CHAPTER 25 The Banker Mentality

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The final part of Dialogue is the banker mentality. This name applies because

IR must ultimately be nimble enough and educated enough on the capital

markets to have parallel conversations with both analysts and investment

bankers. These conversations can still lead to analyst coverage or at least a

closer relationship with an investment bank. They can also lead to suggestions

and tactics that will increase shareholder value over time.

Investment bankers are in the business of helping companies raise capital

to achieve their goals. They also are transaction facilitators that show

CEOs potential acquisition or merger candidates. Across the board, however,

whether raising capital or suggesting M&A opportunities, the transactions

must be beneficial to shareholders over the long run.

Therefore, IR must have the ability to think like an investment banker,

aligning IR’s goals with those of the CEO and the board of directors. Every

tactic or strategy should relate back to building shareholder value over the

long run. Whether it’s an acquisition, a capital raise, implementing a dividend,

or repurchasing shares, IR must be able to stand shoulder-to-shoulder

with the banker and the CEO and know how to position the event.

INVESTMENT BANKERS

A good connection with the right investment bankers, for both public and

private companies, can generate an extremely symbiotic relationship over

time, one that involves transactions for the bankers and value-added, accretive

deals for management and shareholders.

In order for companies to find the best investment banks, however, companies

need to focus on those firms that have a long track record of dealing

with companies of similar size. If a company carries a $200 million market

cap, there’s no need to pursue an investment bank that facilitates transactions

for $5 billion–plus market cap companies. IR professionals, along with

management, must do their homework in this regard and know all the parties

that navigate in their space.

THE CHINESE WALL

The reforms of the last few years have cut ties between banking and research.

There is virtually no communication between these two groups, with

the exception of analysts being “taken over” the Chinese Wall—that is, the

barrier that separates research from investment banking. This would occur

when a transaction is pending and the investment banking department must

communicate it to the analyst before it is announced.

However, despite these strict rules on communication, all investment

banks are allowed to have a strategy where research, sales and trading, and

investment banking are aligned. For example, having analysts publishing on

mega-cap stocks while banking is focused on small caps makes no sense. It

would create a schizophrenic organization where the lack of focus would

most likely doom the effort. Therefore, most investment banks blanket companies

of similar size, and research and banking both are active in pursuing

relationships.

With all that said, there’s a myth that the sell-side will only publish on a

company if there is a pending corporate finance transaction. Although more

true than not in bigger firms during the late 1990s, this myth does not necessarily

hold true today. In fact, analysts are actually looking for good stock

picks. However, companies that happens to be capital intensive, or active in

the equity or debt markets historically, might be more attractive to the entire

organization. Analysts and investment bankers understand this fact and no

communication is needed.

Therefore, we believe that IR should make an effort to track and establish

ties with all logical investment bankers in the sector. This may lead to interesting

corporate finance ideas for management, but for IR’s purposes, it

may be the back door into research coverage, as the company starts to develop

a relationship with the investment bank. This is very useful when direct

conversations with the analyst are not proving fruitful.

The second reason to track bankers is to be ready in the event that management

quickly decides to raise capital or sees a strategic acquisition that

can’t wait. IR should present management with an evaluation of all the players

and discuss the strengths of each organization. Although certainly not a

function of traditional IR, it’s a critical part of a successful IR approach.

Cast a wide net and evaluate bankers based on the answers to the following

questions:

These points fall around the main point: companies want to cultivate relationships

with banks that they believe will be in for the long haul, especially

considering the size and relative infrequency of investment banking

fees.

Management, however, does not have to engage just one investment

bank. While needing larger investment banks as the “lead horse” in selling

equity or debt, a company also can benefit from smaller, regional banks that

may bring analyst coverage and aftermarket support.

Some companies have chosen a lead banker and then think they’re done

with the job. They’re not. There is usually an opportunity for companies to

be economic to a few more banks and include them in the process, and create

more opportunities to preserve or enhance valuation. To that point, aftermarket

support is a major criteria. Does the investment bank fade away after

Quality of Distribution and Trading Support

Which firms have traded the most shares over the last 3, 6, and

12 months? Most active traders tend to have the best order flow;

strong order flow usually means good execution; good execution

gets the company the best value for its money.

Can the firm get the stock out there to the buy-side and continuously

support the desired liquidity of the stock through volume

and trading activity?

Finally, what are the characteristics of the sales force? Are they

professional and experienced, or is it a force simply out for the

commission?

Value Creation

Which firms have done the most to create shareholder value?

Do the investment bankers call with good ideas, and are they

considered trusted advisors?

Do they have an analyst covering the sector, and, more important,

is it a good analyst with whom the management team will

get along and who is respected by his or her own brokers as well

as the rest of The Street?

Which firms have the analysts who have written the most comprehensive

reports, understand the companies’ investment theses,

and have followed through on their research by generating

investor interest in the companies? the transaction or are they aggressive with capital on their trading desk and

with research coverage?

PICKING THE BANKS

Once IR is clear on the company’s objectives, and all internal parties have

narrowed down the investment banking choices to a small few, IR should

continue its due diligence to make sure the bank fits the company’s needs.

To assess a team:

Call their references and make sure they do what they promised on previous

deals. The best bankers usually have impeccable references over a long

period of time. It’s always great to find companies that have not done one

deal with a banker, but three or five, like the IPO, secondary, and a merger

or acquisition. Repeat business usually means good customer service.

Watch the bank’s most recent performance. Many investment bankers

thrive off momentum. If the buy-side has made money off the last three deals

the investment banker has brought to market, chances are that institutions

would be receptive the next time around. When does someone not take a call

or meeting from somebody who has a track record of making them money?

Make sure the banking team, or those that expect to service the company,

are the individuals who will execute the transaction. It’s not unusual

for small to mid-cap companies to experience a bait and switch. The

bankers that pitch the business, whom management is so enamored with,

don’t execute the deal. The B Team does, made up of the folks carrying all

the pitch books to the presentation who never say a word. After the deal is

done, the A Team may want nothing to do with the company . . . until the

next deal is available.

While most investment banks are very competent and professional, this

problem typically arises when a company’s economic value (its fee potential)

is not so relevant to an investment banker compared to other opportunities.

This situation most frequently occurs among bulge-bracket investment

banks chasing deals among small and mid-cap companies.

Does the rest of the firm generally support their deals? Has the trading

desk remained an active market maker after previous deals? While research

is now greatly regulated, ask if the firm has a policy in place regarding covering—

that is, providing research to—investment banking clients. Make

sure the analyst is a credible one, with sector or industry experience. A retail

company does not want a former technology analyst covering it. Ask to

speak to several of the firm’s institutional salespeople regarding reference points to previous deals. These people are the ones who have to get orders

from the institutions.

Companies should use these transactions to either reward the investment

bank with whom they already have a good relationship or to gain the

attention of firms where a relationship could be built.

On smaller transactions, IR should huddle with management and evaluate

the possibility of using a small, regional investment bank, where an otherwise

smaller payday will be substantial. This may lead to analyst sponsorship

down the road. With sell-side tracking, IR should be in a pretty good

position to enlighten a CEO on the ramifications of choosing one small underwriter

over another.

Ultimately, IR has the responsibility of helping companies leverage their

capitalization decisions into fruitful, long-term relationships with the investment

banks. Unfortunately, most companies do not put enough thought into

getting the best execution for shareholders. Traditionally, management allocates

transactions to investment banks based on little-to-no analysis and

more on gut instinct, which is a missed opportunity to maximize the value of

the transaction for shareholders. Smaller companies sometimes think they

should be linked with a prestigious big name bank to gain validation, only

to get lost in the aftermarket shuffle, and other companies engage three

bulge-bracket firms when it would have been more effective to team one

The Bankers’ Scorecard

Score 1–10 Bank 1 Bank 2 Bank 3 Bank 4

Track Record on

Previous Deals

Company Knowledge

Sector Knowledge

Aftermarket Trading

Activity

Quality of Research

Team

Quality of Investment

Banking Team

bulge bracket with regional and boutique firms. IR must be entrenched in

this process and, as a confidant and sounding board for top management,

help the company weigh all of its options.

VALUE CREATION

The first part of this chapter dealt with the valuation positives that can result

from strengthened investment banker contacts. It also dealt with picking

underwriters to widen a company’s exposure and maximize the impact

of a transaction.

The following section deals more with how management teams use their

capital internally to create value for shareholders over time. This is also part

of the banker mentality, and IR should always be in position to suggest these

strategies to management and the ramifications of going forward.

What may be obvious on some of these value creation initiatives, such

as stock buyback, is that the move will have a positive impact on earnings

per share. But what may not be so obvious is that these transactions have the

ability to boost a company’s long-term multiple. This is the domain of IR

which, armed with capital markets expertise, should communicate the

events in their proper context.

ORGANIC GROWTH

Many clients fight the trade-off between increased spending and bringing

profit to the bottom line. The former strategy invests in the future, bucks

short-term thinking, and sets the table for long-term sustainable growth. In

most quality organizations this is, and should always be, the prevailing

mind-set. On conference calls and in one-on-one meetings, however, management

might feel pressure to think on a more short-term basis—perhaps

from shorter-term investors who care little about the company and a lot

about the stock price. Less experienced management teams may react by altering

their philosophy, spending slightly less, and focusing on shorter-term

goals. IR must interject and counsel management on how best to fight this

trade-off.

First of all, articulating to Wall Street that management is spending to

improve the long-term competitiveness of the company is tough to dispute.

Second, if historic returns back up that statement, short-term thinkers won’t

have much to say. Finally, if IR wraps the “spending” issue into a comprehensive

strategy to increase shareholder value over time, management should

feel very comfortable delivering that message to The Street.

One last point on spending: if the stock is materially off its recent high

and a majority of the analysts are disengaged—that is, they have neutral ratings—

management has more leeway to set a comfortable guidance bar. In

other words, if management resets conservative guidance to include increased

spending, short-term pressure will never be an issue.

ACQUISITIONS

IR must also understand the implications of an acquisition and learn how to

communicate the attributes of the combined company.

First, IR should obtain the term sheet from the CEO or CFO and gain a

thorough understanding of the deal terms. Is the transaction an all-stock

deal or a combination of cash and stock, and will the transaction accelerate

the need for the company to access the capital markets? Once the details are

understood, IR must understand the qualitative benefits of the acquisition

and the underlying performance of each business.

Lastly, IR must understand whether the transaction is additive to earnings

and work with senior management to revise guidance to a conservative

range. Conservative guidance sets the stage to exceed estimates, generate buyand

sell-side interest, positive media coverage, and boost employee morale.

One company refused to provide updated guidance when an acquisition

closed because management would not have sufficient time to get comfortable

with the combined/consolidated numbers. IR thought that was fair

enough, but reminded management that in their due diligence on the transaction

the investment bankers presented a base case pro forma (as if the acquisition

was closed on the first of the year) estimate for the year. Even a

conservative version of that estimate would suffice for the outside world.

The client moved ahead with no guidance, risking that Wall Street might

make its own assumptions, raise estimates, and position the acquisition for

financial failure (relative to expectations).

Again, any non-organic growth should be framed in long-term shareholder

value creation. To take control of the process and soundly advise a

CEO, IR must think like a banker and understand why any given deal would

or would not resonate with sophisticated investors.

SHARE REPURCHASES

Moving to a category that could be called “adding value below the operating

line,” management can drive long-term value by sticking to a philosop7-

phy of returning cash back to shareholders. One of the ways management

and the board can do this is to opportunistically repurchase shares and

shrink the company’s market cap. The result is a smaller denominator in the

P/E calculation and higher earnings per share assuming the same level of net

income.

Share repurchase authorizations make sense if a company’s share price

is low and its ability to generate cash hasn’t been hampered materially. In

fact, the company can create a floor for the stock price where management

can repurchase shares, particularly if shares are still coming on the market

after negative news.

IR’s job, again, is to frame out the buyback in terms of long-term shareholder

value creation rather than a one-time event. In other words, repurchasing

$1 million in stock may be accretive in the coming year, but committing

to repurchasing shares opportunistically over time can drive a

company’s multiple.

DEBT REPAYMENT

Another way management can add value below the operating line is to reduce

debt, if appropriate. Again, management can drive long-term value by

systematically reducing debt as part of its free cash flow uses and, in the

process, reduce interest expense and increase earnings per share. IR’s role is

to frame the reduction as part of the ongoing strategies described above. In

fact, it’s a powerful tool to feed the analysts the message that shareholders

come first and the company will use its cash to engineer a better bottom line

as the core business stays the course.

DIVIDEND

Because of recent tax law changes, dividends have become an attractive

means by which to reward shareholders with capital. In constructing a dividend

policy with management, IR must read The Street carefully to provide

accurate feedback on the potential decision.

The first reason a company might issue a dividend is to simply reward

shareholders with capital. In other cases, initiating a dividend can completely

reposition a company and broaden its shareholder base to include

yield buyers.

In almost every case, a dividend should not be communicated as a onetime

payout. Rather, it should be positioned as a regular, dependable allocation

of free cash flow back to shareholders. Initiation of a dividend, or increasing a dividend, is good news to shareholders. Done correctly, it is also

news that can be leveraged to support management’s views regarding creating

shareholder value over the long run.

Figure 25.1 shows how a dividend strategy can combine with guidance

to create multiple positive events over several years.

Initiating a dividend also indicates that it’s the best use of cash, implying

slowed growth prospects or signaling the completion of an event, such as de-

FIGURE 25.1 Dividend and Earnings Guidance Strategy

In 2003 Big Winner Inc., a successful leisure resort operator, faced a

valuation crossroads. They generated superior free cash flow, but the

nature of the business prevented significant expansion over time, presumably

limiting bottom-line growth. Therefore, in addition to organic

growth, management had repurchased stock over the years and dramatically

reduced debt, two options that by definition increased earnings.

Now Big Winner was considering a dividend that would likely

change the way the company was valued and increase the share price.

Big Winner issued a $3.00 dividend and suggested they would target

future payouts at approximately 40 percent of free cash flow. In this

case, the dividend and the strategy of management changed investor’s

perception. The president of the company was relaying confidence in

the business as well as a willingness to reward shareholders with excess

cash.

Stock Price

➀

②

leveraging. As a company pays down debt and de-leverages the balance

sheet, a dividend would signal financial stability and a reallocation of capital

to shareholders.

Calculating an appropriate dividend is no easy task and it’s a senior

management decision. However, IR should play a part in those discussions

because depending on the current share price, a full payout may not

be needed.

First and foremost, however, a long-term financial forecast should be

developed with projected free cash flow. After management is comfortable

with the forecast and the amount of free cash flow the business will generate,

an allocation of some portion of that free cash should be directed toward

the dividend.

When implementing the dividend, management needs to start conservatively

and plan out future dividend payments with an eye toward sustainability

and increases. The reduction or elimination of a dividend can have a

material negative affect on a company’s stock price.

In that spirit, IR must also understand whether a proposed dividend, and

thus its yield, will mean anything to existing valuation. In a low-interest-rate

environment, equity yields are more attractive to income-related investors.

However, if one of the objectives of the dividend is to attract additional investor

interest, IR should compare similar yields (dividend/share price). Initiating

a dividend that yields 1 percent when the sector is paying 3 percent

may not attract much attention.

Finally, the strategy can be more effective at attracting investor interest

than the actual dividend. That’s due to yield perception. If a company’s dividend

strategy is to pay out 30 percent of free cash flow, and free cash flow

has been growing at 20 percent annually, investors may be much more fixated

on potential growth of dividends versus the actual dividend today. This

increases valuation.

Examine a yield range and gauge the appeal of incremental yield within

that range to value, growth, and income investors. Look to see what level of

enduring yield is necessary to support investor interest. A technical analysis

of the stock price at different yield assumptions is important to develop a

range where yield matters (see Figure 25.2).

One company was inclined to institute a very large dividend relative to

its peers, about 5 percent. The business had a strong, reliable cash flow, and

the company was sure they could support this yield on an ongoing basis. It

was an emotional issue for management because their stock had been viewed

as risky, they were trading at a discounted multiple to their largest competitor,

and they felt the whopping dividend would make a big statement.

We recommended that management not show their hand quite so fast.

Projected stock price Resistance Support Annual Dividend

The company could initiate a conservative dividend and keep the option to

increase the payment over a period of time. We suggested a 1 to 2 percent

dividend to start, which The Street would recognize positively. The investment

community would also understand that it only represented a small portion

of free cash flow. Then each quarter, the company would have the luxury

of deciding if it wanted to increase the payment or not.

IR pulled together a list of yield investors and added them to the distribution

list. The dividend and the philosophy was announced on a conference

call after hours, and bottom-line and dividend guidance were established

to keep the analysts in check. The upshot of the announcement was to

create a floor price for the stock and a “yield perception” that created multiple

expansion and strong underlying support. Mission accomplished.

The banker mentality maximizes the company’s position in the capital

markets at any given time. It maximizes outside transactions, where bankers

help management raise capital. It also assesses each dollar spent on the business

and frames decisions on free cash flow allocation in a mathematical

formula. In other words, if the company is going to spend $1, they need to

decide if they spend it on their core business, an acquisition, a share buyback,

debt reduction, or a dividend. The exact decision should derive from

the CEO and CFO’s office or from the company’s investment banker, but IR

should play a major part in the discussions. IR is in the trenches every day

with analysts and portfolio managers, and thus uniquely qualified to gear

market reaction. It’s a critical part of the Dialogue stage.

FIGURE 25.2 Yield Perception on Dividend

Stock Price

Dividend

Conclusion

A Call for Change

We hope this book has demonstrated that a strong, integrated investor relations

program can have considerable impact on how Wall Street perceives

and values a business. Information flow between a company and the

financial markets needs to be based on a shared perception of the company’s

business. This is, somewhat surprisingly however, rarely the case. In our

minds, solid information flow clearly lowers the risk perception of the investor.

By definition, a lower level of perceived risk means that an investor

will pay more for the same equity or debt, implying a lower cost of capital.

Maximizing the delta that often exists between a company’s current valuation

and its potential valuation is a job that falls squarely on the shoulders

of the investor relations function. Investor relations, as a practice and as an

industry, must undergo some fundamental changes in order to truly fulfill

the task with which it’s charged.

First and foremost, IR really must be executed by someone who has direct

knowledge of the capital markets. Without a real understanding of how

the various sales, trading, sales-trading, investment banking, research, and

portfolio management functions interrelate and are motivated, many IROs

start with a disadvantage.

The traditional agencies continue to approach IR as a largely administrative

function and staff their accounts in this manner. Without a capital

markets mindset that thinks constantly about the value equation, little value

can be added to management’s communications, and even further, to its

strategic thinking. Rest assured, cost of capital is high on the list of priorities.

Of course, the charge of every public company is to operate the business

to the benefit of the shareholders.

At our company, Integrated Corporate Relations, we made a strategic

decision at the outset that we would turn the industry service model on its

head. Instead of following the typical agency model of staffing directors with

junior-level account executives, as we grew our business we grew laterally at

the top. We hired strong senior managers, who typically have several years

of very senior-level capital markets experience. We shared administrative

support and demonstrated that it was possible, if you are willing to roll up

your sleeves, to provide a whole new level of advisory service on par with

the McKinseys and Bains of the world. An IR program is only as good as the

person picking up the phone on behalf of the company, day in and day out.

A second imperative for the investor relations industry is that many

IROs (if they aren’t currently doing so) should change their work processes.

They must conduct constant due diligence on a company’s financials, strategic

initiatives, and competitive posture in exactly the same way as an analyst

or portfolio manager—with a skeptical, objective eye and a keen sense of

risk. They must move through the looking glass between the company and

the markets to ask management the hard questions, evaluate the initial answers,

and then advise management on the best positioning for a whole myriad

of issues that are of concern to the capital markets. In this way the assassins

of value, miscommunication, and misunderstanding can be avoided.

Also in this way management’s understanding of Wall Street is heightened,

which is equally as important.

We often tell a potential client to think about what it would be like to

talk to their most trusted analyst about a deal, an earnings report, or an

emergency before they went public with the information. That is the role we

fill; that is what superior investor relations and capital markets advisory is

all about. At ICR, we’ve often brought a whole suite of former analysts or

portfolio managers together to puzzle out a complex event or disclosure

issue. In our experience, the strategy and solutions that come out of that

kind of intellectual capital are of incredible value. Again, that to be forewarned

is to be forearmed seems self-evident. Giving management the

proper tools is really dependent on the filter through which the investor relations

officer views disclosures. Appropriately, that filter is a capital markets

viewpoint, facilitated by a process that mimics that of the analyst.

The third way in which the IR industry can change is that it must work

much harder to develop relationships with The Street. An investor relations

advisor must clearly keep his client as the center of his efforts, but the analysts

who follow it, the portfolio managers who own it, and the bankers who

can help take it to the next level are incredibly important constituencies.

They are also, as a rule, people who are overworked and short of patience

for yet another phone call. This is not the case if the investor relations officer

appreciates their viewpoint, understands their job, and can speak their

language. IR’s contacts should not be viewed as a replacement for the relap7-

tionships that the executive management team must have with The Street,

but rather as an enabler. Providing strong color on the views, personalities,

and functions of these constituencies to the executive team is critical to maximizing

the use of their time and the effectiveness of their contact.

We were fortunate, as former analysts and portfolio managers, to begin

with peer-to-peer relationships with The Street. We knew that, as analysts,

we often would conduct a call with an outsourced IR representative as a

courtesy at best. This was the central reason that we knew there was an opportunity

to have an impact on the industry. Traditional investor relations

officers at outside agencies call to set up meetings for a company. The new

IRO must be able to clearly explain, in under 30 seconds, why it is important

for that analyst or banker to take a meeting and to have that message

resonate. Even today, when business is incredibly competitive on The Street,

we know that many investor relations agencies find ways to actually undercut

the potential of an analyst to be compensated and place themselves in a

competitive role with one of their primary constituencies. We have good relationships

because we know how to help analysts and ensure that they are

compensated.

Finally, the industry must change the way in which it integrates its communications

efforts. Investor relations, in most cases, must become the tip of

the spear for a whole suite of communications functions, including many aspects

of public relations, trade relations, business media, corporate communications,

government affairs, and even advertising. Traditionally, these

functions have been spearheaded by large public relations firms or ad agencies.

They have tended to operate from something of an ivory tower and

often lack the skill set and unifying vision that makes valuation the ultimate

goal. The same analyst on the conference call goes home and reads the

paper, watches the news, sees television commercials, and is aware of the

regulatory environment of the industry he follows. If the message he is getting

direct from management is not properly validated by the other forms of

communication that emanate from a company, he will begin to question the

credibility of the message. Similarly, the public is aware of the opinion of the

market and can sense the disconnection. It’s that combination of Wall Street

and Main Street perception that drives valuation. Therefore, if the fiduciary

responsibility of a CEO is to increase shareholder value, IR should naturally

be pushed to the forefront in many communication decisions.

We formed a public relations and corporate communications group at

ICR because we witnessed some costly disconnects where value was needlessly

destroyed for little benefit. Once again, we looked to hire the best people

who had direct experience in the media, in corporate communications,

and in government affairs. As a result of careful coordination, we believe that every communications effort becomes stronger and more credible. This

reinforces value and again serves as an enabler for management to control

and direct the perception of their business. This approach serves everyone

involved—the investor, the analyst, the media, and the public.

Although we cannot claim to be without bias, the ideal investor relations

effort is unquestionably a coordinated effort between an outsourced

specialty firm and a capable internal investor relations officer. In the absence

of the financial resources to support both, the breadth of services and support

that an outsourced firm can provide is the first priority. Companies routinely

outsource accounting to auditing firms, financial transactions to investment

and commercial banks, legal work to law firms, and marketing to

advertising agencies. They would do well to look at the highly specialized

function of investor relations in the same way. In addition to providing superior

personnel and broader understanding of and relationships within the

capital market, there is a scalability at play within the agency that provides

for access to data and telecommunications services that makes the prospect

of outsourcing cost-effective.

Even considering the not-insignificant cost of outsourcing IR, what is a

15, 10 or even 5 percent increase in earnings multiple worth to a company

and its shareholders? That answer is often in the tens or even hundreds of

millions of dollars. The investor relations professional needs to remain focused

on liberating this value. We hope that this book helps to provide a

better road map for how to do so and a more appropriate yardstick for us

all to measure the performance of the professionals who conduct this essential

function.

Company Function Outside Advisor

Accounting/tax • Auditing firms

Finance • Investment and commercial banks

Legal • Law firms

Marketing • Advertising agencies

Corporate communications • IR/PR counsel

FIGURE C1.1 Outsourcing Expertise