In 1995, foreign issuers were faced with the difficult task of trying to distract US investors away from high-rolling domestic US stocks, particularly in the high tech sector, and towards their own ADRs. It’s a far cry from a few years back, when Wall Street returns paled in comparison to those of the emerging markets. But this kind of volatility is part of the risk ADR issuers face in opening up a new universe.
Faced with the challenge, they are relying on investor relations programmes to broaden their target investor audience. Analysts, once driven crazy by companies referring them to the share registrar for annual reports, now find they usually have almost instant access to information, either directly from the foreign management or through an IR consultant. Even Telmex, long moribund in its IR, has bowed to the pressure and is setting up a department with the help of Southwestern Bell veterans.
Peter Firestein of Georgeson & Co says the Mexican sell-off and subsequent tequila effect in 1995 underline the need for better communication by ADR issuers. ‘Most foreign companies underestimate the importance of communicating with the US market. For that reason they don’t receive fair valuation,’ says Firestein. ‘For non-US companies, direct interaction is critical, not only with stockholders, but with analysts following the country, the region and the industry,’he adds.
In a recent US fund manager survey by Broadgate Consultants, 92 per cent indicated that an active IR programme helps sell foreign securities. The study showed a desire for more corporate transparency and a preference for listed ADR programmes armed with requisite disclosure practices. With widespread opposition to the relaxation of disclosure rules, even in the interests of promoting international listings, 74 per cent said a listed ADR enhanced acceptance by investors; and a full 92 per cent said quarterly results were critical to analysis and decision-making.
Among those interviewed by Investor Relations for this survey – eight securities analysts, four depositaries and two traders – there was unanimous agreement that ADR issuers need solid IR to ensure a healthy secondary market. A key target in achieving this is scoring coverage from analysts, a constituency often overlooked by companies new to US markets.
According to Ken Lopian, senior vice president at Bank of New York, analyst coverage is the single greatest challenge for non-US companies and is critical to developing and maintaining an active investor base. ‘Companies need to know and deliver a consistent message to a core group of analysts,’ says Lopian. ‘If they provide information and ongoing access to top management, analyst support will usually follow.’
BoNY maintains a database of 18,000 brokers, traders, research analysts and institutional investors to help issuers target communications, along with a separate list of 2,000 analysts that can be sorted by industry. ‘Some industries have to look to the US for the best valuation,’ Lopian comments. ‘The tools in this capital market are different, analysts dig deeper, the institutional investor base has its own focus, and retail investors track the market closely.’
That is one reason why many issuers fail to understand the role of sell-side analysts at Wall Street firms. Historically, research has played a much more limited role in non-Anglo-Saxon markets and this has led to frustration on both sides. Examples abound: one analyst recalls a Chilean bank that was afraid of upsetting clients with estimates and predictions; another confides that overseas counterparts are simply ‘less scrupulous’ and that some ADR issuers are sceptical about the efficacy of US regulations designed to ensure the separation of research and banking functions.
But on the whole, Wall Street analysts are knowledgeable, specialised and aggressive. Many are just as at home visiting a developing world factory as they are speaking with American investors. The good ones stop at nothing in their efforts to value companies accurately.
‘It’s incumbent on the company to demonstrate it is worth being researched, to explain the ingredients that make it interesting to a broad base of investors,’ says Morgan Guaranty’s Eric Frank. ‘It’s also important that they understand this research is part of a global effort
Most analysts surveyed emphasise that over the years research has evolved from being country-based to regional and global. Companies are nowadays evaluated in the context of industry peers worldwide and they must be ready to compete that way. For many issuers, communicating the right message in this global research environment can produce higher valuations than in the home market.
Take Nokia, the telecom equipment manufacturer. Trading at a P/E of around 10 in its home market of Finland, its ADR soon traded up to 20-times earnings when US telecoms analysts initiated coverage. Matthew Hickman, director of Latin American equity research at Lehman Brothers, points out that different markets have their own P/E levels, and that ADRs like Compania de Telefonos de Chile (CTC) have detached themselves from local P/Es to find higher valuations in the US.
‘Analysts are always looking for new ideas,’ says Jim Prout of IR firm, Taylor Rafferty. ‘For a company, they’re the first stop in educating the market because they talk directly to institutions. Beyond what analysts publish, their value is in their chat, nudges and winks to fund managers. An ADR is not the end of a capital-seeking process, it’s the beginning. Interest levels drive the market, not the product.’
Kay Breakstone, president and CEO of Ludgate Communications in New York, says her background as a sell-side analyst with Dean Witter partly informs her approach with clients. Before designing a strategy to reach analysts, she gets the management to look at their own company as a US analyst would: looking at size, industry position and economic outlook; financial history and earnings track records; market capitalisation; investment characteristics; industry considerations; and the peer group.
Ludgate then puts together a list of every brokerage house and analyst covering the company, or in a position to initiate coverage, together with the analysts’ earnings estimates, if any, their telephone numbers and other relevant intelligence. Regularly updated, the list acts as a continuing reference for the CFO fielding calls from the Street. Breakstone also hosts seminars to educate management, explaining the roles of sell- and buy-side analysts. ‘You never get a second chance to make a good first impression,’ she quips. ‘From the word go, management has to be up to speed with analysts.’
This all part of cultivating analyst relationships and getting to understand their strengths, which should start from the point when they first select an underwriter.
Peter Duggan, vice president and product manager for depositary receipts at Bankers Trust Co, maintains constant contact with US investment banks, market makers and equity analysts. ‘We present companies with data on the top banks in terms of underwriting and secondary market research,’ he says. ‘They can use the data in their decision-making process.’ Duggan pioneered BT’s ADR Universe, a compendium that has become a handbook of issuers and investors and that is now being expanded to include capital raised, lead manager mandates and legal counsel.
Despite the lull in new issue activity last year, there is little doubt about the long-term benefits of making contact with the Street. ‘Companies coming to the US market find themselves on a huge grocery shelf,’ comments Mark Bach, vice president and head of ADR sales at Citibank. ‘In the broadest, deepest capital market in the world, ADR issuers must actively promote themselves to analysts and investors.’
In its annual survey of ADR investors, the Connecticut-based independent research firm Greenwich Associates shows US pension fund investment in international equities increasing from 5.4 per cent of total assets in 1992 to 8.8 per cent in 1995, and a predicted 11.2 per cent, or $390 bn, by 1998. Greenwich found that most portfolio managers cite creative investment ideas emanating from sell-side analysts as the single most important factor in their international investment decision-making.
To get a better understanding of ADR research from where it actually happens – inside the investment banks – Investor Relations surveyed the top ADR underwriters and traders in the American market. Though some failed to respond, most were eager to display their products, prowess and interest in the market. The following pages look at each of the key players and summarises their thoughts on the ADR. market and its future prospects.
Merrill Lynch: Making the Index
Markus Barth, senior international quantitative analyst at Merrill Lynch, offers an over-riding incentive for issuers dithering about an exchange-listed ADR programme: only exchange-listed companies make up the MLQA ADR Performance Indices, a unique benchmark for investors in international equities. Each week those 267 companies are put in front of up to 8,000 investors in Merrill’s client universe. Supplementing its dominant role in ADR underwriting and trading, Merrill’s index is an important focal point for all issuers.
As for the balance of the 1,500-plus ADRs, according to Barth: ‘If they’re not in our index, they don’t get published and our clients are less likely to hear about them. With few exceptions, ADR issuers foregoing an exchange listing to reach the US capital pool may be bound for disappointment. With an illiquid security, and no financial information available, there is little incentive for analysts to follow the stock. A listing makes it easier for analysts to conduct research, while opening the door to the screen-based option and derivatives work portfolio managers love to do.’Merrill created its indices in 1993 to meet the demand for information on the performance of ADRs as an asset class. The MLQA Composite ADR Index is an equal-weighted index of national exchange-listed ADRs, beginning from year-end 1986. The ADR Composite is also broken down into country and regional indices. As a quantitative analyst, Barth examines market movements rather than company fundamentals. The results of Barth’s studies of liquidity and volatility are prompting more analysts to initiate coverage from a US perspective, viewing ADRs as more than just extensions of companies’ underlying shares.
In Europe and Japan, volatility is lower in ADRs than in the local markets, whereas the reverse is true in emerging markets. These differences are often attributed to ‘investment noise’ but Barth says the lower volatility of ADRs from developed country companies is due to the weaker flow of real-time, market-moving information to investors in the US.
Conversely, with a high proportion of foreign investment in emerging markets, ADR investors effectively become the local market, so these ADRs show more volatility than the underlying shares.
Barth has also found a high degree of correlation between a small basket of ADRs and the local equity market. Even in Asian markets with only two ADRs, correlation is still high. ‘Beyond the convenience of ADRs in terms of cost and settlement, US investors can use the companies in our country indices as a reasonable proxy for cash investments in those markets,’ Barth concludes. He notes another benefit of ADRs over domestic market shares: while Latin American ADRs historically lagged their local markets, they outperformed in 1995 because of the perceived safety of US markets; and the same trends are already discernible in Asian markets. As Asian ADRs grow in number, Barth expects US and foreign investors to use them to tap emerging market growth.
SG Warburg: International Clout
In tell-tale surveys of buy-side managers, SG Warburg rates tops in research and information distribution. With over 200 analysts in 38 research offices worldwide, the firm distributes information to its international clients on 2,400 companies, including 350 ADRs. Pending regulatory approval, the reputation and capacity of Warburgs’ new parent (Swiss Bank Corp) will be added to the US fold. This should raise the group’s profile still further.
Christian von Hoffmann, head of ADR research and sales in New York, says that Warburgs’ strength lies in its international presence. ‘More and more emerging markets companies are doing DRs, and want to get their message to the whole world,’ says Hoffmann. ‘If Warburgs in New York writes a report on a Chilean company, it is distributed in London, Europe, and Asia.’
Warburgs is one of the few foreign Wall Street brokers with a focused ADR research product for US investors which uses dollar terms and takes a global sector approach. ‘Warburgs analysts are a global team with input on similar stocks from analysts in other markets assisting in the valuation process,’ says Hoffmann.
He says that a load of ‘basic fundamental’ international analysis appears on his desk every day and that Warburgs is distinguished by its thorough and constant research. ‘We put our resources, contacts and insights into research reports, and distribute them to buy-side clients,’ he says. And he adds that aftermarket research coverage and distribution are a driver in Warburgs’ underwriting capacity. ‘My primary task is to place transactions by getting research to institutions.’
Goldman Sachs: US-Style Research
David Lambert, co-manager of US international equities at Goldman Sachs, has a standard speech he delivers at conferences and investment seminars. He tells his audience that in 1980 1 per cent of US-held securities were non-domestic. Ten years later, after enhanced travel, research and communications, the figure was between 1 and 2 per cent. Then 1995 came along, and 6 per cent of assets in the US were invested in international securities. ‘The momentum is just beginning,’ concludes Lambert.
‘Investors are finding they can buy an ADR which is representative of the shares on a foreign market,’ Lambert says. ‘More people want exposure to international names, and ADRs let them look at foreign companies the same way they look at US-securities, in terms of accounting, filing and credit. Investors can easily call information up on their screens, and have access to data in a more consistent way.’
Lambert says Goldman Sachs analysts do the same level of quality research on every security, be it US-based, a local share or an ADR. To reinforce the research angle, Lambert suggests ADR issuers make regular roadshow tours of the US, arguing that American investors like to meet management in their office, so they can discuss issues in familiar surroundings.
Goldman Sachs is well-known for bringing analysts and investors together with companies, who can then explain their long-term prospects to their investment audience. At a landmark conference in the wake of the Mexican peso crisis, a dozen Mexican companies were invited to New York to explain to analysts and shareholders what was going on and how they were faring.
‘ADR issuers gain additional presence through US analyst participation,’ notes Lambert. ‘Portfolio managers are exposed to analysts daily; they learn their individual strengths and learn to trust them.’
James Capel: Looking for Liquidity
There are two views on research, according to Richard Abrahams, executive managing director and head of trading at James Capel in New York. ‘Analysts have an outlook of six months to three years,’ he says. ‘Traders have a window of ten minutes to three hours. For us, doing business with US institutions means having all the legs in place: capital, trading and research. Research is the number one reason why they will send us trades.’
With 230 analysts worldwide, James Capel is second only to Merrill Lynch in sheer research capacity and clout. Only 15 analysts are on the US beat, with the rest looking at the world for investment ideas. James Capel leverages off its UK and European base, as well as the Asian strength of parent Hongkong & Shanghai Bank. With strong emerging market research, the investment bank has a big presence in the GDR market in London, and recently led the first Polish GDR, for Bank Gdanski.
‘Providing research to the ADR investor means providing a level of comfort,’ says Abrahams. ‘They may be thousands of miles away from their investment, but we can let them know every time the company breathes. Research is about making people money. You can be wise about fundamentals and earnings estimates, but if you get the trend wrong investors don’t like it.’
Abrahams says that with the growth of funds under management in the US, along with foreign holdings, the need for liquidity has become acute. ‘The single biggest drag on a fund manager’s performance is liquidity,’ he says. ‘One of our main jobs is to show the investor where the liquidity lies. Sometimes it’s the ADR; in other cases it’s the ordinary share.’
Lehman Brothers: Global Reach
An underwriting and trading powerhouse in the ADR market, second only to Merrill Lynch in the league tables, Lehman Brothers believes it brings that all-important ‘global feel’ to research.
According to Maryam Mansoury, head of global emerging market equity strategy there, analysts use their global reach to construct a big picture view of each sector and region, comparing companies across boundaries to uncover the best valuation.
‘Lehman analysts in local markets have a crucial research role to play in defining the value of ADRs,’ Mansoury stresses. ‘Local markets are still the main field for stock growth. As these markets mature, research helps bring in more investor interest and capital. Lehman offers the advantage of a global benchmark to let US ADR investors value markets with a world view.’
Lehman analysts feed information into the pipeline on companies and industries while Mansoury concentrates on macro issues. She considers such aspects as ‘assessing country risk while minimising risk and maximising return over time in a global portfolio with as much diversification as possible’. On the road half the year, Mansoury achieves her top-down perspective by scouring the globe, meeting policymakers, governments, heads of industries and companies.
‘I endeavour to learn as much as possible about market mechanics, sentiment and psychology,’ says Mansoury. ‘I study the economics and politics of every industry and every country. Then I develop an evaluation framework from the collected information. Having branches all over the world helps Lehman form global strategy out of international perspectives.’
CS First Boston: Value-Added Research
When Al Jackson talks about the client relationship, he is referring to both the issuer and the buyer of securities. As managing director of global equity research at CS First Boston, he makes sure that both types of client are served by ‘the best coverage from his best people’, no matter where they are based. When the UK-based Hanson plc first called for US research coverage, CS First Boston fulfilled the request of this heavily-traded ADR by supplying a US-based conglomerates analyst working closely with a local analyst in the London office.
‘Through close relations with issuers, our analysts are up-to-date on information and remain well-known by US investors,’ comments Jackson. ‘Still, some foreign companies believe a New York analyst report increases their visibility with US investors. In certain cases it works, in others it does not. Coverage in the local market combined with strong US distribution is always the best of both worlds.’
Jackson believes global analysis across a specific industry sector can be parochial and misguided, noting that most companies are affected by events in local markets. Bottom-up research in the context of the local market is the foundation of analysis, but Jackson claims that CS First Boston’s valuation methodology – Economic Value-Added – distinguishes it from its competitors. EVA analysis adjusts a company’s balance sheet to give a truer indication of the amount of value being created for shareholders. ‘Earnings per share are subject to manipulation all the time,’ says Jackson. ‘Many companies write things off, but that money does not disappear without a cost. EVA removes that manipulation to show how the company is advancing, as analysts focus more on value drivers like return on invested capital. Companies prefer EVA because it is the language of business, and it makes the dialogue with analysts more interesting when they’re asking about more than just earnings per share.
Bear Stearns: Latin American Bull
When it comes to the wild world of Latin American ADRs, Bear Stearns & Co has always been at the top of the investment banking class. Over the years, it has developed a reputation as one of the foremost research houses for the region. While not a Top Five ADR underwriter, its research commitment to Latin America has made Bear Stearns a leading trader of ADR equities overall.
Geoffrey Dennis, senior managing director and head of the 13-person Latin American equity research team, recently instituted a key change in Bear Stearns’ research method with a move towards regional sectoral coverage. ‘In the old days, investors would take a liking to a country and buy its stocks across the board,’ says Dennis. ‘Top-down country research was the analyst’s mainstay. Now investors prefer to make sectoral comparisons, like looking at the fundamentals of Mexico’s Cemex compared to Cementos Lima or some other international cement company.’
Dennis, who handles investment strategy for Latin America, has a team of six sector analysts covering beverages, cement, construction, electric utilities, steel and autos, pulp and paper, and conglomerates. Three Sao Paolo-based analysts cover the ‘big, important and different’ Brazilian market. A telecoms analyst is soon to be added, and Dennis is planning a slot for banks. Each is expected to cover 12-15 companies from New York, shuttling south regularly.
Dennis says valuing Latin companies starts with inflation adjustments, something that has become more relevant again in Mexico since the peso devaluation. Along with conventional criteria like P/E and price-to-book ratios, each Bear Stearns analyst uses measures unique to the sector – such as market cap per unit case production in the case of drinks companies.
Dennis says that, unlike US companies, emerging market ones don’t usually pay dividends, so yield is not part of the equation.
Dennis says quarterly meetings are important for accessibility to foreign companies, adding that: ‘The base set of company requirements for coverage are accessibility, reasonable visibility, a New York roadshow, and an IR official. Analysts want to know the history of activities, profitability, and the balance sheet. Companies that go the whole way with a listed ADR are easy to know and follow. Instances of inadequate or misleading information are becoming rarer and rarer.’
