicans against. Suffice it to say that republicans don’t get many campaign contributions (or votes) from union members. Finally, consider two of SEC Chairwoman Shapiro’s key appointments to the Commission staff: senior advisor Kayla Gillian, former general counsel at Calpers, the California state workers pension fund, and Richard Ferlauto, former pension director at AFSCME, the union representing state and local government employees nationwide to the investor advocacy office.

Add it all up and it becomes clear that who benefits under the guise of shareholder democracy for all is really a limited number of unions. Now instead of spending union member’s dues in proxy contests they can lay that cost off on the corporations. It’s a nice deal if you can get it.

Getting Useful IR Data for Free

Occasionally, while doing research on the web for something I’m working on, I will run across something that I didn’t know about, pause, and think, “Huh, I wonder if I’m the only one who hasn’t known about this until now?” Such was the case recently when I was engaged in research about the change in ownership of a company.

There is a web site, www.whalewisdom.com that I have found to be very useful in tracking change in investor ownership. The improbable name comes from (I think) the fact that they attempt to follow the investments of some of the largest hedge funds, the whales, and derive some measure of wisdom from what they are doing. The site is set up to help investors track the holdings of hedge funds, but it is also very useful for tracking the change in investor ownership of companies as well. The site has compiled data from SEC filings about investor ownership in companies and put it into reasonably useful form.

As most investor relations officers in the U.S. know, the Investment Advisors Act of 1940 requires that all investment advisors with assets under management of over $100 million file a report of their holdings on a quarterly basis with the SEC. The quarterly reports are known as 13 F filings and are helpful in understanding your company’s shareholder base. There is an entire cottage industry of firms that provide this sort of information to investor relations officers. Generally, this information tends to be expensive and bundled with lots of other services. The advantage of the Whale Wisdom site is that it’s free – and you don’t even have to register to use it. In this day and age of constrained budgets, that’s a big advantage.

There are several useful things you can do on the web site. You can select a company, yours, your competition or some other company, and see who owns them. You can look at ownership changes over time, as the information on filings goes back to September 30, 2007. I find this particularly useful, as when you look at a whole year’s worth of data, trends become much clearer then if you are looking at a single quarter. Are good, solid, long-term holders trimming their positions? Are more hedge funds moving in? Are you losing growth investors and getting value investors in their place? (I’ve seen this with several companies I follow closely as they have hit the wall on organic growth. When you start seeing lots of value investors, you know the P/E ratio will be a long time recovering.) You can even download the information to an Excel spreadsheet if you want to manipulate the data further.

Often times the investors themselves won’t tell you what they’re doing – the larger funds are particularly sensitive to this – so it’s up to you to figure it out. If the type of investor you are getting doesn’t match your story, it’s time to sit down and reconsider reality.

Another nice thing the site does is allow you to type in the name of an investment firm and see their holdings. So if you’ve got a new investor you’ve never heard of before, you can go see what else they own and get a feel for their investment style. You can sort their holdings to see how important you are in their investment universe. You can even see if the firm has any 13D filings, indicating the possibility that they may be a more active (read hostile) type of shareholder.

Due to the schedule of 13F filings – 45 days following the close of each calendar quarter – the information is not up to the minute. You wouldn’t want to rely upon it if you were in the middle of a proxy contest. But if you are interested in looking at longer-term trends in your company’s stock, this site is helpful. And the price is right.

Personal Note: Investor Relations Musings is taking a vacation next week, as I join 8,000 of my closest friends biking across the great state of Iowa in the rolling party known as RAGBRAI. If you are a faithful reader, do not fear, the blog will return in two or three weeks, as soon as I’ve had a chance to recover from my vacation.

The Shifting Sands of Activist Investing

For about the past 6 – 7 years there has been a quiet revolution occurring in corporate governance. It has been an interesting process to watch as shareholders, usually led by union pension funds, have pushed for reforms in anti-takeover provisions, executive pay and director elections.  

The fact that it is the unions pushing for reform strikes me as ironic.  Regardless of how you feel about the need for collective bargaining, unions are not known as reforming forces.  Many union pension plans, in particular, have been grossly mismanaged, so for them to lead the charge for reform in corporate governance seems to be rich indeed.  When I gave this some thought, my conclusion was that a governance system has to be pretty broken for a group of union people to see an opportunity for reform.  So I took a hard look at the issues they chose to contest. 

Start with anti-takeover measures.  Companies usually experience a takeover bid in the form of an offer to purchase the company’s stock that is higher than the current stock price.  So anti-takeover measures, when all is said and done, are designed to allow management to turn down an offer that is higher than the current market price, but less than the managers think the company might be worth sometime in the future.  Presumably this is because the company managers know more about the company than the market and are in a better position to assess the true value of the company.  But wait, aren’t markets supposed to be efficient and incorporate all available information about a company into the stock price?  And aren’t managements supposed to disclose all material information about the firm to investors?  So anti-takeover measures really boil down to company management saying we want the ability to say no, because we believe that our two birds in the bush (the future value of the company) are worth more than the bird you have in hand (the takeover bid), because of information which we haven’t bothered to disclose, but which could make us real valuable in the future.  Sounds like a losing issue to me. 

Executive pay is an issue where corporations ceded the moral high ground a long time ago.  The pay packages you see for most CEOs of major corporations today are obscene.  The irony here is that the unions have persuaded Wall Street money managers, who often make almost as much as CEOs, to vote for reforms aimed at lower pay.  Maybe there’s a touch of envy involved. 

Finally, think about director elections.  I lived in Chicago for many years, so I’m not shocked by elections that are lopsided in favor of incumbents.  But under the current system for electing directors, you only need a single vote in favor of the director to get him elected.  You can’t vote against him, you can only withhold your vote.  This bears a strong resemblance to the old Soviet era politburo elections. 

If this were just about the obscure ways in which companies conduct their internal workings you could file this piece under important, but boring.  However, it seems that by allowing activists to learn how to win votes on easy issues, corporations are now starting to encounter a more sinister foe. 

According to a speech given by John Siemann of Laurel Hill Advisory Group at the NIRI 2008 Southwest Conference, hedge funds have become much more involved in the proxy activist arena.  ISS, the proxy advisory firm, now counts almost as many hedge funds as clients as it does union pension funds. For the hedge funds, the preferred method of attack is the “Short Slate” proxy fight, where an activist hedge fund nominates one or two directors for the board.  Once on the board, the new directors use their positions to agitate for items that may boost the near term stock price, such as special dividends, share repurchases and the sale or spin-off of non-core assets, at the expense of longer range initiatives.  According to Laurel Hill statistics, in 2006 – 2007, there were almost 200 short slate fights and in more than 66% of these situations, hedge funds won at least one seat on the board. Moreover, in almost 80% of the contests, ISS recommended in favor of at least one member of the dissident slate.  

So it would appear that having allowed the camel’s nose under the tent on issues that were hard to defend, corporations now find that they have provided a road map to investors to actively challenge the manner in which a corporation is being run.  I guess you really do reap what you sow.

Investor Relations Year in Review

Like Jimmy Buffet, I sat down last weekend just to try and recall the whole year; all of the faces and all of the places, wondering where they all disappeared. Unfortunately, unlike Jimmy, I didn’t run into a chum with a bottle of rum, so I wound up sitting right here. Writing this post, I may add. Herewith a quick review of some of the more notable things I noticed in the world of investor relations this year coupled with Palizza’s Predictions for 2008:

The World is Going Electronic: The SEC ushered in the era of more aggressive electronic delivery of proxy materials in 2007. Previously, shareholders could opt-in for electronic delivery of the proxy statement and annual report. Relatively few did. Now, companies can force them to opt out of electronic delivery. The first big annual report season for this new delivery method will occur in the Spring of 2008, and given the cost savings in printing and postage involved, most companies will make economically rational decisions and force shareholders to take action if they want to receive a paper copy of the annual report. After all, investor relations reports to the CFO, not marketing. Annual report printers everywhere have to be very concerned about the disappearance of the traditional printed annual report. Companies will like the cost savings and designers of annual reports should be neutral on the subject.

Hedge Funds and Activist Investors have a Bifurcated Year. The first half of the year saw lots of activity by hedge funds and activist investors. Deals were easy to come by and the credit markets were loose. Company managements were always looking over their shoulders to see who was sniffing around. All of this came to a screeching halt in the second half of the year as the sub-prime mortgage crisis caused the credit markets to lock up. Companies that have been underperforming or that are particularly subject to financial engineering because they have underleveraged balance sheets have gained a bit of breathing room. If they’re lucky, investor relations officers will be able to focus more on the longer term fundamentals and less on the short term trading trends in 2008.

A Corollary to the Credit Crunch: Look for the M & A pendulum to swing back in favor of strategic corporate purchasers over the next year or two, until the credit hangover eases. Of course, corporate purchasers will have to try and overcome the heightened price expectation of sellers who have seen the multiples financial buyers paid over the past few years. That should make for some interesting investor relations spiels from IROs as they attempt to justify the price being paid.

The U.S. Dollar weakened throughout the year against the British Pound and the Euro. U.S. equities must look like relative bargains to investors in Europe. On the other hand, whatever gains European investors had in U.S. equities this year were probably wiped out by currency conversions back into the Pound or the Euro. (The market giveth, and the market taketh away.) Look for more interest in U.S. equities from European investors in 2008 provided they start to think the U.S. dollar is at or near the end of its slide.

Four predictions is about all I can handle, so I will close out with best wishes for a happy holiday season for all and a prosperous new year. May the markets be kind to you in 2008!

An Investor Relations Fable

Many years ago a young man from a rich and prosperous family was charged with safeguarding the jewels of the family. He thought long and hard about the best way to preserve the jewels and finally came up with what he thought was a clever solution. He went out and packaged the jewels in a beautiful box. Then he dug a hole in the ground and put the box with the jewels in it and covered it up. On top of the spot where the jewels were, the industrious young man planted a flowering bush. Whenever he was asked about the jewels he described how beautiful they were and how well packaged they were in their box without actually taking the jewels out to show anyone.

Over the years the man, through all types of weather and storms, watered and fertilized the bush, being sure to use plenty of organic manure. The bush grew tall and wide until it was a hedge stretching from one end of the family property to the other. People came from all around to view it and sit in its shade.

Finally, one day many years later, the man came back to retrieve the jewels in order to pay off family debts. In the course of trying to dig out the jewels the man found that the roots of the hedge had grown tightly around the jewel box. While yanking and cutting at the roots, the hedge fell over on the man and crushed him to death.

Moral: The care, feeding and removal of hedge funds is a risky business.

The Death of Investor Relations?

The Death of Investor Relations?

The basic premise of investor relations is simple and works in conjunction with the efficient market hypothesis. In short, good investor relations helps to bring clarity to how a company makes its profits and its future prospects for earnings. The market assimilates this information, together with all other information and arrives at an appropriate valuation for the company’s stock. In short, the more information available, the better the value of the company is reflected in its stock.

There is however a curious phenomenon occurring at least with respect to one company; Sears Holding Corporation is saying less and being rewarded for it. I call it the Mies van der Rohe school of investor relations. (For those not blessed with a liberal arts education, van der Rohe was one of the founders of the modern school of archtecture and one of his more famous sayings is “less is more”.) If you look at Sears’ public disclosures, they file a press release and a 10 Q or 10 K. And they post a lengthy letter from the chairman on their web site. That’s it. No conference call. No PowerPoint slides. Not even (heaven forbid) an investor relations contact person. It’s as if Sears is saying, “It is what it is – figure it out for yourselves”.

And how has the market reacted to this lack of detail? In the past year the stock has gone from $145.43 to $178.31, a gain of 22.6% on operating earnings that are up 18.8%. In short, the lack of detail appears not to have harmed the stock at all.

Now, I’d be the first to tell you that one company does not a trend make, but consider that Sears Holdings’ chairman is Eddie Lampert. Mr. Lampert has a history of being on the cutting edge of things: his hedge fund, ESL Investments, was one of the early hedge funds and was also one of the first hedge funds to become an activist investor, first with Auto Zone, then Kmart and now Sears.

Investor relations officers, watch out. Could it be the smart money is saying that more transparency is a sucker’s game?