How the mighty have fallen in the past two years. Downfalls of giant and seemingly invincible companies have made the news time and time again in recent years, often overshadowing the success story of the little guy – the small-cap company.
Indeed, small-cap stocks have enjoyed a good run on the market, with the Russell 2000 Value Index, a mix of small-cap growth and value stocks, up more than 14 percent in the first four months of 2002 while the Dow and Nasdaq have been languishing in losses.
Similarly, the S&P SmallCap 600 index, which comprises US stocks with a market value of $1.5 billion or less, lost just 1.9 percent in the 12 months before February 2002 while the S&P 500 dropped 16.8 percent during the same period. Funds specializing in small-cap value stocks are up by 11.7 percent for the year so far, even those that have been marred by the technology and internet sector losses of recent years.
There is no secret to the success of small-cap stocks. Most smaller companies have cleaner, less complicated balance sheets and easier to understand business models than large-cap companies. This is often the major selling point for investors who are shy of the complexities of the books of the likes of Enron.
But these small-cap IROs do have to grapple with issues their larger counterparts do not – gaining analyst coverage for instance (see Rent an analyst, page 71), and keeping that interest.
Valuation models for small-cap companies used by analysts and portfolio managers are different from those used to evaluate larger companies. Factors which usually influence buying decisions, such as price-to-earnings multiples, are often ignored in favor of price-to-sales ratios. In fact, most investors expect small-cap companies not to make any money, at least in their first couple of years after an IPO.
At the same time, investors are aware that small stocks have to be approached with caution. Many technology and biotechnology stocks have yet to recover from their previous highs, while others are hurting from the effects of 9/11.
Still, if history is any guide, the shares of small-cap companies tend to do very well compared to larger companies after a recession.
As a result, the investor relations officer of a small-cap company has quite a different task to that of an IRO for the likes of Coca-Cola or IBM. So small-cap companies may not have the resources or clout to compete with the Fortune 500s of the world, but the investor relations officers from a variety of smaller companies can show us how they have succeeded in many areas including launching a high-tech IPO, weathering a volatile market, and even attracting new investment while posting their first loss.
Case study 1: Synaptics
Give Synaptics credit for bravery: not only was the tech firm the first IPO of 2002, but it appears to have been a successful launch. Not the kind of news one expects out of what’s left of Silicon Valley these days.
Synaptics designs and manufactures the touch-pads, pointing sticks and similar input devices now used in 60 percent of all laptops, personal organizers and information kiosks. The business isn’t sexy, but it is sustainable – a fact that investors appreciate.
‘Wall Street is looking for relatively bulletproof companies these days,’ says Alex Wellins, a partner at the Blueshirt Group, the San Francisco IR consultant the company hired. ‘Synaptics has leading market share, new products and it’s relatively profitable.’
On January 29 the company priced its shares at $11 and they quickly rose to $13 on a day when the Nasdaq Composite Index fell by more than 2 percent. A month later, shares were trading at about $15, giving the company a market cap of roughly $335 mn.
Synaptics executives decline to comment on their IR strategy during their post-offering quiet period, but Wellins is happy to discuss the strategy of bringing a high-tech company to market at a seemingly delicate time. For example, he says, IPO underwriter Bear Sterns recommended that Synaptics go with a boutique IR firm rather than handling the responsibilities in-house, in part because the CFO hasn’t had experience with a public company.
‘It’s very important that investors and sell-side analysts have contact with the company executives,’ says Wellins, whose firm also helped design the IR section of Synaptics’ web site. ‘We’ll facilitate that. It’s absolutely crucial that senior management in small-cap companies develops good relations with Wall Street.’
Wellins says Synaptics will follow the classic high-tech IPO strategy once the quiet period ends. This means gathering impressions from people who attended the pre-IPO roadshow, as well as analysts who track the company’s competitors.
‘We’ll determine how to alter the message with that feedback,’ says Wellins, who also plans to raise the company’s profile with buy-side analysts through articles in business publications.
Case study 2: Heidrick & Struggles
Fact: the job market sucks.
Impact: Bad news for everyone from recently graduated B-school hotshots to downsized corporate executives. And if it’s a bad time to be looking for a job, then it’s got to be a bad time for the world’s largest executive search firm as well.
‘This has not been what we expected when we went public,’ sighs Lynn McHugh of Heidrick & Struggles International, the Chicago-based firm that has found executives for large organizations such as Red Cross, Burger King and other similar powerhouses.
McHugh, the managing partner for investor relations, figures there’s no point hiding or sugarcoating the bad patch her entire industry has hit. ‘We made the best choices we could with the information we had at the time,’ she says with unmistakable cheeriness. ‘We did what we thought was right, and it wasn’t too different from what everyone else was doing.’
It was, McHugh offers, a different story when the 49 year-old Heidrick & Struggles launched its IPO in April 1999. The economy was expanding and the biggest growth sector was in high tech and dot-coms. Heidrick’s 75 offices on four continents could barely keep up with the demand for senior executives, board members and consultants. In those days, Heidrick billed an average of $73,500 for executive searches, according to its annual report, and many nascent companies paid in a combination of cash and warrants. When the companies tanked, the warrants became worthless and Heidrick’s pristine balance sheet got all complicated.
‘The business just suddenly dried up,’ says McHugh. ‘We had a ten-year stretch of pretty extraordinary growth and had been ramping up the firm for a very different growth scenario than what happened in 2001.’ The company was forced to cut its own staff, curb benefits and incentives, shrink its board of directors, and make other painful compromises to accommodate a tumbling demand.
Making it all worse, in some ways, was that the newly public company had to explain the situation in detail to anxious shareholders and investors. Nonetheless, the stock plummeted from a high of $70 to about $14 in February 2002.
McHugh says that as difficult as the public disclosure was, in retrospect a public Heidrick probably had an easier time weathering the turbulence than if it still had been privately held. This is because it had plenty of IPO capital to fall back on.
Despite economic uncertainty, McHugh says there are prime factors working in her favor these days. First, Heidrick’s stock is mostly held by professional investors who know the industry and the company – institutional investors own 60 percent of the trading stock with the remainder largely held by employees. Ordinary retail investors have probably sold off their stock by now to count their losses.
Second – and very unusual for a company with a market cap of about $270 mn – analysts cover Heidrick like a rug. ‘We have nine analysts, that’s a lot of coverage, and my job is a lot easier for it,’ said McHugh, who notes that executive search firms are lumped into the heavily scrutinized ‘business services’ category with large-cap IT firms and consulting companies. ‘In 2000 we were a growth company, and in 2001 we were a value company,’ says McHugh. ‘I’ve worked for large, mid-sized and small-cap companies and the challenges are a little bit different, but the IR principles are always the same.
Case study 3: Maxim Power
Although the need for cheap energy is, seemingly, constant and insatiable, Maxim Power of Calgary, Alberta has hit some rough times – none of their making. The quadruple whammy began a year ago when the company began feeling effects of the softening economy. Business for the power producer dropped again with the abrupt downturn after September 11. And it’s true that Maxim has nothing at all in common with Enron, but when you say ‘energy’ these days, well, people instinctively cringe. And, Maxim executives add, Canada’s lovely warm winter of 2001-02 hasn’t helped business either.
‘The power business is pretty tough right now,’ acknowledges Gordon Ross, Maxim’s chief financial officer. ‘Okay, it’s very tough. After September 11, industrial demand just went way down, and the price of electricity is down. Low price and low demand means the margin got squeezed to a minimal level.’
Nevertheless, Maxim is embarking on some ambitious expansion plans, both geographically and technologically. The company hopes to increase by five-fold its current generating capacity – a goal that means raising funds and, consequently, savvy investor relations.
The company is focusing its business efforts on Canada, but also Germany and France – European nations so committed to converting to green energy that their governments are investing heavily in the technology, and subsidizing it significantly. Maxim already has a plant in Germany (it converts a margarine factory’s waste canola oil into diesel fuel) and it wants to do more bio-fuel processing.
‘Europe is where we will be doing most of our growing over the next one to three years,’ said Ross. ‘Their economies aren’t more robust than ours, but they have laws saying that state utilities must buy your energy if it’s green-generated, and they have to buy it at a high price.’
Maxim’s power plants in Canada, Cambodia and Germany operate from a variety of green sources, which Ross is happy to talk about in depth to further distinguish his company from Houston’s house of cards. Ross says Maxim pulled out of Europe to concentrate its efforts on North America and Asia – a big mistake given the economic climate. Maxim Power is listed on the TSX Venture Exchange (until recently called the Canadian Venture Exchange), and it is now mulling a separate listing in Frankfurt.
The company has gotten serious about getting its message out to the Street and just last year took IR back in-house after years with an outside firm that handled a variety of corporate clients. ‘We wanted to be closer to our investors, and we wanted to know who they are and hear what they’re saying,’ says Ross, who has taken up most of the IR functions in support of Maxim president Alan Bobanic. ‘We wanted better communication, both listening and telling,’ Ross adds.
Because the company is raising capital, the CFO says, the company is putting a lot of effort into its roadshows, and maintains ‘close face-to-face contact’ with the ten institutional investors that hold most of the outstanding stock. An investment dealer fields most of the retail calls. ‘We’re looking for new institutions and we’re talking to existing stockholders to get them to buy a bigger piece [of the company],’ he says. The Canadian energy sector, concentrated around Calgary, is well covered by analysts. Ross says that with all the consolidation in the sector, there should be more than enough analysts to go around.
Case study 4: Tickets.com
In November 1999, when the founders of Tickets.com took their company public, the name seemed like a good idea. After all, the company allows fans to buy seats at concerts, sporting events and even the Olympics from anywhere in the world with a few clicks of a mouse. But now that dot-coms have mostly collapsed, officers at the highly diversified company find themselves saddled with baggage they shouldn’t particularly have to carry.
‘The name has proved to be quite a challenge in telling our story,’ admits Eric Bauer, Ticket.com’s chief financial officer and the company’s primary investor relations officer. ‘Obviously we chose the name in a different time, but we really aren’t a dot-com in the commonly understood sense.’
About half of the Costa Mesa, California-based company’s revenues are generated from service charges for online sales. The rest of the business is generated by ticket kiosks in Sears stores and supermarkets, call centers that handle phone sales, and other outlets. The company also licenses ticket-selling software programs to venues as diverse as Carnegie Hall and Washington, DC’s alt-rocking Nightclub 9:30. The service charges for online ticket sales are expected to top $500 mn this year, and the industry looks set to grow as more venues, sports teams and other clients warm up to the idea of outsourcing remote sales.
The company sold $23 mn worth of the Salt Lake City Winter Olympics tickets on the first day of sales, and was the primary vendor of tickets to all Salt Lake City events. Even so, Tickets.com, by Bauer’s estimation, has a scant 10 percent of the Ticketmaster-dominated market – for now. The CFO says his smaller, more nimble company is better able to respond to the needs and innovations demanded by clients such as major league baseball. For example, he says, fans who order seats for a Chicago Cubs game will see pitches for team merchandise and upcoming games. They won’t see advertisements for other Tickets.com concerts or paid advertisements, as they do at Ticketmaster.
As the company signs new clients and streamlines its operations, the bottom line has been improving, sometimes dramatically. The exception was the fourth quarter of 2001, when sales dropped by a third because of September 11. Concerts and other events were canceled and even after they were rescheduled, people didn’t feel like sitting in a vast arena. ‘The sophisticated investors realized it was an unquestionable anomaly,’ explains Bauer, ‘but it hit the heart of what we do.’
Institutional investors and private equity funds, which own about a quarter of the stock each, held on. Retail investors, who hold the other half, got jittery. Bauer points out that even then the company attracted a $20 mn investment from longtime investor General Atlantic Partners, an information technology and communications-oriented fund that now owns a third of Tickets.com.
Bauer, a man who rattles off industry jargon as easily as his customers can talk sports stats, says he connects to Wall Street through the usual channels: conference calls, small-cap conferences, analyst presentations, and an unusually comprehensive IR web site, with an archive of press releases as well as detailed financial data. The $60 mn company has said it expects to start turning a profit by the end of the year.
Case study 5: African Sky Communications
African Sky’s pioneer shareholders are, it seems, at least as interested in doing good as they are in doing well. This company, registered in Canada, is developing a network to teach computer skills and offer distance-learning classes in South Africa. The highly technological undertaking which requires government approvals is not for those who require an immediate return on their investment.
‘For a long time, no one was paying any attention to Africa, but now one thing you hear is that the educational sector needs to grow,’ says vice president Jeffrey Stanger, who adds that the firm emphasizes its good works in all its investor and media relations.
African Sky Communications was founded in 1997 by Henry Corrigan, an Australian, who thought he could help a newly democratic South Africa overcome its often horrific poverty by teaching basic computer skills to Aids orphans, day laborers and other disadvantaged groups. The goal is to make them computer literate today, and sought-after employees tomorrow. The computer centers will also offer classes for a nominal fee to anyone who is interested. Eventually, Stanger says, the centers could offer tools and information that would encourage entrepreneurship, assist existing businesses and expand communications.
It’s the kind of work usually undertaken by non-governmental organizations or non-profit efforts, not a publicly-traded foreign company. ‘We want to create a sustainable enterprise that will be there and can mushroom in other countries,’ says Stanger. ‘There are other centers out there, but the non-profits can’t maintain the equipment’ like a for-profit enterprise can. The company’s revenues will come from government contracts as well as user fees. Although the company is traded on the TSX Venture Exchange (formerly called the Canadian Venture Exchange), its headquarters and nearly all its employees are based in Johannesburg.
‘We’re in Canada because of the market here and the investment community,’ said Stanger, the sole Toronto-based officer. African Sky expects to start turning a profit during 2002, Stanger says, based on a number of projects in the pipeline and contracts not yet awarded. The centerpiece for African Sky’s growth is the proposed expansion of a learning center in Gauteng Province into a $41 mn, 2,400-school network. If successful, the program could eventually be replicated throughout the southern African region.
Although South Africa is by far the most advanced of the sub-Saharan countries, it still has a long way to go to match industrialized nations in terms of infrastructure, education, computer literacy and other development standards. ‘A lot depends on projects we’ve got bids on, and there’s a lot pending,’ explains Stanger. ‘We’re very optimistic.’
So, it seems, are the company’s shareholders, who are all individuals attracted by the company’s ambitious social mission. Stanger says the company has no institutional investors. With shares now trading at about 8 cents (US) each, African Sky has a market capitalization of just over US$2 mn – about one fifth of its 52-week high, admits Stanger. He concludes that most of the fall-off was due to the market contractions that intensified after September 11, proving that even good works and best intentions are no buffer against a volatile market.
