Fair Value

In yesterday’s post, I missed an interesting point Rodney Alfvén made regarding IR target groups. Rodney identified three key groups with different information needs:

Sell-side analysts, who are focused on details, e.g. “why did your margin drop by half a percentage point in this product segment in this market?”

Buy-side analysts, whose information need centers around understanding key value drivers.

Asset managers, who will often use “short cuts” (some follow as many as 800 companies). They are most likely to be swayed by the strength of your financial brand.

Rodney is simplifying of course, but the point is that you need to know your audience and shape your IR messages to resonate with different audiences.

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Rodney Alfvén was the most interesting speaker at today’s IR Nordic Market Awards in my view. He told us that he has so far logged 193 hours as Nordea’s IRO (I guess he is really keeping track). Before that, he was chief analyst at Cheuvreux Nordic. Rodney’s talk focused on the transition from equity analysis to investor relations. He started out by using the Scorpion and the Frog fable to describe the destructive streak of the capital markets and the tension between companies and analysts (the frog being the IRO and the scorpion the analyst…). He then gave the IR folks in the audience some thoughts and advice from the equity analyst’s perspective:

Building your financial brand in a focused way is very important. The average asset manager in Sweden has 200-800 companies on his/her radar screen. Analysing each company in depth cannot be done, so the strength of your financial brand can be a deciding factor in the investment process. The financial brand is different from the customer brand, but if the financial brand takes enough damage, it will start affecting the customer brand negatively (apparent in banking in recent times).

Very important to build and protect your corporate reputation in good times. If your corporate reputation (and your financial brand) is damaged, it is extremely hard to rebuild in times of crisis.

You must address analysts’ and investors’ concerns. A company that does not candidly discuss analysts’ issues and concerns is going to cause enormous frustration. It does not matter if the analyst is right or wrong. What is critical is the company’s willingness to openly discuss the issues.

Proactive transparency. You need to know about and address issues before you get the question from an analyst.

IR needs to have a central position in the company. An analyst can immediately tell if IR is not a prioritised activity (they sense if the IRO is not completely up to speed). And this is very negative for your financial brand.

IR is never better than the CEO. A dispassionate CEO cannot be compensated for. Also, Rodney’s view is that the whole top management team needs to be trained to talk to the market. IR needs to take a lead on this.     

Hiring an analyst as the IRO is becoming somewhat of a trend, at least in the Nordic countries. In the latest issue of Affärsvärlden (nr 47), it was pointed out that both TeliaSonera and ASSA ABLOY have done so recently. They have both improved their position dramatically in the IR Nordic Market Awards ranking of companies’ IR programmes. It will be interesting to see if Rodney Alfvén can improve Nordea’s position in next year’s ranking...

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A client (IR Director) recently told me that his Board of Directors has asked him for an analysis of the company’s intrinsic value, a full-blown valuation. This is not common and I for one hope that this is the start of a trend. I mean, many IR practitioners will tell you that their overriding goal is to achieve or maintain a fair valuation of their company’s shares. Most will also agree that a stock market valuation that differs too much from the company’s intrinsic value is unhealthy. In fact, it can be massively value destroying in the long term, regardless of whether the company is currently overvalued or undervalued.

But how many IR Directors (or CEOs) have a fact-based perspective on their company’s value? And how many still subscribe to the misguided view that the “market is always right” (remember the Efficient Markets Theory?). If the goal of IR is to achieve a fair valuation, shouldn’t companies take more control over their valuation? The first step is to maintain an internal view of the company’s intrinsic value. Without it, how do you expect to evaluate your IR program’s effectiveness? If the goal is to be fairly valued, that is.

I know that there are companies out there that use an internally generated valuation as an important input to IR strategy. But I don’t know how common it is. I would love to find case examples from different countries.

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One of my client’s Board of Directors just approved a new strategy. We are now revamping the reporting framework. This is a very interesting process, but also fraught with danger.

Corporate reporting should reduce the gap between how management views the company’s future value creation potential and the market’s analysis. We want to give investors an opportunity to view the company through the eyes of management. Well, at least if our goal is to be fairly valued by the stock market. It is quite common, however, that the reporting framework actually gets ahead of how the company is governed. I have read tons of reports with very polished sections on strategy. But often, the linkage to the rest of the material is extremely weak. The reasons for this vary of course but it always suggests weak corporate governance.

The exhibit below is from a recent speech by David Phillips of PwC, which I have linked to in an earlier post as well.

David makes the point that it is important for investors to understand the linkages between these building blocks of information. Few corporate reports make this task easy and I would even argue that some actually contribute to widening the perception gap between management and shareholders. Sometimes, it is painfully obvious that the company’s governance structure is not in sync with its communicated strategy. This potential pitfall has to be thoroughly addressed when defining a company’s reporting structure.

I have seen several instances of companies communicating a grandiose new strategy, yet they are unable to make a clear connection to value drivers and KPIs. However, I have also seen first-hand how the corporate reporting process actually starts impacting the way the company is managed, rather than the other way around... Managing by the annual report, sort of. Not optimal of course, but it makes it very clear how important it is that IR must take on a much more strategic role than is often the case today.

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A prospective client I talked to this afternoon said that he was “quite happy with the quality of our annual report’s narrative sections”. He wanted some advice on how to strengthen the financial sections. But then, he immediately went on to say that “The administration report is what it is. We can’t really do much about that part.” Sadly, this is a very common view here in Sweden. I believe it reflects the extreme focus on compliance in reporting corporate performance. Perhaps not surprising, given the constant stream of new regulations and guidelines that companies are required to keep up with.

Supposedly, the objective of this avalanche of regulation is to increase transparency (help investors form an accurate view of companies’ performance and health). It’s proven less than helpful. New regulation was passed in Sweden in 2006 in order to improve the quality of the non-financial information in the administration report (Årsredovisningslag, 6 kap. 1 §). The law is toothless, and the result has been disappointing to say the least.

So, it’s not surprising that there’s an ongoing discussion about revamping the reporting framework. There are a number of organisations that are involved on different levels, e.g. http://www.cruf.com and http://www.ebr360.org.

Regulation is not the main problem here, though. The issue is that too many companies are overly reactive and compliance-focused. As a result, the quality of many administration reports (or board of directors’ reports) is pitiful.

Proactive firms – yes, there are a few – are not content to just abide by conventional reporting guidelines. Sorry for using Warren Buffett as an example again:

 “We attempt to offset the shortcomings of conventional accounting by regularly reporting "look-through" earnings (though, for special and nonrecurring reasons, we occasionally omit them). The look-through numbers include Berkshire's own reported operating earnings, excluding capital gains and purchase-accounting adjustments (an explanation of which occurs later in this message) plus Berkshire's share of the undistributed earnings of our major investees - amounts that are not included in Berkshire's figures under conventional accounting. From these undistributed earnings of our investees we subtract the tax we would have owed had the earnings been paid to us as dividends. We also exclude capital gains, purchase-accounting adjustments and extraordinary charges or credits from the investee numbers.” (From Berkshire Hathaway’s Owner’s Manual, http://www.berkshirehathaway.com/owners.html)

I will surely revisit this topic. I’m always interested in examples of companies with a no-nonsense, investor-friendly view of reporting.

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A few days ago, I and my colleagues at Intellecta Corporate had the pleasure of meeting up with renowned neuroscientist Martin Ingvar. He gave us a lot of fascinating insights on the human brain within the context of communication. But what stuck in my mind was a comment he made regarding the school system whose problems he attributed to its failure to deal with the loss of its “monopoly” on knowledge dissemination.

Monopolies are crumbling everywhere these days:

Sell-side analysts’ role in generating investment ideas has been shrinking for quite a while. The amount of information that is created outside of the analyst community has exploded. The financial crisis has accelerated this development. Alacra, the business information aggregator, recently started offering material from financial blogs alongside the usual broker research reports. They have changed their definition of what an analyst is: “An analyst can be a sell-side research analyst, a rating agency analyst, an industry analyst, or a blogger with the credentials, experience and expertise that makes him or her, in Alacra’s view, an opinion leader.”  If you have an hour to spare, I recommend this O'Reilly Webcast - Equity Research in the Age of Web:

Traditional media is struggling to find a new business model, although some are still stubbornly sticking to the old one. Martin Ingvar mentioned Rupert Murdoch’s attack on Google, and his statement that it is time for search engines to pay for content. Many think that Mr Murdoch is not even wrong. He hasn’t understood the problem. A majority of investors and analysts believe that social media will influence investment decisions to a greater degree in the future:

It is also clear that companies’ authority over their own value story is diminishing. A senior Swedish equity analyst recently claimed that the interest among investors to meet with CEOs has declined dramatically this year. The role and value of the traditional IR website is also unclear. And the same goes for the corporate website. Yet, many companies still seem to think of their IR website as the undisputed source of information for investors and analysts. They should read this account of eBay’s analyst day back in March:

http://www.irwebreport.com/daily/2009/03/12/analyst-days-in-the-age-of-twitter/

So, how should you respond to the expectation that social media will become ever more influential in defining your company’s value story? eBay is certainly one of the most interesting case examples. While their traditional IR website’s coverage of the analyst day was described as irrelevant by Dominic Jones at IR Web Report, people turned to http://ebayinkblog.com/ for information and insight.

Some companies have tried to emulate eBay’s success by launching IR blogs or CEO blogs. Others have created Social Media Newsrooms. But there are no clear-cut, off-the-shelf solutions to maintaining a dialogue with those that collectively shape the perception of your company and its investment case. What is clear though is that more and more companies, at least here in Sweden, are planning to enable two-way communication everywhere on their websites, not just in one or two subsections. Also, people are increasingly thinking in terms of a company’s total web presence, rather than just its own websites. Amalia Syrén, a colleague of mine at Intellecta Corporate, recently wrote about the Social Corporate Website here (in Swedish):

http://intellectawebb.se/2009/09/10/social-corporate-webb/

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My colleague at Intellecta Corporate, Elias Betinakis, recently posted an open question to a number of leading web strategists in Sweden: "how should companies think about their web presence, given today's communications landscape".

Some great replies here (in Swedish...):

http://intellectawebb.se/2009/10/14/webbnarvaro-1010/

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The importance of the annual report in achieving a fair valuation is debatable. The most common criticism is that traditional corporate reporting is too focused on historical information to be of any real use to investors in assessing future value creation potential. In the early 1990s, management guru Peter F. Drucker claimed that corporate reports were like an X-ray of a company’s skeleton, not capable of diagnosing a variety of diseases that could potentially be fatal for a company’s long-term health. Ever since, discussions concerning the creation of an updated reporting model have intensified. I’m not sure that we are any closer now to a generally accepted solution than we were in 1993, however. 

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Warren Buffett is a hero in my book. So when he offers his views on IR, I listen. Nowadays, most companies claim that their goal is to be fairly valued by the stock market (as opposed to stock price maximisation). In reality, very few have a fact-based perspective on their intrinsic value. Many CEOs routinely assume their companies are undervalued and complain that the market just doesn’t get their “value story”. Yet, their IR practices fall way short of the philosophy Warren Buffett applies at Berkshire Hathaway: full and fair disclosure. Berkshire’s annual reports are a testimony to Mr Buffett’s beliefs (http://www.berkshirehathaway.com/reports.html). There is nothing phony about them. Not a trace of spin. It would be very hard not to trust Mr Buffett after reading one of these reports. If something has gone wrong, he is the first to admit it and then goes on to tell you what he plans to do about it. And no accounting shenanigans. Warren Buffett on the widespread use of EBITDA: “Does management think the tooth fairy pays for capital expenditures?”

In my opinion though, what is most interesting about Warren Buffett's approach to IR is not what he does. It is what he does not do:

No narrative included with the quarterly reports: “our owners and managers have very long time horizons and it is difficult to say anything new or meaningful each quarter about events of long-term significance”.

Not a lot of repetition in the annual reports: “we build on what we have told you in previous reports” (referring to the extremely loyal shareholder base).

No efforts to increase share turnover for the sake of liquidity: “a hyperactive stock market is the pickpocket of enterprise ... we hope to continue to have a very low turnover among our owners, reflecting a constituency that understands our operation, approves of our policies, and shares our expectations.”

No stock splits, even though you have to be quite well-off to buy even one share of Berkshire Hathaway: “could we really improve our shareholder group by trading some of our present clear-thinking members for impressionable new ones who, preferring paper to value, feel wealthier with nine $10 bills than with one $100 bill?”.

And no staff specialists are involved in writing the annual report: “unlikely to be in a position to talk frankly on a manager-to-owner basis”. But then again, apart from the annual general meeting, Warren Buffett doesn’t seem to be spending too much time on IR. He is busy delivering on expectations...

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I have been putting off blogging for quite a while. Not for much longer. I've heard Posterous is great, so I decided to at least register an account today. It will probably be a while before I really get into this, but at least I managed to secure stefanpettersson.posterous.com! My name is ridiculously common in Sweden, so I expected to have to settle for "stefanpe67" or something like that. I guess Posterous is not huge in Sweden yet.

Anyway, I plan to mostly write about different aspects of corporate communication, in particular investor relations, my main professional interest. I am currently senior adviser and chief analyst at Intellecta Corporate, a Swedish communications consultancy. The online conversations about IR are mostly in English. I want to take part, which is why this blog will be in English only.

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