Sell-Side Coverage – A Small Cap’s White Whale?

By Dennis Walsh, Vice President

White WhaleI recently was interviewed for an article for IR Magazine titled, “Sell-Side Analysts: The Many and the Few.” The article discussed how some companies manage a full roster of covering sell-siders, while others struggle to maintain or attract just a few. In today’s market, it seems more common that IROs are in the latter situation and are frustrated by the limited return on their efforts to attract coverage.

There are many factors that contribute to the lack of adequate sell-side coverage, and all of these factors relate to the sell-side’s inability to make money by working with a particular company.  Low trading volume plagues companies vying for attention from both the buy- and sell-side. The buy-side avoids low-volume stocks because they cannot easily get out of the stock, and the sell-side won’t cover a stock because the lack of buy-side interest limits their ability to generate trading commissions.  It’s a vicious cycle.  In addition, the lack of investment banking business may create a barrier to coverage.  The bottom line is that the bank needs to make money in some way from the research coverage since they are not being compensated from the buy-side in hard dollars.

So what’s an IRO to do?  First and foremost, develop a solid pitch. Most sell-side analysts already are covering 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 for coverage, you need to provide them with a compelling reason that they should be interested in your company. If they cannot see the potential for growth early on during due diligence, they are unlikely to move forward.

“Just because a company has a low market cap or is thinly traded now, does not mean there is no value in covering it,” said Avinash Kant, Vice President, Senior Research Analyst at D.A. Davidson & Co. “If an analyst initiates coverage early on, they can make a good name for themselves as the company grows and delivers returns to investors. Set realistic goals and outline your systematic strategy for achieving them – but don’t overpromise. We want to see a clear path for how the company is going to generate revenue, improve margins, etc. over the next three to five years.  Analysts remember these promises and will challenge you on them later and use them to benchmark your success.”

Another angle to get on a sell-side analyst’s radar is to make the clear case that by covering your company it will help them to better understand the market drivers that affect the larger businesses they currently cover. If an analyst cannot easily see the benefit to them for covering your company, they likely won’t be interested.

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. The thinking is that if they establish a relationship early on, the company will likely include them in future banking deals. Conduct “company-sponsored” non-deal roadshows with these firms and solicit invitations to present at conferences. 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.

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.  Nurturing a relationship with an analyst takes time, and they need to see that there is buy-side interest in your company.

“It’s like a dating period,” said Kant. “When management participates in bank-sponsored events, we see that they are willing to commit to corporate access days, but we also get the opportunity to better understand the company, learn what the investor concerns are and gauge the level of client interest.”

While it may seem like a lost cause to try and secure new sell-side coverage, there is hope.  Revisit your pitch and make sure it demonstrates a clear strategy for growth. Expand your targeting 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.

Dennis Walsh is Vice President at Sharon Merrill.  He counsels clients on a broad array of investor relations and corporate communications issues such as market research, competitive intelligence, earnings announcements, investor targeting, roadshow planning and social media. Dennis oversees Sharon Merrill’s Socialize IR consulting service, which is designed for public companies that recognize the benefits of incorporating social media into their shareholder engagement program.

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Filed under Investor Relations, Roadshow Planning, Sell-side Research

2 responses to “Sell-Side Coverage – A Small Cap’s White Whale?

  1. Dennis is absolutely correct in his assessment. Sell side coverage for small caps is increasingly difficult to secure because the commission model that supports it is broken. As a result, it’s essential you demonstrate a willingness to help sell-side firms “monetize” their investment in coverage over time. Marketing is one of the most significant ways for sell-side firms to do this – so make sure to not undermine or eliminate that potential compensation.

    Even though an IRO can easily call current or prospective investors to arrange meetings or a road show, it is far better to leverage that revenue opportunity by directing it to firms providing research or other forms of sponsorship. That way then can get credit (and get paid).

  2. Todd S. Douglas

    This is a conundrum that is unlikely to change in the near future and it behooves IR departments to consider changing the business model. The sell-side has been eviscerated and if a small-cap company cannot offer a profitable banking relationship to offset the loss leading analysis of its company then it’s unlikely to receive coverage. On the buy-side portfolio managers and their teams often run multi-billion dollar portfolios. It would take an internal Act of Congress to force these investment professionals to invest their time in companies that cannot move the needle even if their share price quadrupled.

    It has been my experience small(er)-cap companies are rewarded for focusing their efforts on middle-market investment advisors and high net worth investors. Both of these groups are less fickle long-term holders and more appreciative of management’s time. It also creates a virtuous circle where the more retail-like base of clients begin to move a stock and the technical screens of larger investment managers suggest further investigation.

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