View: How to woo quality investors

By Vikram HosangadyThe jury is still out on how much money will actually flow to mid and small caps on the back of the recent Securities and Exchange Board of India (Sebi) regulations regarding allocation of flows in multi-cap funds. But there are factors that would encourage funds to invest in mid and small caps, despite the inherent limitations of liquidity and vulnerability, due to the absence of scale. Vision, purpose & execution strategy: Where does a company want to be in 3-5 years? What are the steps it is embarking on to get there? Covid and other extraneous factors that increase volatility in business conditions are now the ‘new normal’. The key is that this is a journey and ‘progress over perfection’ is monitorable. A clearly articulated ‘purpose’ for all stakeholders, including employees and investors, needs to be in place. Shareholding and float: A promoter holding 50-55% is a good start to ensure adequate float. This also allows the promoter to increase stake in volatile markets. If there is a pledge, a good sense of the rationale and timeframe to free up the pledge is key. Investors dislike pledges, potential margin money calls and unrelated investments using equity as collateral. Business model and key performance metrics: A clear articulation of the industry, and a company’s positioning with a focus on how the company is dealing with a VUCA — volatility, uncertainty, complexity and ambiguity —world in terms of benefiting from shifts like unorganised to organised, premium-isation, impact of digital transformation in the operating model, geopolitical factors and fundamental principles around reducing concentration on product, customer, etc, is imperative. The ability to be innovative and nimble is a key differentiator in building a moat. Mid and small caps need to demonstrate how, within a defined period, there is an opportunity to scale up and be dominant in their niche. Investors look to both growth and return ratios as they evaluate companies. Diversification to ‘market-friendly’ segments (currently, pharma and speciality chemicals) without having a well defined rationale is a huge negative. Return ratios like return on capital employed (ROCE), return on assets (ROA) and the ability to earn free cash —earnings before interest, taxes, depreciation and amortisation (Ebitda) to free cash flow (FCF) are key monitorables. A well-articulated dividend distribution and borrowing policy is a big plus. Corporate governance: This is a key factor to drive quality investors. It would include having an independent board, a good management discussion and analysis, and a clear articulation of how the company is dealing with both opportunities and threats. Revenue and profit guidance has to be given only with an adequate sense of factors that could change this as the street dislikes surprises. Material events — a sharp change in tariffs, loss of a key customer, exit of key managerial personnel, etc — should be communicated before the street knows it. Keeping corporate structures as simple as possible is best. Related party transactions: This is a huge ‘smell test’ for investors, in terms of family members of the promoters engaged in the supply chain, or employed in the company. If there are such transactions, the key will be to highlight the rationale, but the best would be to minimise such dependence. This applies to both reported related party transactions and those that don’t fit the definition for reporting. Management team: While investors understand that founders are key for the success of most small and mid caps, broad-basing of management — especially in support functions like finance, IT and R&D — is a huge positive. Pedigree and their ability to talk to the street on investor calls are key too. Frequent changes in these roles are a red flag in terms of the ability to attract and retain diverse talent, so pivotal for building scale. Communication with investors: This is a double-edged sword. We often see over-eager managements. Investor communication is an art, and the balance between what is relevant and transparency is a key objective of communication strategy. Annual reports, investor calls and analyst meets are great platforms to communicate effectively. Family settlements and managing the transition: Very often, family settlements can throw up shocks for investors. This could be in the form of loss of managerial talent, or promoter shares finding their way with speculative investors. This needs to be dealt with proactively to ensure investor confidence is not shaken. A proper transition plan to manage loss of talent or ensuring that shares are placed with quality investors will go a long way to ensure investor confidence.(The writer is partner, KPMG India)

from Economic Times https://ift.tt/36WdkiY
via IFTTT