F&P Quarterly: Company commissioned equity research – from ugly duckling to swan?

Company commissioned equity research – from ugly duckling to swan?

In the wakes of Mifid II, the number of providers of commissioned equity research has started to increase. The question is how listed companies will – and should – respond to this shift, and if this really is to be considered a serious alternative to the traditional equity research.

Mifid II’s impact on equity research
Following the introduction of the Mifid II regulatory framework in January, banks and financial advisors now must apply separate pricing for products that previously could be bundled as part of the brokerage fees, such as equity research. However, the customers (i.e. asset managers) have decided to not pass on this cost to their unit holders, meaning that they are paying for research out of their own pockets. Consequently, the willingness to pay for research has gone down dramatically and banks and brokers will see a significant decrease in revenues related to their research offering. In order to keep coverage, especially on small and micro cap companies where equity trading is limited, they will have to look elsewhere for revenues to fund their research departments. The impact on many smaller companies will be that they face a future where they find it difficult to get proper research coverage from the higher ranked banks.

How is the market changing?
So far, the changed legislation has not made any large visible impact. In general, one can assume that large caps, and to some extent mid and small caps, will still be able to rely on coverage from traditional analysts, assuming there is an interest in their stock. However, an increasing amount of the larger banks have also started to offer company commissioned equity research as an add-on to the traditional research. Commissioned equity research means that it is the company under coverage that is paying for the research. This is not a new phenomenon in the market, as several specialised research firms have done this for years primarily for smaller growth companies, that wouldn’t have been able to get coverage otherwise. However, this form of equity research has been met with some scepticism, given the potential conflict of interest; can the investor rely on the analyst’s unbiased view given that the research note has been paid by the company in question? But as the larger banks are starting to offer commissioned research, it is likely that the acceptance for a paid research note will increase, making it less of an ugly duckling.

Different research offerings
As the larger banks’ research departments are starting to offer commissioned research, a broader field of products to choose between will emerge. The most common selling point used by the majority of the providers is the distribution capacity – their research notes will reach a large number of investors through various channels, both their own and via collaboration partners such as Bloomberg and FactSet. A company can also publish and share the research on its own website and in other digital channels.

The larger research departments – especially the ones with high rankings in external surveys such as Prospera and Insitutional Investor – are more expensive but can offer a more sophisticated target audience, comprising both high net worth individuals and institutional investors on local and international basis. And if the analyst in question also covers shares on a traditional basis, i.e. without being paid by the covered company, this will most certainly add an extra seal of quality to the product.

Lastly, the providers differ in how they recommend the shares – some stick to traditional “Buy” and “Sell” recommendations with a fixed target price, whereas others prefer to set a price range based on different scenarios and without an explicit recommendation. The latter may be a preferred method if one wants to avoid the risk of the above-mentioned conflict of interest.

How to act as a listed company
Commissioned research may be positive for a company’s image and awareness in the capital markets, and provide a building block to increase the understanding of the equity story. It can also support the creation of a consensus on expectations, thus reducing the risk of surprises when communicating the results.

However, companies’ must do their homework before paying for research – it should be one activity of many in the long-term investor relations plan. All IR activities must have a clear purpose and objective, for instance improving the quality of the shareholder structure, or reducing share price volatility. In both these examples, commissioned research could be a way of reaching the objective.

To start off, one should investigate whether it would be possible to get traditional coverage and have a plan to increase coverage without paying for it. If this isn’t possible, the next step is to evaluate all providers to find the perfect match with your company’s needs and ambitions. Important checkpoints are the target audience, the provider’s brand and status in the market, the analyst’s track record, if the analyst is familiar with your sector and possibly already has coverage of your peers, and what level of attention to expect, i.e. how often the analyst will publish updates and how thorough the initiation report will be.

As the number of research providers is increasing, one might also have a negotiation opportunity regarding the price tag – however, the priority should be how the research will contribute to the long-term objectives. Also, as it is likely that commissioned research will be the only way for smaller companies to get analyst coverage in the future, the expense could be treated as part of the cost to be a listed company.

Looking ahead
All in all, company commissioned equity research is still something of an ugly duckling in the market. However, the changing market conditions following Mifid II will certainly become more tangible over time. It is reasonable to assume that an increasing number of companies will start to pay for equity research, and in combination with more of the established research departments entering the area, its status may very quickly turn into a swan.