The investor relations function at your company is under attack. You’ve seen the signs. Something’s up and, suddenly, no-one’s letting you in on the secrets anymore. Are those whisperings by the coffee machine about you? Did that door swing shut as you walked past? Is the CEO really in a meeting every time you call?
It may not manifest itself in quite this fashion but there are times in every company when the IR function has to show what it’s worth. At the worst, your job may be under threat; at the best, senior management may want some hard targets and results from IR. Whatever, you’re going to have to produce a decent appraisal of where you’re at and why investor relations is so crucial.
‘Half of our problem in this discipline is that too many chief executives look at the share price as the only measure of IR,’ says Neil Ryder, a director of London-based consultancy Sage Partners. ‘Equally sadly, it’s still very true to say that there is no absolute argument in favor of or against investor relations.’ There may be no absolute argument but, as one might expect, Ryder can come up with a range of suggestions as to the true benefit of IR.
He strongly believes that investor relations is a strategic marketing exercise designed to cope with the problem that in the long-term there tends to be an oversupply of securities in the market leading to competition to attract capital. If you don’t effectively compete then you’re going to lose out.
The method of competition? Ensuring that current and potential buyers of your securities know what your product, in this case your stock, is all about. ‘You can produce the best widget in the world but if you can’t market it someone else will succeed where you failed.’ In short, people can’t and won’t buy what they don’t know about.
Close, but no cigar
So there we have the first part of your presentation to your CEO. He’s called you in to find out why on earth he should continue paying your salary. And you’ve gone and bamboozled him with a load of IR theory. ‘Bunkum,’ he barks. Something more is called for.
Next up comes the Bradley Allen defence for IR. Allen’s spent many years in the investor relations business, most recently as director of IR and corporate communications for Minnesota-based Imation Corp. He should know a thing or two.
Allen takes a slightly different tack. He casually points out that one assumes we’re dealing on a level that is over and above the basic need to meet statutory reporting obligations. It’s a neat shot – putting anything beyond that onto a much higher plane.
First on the priority list is the need to satisfy the requirements of investors. He points out that the audience has ‘become much, much more institutional’ and is driven by the need to identify a larger number of investment ideas very quickly. ‘For you as a company to be seen in that marketplace you need to market yourself appropriately.’
Next in line are the internal audiences. ‘More companies are using external [financial community] evaluations to make sure they’re on track. IR provides that external view internally.’ It also, Allen suggests, adds value when employees have some form of stock-related compensation package. ‘A large part of an IR strategy is to engage employees at all levels.’
Finally, chuckles Allen, it wouldn’t go amiss to point out that many CEOs have noted a link between the length of their tenure and the strength of their company’s relationship with the financial community. Maybe you should keep this last point up your sleeve until things get really desperate. After all, as Allen points out, as an IR officer ‘you’re a member of the diplomatic corps.’
First base
Let’s assume here – your diplomatic credentials being complete – that you’ve rescued your position; the CEO is convinced in the short term. But he wants more in the near future. Rusty Page of Rusty Page & Company in Charlotte, North Carolina has some answers. Page, who spent many years as in-house IRO at NationsBank before moving into consulting, notes that for a consultant to defend the role of an in-house position might sound like heresy.
Not so: ‘The truth of the matter is that every company that is publicly-held owes it to its directors, owners and employees to have the investor relations function in-house and be as proactive as it possibly can be. It’s incumbent upon each company to treat its equity as if it were one of its products.’ Page doesn’t tend to mince his words.
Carol Ruth, president and chief executive officer of Edelman Financial Worldwide in New York and a former chairperson of Niri, believes that internal justification and credibility building for the IR role is the ‘number one problem’ for investor relations officers. ‘You’re often the only one in the organization; other people don’t necessarily understand it; and people want to know what value you’re bringing to the table.’
Ruth, like other commentators, argues that one of the most valuable options is to do some form of investor relations audit and then present it to the key people in your company to broaden understanding of what you are trying to achieve. ‘You should try and bring forth the external perceptions and some quotes so you can say, This is what people are saying about us now. Here’s my program to correct the misconceptions.’
Ruth argues that it’s difficult to do such an audit without outside help. While acknowledging her consultant’s self-interest here and that you can sometimes do such a study using internal resources, she sticks to her guns. ‘Otherwise you won’t get people to say what they really think.’
An investor relations officer can, however, use measuring techniques other than a qualitative survey of financial community opinion to help gain credibility. Ruth suggests a comparison with four or five companies in your peer group looking at areas such as analyst coverage, research reports and shareholder base to produce some hard facts to present to colleagues. ‘Then show what you want to achieve accordingly.’
Cost benefits
Of course, no-one ever said that getting an effective measure of IR would be easy. Many people talk about IR lowering the cost of capital (see Praying for shareholder value, below), but going about measuring it is another matter. Still, Page insists that there are ways and means. It won’t necessarily be cheap, of course, but anything that has value can be measured. IR is no exception.
In some cases, he continues, it may well be necessary to ask for permission from senior management in order to gain the resources to conduct such a study. But remain confident that the benefits of benchmarking your program will often outweigh the downside of extra costs. It won’t help your cause if you’re inefficient and inept, of course, but then again, it is likely to help the longer-term cause of the company when the axe falls. Having some concrete targets to work toward will probably aid most good IR officers.
‘I don’t think any corporate function should exist unless it adds value,’ says Page. ‘If a company is newly public then it should be looking at its P/E and level of analyst coverage. If it’s more sophisticated and mature, then its IR program should be looking at the shifting trends of institutional investors and ways of targeting them. It’s all very measurable.’
Beware the need for a control group, though. John Lewis, president of California-based Valuation Technologies, points to the situation whereby the annual AIMR report citing companies with the best IR programs can significantly affect the performance of the nominated companies while they are on the list. It’s a chicken and egg situation and it’s extremely difficult to know which comes first.
Peer group comparisons may well raise another problem. Who is the peer group in IR terms? Is it your domestic or international competitors? Kathy Bloomgarden, president of New York-based Ruder Finn, points to these issues, particularly when looking at the European market. She suggests that if companies are looking for a very simplistic measure of IR effectiveness they should plot share price relative to press release dates over a period of time. Alternatively, IROs should turn back to senior management and get them to evaluate the level of questioning they are getting in presentations to the investment community. ‘A really well-informed audience asks good questions and for most managers that’s much more reassuring than irrelevant questions.’
Brad Allen agrees with Bloomgarden and sees IR value being measured directly by performance. ‘Most senior management immediately recognize the value of investor relations when they’re going out to meet investors. They’ll see if you can provide feedback, if you can say how the interaction is viewed and if you can demonstrate a really solid relationship with the financial community.’
If it’s done well, it’s something that’s worth hanging on to.
An end to IR?
Investor Relations magazine asked whether there are ever any circumstances in which a publicly-listed company could justify abandoning the IR function. We gave the theoretical situation that a company was generating so much cash that it did not need to worry about tapping the markets again for the foreseeable future. It does not have to worry about its cost of capital, so should it worry about IR?
Neil Ryder, Sage Partners
Ryder argues that if a company was in this theoretical position it should eventually aim to buy back all of its shares and return to the private sector. If not, it is imposing unnecessary cost burdens upon itself by maintaining its status as a public company. But it is unlikely that such a situation would ever arise as few companies can predict their financing needs such a long way into the future.
‘Some companies can predict that for a short period of time, but you’ve got to be very brave to think further ahead.’
Rusty Page, Rusty Page & Co
Page argues that a good, publicly-owned company owes it to its shareholders not only to increase earnings and its ability to grow over a period of time but to ensure the worldwide investment community is aware of its performance. It has an obligation to manage the expectations of the investment community and maximize its valuation accordingly.
‘Only by going private should a company absolve itself of its responsibility to effectively communicate its story to the investment community.’
Praying for shareholder value
Like a mantra chanted in prayer, the idea that good IR reduces a company’s cost of capital has sustained many an IR department. But with designer valuation models displacing good ol’ accounting metrics, IROs have to get much more than a mantra rolling off the tongue. These days a whole sermon is demanded.
For example, ‘cost of capital’ is by no means immutable. Holt Value Associates and Stern Stewart each have their own definitions. Stern Stewart’s approach uses an historical relationship of equity returns compared to a risk-free rate and beta (stock price sensitivity to market movement). Holt uses a forward-looking approach keyed to today’s stock prices and dismisses beta as being useless for valuation analysis.
But even that’s too simple for today’s savvy IRO. According to Holt’s methodology for calculating cash flow return on investment (CFROI), cost of capital is the investor’s required return for investing in a company. ‘We ask, How much are investors demanding for the use of their money?’ explains Holt partner Timothy Bixler.
What that return has been over time is a known quantity: around 6 percent. Because investors try to beat inflation and maximize after-tax returns, inflation and taxes are the two key drivers of the discount rate. ‘So we have a discount rate that is real as opposed to nominal – and the difference between real and nominal is inflation.’
‘Given today’s level of inflation, which is quite low, and today’s tax laws, which are also low relative to history, investors are demanding a very low real rate of return for the use of their capital,’ says Bixler.
It appears that cost of capital has a lot of different factors – and IR doesn’t really enter into it. ‘The role of IR is not to reduce the cost of capital,’ Bixler avers. ‘The role of IR is to communicate the cashflow pattern of the comapny more effectively: This is what we’re doing, this is what we’re investing in, and these are the returns we’re going to get.’
One view has it that an effective IR program can reduce the company’s riskiness in the eyes of investors; or it can close a communications gap and remove a stumbling block for investors, thereby lowering the cost of capital.
Not so, says Bixler. ‘What you’re really doing is communicating about the cash flow of the company, giving the investor more reliable forecasts of the future cash flows of the business. IR does not arbitrarily affect the cost of capital.’
Bixler explains that investors have traditionally focused on EPS growth rates and PE multiples. ‘Unfortunately, when you try and correlate these two measures, you find there’s no relationship.’
The result is a focus on cash flow, with more and more companies and investors alike looking beyond EPS. First they’re cleaning up accounting information and measuring economic cash performance, then they’re applying valuation models to the cash flow and the business to see how much the company’s really worth.
In the end, if an IRO’s influence to the cost of capital seems untenable, at least his value in explaining new valuation measures should not be in doubt.
