Sell-side Research, Phone Home

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You probably think of “E.T. The Extra-Terrestrial,” as a relatively modern movie, but it was released when mechanical stock tickers were still in use on Wall Street, more than a decade before mobile phones were anything but a novelty. There was no place to view E.T. but the movie theater. In the following years a Motorola DynaTAC could be yours for circa $4K, measuring a foot long and weighing almost a kilo. It could store 30 phone numbers. The Apple Macintosh, with 128K of memory and a 3.5 inch diskette reader, was launched in 1984. Today, we can watch E.T. on our iPhones and then read on that same device dozens of financial journalists speculating about the future of “sell-side research.” The links to these experiences feel to us like a continuum, but that’s because it’s too difficult and time consuming to identify the scope of the fundamental change we’ve experienced in our lifetimes.

Ringing in the New Year, but with No Bells

Our brains hang on to familiar words, concepts and practices in an effort to deal with rapid change, well after they’ve lost their original meaning.  This is good when our brain is preserving its processing power for more important tasks, but a handicap when planning for the IR future using communications tools as outmoded as the DynaTAC and the first Mac. As the clock ticks (oops, not much “ticking” going on today either) into a transformed post-MiFID II capital market, I’m grateful for its January 3 implementation date. We’ve got a week or so of relative breathing room in most IR calendars, and the New Year is a time that has encouraged positive change and marked renewal for all of human history. Chief among the opportunities for transformational change facing IROs and senior managements is to turbocharge collaborations with sell-side analysts from plodding process-oriented interactions into highly productive partnerships. Contrary to media headlines about the death of the sell-side analyst, their role could be greatly strengthened by MiFID II implementation. As the year begins, devoting some brain power to the practical aspects of breaking with the past when working with sell-side analysts may help you soar above IRO’s stuck in their old ways, and you don’t need a three-foot alien sitting on your handlebars to do so.

Suspending Capital Markets Disbelief

The pre-MiFID II sell-side equity research model began forming in the heyday of telegraphs and railroads, and has been twisted into an almost unrecognizable form over the last couple of decades as analysts were forced into selling low grade and glaringly conflicted corporate management meeting planning to the companies they followed. So it shouldn’t be a surprise that the structure of sell-side research disconnected from the forefront of today’s professional investment information marketplace. If you define equity research as intellectual content that informs portfolio managers’ investment decisions, the relative impact of sell-side equity research as discussed in professional fora and financial media coverage is as far removed from the reality of investor decision making today as the DynaTAC is from the iPhone. But just as Apple was written off for dead prior to the second coming of Steve Jobs, sell-side research is still here, still important, and there are big market opportunities on the buy-side for the best sell-side analysts.

Sell-side Analysts, Who Cares? Or, Sell-side Analysts Who Care

At Taylor Rafferty, we still see a good deal of high quality sell-side research on our clients, particularly in science and technology driven industries where articulating medical, scientific and engineering expertise adds clear value to the portfolio manager’s understanding of a company’s prospects. Sell-side analysts whose careers began during or before the mid-90s are highly valued by our clients and their investors for the wisdom that comes from navigating market cycles and fundamental change, but it’s been difficult to package that wisdom for mass consumption. Our client managements and IROs drive goal-oriented capital markets communications programs, and we can measure the real difference made by a sell-side analyst who cares about a company and its valuation, regardless of their recommendation or price target. From our vantage point, it’s clear that sell-side research will shrink in quantity, but improve greatly in quality and transform in content (we’ve already seen a good deal of this from non-bulge bracket sell-side firms and boutique research houses). This is good news for the capital markets, especially for the time constrained IRO whose real challenge has never been the analyst who cares and is passionate about the investment story and management team (whether they support them or not), but the one who constitutes “coverage” and requires an unreasonable amount of handholding when it comes to providing readily available facts and walking through financial models.  So as 2018 unfolds, I suggest using the following checklist to assist both you and the analysts you regard the most highly to:

  1. Remind yourself, and the analyst, that they’re not getting paid to set up meetings anymore. Obvious? Yes. But when things have been done one way for decades – and uncertainty remains regarding the new way forward – it’s always more difficult than one expects to fully engage a new approach. Work through the structure of your investment thesis and their analysis using time that had been wasted on being pitched for and discussing corporate access roadshows that both of you know aren’t optimal for either the corporate’s or the analyst’s interests. 
  2. Start measuring both your IR program’s and analysts’ success at highlighting your investment thesis.  This refers to “highlighting” regardless of the analyst’s level of skepticism or enthusiasm regarding management’s strategy and/or your stock’s valuation.  If they are not building their communications upon the ways management is articulating its plans for financial performance and other KPIs, then they aren’t doing their job (or you as the IRO aren’t giving them the tools to do so). Taylor Rafferty regularly assists clients to develop and implement simple, straightforward ways to measure success at this, ones that also challenge management to sharpen their messaging discipline (everyone gets a bit more focused when scoring is involved).
  3. Discuss how the analyst’s research may be sharpened facing the opportunity of higher value ascribed to higher quality sell-side research. The IRO has unique insights into investors’ perspectives on their company’s stock and investment story, including aspects that can only be properly covered by a third party. These can indicate clear market opportunities for more incisive sell-side research. While no one knows precisely how the sell-side research payment model will evolve, winning approaches will certainly feature quality content focused on investors’ priority interests and concerns and areas the company can’t illuminate.

Obvious to anyone who has read this far is the fact that MiFID II does not extend across the Atlantic, that the SEC has issued a no-action letter giving the US markets time to sort out their approach to the European regulations, and that none of the above technically refers to US-based analysts. My experience is that the US-based sell-side analyst that engages in a non-US company’s IR program is already open to the above, because they’re the analysts looking for new ideas and a marketing edge and willing to adopt new ways to cover and write to gain an edge.

Strong Institutional Marketing Upside Potential/Limited IR Program Downside

In keeping with my view that MiFID II presents big opportunities for non-US companies to steal a march on their US peers, the increase in quality of non-US generated sell-side research should improve its effectiveness at advancing a company’s investment thesis, regardless of the extent to which the US buy-side moves towards MiFID II compliance. US institutions will welcome more incisive sell-side research on your company and there is no downside to exploring new approaches with those sell-side analysts you regard the highest. The upside includes learning things first about the ways sell-side analysis will change, working more collaboratively with talented analysts who know well your company and industry, and launching yourself and your IR program above your competitors.

“I showed my teenager a 3.5 inch floppy disk I’d found at the bottom of a desk drawer. I asked him if he knew what it was. He guessed that a company I follow had made models of the “save” icon as a corporate giveaway.” - Sell-side analyst, as told to me at a client capital markets day.