Company Sponsored Research
C S R
A Pressing Need for Small Cap Companies
Over the past 15+ years, obtaining research has become increasingly difficult for smaller capitalization, less liquid securities ("SmallCaps"). Industry dynamics have made it uneconomical for high quality securities research firms to publish on these companies due to:
- substantially reduced trading activity from actively managed funds, whose assets under management (AUM) has decreased dramatically due to the advent of exchange traded and index funds and other passively managed vehicles;
- commission rates which have been driven substantially lower due to fierce competition;
- the substantial costs of running a securities research business given regulations which preclude its subsidization by the investment banking departments; and
- ever increasing compliance and regulatory burdens.
All of these factors has made if increasingly difficult for money managers to adequately compensate brokerage houses for providing securities research through the traditional means (i.e, trading commissions). Should the impact of MiFid II begins to be felt on our shores, small cap research is predicted to decrease even more dramatically as the buy side will now have to pay for securities research out of their own pockets or undergo an arduous process of justifying its research spend to the holders of the funds they manage. Globally, McKinsey & Company expects more than $1.2 billion less to be allocated securities research as a result of this new law.
Accordingly, many SmallCaps are effectively becoming “orphaned,” with no credible independent means of communicating their investment theses to the investment community. The result is lower trading volumes, impaired liquidity, inefficient pricing/valuations and a lack of institutional investor support for SmallCap securities. In essence, the SmallCaps are incurring all the expenses of being a public company, but reaping few of the benefits.
Notwithstanding the above, institutional investors, high-net-worth individuals, family offices and retail investors still value credible securities research as SmallCaps are frequently an excellent source of “Alpha.” Moreover, the growing numbers of “quant funds” (comprising a significant portion of trading today) need well-informed revenue and earnings estimates from trusted, independent sources, to attempt to capture this “alpha” through their trading algorithms. Unfortunately, these investors have few places to turn for such independent, trustworthy information.
The Sidoti Solution
Sidoti believes that like the debt markets, where issuers pay agencies like S&P and Moody’s to rate their securities, companies-- in in effort to increase their corporate visibility and promote their investment theses--will begin to compensate high quality, non-conflicted securities research firms to provide trusted, independent analyses of their businesses. This view is supported by both the Securities and Exchange Commission's Advisory Committee, academic studies and other authoritative sources:
A report entitled “Research for sale: determinants and consequences of paid-for analyst research” by Marcus Kirk, University of Florida, Gainesville, October 2010 (the “Kirk Study”) provides evidence about the impact of sponsored research. After examining “changes in a firm’s information environment after hiring an analyst” the author finds in most instances in the quarters following the initiation of paid-for coverage:
- lower cost of capital (Healy and Palepu, 2001; Barth and Hutton, 2004; and Irvine, 2003).
- increases in institutional ownership;
- liquidity (e.g., bid-ask spreads, stock turnover); and
- the number of sell-side analysts
Thus Sidoti CSR may help management teams assuage concerns it may have, as expressed by (i) the former president of NASDAQ, that: “Lack of analyst coverage affects the majority of publicly listed firms and impacts company valuation, liquidity and ultimately the welfare and growth of public companies" and (ii) a report commissioned by the SEC (supporting CSR) highlighting lack of analyst coverage as an existing problem with adverse effects such as reduced firm valuation, higher financing costs, decreased market efficiency, lower liquidity, and an inhibitor of investors’ resource allocation decisions.
Increasingly, the buy-side is calling for under followed firms to commission CSR. In a recent Bloomberg article, one $3.5 billion fund stated: [While paying for research] “will lead to a moderate expense for you, we are firmly of the opinion that the increased visibility will deliver a stronger and better informed shareholder base.” Moreover, an advisor to over $1.3 billion in funds commented: The onus is likely to fall more on the C-suite of the businesses themselves to raise their profiles, undertake their own roadshows and proactively engage with their shareholders or potential shareholders to keep their share prices healthy and improve news flow." A synopsis of that article can be found here.
Sidoti CSR Attributes
VIRtUALLY IDENTICAL TO "TRADITIONAL" PRODUCT
Sidoti CSR is identical in virtually every respect to its “traditional” research product (examples of CSR can be found here), with the exception that we do not provide a Buy/Neutral rating and do include a risk rating. However, we provide stock price targets and full earnings models through which institutional and other sophisticated investors can derive an investment opinion. The same analysts who provide traditional research coverage are the authors of our CSR product as we make every effort not to distinguish between the two but for the relevant disclosures.
NON-DEAL ROADSHOW MEETINGS
Many CSR candidates could possibly engender more interest from the institutional buy-side if our analysts discussed their investment theses with them. When possible, we endeavor will to assist management in meeting selected investors where there is a mutual interest in establishing a dialogue.
We always provide an initiation report and at least one report following each earnings release for the next four quarters, although in practice we publish “Notes” whenever something about a company/industry is newsworthy and we seek to have at least one published communication with our investor base every six weeks.
One year of research coverage costs $40,000. For many companies, this amount will represent less than one half a penny per share to reap the benefits of sponsored research. We believe most institutional investors are would agree that the cost of Sidoti CSR could easily be rationalized because your company could very well benefit by more than the <$0.005 per share (on the upside) or preserve >$0.005 per share in value (on the downside) by virtue of Sidoti CSR coverage. Further discussion of this topic can be found here.
We distribute CSR to our nearly 500 “entitled” institutional clients in the U.S., Canada and U.K., which includes many leading managers of portfolios with $200 million to $2 billion of assets. These asset managers are generally underserved by brokerage firms targeting larger managers. We make our CSR available to subscribers of services such as Bloomberg and Factset and post it on our website. Our CSR earnings estimates are picked up by First Call, Zacks and other aggregators. But most importantly, we make the research available to you to use with your IR team and we can work with your IR team with ideas on how you might place the research in the hands of potentially other interested parties.
Sidoti hosts two investor conferences each year in New York City, where our CSR clients can have the opportunity to present their stories and hold 1x1 meetings with investors. Our Fall 2017 conference had 93 presenting companies with an average market capitalization of $528 million (range from < $100 million to > $3.2 billion) where over 500 institutional investors registered as attendees. Information about our upcoming Spring 2018 conference can be found here or by contacting Caitlin Adams at email@example.com.
*additional presenters fee applies
EXTRAORDINARY MEASURES TO AVOID CONFLICTS
The Kirk Study and common sense both suggest that benefits of CSR are strongest for fee-based research firms with established policies that reduce potential conflicts of interest. The study points out that in the debt markets, firms like Moody’s, S&P and Fitch have been recognized as authoritative sources of information throughout the financial community despite the fact that ratings are paid for by the companies that themselves are being evaluated. They note that like Sidoti, the need for ratings agencies to return time and again has created a “large body of evidence shows that reputational incentives can outweigh these conflicts,” stating “fee-based firms also have strong incentives to protect their reputations similar to credit rating agencies (Covitz and Harrison, 2003).” The study goes on to suggest that traditional sell side research may by fraught with conflicts due to “other business relations, specifically investment banking.” While regulatory actions have attempted to separate the provision of research from a brokerage’s investment banking arm, Sidoti believes that the provision of research by many providers can only be economically substantiated if the brokerage is able to win several seven or eight figure investment banking mandates by virtue of providing coverage. In Sidoti’s view, institutional investors are more likely to question the integrity of research tacitly connected to an investment banking transaction than to believe a sponsored-research firm would damage its reputation for a relatively small fee. Our CEO suggests here that the buy-side has great faith in Sidoti's CSR because they "know their provider."
Sidoti has taken significant measures to maintain independence and minimize conflicts; we will deny the provision of coverage in any instance where the specter of bias could exist as discussed at right:
- No Investment Banking: Sidoti does not generally engage in investment banking activities and will not accept investment banking business from CSR clients.
- An Independent “Selection” Committee: Sidoti has a CSR committee, with two independent members, whose mandate is to ensure that only “quality” CSR clients are accepted and analyst opinions are unbiased.
- Same Analysts as with Traditional Research: Sidoti utilizes the same analysts to publish CSR as it does its traditional product, with the traditional product remaining the majority of their output. To maintain their reputations with institutional investors, analysts can ill afford to work with anyone but high quality CSR candidates.
- Sidoti Prices CSR to Avoid Conflicts and Maintain Quality: Sidoti currently charges $40,000 for a year’s worth of research coverage, an amount any brokerage can much more easily forego in the event that “issues” arise with a company than a seven or eight figure investment banking fee. At the same time, it does not charge an amount that is so low that Sidoti must become a “CSR factory,” where driving volume, rather than emphasizing quality, becomes the road map to a profitable business.
- Full Disclosure: Unlike many other sponsored research houses, Sidoti is a registered broker dealer and must abide by many stringent regulatory requirements. Sidoti fully discloses the nature of its relationship with each covered company.
- Upfront Fees with No Right to Review or Halt a Negative Report: Sidoti makes its clients, who have no right to review or influence a report prior to its issuance, pay the CSR fee prior to each report’s issuance. No CSR client may preclude Sidoti from publishing an unfavorable report. These policies are in keeping with almost every authoritative recommendation we have seen about the manner in which to keep a sponsored research offering credible and reduce the possibility of conflicts.
Performance of our CSR Clients
Companies interested in participating in Sidoti's CSR program and Institutional Investors: if you wish to receive information about the stock price and liquidity performance of Sidoti's CSR companies under coverage, please contact Katherine Apfel and John DeBono at firstname.lastname@example.org. Individual Investors: please contact your financial advisor.