Several years ago a good friend of mine, Rick Gossage, wrote a book called The Safe Child in which he encouraged parents to “Street Proof” their kids. The basic message in the book was that to avoid putting themselves in harm’s way out on the street, kids should stay on guard and listen to their instincts.
In my twenty five years working with public companies, I’ve come to see how a similar message might help CEOs avoid some of the harm that can come their way in dealing with the potholes and pitfalls found on Bay Street.
Of course there are volumes of rules and legions of regulators that will help public company CEOs decide what should be reported, when and to whom. With proper legal and accounting advice, these written rules are fairly easy to follow. But there are also some unwritten rules of the Street that every CEO needs to know. Break these, especially in the closely-knit community of the Canadian capital markets, and you may do your company serious harm.
Rule # 1:The biggest investment bank is not always best
I once had the CFO of a Canadian-based micro-cap technology company ask me when he should expect to see some of the big New York investment banks lining up to help him raise money. I explained that investment banks, like issuers, come in all shapes and sizes. Some of the smaller independent ones are very niche-focused and would be much better suited to serving his needs than a large bank-owned firm. While they are obviously capable of supporting the needs of smaller clients, big investment banks have a lot of infrastructure to support and it’s generally more efficient for them put these resources against larger clients that generate bigger fees.
Issuers of public equity need to think about capital like any other input to their business. There are many suppliers to choose from and lots of variations on how deals are structured. This means an issuer needs to consider what they are getting from their investment bank besides fresh capital in their treasury.
Most of Canada’s tier-two investments banks are as capable of leading a syndicate for a $50 million financing as any of the bank-owned firms. All investment banks try to avoid competing on price, so this means other considerations need to be taken into account in selecting an underwriter. If you want to boast about hiring a big name firm, then it’s an easy decision. But if you want to get the attention and allegiance of the investment bank, not just for the financing, but also with research coverage and post-closing marketing support, then you should give equal consideration to some of the smaller independents.
Rule #2: Respect the research relationship
Investment banks don’t make any money publishing research. This is a cost of doing business that they need to recover either from trading commissions, underwriting fees or advisory fees. I counsel my clients to keep this in mind when they decide to award underwriting mandates. Forgetting this basic rule can be costly. One small cap issuer that I know of recently made the mistake of cutting every firm that covered their company out of a financing syndicate even though they all had positive recommendations on the stock. Instead, they awarded the mandate to a banker who hadn’t invested any time in covering the stock – but had a bigger name. When the syndicate was announced, the result was an immediate 18 percent haircut on the company’s share price as every friend they ever had on the Street said a collective “sell”. They closed the financing, but at a 30 percent discount to recent trading. While this turned out to be costly capital, the real cost to the company was the shredding of management’s credibility with the Street.
An investment bank that writes research is saying to the Street “we have put time and effort into developing a point of view on this company”. Unless that point of view is completely off base or the company has more research coverage than it needs, an issuer that excludes a publishing investment bank from an underwriting syndicate is effectively saying to the Street “we don’t place any value on the work of analysts so don’t bother putting in the time and effort to publish research”.
Rule #3: Compliance is no guarantee of comprehension
I have many friends who are securities lawyers or accountants. T hese are highly trained professionals whose first job is to know and explain all of the written rules that a public company needs to follow in disclosing information to investors. These people are indispensable in helping CEOs keep their interactions with the Street within the bounds of compliance. But C-level managers, and especially the boards to whom they report, need to remember that compliance does not automatically lead to comprehension. Getting investors and analysts to “get it” usually requires an understanding of what lies behind the numbers and beyond the notes.
CEOs should look at every outbound communication to their financial stakeholders as an opportunity to increase the Street’s awareness, understanding and comprehension of the company’s investment story. There are lots of opportunities to do this, starting with the Management Discussion and Analysis (MD&A). Keeping in mind that the “D” stands for “discussion”, management should write this report so that it meets more than the minimum threshold of disclosure compliance. It should give the reader some perspective on how the company’s recent performance lines up with its broader objectives and long term strategic plans.
On a recent trip to New York, I came across a copy of a 1964 Annual Report from Pan American World Airlines. The 20-page report included a comprehensive ten-year financial review, current financial statements (with no more than a page and a half of notes) and in place of the obligatory MD&A, there was a straightforward message from the CEO that told you, in plain English, where the company stood, where it was going and what risks and challenges it faced in getting there. You could read the whole report from cover to cover in about 15 minutes and understand what you needed to know as a prospective investor. Unfortunately, over the last 43 years it seems the compliance obligations placed on public companies have grown exponentially but so has the challenge of comprehending what all of this added disclosure means to the investor.
Conclusion
The Street is supposed to be a route that leads a company to the lowest possible cost of equity capital. But it’s not all freshly paved blacktop with clear lane markings. Right after you pass the gleaming IPO tollbooth, it can turn into a narrow laneway with sharp curves, dead ends and lousy signage. Keeping these unwritten rules in mind may not prevent you from making a wrong turn, but they can keep you from losing control when you hit a patch of black ice that you didn’t see coming.
John Sadler is founder and Managing Director of Toronto-based Genoa Management Limited. Genoa helps Canadian public companies maximize shareholder value through a wide range of services including shareholder development, institutional investor networking, broker outreach and relationship management with the investment banking community. A former corporate executive with a major TSX & NYSE-listed financial institution, John has more than twenty-five years of experience helping corporate and government leaders manage capital market issues. You can contact John at 416-962-3300 or by email at jsadler@genoa.ca
Since 2005 ITB Solutions has provided listings development services to stock Exchanges in Canada such as the Canadian Securities Exchange. ITB Solutions currently provides New Listing Services to the NEO Exchange. We assist companies with the listing application and managing the process to become publicly tradable in Canada, as well as offering advice on how to make the most of your public listing. You can reach Jeffrey Stanger at 647-500-0492 or by email at jeffrey@itbsolutions.ca
