INSIGHT. 05/03/17

The Ten People Who Determine Your Valuation

By James Palczynski

There is a tee shirt popular among social psychologists (admittedly a niche market) that reads, “Stereotypes are a Real Time Saver.” These scientists, many of them management professors, appreciate the ironic humor. They know, through their close study of behavior, that we are all cognitive misers with too much to do and too many things to understand.

Distilling information is essential for capital markets professionals, who typically must understand hundreds of individual companies and the constellation of personalities involved in each. The equity capital market is a complex, dynamic and nuanced system that essentially seeks to synthesize a vast array of risks and opportunities to derive a price.

It’s also common wisdom that Wall Street prefers to “bet on the jockey not the horse.” In our experience, valuation is largely determined by the opinions of a few, influential players in any given stock. Their voices and actions in the market drive the behavior of the larger herd of investors. Their perceptions about management matter a great deal, even when they are formed too quickly. In the interest of fairness, stereotyping works both ways, particularly given the common cast of characters on Wall Street.

In that spirit: there are ten people who determine your valuation.

#1 -The Axe

Damian Lewis and his character’s namesake firm on Showtime’s Billions are a little bit of an inside-baseball joke. In common Wall Street parlance, the analyst with the most influence and impact on a stock…. that’s the “axe.”

That analyst’s reports get read first. That analyst is one who is wanted on the air by CNBC, to which most trading floors are permanently tuned. To the analyst, that is like free advertising that drives sales and trading commissions. With a “buy” rating, this is also the analyst that likely has management for a non-deal roadshow. While times have changed some, the analyst’s firm is well aware that this helps them capture investment-banking business.

The axe is one of the ten… particularly if, God help you, the axe is saying sell.

#2 –The Activist

While they come in all stripes, one common variety of activists seem to embrace Saul Alinsky’s idea that “ridicule is man’s most potent weapon.” Activist investing is one of the most prevalent trends in capital management. They are everywhere now, advocating for change, including spare change from the company’s coffer! Every public company needs to have a plan, not only to deal with an activist but, better, to make sure to not be an attractive target for one in the first place. Many times, when an activist becomes a shareholder, it is because there were too many doors left too obviously open, particularly in the areas of governance and capital allocation.

The presence of even a small position from an activist can have an impact on valuation. In a more heated situation, often involving embarrassing letters made public via 13D filings, the narrative put forth by the activist can become absolutely central to valuation. This is often true over extended periods of time. The short activist can be a particularly nasty variety that seeks to corrupt the thinking of everyone on our list to make a buck at everyone else’s expense.

The activist is one of the ten people on our list, one that always requires some careful management and a good plan.

#3 –The Big, Long-Term Holder

This portfolio manager has conviction about the stock and has been in it, in size, for a long time, in many cases since the IPO. He or she knows management well, talks to colleagues about the company as one of his favorite ideas and generally can be expected to have a deep understanding of the company and its competitors. He or she can pick up the phone and call the CEO and get him or her on the line, or at least get a relatively quick call back. Unfortunately, he or she is also a bit stuck as the level of his confidence is on full display given the size of his or her position. Other investors will take a cue from any change or even the rumor of one.

If a company is fortunate, it’ll count (and deserve) at least one and hopefully a number of these people on its list of ten.

#4 –The Hedge Fund Manager

Bobby Axelrod himself is the extreme example here. While we know more than a few hedge fund managers that are certainly interesting characters, we haven’t actually come across any actual villains! That said, it is true that most of these folks are intently focused on short-term catalysts like news, rumor, short-term results, and fast-moving sector-level trends. They are not investors, per se. In general, hedge funds tend to create (and thrive on) volatility. While, like activists, they come in all stripes, the most prevalent are the momentum-driven hedge funds that keep buying a stock as it goes up, driving valuation beyond what most might consider intrinsic. At the same time, they tend to run for cover and sell very quickly on any sign of trouble. There are plenty that will unmercifully short a stock and do what they can to make that a self-fulfilling prophecy too.

They often canvas the analysts and other holders, seeking any kind of informational edge as to what might constitute or change overall sentiment and valuation. They test other market participants with tactical trades to find the break-points on valuation set up for a bigger trade, which might be long or short depending on what they discover. Most of them tend to be agnostic on that point and some will reverse their position entirely from long to short, even intraday.

They belong on our list for their short-term influence and, because significantly increased volatility can, if persistent, have longer-term consequences for valuation.

#5 –The Financial Reporter

Even in this age of “fake news” and “alternative facts”, there is a particular reporter recognized as the best in each industry. Usually writing for places like the Wall Street Journal, Bloomberg, Fortune or Forbes, or commenting regularly on CNBC, this reporter knows the sector and the players (including on Wall Street). Reporters also will tend to talk about the bigger picture, adding any public interest or other angle to heighten the interest of a particular company’s story. High profile, well-written stories can help. If they take a negative slant, they can be particularly detrimental. In either case, they will certainly have an impact on perception and, therefore, on valuation.

Reporters are mindful of and value their relationships, particularly if they’ve been around a particular industry for some time. They also appreciate engagement and a helping hand with their stories. Educating them can turn their understanding toward your view of the world. Failure to engage and build relationships not only has opportunity cost in the short-term, but if that causes long-term friction, financial news can obscure your message and certainly impact perception, thus valuation.

In any event, given a clear ability to move the needle on a stock or even an entire industry, an interested and engaged financial reporter deserves a spot on our list.

#6 –The Competitor

It is an axiom in the Investor Relations business that if you don’t tell your story, you can bet someone else is going to tell it for you. Most executives will not talk publicly, like on an earnings conference call, about their competitors. In private conversations, however, the questions are inevitable and it would be naïve to think that many, if not most executives don’t take the opportunity to undercut their competition.

Understanding who those competitors are and, just as important, who they might influence, can be critical in mitigating false narratives or, for that matter, subjective narratives that if taken as fact would be harmful to valuation. As a general policy, taking the high road is usually the right course of action, though sometimes things can get serious and ugly.

In any event, particularly if there’s a story vacuum to fill, the competitor is on our list of ten.

#7 –The Investment Banker

Investment bankers don’t communicate with the markets, but the structural finance work and the mergers and acquisitions work they do can have profound implications for valuation. While it’s not perfectly true, investment bankers tend to be some of the most sophisticated and most thoroughly minded people in the capital markets. Their advisory work can make or break a company and the story it tells. They also have tremendous access to data and analytics that can illuminate quantitative determinants of value.

The value and perspective that an engaged and knowledgeable investment banker brings to the table is, particularly in the context of any public market transaction, obviously critical for valuation.

The one for which you have the most respect goes on our list.

#8 –The Management Team

While we have this one far down the list, the C-suite of a company should be the most influential voice for valuation. When a CEO has a maximum level of credibility and influence, a stock can even develop what we call a “cult” valuation. Visionary leaders in the vein of Elon Musk, Steve Jobs and Mark Zuckerberg have real gravitas in the financial markets that drives valuation. In contrast, measured comments and careful language that communicates a clear view of risk are a CFO’s job. The balanced message that creates, particularly when the boss is a visionary leader who sets big aspirations, is generally beneficial to valuation.

While obviously not every CEO will inspire blind devotion and a massive premium multiple, certainly every management team can aspire to have a clearly communicated strategy, a well defined corporate culture, a mission and vision that translate into value creation, a sense that their view of the world is also realistic and prudent. That’s a good path to instill confidence in not only the company’s investors, but also in employees, customers and other stakeholders.

Management should speak with one voice and is therefore on our list.

#9 –The Securities Lawyer

The public conversation that determines valuation is bounded by a dizzying range of laws and regulations, some of which have serious teeth. While we don’t recommend management think of Damocles during a Q&A session, it is essential to have a securities lawyer provide some thoughtful advice on disclosure, particularly in the event an activist is present.

Of course, counsel’s advice is intended to mitigate liability and, as a consequence, sometimes involves a sacrifice of disclosure. Which way to lean is sometimes a tough call as the forward-looking statements or rhetoric that worry a lawyer tend to be the same things that inspire confidence and foster improved valuation for the Street. To be sure, we recognize the importance of staying out of trouble, particularly any that involves regulatory agencies or a court of law. At the same time if it’s too tightly wrapped, the cloak of legal protection can take away management’s agility to play the game well!

Disclosure policy and practice are critical to valuation and with the power to affect both, the securities lawyer is certainly on our list of ten.

# 10 –The Strategic Communications Advisor

Management and the Board are responsible for determining and executing a company’s financial communications strategy. An outside advisor with broad experience across a range of companies and situations and a highly objective point of view can provide critical input to that effort. Even the best companies can fall victim to insular thinking or be guilty of believing their own press clippings. Collecting unvarnished feedback from investors and its unbiased interpretation is key to achieving and maintaining optimal valuation. Unfortunately, most investors will rarely tell a company exactly what they think for fear of offending management and limiting their access. A trusted and respected third-party advisor, ideally one that comes from Wall Street, can provide that insight. An integrated and strategic approach to all communications and constituencies, can take this insight even further. Only by addressing the participation of each of the people on our list, can a company achieve the best possible corporate reputation and, by extension, valuation.

The Strategic Communications Advisor therefore rounds out our list. A bit oversimplified perhaps, but these are the ten people who determine your valuation.

James Palczynski

James joined ICR in 2000 and has developed wide-ranging expertise across the field of strategic communications for a wide range of industry verticals. He currently heads ICR’s diversified industrials team and is a senior advisor for both domestic and internationally domiciled companies at all stages of corporate development.

A sell-side analyst prior to joining ICR, James has served as a key strategic communications advisor for initial public offerings, transformational mergers and acquisitions, ongoing advisory assignments, and a range of crisis communications projects, including shareholder activism and hostile takeover defense.


 

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