Mifid II: US small caps said to eye paid-for research

Increasing numbers of small-cap companies in the US are considering commissioning research in an effort to offset any negative impact fr om Mifid II, according to research provider Sidoti & Company.

‘The impact of the regulation on our shores has been difficult to predict and remains somewhat uncertain,’ Peter Sidoti, CEO at Sidoti & Company, tells IR Magazine. US small-cap companies are taking a ‘reactive approach’ to the landmark European reforms, he adds. They know what the potential downsides may be and are putting plans in place pre-emptively.

‘For example, we are getting more inquiries about our company-sponsored research product fr om IROs and IR firms, as investor relations professionals are figuring out how best to advise management teams if they lose one or more research providers, as so many predict they will,’ Sidoti explains. The boost in interest has prompted his firm to launch a new website devoted solely to its company-sponsored research. 

Sidoti was speaking around the 50-day mark since the regulation – which in terms of IR mostly impacts corporate access and research coverage – was implemented on January 3. Although Mifid II was put in place by European authorities, IROs in the US and elsewhere are likely to eventually also feel the repercussions, with small caps long predicted to suffer further cuts to both research and corporate access as a result of the new rules. 

Mifid II, corporate access and small-cap research are all on the agenda for the IR Magazine Forum & Awards – Small Cap Europe, being held in London on April 12. 

The feared reduction in research is part of a global trend that has been making itself felt in recent years. ‘Clearly, broker-dealers are continuing to find it less profitable, and even unprofitable, to provide securities research to companies whose coverage just several years ago was economically viable,’ Sidoti continues. 

‘With passively managed funds becoming a greater factor in the investing landscape every day, active money managers simply do not have the same repository of funds to pay research providers for their services. We continue to see good companies lose coverage and all the benefits associated with such coverage as a result.’

Perceptions of paid research

When OTC Markets surveyed 117 small-cap companies in June 2017, it found that 68 percent had no covering analysts. Options are limited for these companies. There are actions firms can take to help get their names out – such as making use of social media, getting cited in trade publications or even putting together their own research – but these will never rival independent research.

Despite this, the same study finds that only 28.5 percent use, or intend to use, commissioned research. OTC, which partners with Sidoti, Edison and ACF Equity Research to connect its listed companies with company-sponsored research suppliers, also finds that 10 percent of the companies in its study had never heard of paid-for research.

One issue around paid-for research is the perception that commissioned research lacks the independence of organic research. But as a provider of such services, Sidoti argues their benefits. ‘Who is more conflicted: sell-side analysts providing coverage because they are looking to earn a seven or eight-figure investment banking fee? Or an independent research provider like Sidoti that does not employ investment bankers, that stands to earn a fixed fee for providing research and whose 19-year reputation on Wall Street would be destroyed if it became a take all-comers paid-for research factory?’ he says. 

He notes that commissioned research has been widely used in, and accepted by, the debt markets for decades. Sidoti also points to factors that contribute to what he describes as his firm’s reputation ‘for credibility, integrity and independence in the investment community. We have taken extraordinary measures to ensure this is maintained. Our company-sponsored research product is nearly identical to our traditional product; it is authored by the same analysts and we have an independent board that reviews and approves all of our company-sponsored research coverage decisions.’ 

A study conducted in 2014 – eight years after the SEC officially endorsed commissioned research – found credibility to be an important factor in paid-for research and declared company-sponsored research a ‘viable’ option for firms that lack analyst coverage as the reports ‘have information content’ for investors – in other words, investors traded on them.

The study, conducted at Emory University’s Goizueta Business School, found that high-credibility companies, defined as pure research firms wh ere the analysts were not allowed to hold or trade stock, had a greater impact on stock performance, turnover, institutional ownership and sell-side coverage.

OTC issuers  

Jason Paltrowitz, executive vice president of corporate services at OTC Markets Group, tells IR Magazine that the ‘vast majority of the OTC issuers currently do not have research coverage.’ For these firms, he maintains that paid-for research has been an ‘extremely positive’ experience, ‘enhancing the profiles and credibility of our OTCQB and OTCQX issuers and helping to maximize their public market visibility, valuation and liquidity.’

OTC is in a similar boat. ‘As a $300 mn market cap company, we rely on bona fide third-party coverage,’ Paltrowitz says. ‘Our research providers communicate with us, review our filings and extrapolate our story. They synthesize the information at hand and aggregate this into an easily digestible format that is recognized by the buy side.   

‘This broadens our footprint among investors and allows for exposure we couldn’t have realized before: fund managers call on us and participate in our earnings calls. The research has provided our company with an entry point to investors that we wouldn’t necessarily have found on our own.’  

Most companies opting for commissioned research have no covering analysts, which is the reason all of its company-sponsored research clients use the service, Sidoti says. French mid-cap Mersen is unusual in that it has seven analysts from six brokerages covering it but has also tried paid-for research in a bid to target US investors. 

‘Traditional brokers were not interested in organizing a US roadshow’ with the electrical power and advanced materials specialist, Véronique Boca, vice president of corporate and financial information at Mersen, tells IR Magazine. ‘We are too small, and we don’t have enough liquidity.’

Having convinced senior management to give US paid-for research a try, she says it wasn’t a real success: ‘We needed to find solutions to meet US investors but I’m not sure the targeting was appropriate. For example, we met people who could not buy European stock.’ 

Boca says she has now taken the decision to stop using paid-for research and, as a result of Mifid II, is looking at online platforms that would allow her to organize meetings ‘directly’ with investors.

Bright side of Mifid

It might be tempting to think Mifid II is all doom and gloom – particularly as far as small caps are concerned – but Sidoti notes that the regulation means IR professionals are set to become increasingly important to management.

‘But with this comes a difficult undertaking,’ he warns. ‘IR professionals are going to need to have a hard discussion with the C-suite about the likelihood that companies will be bearing more responsibility, using their own human, monetary and marketing resources, to have their investment theses heard.

‘IR budgets may need to be adjusted to account for an impending shift wh ere the issuer, and not just the investor, compensates a broker-dealer for securities research coverage, investor conferences and other forms of access to buy-side clientele.’ This is an idea European companies have been grappling with for some time in the run-up to Mifid II implementation.   

‘For most public companies, we believe the cost of doing this will be less than one half-penny per share on an after-tax basis,’ Sidoti says. ‘IR professionals will need to relate to CEOs and CFOs that the benefits of investor access, and of credible securities research in terms of more informed valuations and potentially enhanced liquidity, are certainly worth the half-penny.’