Are private investors worth all the cost?
Companies wrestling with the annual or half-yearly task of communicating with four or five thousand private shareholders should spare a thought for the shareholder communications department at British Telecom. Among the first of the UK government's privatizations, BT attracted some 3 mn shareholders onto its register.
Fourteen years later that figure has fallen to around 2.1 mn but servicing them still represents a huge burden in time and money. If each shareholder opted to receive the full annual report and accounts, BT's bill for printing and distributing just those would run to £10 mn or more. As it is, the company prints around 175,000 copies of the full annual report, with about 80,000 going out to those shareholders who have specifically requested it.
Andrew Wood, BT's shareholder communications manager, says that sending literature to each shareholder costs ú500,000 a time in postage charges alone. A huge expense and more than many other IR departments could even dream of mustering. So does the benefit of having private investors outweigh the cost of servicing them?
No simple answer to that one, admits Wood, adding that private investors are certainly viewed by the company as valuable and loyal. Indeed, BT now tries to gain from the cost of sending out information to its massive register by using shareholder mailings - principally an annual review and two lots of dividend checks or tax vouchers - to promote BT services or other suppliers' goods.
'We began by treating shareholders just as shareholders,' Wood explains, 'and not as actual or potential customers. But we found over the first five years or so that most shareholders were not able to distinguish between the two roles.'
Between 4,000 and 5,000 shareholders are leaving the BT register each month and the company is currently working on what Wood calls an 'easy exit route' share-dealing scheme for BT private investors, particularly those who are locked-in with comparatively small holdings.
He believes that BT has built up a good degree of trust and confidence among its investors. 'We've been through a lot with our shareholders. The past 14 years have been a mutual learning experience. We had to learn how to deal with private and institutional investors, and many individual investors had to learn what being a shareholder was all about.'
Welcome to expense
BT's experiences are shared by many large cap companies and, welcome though retail investors may be, the cost of private shareholder information programs is a major item in many companies' budgets.
'The number of private shareholders does pose a problem,' concedes Jean-Claude Delvaux, head of the shareholder department at the French multinational Air Liquide. 'It costs a lot of money to send them information.' With 300,000 private shareholders holding around 48 percent of the equity, Air Liquide estimates that it costs Ffr3 a time to communicate with each of them.
Each Air Liquide shareholder receives four letters a year from the company, and additional letters are sent out when special circumstances arise. 'For example,' recalls Delvaux, 'during the Gulf War the company's president wrote to all the shareholders explaining that the situation in the Middle East did not affect our company. We were not involved. Also, when some shareholders were worried by the recent Asian stock market crisis, the president wrote and explained clearly that the effect on our Asian subsidiaries would not be that great. The markets' problems would only have a slight impact on our profits - and that proved to be the case.' So far, at least.
With the somewhat double-edged distinction of mounting the biggest general meetings in France each year, when 4,500-5,000 shareholders attend, Air Liquide is the only French company to send all shareholders a full and detailed account of each meeting. These missives include the president's remarks and the questions asked and answered at the meeting.
Delvaux believes the company's large private shareholder base is a considerable asset and well worth the cost of servicing it regularly. And he adds a slap in the face to most fund managers: 'Our private shareholders are very loyal,' he claims. 'They keep their shares longer than the average institutional investor and they tend to be better informed, too.'
He gives another reason for Air Liquide's adulation of private shareholders. 'Virtually all of our capital requirements are met by our shareholders. In our most recent stock issue, for instance, the offer was 103 percent covered and we had no need to have recourse to the banks. We prefer to be financed by our shareholders, and they have benefited by standing by us over the years.'
Headline attractions
At the other end of the scale, small cap UK publisher Hodder Headline has around 400 private shareholders, including directors and staff, who hold about 27 percent of the equity. Mark Opzoomer, deputy chief executive, says that the company puts a great deal of effort into communicating straightforwardly and effectively with its shareholders. And, let's face it, these particular small investors have a great deal of clout.
'Our annual report is the main thrust of our investor relations program. We write it internally and try to get the whole story over in the first four pages,' Opzoomer says. 'We don't have an excessively elaborate program and we rely mostly on press and broadcast coverage to ensure that our shareholders know what is going on. That means being readily available to the media, both for good news and bad news.'
Hodder Headline distributes around 6,000 copies of its report and accounts, and is proud of its achievement in winning (for the second year running) the best small company category in the annual London Stock Exchange and UK Chartered Accountants' published accounts awards. 'We treat all shareholders equally,' says Opzoomer, 'and as far as we can judge our private shareholders are fairly loyal.'
Reducing the numbers
One way of dealing with private investors is to get rid of them, of course. Welsh water, electricity and infrastructure group Hyder might not use that terminology to describe its small shareholder buy-back program, but the effect was largely the same.
The scheme involved mailing holders of fewer than 100 ordinary or preference shares to offer them an easy-to-use facility to sell their shares, with Hyder picking up the transaction fee and commission charges. Just over 11,000 of the 40,000 individual shareowners agreed to sell and their shares were bought by corporate and institutional investors. One result is that Hyder will save an estimated £40,000 a year in annual report printing and mailing charges and in dividend payment costs.
Shareholder Communications Corp, which consulted Hyder on the program, is privately happy to give a nudge and a wink about those bottom line figures when scouting for new clients, but the public approach has to have more of a PR spin. You can't say you want to get rid of small investors; you want to help them divest unwanted (that is, uneconomic for the company) holdings. Those with small holdings cannot get out easily without incurring disproportionate dealing costs and small shareholder programs of the type run by Hyder provide a valuable solution.
While this is undoubtedly true, look at it the other way and the reality is that companies can save substantial costs in the future for relatively modest outlays now. Persuading small investors to sell their shares could seem highly attractive to CEOs with rising printing and distribution costs.
Hyder's reduction program came about after a restructuring of its capital and the purchase of an electricity company boosted its private shareholder base to an expensive and time-consuming level. In other cases, particularly in privatizations, retail investors are drawn in by the success of the IPO marketing campaign and newly-floated companies often find themselves faced with huge cohorts of relatively unsophisticated, often mercenary, and generally small-time private shareholders.
While there are obvious cost and time advantages in concentrating IPO bookbuilding efforts on institutions, companies and their advisors are increasingly recognizing the benefits of having a large number of retail investors on board from the start. The most cynical reason for this is that the institutions will then be forced into the market when dealings open.
This tactic was used to particular advantage by Lufthansa when the remaining government-held 37.5 percent of its stock was sold off last October. Dewe Rogerson's German office handled financial communications for the IPO and immediately homed in on the private sector.
'Private investors in Germany play a key role in the success of a privatization,' says Dewe Rogerson's Bernhard Meising. In the Lufthansa team's analysis, the more shares allocated to retail investors, the fewer would be available for the institutions and the fund managers. As a consequence, after the IPO, institutions would have to buy shares in the market, thereby triggering a price-lifting run on Lufthansa's stock.
Reading between the lines of the Lufthansa IPO story reveals a two-stage and perhaps slightly patronizing approach. The company image was heavily pushed during the first part of the campaign. Only after that was the actual offering explained. It was heavily oversubscribed, with over 50 percent of the equity going to retail investors.
Dewe Rogerson surveyed shareholders and asked them their intentions. Over half said that they would hold the shares for more than three years; one in five expected to keep them for longer than six years. Only 10 percent planned to sell the stock within twelve months.
Staying with friends
Meanwhile, Austrian-based Erste Bank gives a different reason for looking to the retail market in its IPO. Forcing the share price in early market dealings was not one of the motivations behind its decision to focus on the private sector. Gregor Lanz, head of IR at the Austrian commercial bank, explains that the bank had always dealt predominantly with the middle and upper income sectors.
'We specifically targeted those investors and substantially cut the proportion of the stock that we made available to the institutions,' he says. This did not please the professionals very much, but the offer generated the largest level of retail demand in an Austrian IPO.
The company provided three strong retail investor incentives. First, there were no transaction costs on IPO purchases. Second, applicants within the first week of the public offer were guaranteed double the actual allocation rate, in the event set at 40 percent of the total subscribed, so they received an allocation of 80 percent of their subscription. Third, shareholders are guaranteed a bonus of 5 percent of the issue price if they stay in the stock for 18 months, to be paid with the first dividend for 1999.
Approximately 47 percent of the equity is held in Austria, says Lanz, mostly by around 40,000 private shareholders, with the balance held overseas, mostly by institutional investors.
Lanz says that Erste Bank is happy with the outcome. 'We're trying to build a stable core of investors and private shareholders are not as ephemeral as institutions. We are treating them as part-owners of the business, and getting them to look differently at the bank. Many of them, of course, are long-term customers too.'
And keeping shareholders who are also customers happy would seem to make good business sense. It may cost a bit more in IR terms but the extra expense can pay dividends - to both sides of the equation.
Energy complications
The Energy Group's deputy company secretary Roger Tyson recognizes that private shareholders are loyal but that this can sometimes be confused with apathy or confusion. 'Many small shareholders are just not able to manage their investments in the way they should,' he says. 'They can inherit or buy a share and forget about it.' This is exacerbated when a shareholding is split into parcels because of divorce settlements or bequests. 'Over a period of time a company can end up with loads of very small holdings.'
Currently under assault from US power company PacifiCorp and rival Texas Utilities, TEG has around 125,000 private shareholders. They represent 83 percent of the number of holders but only 9 percent of the equity.
'Small shareholders can create complications for themselves and companies,' says Tyson. 'If they lose their share certificates, these have to be replaced, involving unwelcome administrative and indemnity costs and added paperwork. Only about 40 percent of private shareholders mandate their dividends to be paid into a bank account, and that means many small-value checks may not be cashed by shareholders.'
On its demerger from Hanson last year, The Energy Group introduced a short-term postal share dealing service for its small shareholders, allowing them the opportunity of selling or buying more TEG shares. Tyson says this allows shareholders to address their investment in a convenient way. The cost of servicing each shareholder is a high one, he underlines, and unnecessary expense is not in the best interests of either the company or its shareholders.
'You have the situation,' he argues, 'where each copy of an annual report may cost pounds to produce and mail but few people are actually interested in it. We asked shareholders if they wanted the full report or a summary. Less than 5 percent asked for the complete document.'
In Tyson's view, much of UK company law remains steeped in Victorian principles (something the UK government says it is about to rectify) it needs to be updated, for instance by allowing the automatic mailing of summary documents to shareholders. The full document would always be available to all shareholders free of charge on request, of course.