CHAPTER 13 Positioning IR to Succeed

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The often costly disconnect of information, from company to analyst, and

the gap between true value and the investors’ perceived value, can bring

people into the investor relations field. Those people should not only have

communications skills but also have the ability to understand the capital

markets and value companies as an investor would. Capital markets professionals

seem to have the best background for the job in that they have a

unique understanding of Wall Street and specifically how investment banks

operate. It’s tough to obtain that skill set in any other way.

STRATEGIC IR

An improved investor relations program, grounded in capital markets experience,

can help a company achieve a higher level of strategic communications,

which consequently should position a company for maximum equity

value at any given time. This expansion of multiple lowers a company’s cost

of capital, positions it for more favorable financing terms, broadens its potential

shareholder base, increases chances for analyst coverage, and increases

the wealth of all stakeholders, including employees.

In addition, everyone benefits when the IR function is approached with

firsthand capital markets knowledge. Analysts feel comfortable knowing

that all possible events, good or bad, will be communicated properly with

the right messages. Portfolio managers feel the same way because their investment

is presumably protected from a communications misstep. Finally,

management wins because they build credibility with the markets, a major

factor in determining multiple and valuation.

IR RESPONSIBILITIES AND OBJECTIVES

The type of IR described in this book requires that the team know how to

anticipate Wall Street needs and stock movements, be able to read financials,

model quantitative factors, appraise qualitative elements, garner sector and

industry intelligence, develop investment highlights, nurture capital markets

relationships, harness honest feedback, think analytically, and communicate

clearly and credibly, both verbally and in writing. It’s quite a basket of responsibilities,

requiring a professional who has strong buy-side and sell-side

know-how, the conviction and knowledge to convince a CEO or CFO of the

proper course of action, and the ability to act as a peer and confidant on

high-level business decisions.

Strategies to maximize equity value are specific to each company. Even

so, the process should be systematic and thorough. This section of the book,

Part IV, which gives an overview of this new way of practicing IR, is broken

down into three sections (see Table 13.1): Definition (chapters 14 and 15),

Delivery (chapters 16–20), and Dialogue (chapters 21–25).

All three aspects of IR, Definition, Delivery, and Dialogue, overlap, intersect

and constantly change because stock prices and valuation are always

changing. IR’s function is to integrate these three tasks into a cohesive, comprehensive

strategic discourse with the capital markets, one that supports

the mission of the company and prompts Wall Street to keep its vision on the

long-term goals and operating performance of the company.

DEFINITION

Every company needs to communicate who they are to the capital markets,

the media, employees, vendors, and so on. In order to do this, IR must undergo

a process similar to that performed by analysts and portfolio managers:

an IR audit. An IR audit deconstructs the current company view and

rebuilds it from the bottom up to create a story that serves as the company’s

face to Wall Street given the current valuation.

Defining a stock to Wall Street is actually not so different from marketing

a product to a consumer; much of the success lies in packaging. Packaging

the product takes some skill, starting with learning about the product’s

strengths and weaknesses and defining its value relative to its peers.

For example, a company that chooses to develop a sports drink and

places it on the shelf next to Gatorade does so if it believes that the sports

drink will appeal to consumers and deliver value. To that end, sports drink XYZ may have 20 ounces versus Gatorade’s 16 ounces yet cost half the

price. If the drink does the job for athletes just like Gatorade, XYZ is probably

a bargain and consumers will be very interested. A stock is no different.

A company that knows its peers and understands its value relative to those

peers can do a better job of communicating its value story. Defining the company

through an IR audit is the key to this process, and it sets the foundation

for communicating to the outside world.

DELIVERY

Targeted communication involves several levels and vehicles. The company

should be committed to actively presenting itself to the appropriate audience

with a commitment to conservative guidance, transparency, and consistency,

in both good times and bad.

An integral part of this step is finding the professionals in the investment

community who might be interested in the company. Once a company recognizes,

based on valuation and growth prospects, if it’s a growth or value

vehicle and to what degree, it can discover its audience of potential sell-side

analysts and buy-side funds. When this segment is identified, IR can approach

them.

Reaching out to the target market includes a commitment to basic correspondence

that includes earnings announcements (and pre-announcements

when appropriate), conference calls, non-deal road shows, or material press

releases. These points of the delivery stage are the make-or-break fulcrum

upon which the company’s investment thesis relies.

TABLE 13.1 Description of the Three Ds

Definition Delivery Dialogue

The IR Audit Preparation Maintaining and building

Review disclosures Guidance relationships

Interview management Targeting the audience

Identify comps Integrating with PR Meeting The Street

Determine relative value Infrastructure/Disclosure

Get capital markets Event management

feedback Action

Gather industry Earnings announcements Banker mentality

intelligence Conference calls

Excavating value Pre-announcements

DIALOGUE

Packaging the product, targeting the audience and telling the story are all a

good start, but the ongoing dialogue with investors and analysts is critical in

supporting the approach. Dialogue includes nurturing relationships with

capital markets:

Collecting not just feedback, but constructive, strong, honest criticism

Staying on top of Wall Street’s ever-changing industry perceptions and

hot buttons

Balancing management’s efforts for awareness vs. promotion

Recognizing communication that distracts from the message

This dialogue requires the IR professional to break down the buffer

around the CEO and become a confidant to both senior management and

their Street counterparts, stripping away any illusions that company executives

may have about their standing on Wall Street. Access to management is

essential, and very few portfolio managers or analysts are going to jeopardize

that access by criticizing the CEO or CFO when they deserve it.

This speaks to the classic “Emperor Has No Clothes” tale. CEOs and

CFOs need to know what the crowd is saying, and IR should be the conduit.

Additionally, IR is responsible for helping senior executives deliver bad

news, keeping short-term disappointments or mistakes and their ramifications

in perspective, and focusing on long-term goals. Investor relations cannot

be the domain of a reactive administrator or a comfort zone for yes men

or women.

Pre-Definition Decisions

CEOs and CFOs need to take IR and corporate communication very seriously.

Approached strategically and with a capital markets perspective, IR

staffed with the right professionals will position any company to preserve

valuation, enhance shareholder wealth, build a company’s reputation, and

prolong and/or enhance a CEO’s or CFO’s career.

However, before a structured IR program can begin, every company

should address its infrastructure needs, which almost always depend on the

size of the entity. An effective IR/PR program can be done internally, externally,

or through a hybrid approach that marries the best of internal expertise

with an outside agency. Regardless of which avenue management takes,

however, every public company, and many private ones, should plan a Wall

Street–savvy strategic program to communicate to all stakeholders.

MEGA CAPS

Most stocks with market values in the tens of billions bring the IR/PR function

internal and staff it, on the IR side with CFO-caliber people, and on the

PR side with experienced corporate communications executives. They can

afford to subscribe to all the information services, and run a very tight, selfsufficient

program. A company of this size should never fully outsource the

capability, nor would they.

However, every public company experiences the “Emperor Has No

Clothes” syndrome where buy-side and sell-side analysts avoid honest, unfiltered

feedback in an effort to preserve access. And on the corporate communications

side, even the biggest of firms need to audit their practices and

see if the media and other stakeholders perceive the company on par with

the internal group. For that reason, mega-cap companies should consider

complementary, cost-effective outside help that can deliver the current Street

perception and help craft a response plan to all constituents.

LARGE CAPS

Stocks with a value between $2 and $10 billion are middle ground in our

view. They could outsource the IR/PR function, but they are so widely held

with so many moving parts to the business that they will invariably benefit

from having one or two full-time, internal people on the job. The internal

staff in this case is most likely senior enough so that any outside agency must

also be staffed with experienced senior-level counsel, or it will be cost prohibitive

(that is, not worth the incremental expense).

As a rule of thumb, the smaller the company, the more help it should

seek from the outside. Not only is the independent feedback and outside perspective

critical, but all the information services, which can run into the hundreds

of thousands of dollars, can be accessed at a lower price. For even a

large-cap company, there is no reason to buy these services internally. A

good bet under this scenario is to hire a qualified third party to deliver and

interpret the information and create a plan to act accordingly.

SMALL CAPS

Companies whose valuations are below $2 billion typically do not have an

internal investor relations group and may have a sparse corporate communications

group that’s tucked into marketing. In IR’s case, the CEO and

Positioning IR to Succeed 91

CFO split the duties, and it’s usually done with the help of internal administrative

support.

In our view, this situation almost always calls for an expert third party.

An outside agency can deliver on all the administrative aspects of the company’s

IR/PR strategy, provide all the financial information service needed,

and most importantly give the kind of advice that will protect management

from making a mistake when communicating its story to the capital markets,

the media, or any other stakeholder.

When the CEO or CFO takes on these corporate communications duties,

they almost always move down the priority list. The primary job of a

CEO or CFO is to run the company and deliver the expected financial performance.

When they also have to manage the IR function that simply introduces

risk into the equation, and Wall Street doesn’t like risk.

IPOS

Initial public offerings are a whirlwind for a small company. Creating the

S-1 document—the SEC document that describes the business and its historic

financial results —is an absolutely hectic time. Moreover, there are endless

meetings with bankers, lawyers, and accountants preparing management

for its two-week road show that actually sells the shares to the

buy-side and raises the needed funds.

With all this distraction, management must not forget the corporate

communications function. Upon pricing, management will find itself in a

strange new world with buy-side and sell-side analysts calling for appointments

and information, and reporters clamoring for the next story. In addition,

the CEO may catch employees watching the daily stock price, becoming

more obsessed with the market’s fractional movements than with their jobs.

This scenario is trouble waiting to happen as management, with no

communications plan whatsoever, finds itself spending 20 to 25 percent of

its time reacting to events as a public company, rather than decreasing that

percentage by being proactive. To make it more difficult, this situation usually

comes at a time when management has tremendous pressure to deliver

stellar financial performance.

We believe companies that find themselves on the road to an IPO

should get an IR/PR team involved two to three months before the start of

the road show. IR can create the company’s infrastructure to be public, create

a 12-month plan, and implement a system that actually allows management to run the company without significant interruption—including dealing

with shareholders and analysts, the media, and employees, as well as developing

a crisis plan so management looks calm and polished no matter

what the circumstances.

This type of proactive communications planning is how companies garner

a premium valuation: the goal of the CEO and the goal of all shareholders.

The most cost-effective way to do this for a small-cap IPO is usually

a very qualified third party. It’s at least half the cost of bringing the

function internal in most cases.

HIGH YIELD

As we mentioned, private companies with public debt must adhere to all

SEC regulations, including Reg FD, yet many of these CEOs tend not to take

corporate communications as seriously because they are not overly concerned

with the investment community’s perception of their debt. After all,

equity value equates to personal wealth and bonds normally do not.

That said, if the company intends to issue public equity in the future,

its credibility with bondholders and other stakeholders will make a difference

in its potential equity valuation. Also, even if the plan is to stay private,

bonds influence cost of capital, and to ignore the role of communications

is to ignore the maximizing of shareholder value, even if they are

private investors.

PRIVATE

We believe that all companies should take IR/PR seriously. Every company

needs a solid PR group to highlight the products and the brand and drive

market share and profitability. However, private companies also have an opportunity

to get their point of view across with Wall Street by developing a

limited, but smart, IR outreach program.

The pursuit of one of the best forms of third-party validation, the sellside

analysts, will pay off for these companies. Analysts are always looking

for new companies and a new understanding of the industry, and often they

are happy to publish a company’s point of view in their research, regardless

if they agree with it.

INTERNATIONAL

International companies have a big opportunity to raise their exposure in the

United States. However, the United States has new disclosure and reporting

rules and the game isn’t necessarily the same as overseas. European or Asian

management teams must have the right information and the proper plan to

guide their IR process in the United States, including targeting and meeting

with the right institutions.

Proactive communications in the United States by international companies

is welcomed by domestic institutions and the U.S. media. If successful,

it also gets the international company’s growth strategy factored into its

multiple, and most likely into the multiple of its U.S. competitor. This, by

definition, affects the competition’s cost of capital. For example, after meeting

with an international company that has a convincing growth strategy,

maybe the U.S. portfolio manager will only be willing to pay a discounted

multiple for the U.S. competitor that’s currently trading at a premium. That’s

well worth the effort. As with all companies, the international company’s

story must be properly packaged and told in the correct manner to the right

audience, or the communication strategy is defeated before it begins.

THE APPROACH TO STRATEGIC IR

The gist of strategic IR, for every company, any size, public or private, is

smart and timely communication to the right audience. This communication,

based on an understanding of the valuation process and the intricacies

of capital markets, helps companies maximize equity value. For that

reason IR can be more art than science, and an explanation of this approach,

from IR audit to a long-term cycle of discourse between the company

and its constituencies, can help companies garner the best value at

any given time.

It starts by answering the question: how are companies valued?

UNDERSTANDING THE ART AND SCIENCE

OF VALUATION

Investor relations officers must have a solid understanding of valuation before

the definition process can begin. However, that does not mean just the

mathematics of P/E or EV/EBITDA; it means a comprehensive understanding

of the two slices of the valuation pie that are constantly in motion.

While financial performance is the primary determinant of value, a certain

component of valuation deals in intangibles. This part of valuation has

to do with perception, either good, bad or indifferent.

In our view:

Equity Value = Financial Performance + How That

Performance Is Interpreted By a Variety of Constituencies

How do we know that perception plays a part in valuation? Well, a

fairly standard method of valuing companies is assigning a P/E ratio based

on future earnings estimates. If fundamentals were the sole focus of investors,

P/E would probably mirror the EPS growth rate. Yet often, one can

see two 20 percent “earnings growers” in the same industry, with one company

trading at a 10 P/E and the other at a 20 P/E. This disparity, in many

cases, is the result of perception.

Valuation is both science and art. The science factor is financial performance

and the standard valuation measures that are assigned to all companies.

The art element is how that financial performance is communicated

(how, when, what, to whom, and by whom) relative to expectations.

We strongly believe that the art portion of valuation can make up anywhere

from 20 to 40 percent of the total valuation at any given time. This is

a huge piece of a company’s market cap, worth tens of millions of dollars in

shareholder wealth. Managing the art portion of the equation is ultimately

IR’s responsibility; that person, either internal or external, needs to know

what they’re doing (see Figure 13.1).

All things being equal, Wall Street would assign a multiple to earnings

or cash flow based solely on the company’s financial outlook and there

would be no need for IR or corporate communications. But this isn’t the real

world, and IR should help the company control the variance.

Management, along with IR, should be wary of several traps when managing

the art side of the art/science equation:

A company that identifies the wrong comp group—or worse, fails to

identify any comp group at all—allows The Street to define its relative

Positioning IR to Succeed 95

“Earnings, and expectations about them, have become the major

driver of stock prices.”

—Barron’s, March 22, 2004

positioning. This stock’s price will often trade at a discount if it’s valued

in the context of a group-multiple that’s too low for the company’s shifting

business model, market potential, and/or prospects.

A company that doesn’t specifically target the appropriate investors. By

not finding investors who buy similar stocks and have objectives that

are in line with those of the company, management might be missing the

opportunity to corral dozens of large, long-term buyers. They are also

wasting time and money in the process.

IR that allows management to establish optimistic guidance or no guidance

at all. Either of these scenarios increases the risk that management

will regularly miss estimates over time, the ultimate bogeys by which

every company is judged. For example, in the “too optimistic” category,

a 20 percent earnings grower that guides investors to expect 25 percent

growth will rarely get the same multiple that a 20 percent grower will

get if it prompts investors to expect 15 percent.

IR’s job is to balance the fine line between optimism and realism because

when that line blurs, valuation suffers. To that point, aggressive guidance

that normally leads to a higher short-term stock price can be very counterproductive.

It often forces an analyst to downgrade the rating, attracts short

sellers, and increases the risk of volatility, all of which can be distracting and

a massive time drain to management.

FIGURE 13.1 The Art and Science of Valuation

P/E

Financial Performance

Perception Valuation

THE MANAGEMENT PIECE OF VALUATION

A substantial part of the 20 to 40 percent that is attributed to perception relies

on management, pure and simple. Considerations include:

Can I trust management?

Do they return calls in a timely manner?

Are they forthcoming with information?

Do they appear to answer questions openly and honestly?

Have they executed against what they have communicated to their financial

markets?

Do they seem promotional?

If management has developed credible relationships with The Street,

then investors and analysts are much more willing to listen to a company

and maintain support should a marginal event transpire. The Street needs to

believe that management is consistently accessible, honest, and straightforward,

no matter what the circumstances.

For example, if a company misses earnings by a penny or two, some analysts

would downgrade the stock. However, those that know management

and have built a relationship over time may give management the benefit of

the doubt and maintain their rating (especially if the company is in the practice

of pre-announcing anticipated misses, as we discuss in chapter 20). This

benefit of the doubt can take years to accumulate—and can be erased in one

day with one poorly handled communications incident—and IR needs to

continually regulate the way the management team conveys confidence and

capacity.

Management must meet the credibility checklist:

Accountability: Shuttling blame usually has the opposite effect. Devise a

plan to turn weakness into opportunity, and communicate the issue with

The Street.

Transparency: Be simple and clear. Concisely present financial statements

that focus on the health of the business, add incremental information

that highlights the major driver of earnings, and relay specific explanations

of objectives and strategies.

Anticipation: Be proactive. Catch-up and spin are exhausting and ineffective.

Stay in front of salient news and employ a policy of proactive communication,

such as the earnings pre-announcements. A proactive plan saves

time and money.

Positioning IR to Succeed 97

Visibility: Slick management teams who come across as promoting their

stock present a risk. Promotion does not generate sustainable value. While

CEOs must be dynamic enough to generate interest, their job is not to talk

about valuation and promote the stock. The CEO’s job is to deliver earnings

and to articulate results and future strategy transparently and in a timely

fashion, good or bad.

Ego: Management should check egos at the door and be open to suggestions

from IR and The Street. Ultimately, an unhealthy ego and a knowit-

all attitude are judged as major flaws by professional investors and

analysts.

The capital markets are an arena of conviction. Management actions,

or sometimes their very presence, can materially move a stock. For example,

a new management team with a reputation for success comes to a company,

and up goes the stock. A turnaround specialist takes over the reigns of a

broken-down company and stabilizes the business, and institutional demand

increases. A CEO is distracted by another venture, and owners get

skittish. A CFO gets defensive or emotional on a conference call, and Wall

Street backs away.

If management runs the company and, along with IR, properly packages

and articulates the financials and the qualitative story to The Street, they will

slowly and steadily build credibility and value. IR must control deviations in

perception and maximize opportunities to garner a premium multiple.

Establishing the valuation begins with the IR audit.