Analysts are probably the most important gatekeepers to the capital markets. They act as a spokesperson on behalf of your company. They speak to their sales desk, retail investor networks, institutional clients, and they are often quoted in the media. In some cases, broker-dealers will not allow their retail broker networks to trade your shares without active analyst research coverage from one of their own analysts.
So how can your company get a broker-dealer to allocate analyst research coverage to your story?
Analysts do not (and should not) launch research coverage overnight. To obtain coverage from an analyst requires a much broader understanding of how capital market relationships work. You need patience and discipline to develop healthy broker-dealer relationships over the long-term.
Targeting the Right Analyst
The first step in establishing research coverage is to determine who should realistically cover your company. The fit between the company and the broker-dealer matters. The size, industry focus, situation, and stage of both the company and the broker-dealer will determine the fit. And without a good fit, trying to achieve coverage will likely just be a waste of time and resources. Market Climber can help you target the right broker-dealers to ensure you receive the highest level of service and performance.
How Analysts Stack Up
Brendan Woods ranks analysts annually based on the returns of their buy and sell recommendations. Have a look at who the top ranked analysts are for your sector.
Pick Up the Phone
Once you know who you want coverage from, the next step is pro-active outreach to the research analyst and their director. Ask to arrange an introductory meeting to build a relationship. Once that happens, routinely follow up with updates. Then you’ll also want to make contact with the broker-dealer’s investment banker that covers your sector. Over time you will get to know them, and they will get to know you.
Quid Pro Quo
Everyone has to eat and writing research reports doesn’t put food on the table in and of itself. It costs a broker-dealer between $200,000 to $250,000 per year to provide analyst coverage. So here is the ugly truth… Broker-dealers allocate research coverage and resources to public companies either because:
- Their clients on the buy side ask for it, and/or
- The broker-dealer believes that providing coverage will eventually lead to compensation.
A broker-dealer that provides you with research coverage will expect to be compensated through participation in raising debt or equity on behalf of your company or through merger and acquisition (“M&A”) advisory. That said, for companies that are not regularly raising debt or equity capital and are not engaging in M&A transactions, it is still possible to obtain research coverage. It just might take a bit longer.
Rules and regulations
MIFID II – Europe’s Markets in Financial Instruments Directive II
MIFID II came into effect in January 2018. It forces fund managers to break out what they pay for research separately from what they pay for trade execution. While on the surface MIFID II seems harmless, it has managed to completely disrupt the funding model for analyst research. And even though it is specific for financial products sold in Europe, the impacts are global.
Broker-dealers selling to European funds now have to price research separately from trade execution. In other words, broker-dealers can no longer fund research through trading commissions. With less money to go around for research, it has become even more difficult to attract and maintain analyst coverage. Public issuers must prepare for longer lead times in establishing research within a shrinking analyst universe.
Implications for Corporate Access
MIFID II has also made it more difficult for North American companies to market in Europe. In most cases, before a European fund will consider taking a meeting, a broker-dealer needs to have a subscription agreement in place with them. There is now a limited number of broker-dealers that can effectively arrange marketing in Europe for North American companies. Market Climber can help you identify the right broker-dealers to engage the European market with.
Sarbanes-Oxley’s Impact on Securities Analysts
The Global Research Analyst Settlement and the Sarbanes-Oxley Act of 2002 (“SOX”) eventually led to a number of rules, including FINRA rule 2241, that govern the relationship between public corporations, securities analysts and investment banking departments. In short, these rules impose a separation between investment banking and securities analysts that:
- Insulate research analysts from pressure to adjust their recommendations to favour a broker-dealer’s investment banking clients;
- Prohibit the offer of favourable research or a specific rating in return for business; and
- Prohibit analysts from soliciting investment banking business.
In practice, it means that your analyst and investment banker don’t interact directly, and that it is unlikely you will ever meet with the two at the same time.
How to Manage Being Over-Brokered
If you’re successful in attracting analyst research coverage, eventually you will be unable to accommodate the wants and needs of all the broker-dealers covering you. This is called being “over-brokered”.
We typically recommend using three criteria to determine who to prioritize in this situation:
- Which broker-dealers have provided the best broker-dealer support over the long-term? Your answer should be based on an analysis of trading and the success of the buy side relationships facilitated by the broker-dealer on your behalf (both institutional and retail broker). Only a professionally managed investor relations program, that rigorously tracks outcomes, can provide accurate insight into the quality of your broker-dealer support.
- Which broker-dealers are the right match for you in terms of size, service, and industry coverage?
- Who do you trust?
Our only caution on the third criteria is that, as humans, the quality of our judgement on who to trust can be off at times. The first two criteria are more objective, and should carry more weight in your decision making.
A word on paid-for research
There are a variety of non-dealer firms that offer public companies research in return for money, equity or options. The capital markets have traditionally put zero faith in this research.
Our previous recommendation was to avoid paid-for research at all costs. However, in a post MIFID II world, paid-for research may become a necessary evil, especially for small-cap companies struggling to establish coverage. Broker-dealers are even considering a pay-to-play model for research as they seek to find a viable funding model for the research they provide.
However, until paid-for research is established as a credible source of information for the buy side, it should be approached with caution. It could be a waste of resources and a threat to your company’s credibility.