Riddle, Mystery or Enigma? Winston Churchill was talking about the potential for Russian military involvement at the outset of World War II when he uttered that now-famous phrase. But the concept
also describes how many small-cap management teams feel about the process of obtaining sell-side analyst coverage. Some companies manage a full roster of covering analysts, while others struggle to maintain or attract just a few. The bank research business model is in considerable flux, and IROs increasingly find themselves in the latter situation, frustrated by the limited return on their efforts to attract coverage.
Many factors contribute to the lack of adequate sell-side coverage, and they all relate to the sell-side’s inability to make money by working with small cap companies. Low trading volume plagues companies vying for attention from both the buy- and sell-side. Investors avoid low-volume stocks because they cannot easily get in or out of the stock, and the sell-side won’t cover a stock because the lack of buy-side interest limits its ability to generate trading commissions. A lack of investment banking business also will create a barrier to coverage. The bottom line is that a bank needs to make money in some way from the research coverage, because it isn’t being directly compensated by investors.
So what’s an IRO to do? Here are some helpful hints.
First and foremost, develop a solid pitch. Most sell-side analysts already cover a heavy load of companies, and their support team is often limited. This leaves little room for new companies in their coverage universe. When targeting analysts, you need to provide them with a compelling reason to be interested in your company. If they cannot see the potential for growth early on during due diligence, they are unlikely to move forward.
Set realistic goals and outline your systematic strategy for achieving them - but don’t overpromise. If an analyst initiates coverage early on, he or she can create a solid reputation as the company grows and delivers returns to investors. Analysts want to see a clear path for how the company is going to generate revenue, improve margins, and achieve other targets during the next three to five years. Analysts remember these promises and will challenge you on them later and use them to benchmark your success.
Small banks cover small companies. Micro- and small-cap companies should focus on targeting boutique sell-side firms for a better chance of success. Some boutique firms prefer to find under-covered stocks and be the first to initiate coverage. There are two main reasons for this. First, if boutique banks establish a relationship early on, the company is more likely to include them in future banking deals. And second, analysts’ coverage can have a greater impact than when there are a large number of banks covering a large-cap company.
Build the relationship. Attending conferences and participating in non-deal roadshows with non-covering banks is one of the most effective strategies for attracting new sell-side coverage. Your management team should be prepared to attend a conference at the last minute, as banks will often extend invitations to companies they don’t cover when there is a cancellation. Nurturing a relationship with analysts takes time, and they need to see that there is buy-side interest in your company before taking the step of coverage. Think of it as a dating period.
Unwrapping the riddle
Obtaining sell-side coverage may seem like a mystery, but it’s one you can solve. Revisit your pitch and make sure it demonstrates a clear strategy for growth. Expand your universe of sell-side analysts to include boutique firms. And don’t be afraid to go on a few “dates” with different analysts in order to establish a mutually beneficial relationship that will ultimately result in coverage and greater exposure to investors.
David Calusdian, executive vice president and a partner at Sharon Merrill Associates, oversees the implementation of investor relations programs, coaches senior executives in presentation skills and provides strategic counsel to clients on numerous communications issues such as corporate disclosure, proxy proposals, shareholder activism and earnings guidance.