Whether notification comes from an open filing with the SEC, a private letter or an inbound call, the mere presence of an activist investor or fund in a company’s stock is enough to put even the most stalwart management team on edge. In recent years, the growth of specialty and hedge funds has led to a dramatic increase in shareholder activism, which has brought both problems and benefits to investors and managements.
One important point to keep in mind when dealing with activists is that despite their loud voices, activist shareholders’ opinions should not outweigh those of other shareholders. That said, as shareholders, activists’ opinions are important and can be very helpful if approached with an open mind, as most activists seek increases in a company’s share price just as management teams do.
However, interests often diverge with the time frames and methods each would like to see. Activists often seek to unlock existing value as rapidly as possible, often through reorganization and austerity, while management teams often take a longer-term view that focuses on investment and franchise expansion. Depending on the specific case, either approach could be the best path for shareholders as a whole.
We have been fortunate, and sometimes unfortunate, to have observed hundreds of companies go through an initial public offering (IPO) process, and then begin trading as a public company. What is astounding is how frequently healthcare IPOs “blow up” within the first few quarters of their public life. This happens so much so that a small group of investors has made a career of buying these broken IPOs. Why? Because they know that a broken IPO does not necessarily make a broken company.
The challenge, of course, is that once a newly priced IPO blows up, and the stock drops to a point where it is deemed broken, there is an incredible amount of work, credibility re-building, energy and time required to gain back lost valuation and earn back Wall Street’s trust.
Why do companies blow up and when does permanent credibility damage occur? Here are the most common issues that we see:
As my hairs have gotten grayer in the last decade, I can’t help but to have noticed the major transformation that has altered how humans interact with one another. The digital revolution has permeated every facet of my life (as I’m sure it has yours): from how I get my news, to how I stay in touch with my family, to how I do business each day.
The “greatest generation” (i.e., those who grew up during the Great Depression) saw the widespread adoption of telephones and television sets. This generation spent the majority of its working years communicating through pen and paper, typewriters, and “snail mail.” The children of this generation—i.e., the “baby boomers”—grew up with much more access to information than their parents, but the information was not immediate, not “in your face,” and not coming at you from half a dozen devices at once. The way these two generations worked was very different, but the two groups’ outlooks were not necessarily in opposition. Like me, many of you reading this are probably part of Generation X or Generation Y. While we also have distinct world views and experiences compared to the generations who preceded us, we still are markedly different from the youngest members of today’s work force.
Unless you’ve been stranded on a distant planet, you’ve noticed that equity markets have been hitting new highs lately, and that’s been accompanied by an increasingly robust capital markets environment, even including initial public offerings (IPOs). In fact, the current public healthcare IPO backlog stands at 14, with many more companies already confidentially initiating plans to pursue going public over the remainder of the year.
As recently as six months ago when we would meet with CFOs and CEOs of private companies (or their venture investors), they would have long lists of reasons why their company would never go public. The reasons included cost of capital, the hassle of being a public company, legal requirements, and compliance costs. All of these are particular burdens for smaller companies. In addition, if executives or investors were looking for an exit, they calculated better valuations if they sold to a strategic acquirer or private equity firm. An IPO was truly an option of last resort. Today, when we meet with these same constituents, we see a dramatic shift in their attitude towards going public.
Changing Tides for Healthcare Companies
So what has changed? The overall equity markets are much stronger, IPOs are getting done and trading up in the aftermarket and sentiment from the buy-side has become much more favorable. Some of this positive change has to be credited to the federal JOBS Act—a series of measures that allows private companies to become public in ways that are less burdensome and less costly.
Last week, we wrote about Regulation FD, now in its 13th year of implementation, and offered Part One of a quiz designed to test how well you understand the regulation. Here, we offer a slightly more challenging Part Two of the quiz. We hope you will find this helpful as you think about real life Reg FD situations. Since the following answers should not be construed as legal advice, we also urge you to talk with your legal counsel before deciding what practices are best for your company and its particular disclosure situations.
Reg FD Quiz, Part Two- Violation or Not?
1. CEO is aware that your company will likely miss quarter consensus estimates, but this hasn’t been disclosed. CEO looks downtrodden in 1×1 meeting, and talks about what a tough macro environment it has been for the industry. A week later, your company announces lower than expected revenues. Stock trades down sharply on higher than normal volume.
Did the CEO violate Reg FD? (YES) The CEO selectively disclosed material, non-public information through non-verbal cues. Hindsight is perfect; hold a poker face or don’t talk.
2. At a webcasted analyst day, management outlines its new product pipeline, how the products compare to existing technologies and treatments and the timeline for product launches. Two weeks later, in a 1×1 meeting with an investor who missed the analyst meeting, management answers questions about how some of the new products differ from competition.
Regulation FD, now in its 13th year of implementation, remains a source of consternation for senior management and investor relations teams in their communications with investors. Some companies err on the side of excessive caution and end up rarely engaging in regular, productive dialog with The Street. Other companies go the other extreme and provide copious amounts of detail while filing an abundance of 8Ks. Finding the appropriate balance is the best strategy for open, useful relationships with investor audiences while steering clear of actions that could lead to SEC penalties.
Here, we offer a brief description of what Reg FD is, followed by a simple test to help you determine your level of compliance with the regulation. We hope you will find this helpful as a starting point as you think about Reg FD. Since the following answers should not be construed as legal advice, we also urge you to talk with your legal counsel before deciding what practices are best for your company and its particular disclosure situations.
What is Reg FD?
Reg FD is the SEC’s attempt to level the playing field for all investors – institutional and individual – by prohibiting selective disclosure of material information.
Sell ratings got you bothered? Can’t shake the feeling that an analyst is holding a grudge? Wish you could just make them go away?
Let’s discuss your negative analyst strategy in 3 steps:
- Remember the big picture
- Avoid the pitfalls
- Engage and execute
1. Remember the big picture.
There will always be analysts who are negative on your company. They won’t go away. Why?
A “miss” relative to a company’s financial guidance can happen to even the best management teams. Misses can arise from a hiccup in company operations or they can be related to factors outside your company’s control. In either case, the ways in which you assess the problem, communicate it, and follow up in later quarters will have a powerful and lasting impact on the Street’s views of management’s credibility and thus your stock’s long-term valuation.
Assessing the problem
Before you communicate with the Street, make sure you’ve honestly assessed the reason for the miss and its ongoing impact to your results. Was this merely a soft quarter for seasonal or other factors, or was there a one-time event? While it’s possible that ongoing results won’t be impacted, it’s also possible that greater forces are at play: a business segment could be maturing, or your internal growth expectations may have to be moderated. Even if the miss is truly related to an issue out of your control, such as a reimbursement change, make sure you critically evaluate the impact before you communicate any revised guidance.
If it seems to you that there is an investment banking conference every week, you’re just about right. Investment banks routinely hold investor conferences that tend to focus on certain industries (like healthcare or technology). A few Wall Street firms also hold what I’d call “best idea” conferences, which include representative companies from different industries.
Attending a conference can be a valuable part of your investor relations strategy. It’s a great way to get more investors to know your company, and to make vital business connections. But, if you have, say, 15 analysts covering your stock, and each one hosts a conference, that can mean you’re getting invited to 15+ conferences a year. How can you possibly accept every one of these invitations?
Before deciding “yea” or “nay” on attending upcoming conferences, it’s important to understand why they’re held. Decades ago, Wall Street’s equity divisions made money primarily by underwriting stock offerings and trading stocks. As institutional commissions have shrunk, trading has become much less profitable. However, while the buy side is no longer paying as much for trading execution or research services, buy side firms and analysts will pay for access to management. Therefore, Wall Street has strong incentives to arrange venues where they can introduce companies to investors.
All management teams and boards of directors want to know how they’re doing. For public healthcare companies, the wide variety of stock indices makes it easy to draw a comparison with peer companies. But finding the right index is key to making a meaningful comparison. Just because an index includes “technology,” “healthcare” or “mid-cap” in its name doesn’t mean it’s right for you. And the most popular indices are not always the right choices.
Fund managers, especially those who may not understand nuances in various healthcare sectors, will use an index to evaluate your firm’s performance. But, comparing against the wrong index can have serious implications: for instance, if an index that includes many larger cap companies (over $1 billion in market capitalization) is rising, but smaller companies aren’t sharing this momentum, then your smaller firm will compare poorly against the index – and undeservedly so. Further, smaller companies are more vulnerable to certain financial issues than multi-billion dollar firms; access to capital, product pipelines and market volatility can have an outsized effect on a small-cap firm’s stock performance.