Investment Community Research HARNESSING IR S POWER TO IMPACT A COMPANY S VALUATION Investor Insight 2013 Rivel Research Group. All rights reserved. RIVEL RESEARCH GROUP JANUARY 2013 No part of this publication may be reproduced in any form or by any means, without permission in writing from the copyright owner.
What drives valuation and helps lower the cost of capital? There are any number of popular culprits: managerial prowess, strategic acumen, favorable secular trends, R&D breakthroughs signaling growth potential, a track record of financial success, reliable returns the list goes on and on. But for all of these value drivers, there is a very simple common denominator without which the institutional investors who have the power to move your stock price are immobilized knowledge. Given the intense competition to gain a sparkle on the buy-side radar screen, it is imperative for public companies to ensure that investors are endowed with as fully comprehensive array of information and insight as possible. Doing so facilitates and prompts informed investment decision-making by the investment community.. If the story has not been communicated effectively, if the facts are not readily at hand, if the right senior executives have not been made available, full investor knowledge is not achieved and fair valuation could be compromised. Enter investor relations (IR), perhaps one of the most underappreciated and underrated sources of knowledge and purveyors of company investment insight. Think of all the money, the millions upon millions spent every day marketing products and services to the general public, consumers and business-to-business clientele. The new product and concept tests, the national ad campaigns, the PR initiatives, the lobbying the cost is staggering (and rightfully so). IR, more than any other venue, is the road by which investors learn about a company s investment appeal, stay current on important developments and receive the insights necessary to support informed and favorable investment decisions. By comparison, however, one of the most powerful audiences commanding day-to-day influence over a company s market value often times doesn t get its proper due the institutional investment community. The amount of money spent in capturing the attention and support of the buy-side pales in comparison to these other well-established forms of corporate outreach. Simply put, IR warrants the greater emphasis and focus typically lavished on other marketing initiatives. After all, it is charged with marketing something equally as important as any product or service its currency the company s stock. Around the world, a typical IR budget for a mid-cap company one with a market capitalization of say, $1 to $5 billion dollars often is not much more than $500,000, not even enough money to pay a couple lobbyists or buy 30 seconds of advertising time during the Super Bowl. Investor relations officers (IROs) often have to fight tooth and nail for their fair share of a budget a company allocates to external communications. It shouldn t be this way. Research shows that IR has an undeniable impact on valuation. This is because IR, perhaps more than any other venue, is the road by which investors learn about a company s investment appeal, stay current on important developments and receive the insights necessary to support informed and favorable investment decisions. These are the very decisions which drive valuation. 2
Measuring the IR effect The institutional investment community believes in investor relations. They accept IR as an essential conduit to the inner workings of a corporation (management s mindset itself at times), and its investment appeal. When asked to identify the sources of information they value most when learning about investment opportunities and, more significantly, when making investment decisions, buy-side analysts and portfolio managers invariably rely on the bevy of intelligence coordinated by the investor relations department. This includes earnings calls, management access, face-to-face meetings, roadshows, conference presentations and the IR website. Investors look to IR as an invaluable resource in which to corroborate the often bewildering array of material information available to them on the hundreds of companies that they follow. In short, IR is the gatekeeper to much of the unadulterated intelligence they require to support their investment decisions. 70% Percentage of US institutional investors that believe IR has a meaningful impact on a company s valuation Accordingly, the buy-side believes investor communications has a tangible impact on a company s valuation (one that is even more pronounced when a company is burdened by IR that is perceived to be poor ). Earlier this year, a nationally representative sample of 164 US buy-side analysts and fund managers from various industries and with an array of different investment objectives, were surveyed on, among other things, whether or not good IR has a meaningful effect on a firm s stock price. The results were convincing. Better than two out of three (70%) said they believe it does. As a few respondents pointed out: Companies have no idea how much impact the personality of the individual IR person affects the view of a total company. If they chose an experienced person in that role, it pays back in spades, but they can t see it. Yes, it affects how people perceive the company. They are the voice to the Street. Buy-side analyst If it is good IR but the news they have to communicate to me is bad, then even if the stock doesn t sell at a premium, maybe it makes me more interested in buying the stock in the future. Ultimately, the quality of the IR is kind of important in my investment choices. Buy-side analyst When asked to quantify this impact, the results were quite compelling and have been so on a consistent basis over the last five years. In 2012, the US buy-side believes IR accounts for a total variance of 30% in a company s valuation ranging from a premium of 10% for superb IR to a discount of fully 20% for poor IR. -20% The Poor IR Discount 3
While the premium associated with top-notch investor communications is impressive (a consistent 10% bonus), the valuation penalty of ineffective IR is far more dramatic and appears to ebb and flow with the economy. It peaked at a negative 25% in 2009 at the rock bottom of the global economic downturn, lessened as the economy recovered in a fitful manner in 2010 and 2011, but has again ramped as macro uncertainties persisted and fear of a double-dip recession once again intensified. The chart to the right illustrates these findings. The evidence of IR s power extends well beyond the United States and is felt even more acutely in other countries. For example, the delta between good and poor investor relations is 33% among investors domiciled in Europe and fully 40% for those based in Asia-Pacific countries. It is worth noting that European and Asian institutional investors are more apt to attribute more upside impact to the valuation from effective investor relations. At a minimum, these data points reveal sufficiently compelling evidence so as to warrant companies to re-evaluate their investor relations effort and the corporate resources devoted to it. Any impartial cost-benefit analysis demands it. But paying lip service to a commitment to proactive investor outreach, regardless of how well intended, is the easy part. This includes touting unrivaled responsiveness (gamely promising same-day or 24-hour turnaround on any and all investor inquiries) or hiring seasoned, highly-respected IR professionals. Superb investor relations requires much more. Some of the touchstones of a superb IR program include an ongoing commitment of time, effort, forthrightness, transparency and robust disclosure as well as a C-suite that regularly avails itself to the investment community. Only those companies with IR programs that are firing on all cylinders will reap the full valuation benefits (while waylaying the negative effects of poor IR). That said, an optimal corporate IR program should in no way come at the expense of peak operational execution by the C-Suite and management. No one on the buy-side expects or advocates this. Rather, investors are advocating ensuring that the essence of a company s investment thesis, its strategy, key risks, benefits and opportunities are widely known so that 4
informed investment decision-making is triggered rather than decisions made on supposition and incomplete information available from external sources. There are some fundamental expectations of the C-Suite: Management Access Despite the C-Suite s natural aversion to roadshows or one-on-ones, there is no substitute for direct management interaction with the buy-side. Certainly, the IRO can play the proxy CEO/CFO at times and advise investors about the investment merits of a company s stock. But when it comes down to brass tacks, the one-on-one meeting with senior management is often a buy-side-mandated prerequisite. It is an absolutely invaluable means by which investors investigate and weigh the pros and cons of a company, to personally test the mettle of a CEO or CFO (kick the tires if you will) in deciding whether to invest, to sustain or add to an already existing position or sell a stock in favor of an alternative investment. I will not take a position without meeting with management. We have a policy that we will not buy a company s stock unless we ve met management recently. It s a nonstarter if we don t. It isn t important before I take a position, but it is important before the position becomes a large position. We can take the position and meet with them later. There s how I feel about it and there s reality. How I feel about it is absolutely essential. Reality is that I don t always get that opportunity. If it s a company that I am totally unfamiliar with, then I would like to meet management. I ve been managing portfolios for over 30 years, so if I have knowledge of the company and know the management and what they ve been able to produce in the past, then I am less likely to require a meeting. If there s a new management that just took over, then I would require it. For reasons such as these, companies that do not facilitate direct interaction between senior management and the buy-side risk alienating one in three North American investors (36%), virtually half of those based in Europe (48%) and fully three-quarters of those domiciled in Asia- Pacific countries. As the following chart indicates, these are the proportions of institutional investors around the world who earlier this year stated that they would still need to meet senior corporate management before buying a given company s stock, even if the IRO was able to answer all their questions about its investment appeal or thesis. Clearly, it is a mistake to hire a skilled IRO with the expectation he or she will obviate any need for the CEO and CFO to regularly meet with the Street. 5
Moreover, one meeting very often is not enough. Buy-side analysts and investors the world over usually don t invest in a stock after a single management session, even if that meeting was with the CEO or CFO and considered highly informative or beneficial. The natural inclination of many investors is to weigh the merits of taking a position in a stock over time, often seeking to test the management waters more than once before taking the plunge. From another standpoint and using an even more compelling analogy, it is a rare circumstance indeed when people decide to marry after a single date. Accordingly, fulfilling investor requirements for superb IR and the requisite amount of management access mandates extraordinary patience on the part of CEOs and CFOs and the empathy to put themselves in the shoes of potential investors who quite naturally resist making what they may believe is a hasty decision. Just because a fund manager does not invest in the company after a one-on-one meeting does not mean the session was not a success. The manager in question is often simply processing the information that has been disseminated and carefully weighing the pros and cons against a myriad of possible alternative investments. Furthermore, there are often times other considerations that weigh into the timing of a buy decision, such as top-down industry concerns, macroeconomic concerns or valuation concerns. In such instances, managers want to have all of the due diligence complete so they are ready to act when they deem these outlier conditions to be optimal. An important rule of thumb to keep in mind is that it will usually take at least one, preferably two (from the perspective of the investor), management meetings before a portfolio manager can summon the confidence necessary to invest in a company perhaps even three if you happen to be targeting an investor in one of the Asia-Pacific countries. 6
69% Transparency Mean: 2.3 2.1 2.1 3.1 Rivel Research Group 2012 To earn the premium associated with top-notch IR, senior corporate management also must scrutinize and consider enhancing the quality of the information it allows to be disseminated to the investment community. After all, no matter how capable the IRO, he/she can only share company insights and data (and be exceptionally articulate and responsive in delivering it when requested) that first has been approved from above. The key variable is a willingness to go beyond simple disclosure and commit to greater transparency in financial communications. Now, one might wonder what the difference is between disclosure and transparency. There is a big difference in the eyes of the investor. Investment professionals define transparency as clear, unambiguous information through which companies articulate definitive strategic goals, why they are important and the drivers governing their achievement. In essence, it s the clarity of message that brings forward key Being transparent when times are tough goes a long way and is genuinely appreciated by the investment community. challenges, how they are being addressed and the frank, forthright discussions of the company s prospects in both good times and bad. That last part is quite important given the macroeconomic and industry challenges that roil the equity markets. Being transparent when times are tough goes a long way and is genuinely appreciated by the investment community. On the other hand, investors are becoming wary of disclosure that they perceive to be focused on providing routine data, metrics, and operating figures on the many facets of the company in the financial realm. But what they often crave is insight into market share data, product development, the pipeline, competitive advantages, etc. All too often, disclosure in itself provides insufficient color or interpretation on management s part. A company can supply mountains of data on their operations, but fail to provide any discussion or insight into what it 7
means now or in terms of future performance. They look to the company to provide the what does this mean and the company s interpretation lessening the potential for misguided investment community conjecture. Black is always preferred to gray. For example, how they are connecting the dots between A and B (A being where they are now and B being where the company expects to be in the future). Also, it can t be stressed enough that the key to having transparent communications is openness, honesty and frankness. If I get transparency from them, that s good. Transparency is really, really big for us. So understanding what it is that the company does. A pretty clear presentation on the future prospects and cost structure and operating leverage things like that. Buy-side analyst Straightforwardness. I m getting tired of hearing spin. I would say an ability to have an open discussion of the puts and takes around the various opportunities on the income statement margins, costs, revenues. I would say an ability to articulate the long-term plan with detail. Their ability to answer our questions thoroughly. The receptiveness to meet with and talk with potential investors. And those individuals that provide information above and beyond financial statements. What I mean by that are presentations, conference calls and roadshows. Buy-side analyst- Being candid. I think that is the number-one thing. To be very candid with the investors. Not giving us a line of bull. And not dodging questions. These are tough issues these days so there are tough questions to be answered. If they are very candid in their answers, for that they get respect. Buy-side analyst- Guidance The subjects of guidance and transparency are tightly intertwined. A definitive element of transparency to many on the buy-side is having a company s own perspective on the future, how the strategy will play out in terms of financial and operational performance. At the same time, guidance allows issuers to proactively set the agenda with which a company s investment appeal is judged, as opposed to letting others, most notably the sell-side, determine it. While not all companies supply guidance and many buy-siders can be tolerant about not receiving this type of forward-looking insight, guidance is often perceived as a critical distinguishing element of superb IR (of course when done with care, prudence and a keen eye 8
on not over-promising and under-delivering). Providing guidance is an attribute that can elevate the investor communications caliber of one company to a notch above that of its peers. Guidance sets the stage for bolstering the allimportant rating of management credibility (the single most important driver of investment decisions over the last decade) through the setting of key goals, the time frame by which they are expected to be achieved and the communication of success when the goals are realized. CEOs who consistently do what they say they are going to do are the darlings of the investment community and nicely set the stage for maximizing the size of their captive audience. To retreat from active engagement with the investment community will only serve to fuel rather than diminish concerns which may, and often are, blown out of proportion in the absence of nuanced strategic insight and prudent guidance. The 2008 market implosion has significantly altered expectations about guidance. It need no longer be all about earnings. Relative to a set of five types of corporate insight, earnings guidance actually ranks fifth today. What the investment community is looking for is qualitative insight on the strategy as well as important operational metrics. When will a new plant be operational? How much is expected to be spent on R&D? How are you going to execute your strategy to achieve the goals you have outlined? As the equity markets have churned and the economy given no signs of strong recovery, investors increasingly have been saying help us to connect the dots. So while it is difficult to strike a balance between too much information and too little, studies show that investors do understand the competitive nature of the business and are aware there s a fine line there. What they prefer is a sufficient level of disclosure surrounded by a discussion on what management thinks about it, not volumes upon volumes of filler (read: 9
useless) data. They seek management s take on the data and how that will translate into future financial performance. After all, managements theoretically have the best vantage point into what s going on in their company and their industry. The obvious challenge lies in further clarifying future goals without divulging competitive insight, regardless of whether or not management thinks that what they are giving is adequate. Since the IR program is almost always viewed as an extension of management, if a company wants that premium of 10%, then developing a superb IR department means having to provide transparency in their communications. It s not necessarily MORE information, but rather, the right information and the right level of transparency This is our strategy, these are the key elements, this is some detail around those key elements, and this is how we think this will produce future financial performance. Without it, companies risk being judged on the poor side, and with the continued market malaise. Why run that risk when detailed and transparent investor communications are entirely possible with the right amount of work on the company s part? We're interested in managing for the long term, and we're adults there will be surprises, negatively or positively. The mistake is not providing guidance. If a company does not provide guidance, the Street is completely guessing and you do not have any idea as to what their earnings will be. Refraining from providing any guidance at all [is a problem]. When management has no insight on the future, that's always a bad sign. It's fine for companies to correct and update the guidance, because I don't expect 100% precision no one is superhuman but they should tell investors what's going on and why the numbers are moving in a different direction. Buy-side analyst In many respects, this article can be considered a call to action for CEOs and CFOs alike to work hard in guarding against marginal proactive outreach during difficult and unpredictable economic times rather to consider fortifying IR with additional resources (and a bit more of their own time) in the function s perhaps less-than-fully appreciated role of marketing the company s stock. To retreat from active engagement with the investment community will only serve to fuel rather than diminish concerns which may, and often are, blown out of proportion in the absence of nuanced strategic insight and prudent guidance. The resonance of a company s investment appeal is in large part dependent upon repeated exposure to the story, growth drivers and management itself. Investors clearly need to understand the underpinnings of a company s success in good times and in bad, the strategies that will be deployed to soften any downward macroeconomic or industry pressure and the credibility management brings to bear. At the end of the road is the unique promise and enhanced valuation implicit in providing superb investor relations. 10