By: Peter T. Sidoti, CEO, Sidoti & Company, LLC
Several years ago, I called an emergency meeting of our executive management team. The mood was somber, as I reviewed the headwinds our industry was facing:
- Commission revenue paid by the long-only buyside was dropping precipitously year-over-year, largely because active money managers were losing assets at an accelerating pace to passive funds, leaving them less able to compensate the sell-side for providing research insights.
- Services provided by our firm to the buy-side, which once prompted them to steer significant additional business to us, were no longer providing us a return on investment. Our firm had spent 7 figures hosting investor conferences in the prior twelve months, and the traditional strong uptick in trading we usually saw in the events’ aftermath had all but evaporated. Moreover (and especially after MiFid II regulations came into effect, making it dramatically more onerous for the buyside to compensate sell-side research shops) the amount an account would provide us for traveling to see them with a covered company’s management team was becoming uneconomical, sometimes barely covering our costs of hosting the day(s).
- The cost of providing equity research to a company was increasing, in large part because indirect costs required by more stringent regulations required us to devote more resources to editing, compliance and supervision, as well as data and technology. We estimated that we spent at least $30,000 – $35,000 a year all-in to cover a single name, and analyst compensation could not reasonably by reduced to offset cost pressure.
- Unlike many of our competitors that funded investment banking departments, our firm did not generate a level of syndicate business to meaningfully subsidize the costs of running a research department with over 250 names under coverage.
An Evolution in the Making
As our team huddled to find a solution to what we called the “broken equity research model,” we kept coming back to the fact that quality, independent third-party research still was coveted by issuers and investors, as it played an important role in helping ensure equities were fairly and efficiently priced, in promoting liquidity and in providing corporate visibility. We also knew that many issuers were disappointed with what many characterized as the bland, less insightful and routinized “maintenance” coverage they received by certain of our fellow research providers – some confided in us that they believed that research was only forthcoming because our competitors sensed there would be a financing transaction in the foreseeable future and wanted to secure a piece of a seven or eight figure underwriting/placement fee. At this point the lightbulb went off, as we posited:
The equity research business will come to resemble the debt marketplace, where poor economics limit the willingness of brokerages to provide research, leading issuers seeking coverage to commission research providers for those services (for decades debt issuers have compensated S&P, Moody’s and Fitch to provide research and ratings).
Providing Issuers Significant Value by Changing the Model
Offering Company Sponsored Research (CSR): Sidoti realized that certain companies looking for coverage — and even some currently under coverage — would generate such low commission revenue (due to their trading characteristics and otherwise) that we could not economically provide coverage. Accordingly, several years ago, we started offering companies the ability to commission equity research coverage that is virtually identical to our “traditional” offering. At first, many companies were reluctant to embrace the product because they still had a number of brokerages covering them for “free.” But over time, these same firms began to reconnect with us, as those “free” research providers either left the business or rationalized the number of names under coverage due to economic considerations. But perhaps more telling was the acceptance of a group of companies we had under “traditional coverage” to convert to the commissioned side. Obviously, they valued our research services enough to compensate us for it. We believe quality commissioned research, written by reputable providers will play an increasing role in providing value to issuers and investors alike.
Providing New Value-Added Services:We also came to understand larger issuers that had “sufficient” coverage on Wall Street were troubled by the diminished quality of that coverage and the decreasing level of corporate access they were receiving, as even the larger brokerages rationalized research departments and eliminated/downsized “free” conferences and the hosting of non-deal roadshow days. In response, Sidoti undertook two revenue generating initiatives, which issuers seemed willing to embrace as long as they filled a growing void:
- Conferences with Presenter Fees. Several years ago, Sidoti began to offer small and microcap conference events for which they charged presenting companies a fee. Unlike many “free” conferences, that focused on generating investment banking business, our sole aim was to provide meaningful interaction between issuer and investors. The vast majority of Sidoti’s covered companies now present at one or more of our conference events each year and a large number of non-covered companies also register as presenters. We believe this is because traditional sources of investor access have become elusive. To wit, many IR firms are encouraging their clients to attend our events because quality access is simply not as readily available elsewhere.
- Compensated Non-Deal Roadshow Days. While we believe our conferences offer companies the most efficient way to obtain access to investors, a number of our issuers prefer having a day to themselves. Some of these covered companies value the service sufficiently that have offered to compensate us for providing this individualized access.
The research model that worked for 35 of my first 40+ years in the brokerage business is no longer viable, nor are securities research firms that are unwilling to adapt. That does not mean the research (and attendant services) provided by brokerage firms are no longer coveted or fail to add value. Rather industry economics simply dictate that brokerages are likely to need to ask issuers to absorb a portion of the cost they incur to provide services that benefit issuer and investor alike – and this is particularly true for issuers that cannot offer the carrot of a foreseeable investment banking fee. The model that we believe will work well into the future is one where brokerages fulfill certain unmet needs of issuers by providing quality issuer-oriented services, without — and I cannot emphasize this enough (especially for those of you too new to the business to remember the Global Settlement) — compromising the quality, credibility, independence and reputation of their research services as issuers become fee-paying customers.
About Sidoti & Company, LLC
For over two decades, Sidoti has been a premier provider of independent securities research focused specifically on small and microcap companies and the institutions that invest in their securities, with most of its coverage in the $100 million-$3 billion market cap range. The firm’s approach affords companies and institutional clients a combination of high-quality research, a small- and microcap-focused nationwide sales effort, broad access to corporate management teams, and extensive trading support. Sidoti serves 500+ institutional clients in North America, including many leading managers of portfolios with $200 million to $2 billion of AUM. Sidoti promotes meaningful interaction between issuers and investors through its conferences (www.sidoticonference.com) and the hundreds of non-deal roadshows hosted each year.
Sidoti Events Team
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