What’s a value stock to do? What’s a company with sound fundamentals but a lackluster valuation relative to its peers to do in order to raise its valuation?
Certainly not wait quietly for investors to walk across the room and ask for a dance. This is the wrong market for bashful investor relations efforts. As the Dow continues surging into record territory, it seems only those companies that can beat an estimate or peddle an exciting story (usually relating to the internet) are rewarded.
Of course, most senior management teams believe there is something of a valuation gap between what they think their company should be worth and what value the market actually places on it. That’s the way of the world. But there are many companies which are more justified in thinking that they are getting a rough deal from the valuation experts in the financial community.
Consider Saks Incorporated. At the end of the first quarter, despite attractive growth prospects as confirmed by most analysts, the stock was trading at less than half the price-earnings multiple of the S&P 500 and at the low end of the department store sector. The stock was selling at a 43 percent discount to its projected growth rate of 20 percent.
‘This is a very complex company,’ explains Julia Bentley, senior vice president, investor relations. ‘Prior to merging with Saks in September, we were Proffitt’s. We’ve had a series of acquisitions overall, so our financial statements have been restated. It can be a very complicated financial picture to understand.’
Constant contact
In order to educate investors, Bentley says she tries to provide as much financial information and as much detail as possible, both in terms of understanding the past, as well as projections for the future.
‘Fifteen analysts cover us, and the overwhelming majority has either a strong buy or a buy recommendation on us, with the exception of one analyst. I think Wall Street analysts are very attuned to what we’re trying to do and what our growth prospects are. We’re in constant contact with them to make sure that’s the case,’ she explains.
Unfortunately, the buy-side has been slow to catch on. Again, Bentley points to the changes in the company. Where Proffitt’s was a regional department store company, it now includes the Saks Fifth Avenue showpiece. Some investors worry management deviated from its strategy. In response, Bentley has spent several months working to change that perception, and she has been aided by the aggressive cheerleading of Saks’ popular chairman, Brad Martin. Speaking to as many shareholders as possible, both potential and current, Bentley and senior management have articulated their strategy and explained the rationale behind the Proffitt’s-to-Saks transaction. Now, as Bentley explains, ‘it’s a question of, are we going to make the numbers?’
Battling the old guard
For Harrah’s, a casino company whose trailing twelve month PE lags behind that of its peer group by coming on for 50 percent, the issue has also been one of misunderstanding, though that is not due to its recent acquisitions. Instead, Harrah’s has had trouble convincing gaming industry investors and analysts that its revolutionary strategy can be executed. Harrah’s just does not want to play by the usual rules and the financial community is suspicious about its ability to change the way of the game.
‘This industry, over the last 15-20 years, has been evaluated by the investment and analyst community as an industry that sees growth through the deployment of large blocks of capital,’ says Colin Reed, CFO at Harrah’s. ‘But in an industry where the return on invested capital has in fact declined substantially over the last five to ten years as supply has held with demand, this strategy is not in the best interest of our shareholders. Instead, we’re trying to build a compelling strategy around customer loyalty.’
The problem, as Reed explains, is that the people who have traditionally been the investors in Harrah’s industry find a strategy of same store sales growth a little difficult to believe. ‘We want to better understand our customers in order to earn a bigger piece of their budget,’ says Reed. ‘To achieve this, we’ve expanded our technology, and we’ve put in service standards to supplement the effort and build customer loyalty. Investors believe you can’t do this, though we’re starting to prove that notion wrong, just as other industries have proven it wrong.’
The goal of investor relations at Harrah’s has been to open the company up to investors and allow them to see and understand the changes and strategies clearly for themselves. But because the complex strategy took five years to fully implement, the investor relations component has only recently swung into action to articulate the new processes.
‘Our technology platform is as complex as any you’ll see in the entire service-related industry, and that takes time to complete. We also didn’t want to tip our hat to the competition and let them know what we were up to before we had it in place,’ explains Reed.
With each piece of the plan now in place, and with an investor relations effort in full swing, the company announced strong first quarter results which matched Wall Street estimates and included record-high revenues and net income.
The .com dilemma
CVS has run up against more than investor confusion. At the end of the first quarter, rival Walgreens was trading at 47 times estimated earnings, while CVS came in at a forward PE of 32. While most analysts agree that CVS deserves a higher valuation, and despite having a management team that has placed shareholder wealth creation at the top of its list of priorities, the company has seen its efforts to raise its profile in the financial community and valuation to a ‘fair’ level hampered as its stock and its industry have been shaken by cyberspace and changing perceptions.
‘While the internet drug stores have not had a really negative effect on our business, it’s the perception around them that is having a negative impact on our share price,’ explains Nancy Christal, vice president of investor relations at CVS.
Although she acknowledges other external factors have created a drag on CVS’s valuation despite the company’s extremely strong operating performance (for example, competitor Rite Aid missed Q4 1998 earnings per share estimates by a wide margin in March), Amazon.com and its investment in Drugstore.com has been the real killer. ‘There were already other internet-based drug stores that no-one was overly concerned about, but when Amazon became involved and was on every talk show and magazine cover, it became an issue affecting our valuation. I think most of our shareholders understand that we have very significant competitive advantages as both an internet and bricks-and-mortar drug store chain. But even still, investors are worried about perception,’ says Christal.
To correct investor perception, CVS has launched an aggressive information campaign, including one-on-one meetings, group dinners, and a major analyst event in New York. Christal says senior management is devoting more time to the investor relations effort. She notes a recent analyst’s conference call which, in addition to covering the usual earnings update and general business trends, included an articulation of the company’s internet strategy to clarify any potential misunderstanding. The conference call was also web cast for the first time. At the same time, the company is bolstering its internet presence. In April, CVS agreed to pay $30 mn for Soma.com, an internet company that allows customers to order pharmacy products online.
‘Everyone is concerned by what happened with Barnes & Noble and Amazon,’ says Christal. ‘We think the standalone internet drug stores have significant competitive disadvantages. We’re going to make sure people understand that healthcare is not selling books. To succeed in this business you really have to understand how healthcare works.’
Success story
One company that successfully pulled its valuation more into line with that of its peers is Deutsche Telekom. The German telecoms giant, whose ADR more than doubled in value last year, was enjoying a PE of 46.7 at the beginning of Q2 1999, well ahead of that of its European peer group at 28.5. While Deutsche Telekom took the necessary steps to convey a clear message and banish misperceptions, it also worked to manage expectations. According to Thomas Winkler, executive director and head of investor relations, that was one of the key steps toward success.
‘When I joined the company a year ago, I think we weren’t managing market expectations well,’ says Winkler. ‘There was no clear understanding of what market expectations were out there, besides an IBES or First Call earnings consensus, which is a very rough guideline. When I arrived, my primary task was to make sure management understood the market expectations, as well as to bring market expectation much more in line with the management’s expectations for the ongoing financial year.’
Winkler believes he raised Deutsche Telekom’s credibility through his actions by putting a hefty dose of reality in front of the financial community. And despite market expectations that were on the high side of the company’s own expectations, the stock price has still more than doubled in the last year. ‘We tried to figure out the three-to-five foremost reasons for this gap in understanding, and we tried to address them in a half-year roadshow,’ says Winkler. ‘We built up a credibility bonus which translated into making up some of the distance between us and the rest of our peer group.’
In addition, Deutsche Telekom has doubled its investor relations team, and the company placed a full-time staff member in New York. ‘He’s someone who is really involved on a day-to-day basis through at least one hour of conversation with us in Germany,’ says Winkler. ‘And we have strongly built on a US base of investors who prefer, relative to European investors, an undervalued stock story. We’ve increased the US shareholder base from 15 to 30 percent of free float by putting a lot of effort into this group, and putting a person there who can not only take questions, but answer 80-90 percent of them.’
Common strategy
Winkler and his counterparts all seem to point to a common strategy of managing expectations, clear communications, and a well-articulated strategy. It’s not exactly rocket science as far as IR goes but it is amazing how many companies ignore such basics. And despite an earnings-centric market, long-term investors still value companies based on fundamental investment principals. Howard Kornblue, senior vice president at Pilgrim America Investments, a $7 bn value-oriented money manager, agrees that the most important step an investor relations officer can take toward promoting a stock is to simply provide the facts, and make those facts as easy to understand as possible. ‘In this kind of environment, I think it behooves management to make it as easy as possible for investors to understand their company.’
Despite current market trends, Kornblue advises companies to avoid portraying themselves as something they are not in order to appeal to growth investors. ‘There are lots of choices out their, and if you can’t make it easy for investors to understand your stock, there’s another stock just down the road that is making it easy,’ says Kornblue.
