The small-cap situation
Encouraging news for small caps is hard to find. Listen to Gary Griffin, CFO of Shuffle Master, a $90 mn casino supplier: 'I'm having a tough time coming up with any reasons why it's good to be small in the investor world. You feel like you're swimming upstream most of the time.'
That may be typical, but aggravating the situation is a sense that all small caps aren't created equal. The newer dot-com and biotech companies are warmly embraced as Wall Street darlings, enjoying terrific returns on the stock market and stirring up envy among their neglected peers.
'The internet stocks have changed a lot of things,' observes Joseph Mansi, managing partner at KCSA Public Relations Worldwide in New York City. 'You can have a small-cap internet-related company where you'll get tremendous response.'
But that's not the way it is for all. Douglas Sherk, CEO of RedChip Partners, a San Francisco-based firm with a popular web site that helps public companies reach investors, attributes some small-cap woes to 'bracket creep'. Within the last few years, the definition of a small cap has steadily inched its way up from $500 mn to as high as $1.5 bn. As a consequence, the pool of companies deemed to answer the description of small caps has expanded, creating more competition among companies that are already struggling for their 15 minutes of fame. 'The small-cap bar,' says Michael Noonan, director of IR and corporate communications for $200 mn valued Integrated Electrical Services in Houston, Texas, 'has been raised and raised and raised.'
Internationally, the definition of a small-cap stock is equally fluid. Alison Chow, CEO of irasia.com, which provides online IR information about Asia's listed companies, defines all public companies in Hong Kong that aren't included in the new Hang Seng 100 Index as small caps. Chow notes that the 700 companies outside the Hang Seng account for a mere 14 percent of Hong Kong's entire market capitalization.
Ever resilient, small caps are experimenting with new approaches to IR. The internet is one way for them to extend their reach at relatively little expense. Individual investors also represent a new and growing source of investor interest. And some IR officers are combing through lists of money managers, looking for smaller funds that might be good fits, as well as seeking coverage at newer, non-traditional research firms.
Tried & true
Hong Kong-based GreaterChina Technology Group, which went public in April, finds itself in the same boat as many smaller public companies in the US, Europe and Latin America. 'It is difficult to get analyst coverage because of our small market cap,' says Godfrey Mak, CFO of the $55 mn company. The company's internet portal for traditional Chinese medicine (www.greaterchinaherbs.com) has attracted attention but no research reports.
'The small-cap stock is stuck in terms of finding investors,' avers Carl Thompson, CEO of Carl Thompson Associates, a Louisville, Colorado-based IR consulting firm specializing in small-cap clients. Chow of irasia.com makes a similar point. Small caps, she says, 'are at the mercy of whether institutional brokers decide to follow them or not.' Securing analyst coverage is difficult for a small cap, she continues, 'unless the company has a very "sexy" story, or is in the "right" industry at the right time.'
Traditional IR avenues seem to be working for Argentina's Impsat Fiber Networks. Morgan Stanley is following the company and IRO Gonzalo Alende Serra expects that Salomon Smith Barney will soon initiate coverage as well. Impsat is also enjoying plenty of institutional interest. 'We're in the infrastructure part of a very hot industry,' explains Alende Serra. 'And our business is quite unique in a region that's experiencing tremendous growth. That is what has led to so many portfolio managers looking at us.'
RedChip's Sherk cites another problem for small caps, which is that funds specializing in small caps are not faring particularly well. As a result, investors have fled. In fact, one prominent small-cap money manager told Sherk that his fund was losing a million dollars a day in assets.
Persuading a troubled institution to take a chance on a new investment is no mean feat. 'You can market to those institutions 'till you're blue in the face,' maintains Sherk, 'but if they've got a shrinking base to invest in small-cap companies, you've got to be a real standout story to make them take money out of assets that are already under pressure and put them into your company.'
Despite the difficulties, ferreting out institutional interest is far from impossible. Mansi tries to identify those investment funds looking for low-priced stocks that are undervalued; or those seeking micro caps with strong growth potential. Noonan takes a similar tack, turning to the internet for assistance. He uses bigdough.com, an online database of institutional money managers and their stockholdings, to target potential institutions.
Thompson recommends approaching smaller money managers, and has dubbed such a strategy 'hand-to-hand combat' since funds with less than $100 mn under management are not required to file 13Fs and so are hard to find. Delta Partners, a Boston-based fund with just $10 mn, is precisely the type of institution that Thompson is seeking. Partner Chris Argyrople says he concentrates on small stocks because if a company has less than a $100 mn market cap, Delta can acquire a substantial stake for just $1 mn. 'We can take a meaningful position and get good access to management,' he says.
Mom & pop
Sherk is convinced that the traditional investor relations routes are no longer working for small-cap companies. 'The problem today,' he comments, 'is that there's such a dwindling audience for your story. It's much more difficult to bring home tangible results when institutions and analysts are the focus of your investor relations effort.'
He argues that his solution - wooing the individual investor - is not a default strategy, but one that makes sound sense given the tremendous increase in individual investor participation in the market. The percentage of smaller than 1,000 share blocks traded on Nasdaq rose, he notes, from 46 percent in 1996 to 65 percent in 1998. In addition, the web has dramatically changed the economics of servicing retail investors, who are clearly looking for IR information online. By way of proof, Sherk says that personal finance recently eclipsed pornography as the number one destination for all internet users.
Cultivating individual investors is, at heart, a strategy well-suited to small caps. 'Companies like AT&T aren't going to spend their time focusing on the individual investor,' argues Sherk. 'They don't need them as much.'
William Spell, CEO of $105 mn Eagle Pacific Industries, soon to be renamed PW Eagle, offers a slightly different argument for why small caps should embrace retail investors: 'Institutional investors drive the market today, but they're fickle. The retail investor tends to be a more patient, long-term investor.'
Individuals potentially bring other benefits to small companies, especially those committed to converting customers into shareholders and vice versa. As an example, Sherk cites small-cap Chalone Wine Group, which gives discounts and special vineyard tours to its shareholders. Perks like these allow small caps to deepen both their investor and their customer relationships, asserts Sherk. He argues that small-cap companies can better weather quarterly shortfalls if they're providing value in more than one way - for instance by handing out coupons or other promotions to their shareholders.
Finally, Sherk advises all small caps to place their ticker symbols on their stationery, invoices, and business cards, describing this as a 'no-brainer' way to market to potential investors. 'You've got to do it in a legal, tasteful, subtle way, but you've got to let everyone know you're public,' he says.
New routes
'When you're a one-man investor relations show, you've really got to embrace technology,' asserts Noonan of Integrated Electrical Services. Sue Gourlay, an IR consultant for Forrest International in Hong Kong, agrees. She underscores the importance of the web for her Asian clients. 'The internet is a great leveler in investor relations. It is an extremely effective way to communicate information about a company to a wide audience,' she says.
'The fact is,' continues Gourlay, 'that most small-cap Asian companies do not cross the radar screens of the majority of fund managers.' She believes that the internet allows companies like Hong Kong's QPL International Holdings, which is one of her clients, to reach highly-specialized groups of analysts and institutions.
The internet represents a good gamble for a company like Shuffle Master. 'To a certain extent, the internet offsets the lack of research coverage,' says CFO Gary Griffin. He notes that if you're lucky enough to get on the radar screens of sites reaching retail investors, these sites will publicize your company free of charge. At Shuffle Master, retail investors account for 80-85 percent of the overall shareholder mix.
Sherk also commends the web as a way to make shareholder communications affordable for all companies, even micro caps. Smaller companies simply can't dedicate the IR staff to answering shareholder questions on the phone, but a web site provides the investor with much more detailed information than could be culled from a personal conversation, and at a dramatically lower cost.
Of course, creating a user-friendly, information-packed IR site isn't easy. 'The goal should be to have some fresh component on your IR site daily,' says Sherk. A daily contribution could be anything from an archived conference call to a trade media article.
Another way of making the site more shareholder friendly is furnishing management bios, says Thompson: 'Everybody talks about dot-coms, but how about the people behind the dot-coms? Providing bios raises the comfort levels.' He also suggests placing slide shows online and publishing the annual report in HTML since many individuals dislike the hassle of downloading PDF files.
The web is the cornerstone of many, but not all, emerging strategies for small-cap companies. However, other new sources of industry research are blossoming, too, and these avenues are decidedly off-line. It's an open secret that analyst coverage is often tied to a public company's corporate finance business: those companies that hire investment banks for M&A or other corporate finance assistance are then written up by the banking houses underwriting their deals. It's a state of affairs fraught with conflicts of interest that's also inclined to leave many small caps with no coverage at all.
To fill the research void, new companies are entering the fray. BlueFire Partners, a Minneapolis, Minnesota-based IR firm, recently registered with the SEC to issue its own independent research, according to managing director Karen Snedeker.
Out of Snedeker's belief that many of her clients deserve coverage they're being denied, BlueFire Research has begun by initiating coverage of its own clients.
Although it's easy to question the 'independence' of such research, Snedeker contends that the conflicts of interest are no different - and perhaps less glaring - than those inherent in a brokerage house rating a stock that the brokerage house actually owns. Snedeker says that BlueFire's research is already achieving the trappings of legitimacy: First Call and I/B/E/S want to disseminate its reports. Best of all, Snedeker's clients are thrilled. 'Most of our small caps,' she says, 'are dying to have even just one person write about them.'
'The key part for us is that someone is writing on us, and researching us, and the information is getting out into the market,' adds Shuffle Master's Griffin.
Another factor that is making it harder and harder for small caps to attract or even to retain analyst coverage is all the consolidation in the financial services sector. A mainstay for many small caps has always been small regional brokerage firms, which often make a name for themselves publishing research on small local companies. But the big bucks on Wall Street are out hunting for such little guys.
Take Nashville, Tennessee's JC Bradford, one of only six or so investment banks based in the southeast US, for example, which is being acquired by PaineWebber. Many of the regional companies currently followed by JC Bradford only have a handful of analysts covering them, sometimes just two or three. As PaineWebber consolidates and cuts corners, many of those small companies may find themselves with one less analyst publishing research on them. After all, for an underperforming southern small cap, making JC Bradford's research list was a lot easier than securing a place on PaineWebber's busy roster.
A better tomorrow?
Some believe that current market conditions won't last much longer. These days, 'People don't care that you have a PE of 4. If you're not an internet company, you're passe,' warns Thompson. But he predicts that the bubble around internet stocks is sure to burst: 'If these dot-com stocks are tripling and quadrupling in a matter of weeks and months, people will have to look for other opportunities.'
If and when internet stocks do lose their luster, other small caps will have a better chance. In the meantime, though, small caps appear closely identified with the fleet of volatile tech stocks grabbing the headlines. Throughout the ongoing correction that began gripping the market this spring, both the Nasdaq and small-cap markets experienced closely aligned surges of investor interest. Problem is, those upticks have tended to be brief and almost always followed by abrupt downturns. By some indications, small caps as a group look in better shape than their larger tech counterparts. Take the last week in April, for example, when the small-cap and Nasdaq markets rebounded despite economic reports showing rising inflation and fears that the Fed would step in to slow the pace of the economy. At that point, the Nasdaq Composite Index was still 23.5 percent below its March 10 high, while the Russell 2000 small-cap index was faring better at 16.5 percent below its all-time high on March 9. Some analysts saw the exuberance of small caps in the shadow of bearish economic news as a sign that the worst of the market correction was behind them.
A comforting truth is that small caps companies have always shone with investors that desire extraordinary gains. Just look at Charles Rinaldi, manager of Strong Small Cap Value Fund in New York. His portfolio returned over 50 percent in the year up to the end of April, well up on the S&P 500's 13 percent gain. Over 90 percent of Rinaldi's portfolio is devoted to stocks in the Russell 2000 Value index, making him a true-blue small-cap devotee. Rinaldi's strategy is to find undervalued companies that are poised for a dynamic change, say a new product, new management or some other turnaround. He also declares an affinity for stock buybacks.
'Aggressive investors tend to prefer small caps, as there is the potential for higher return,' comments Alison Chow of irasia.com. And Spell of Eagle Pacific echoes this view: 'At times certain small caps are grossly undervalued and you can make a cogent argument that the stock should be looked at and purchased. You really have a good investment story.'
Noonan concludes on an equally optimistic note as he describes the situation he and other small-cap IROs face: 'When you look at the big multinationals, they've got their story and they're well publicized, but these IR people have less flexibility. Our businesses are growing and there's a lot of excitement.'