So you're the CEO or CFO of a public company, growing in line with expectations, meeting your profit targets, and maintaining or expanding your market share. Life looks great until you check your stock price, which is one-half to one-third of its level two or three years ago. What's going on here? First of all, don't blame yourself or your investor-relations team. Several forces are at work:
Supply has increased. During the last decade the universe of public companies in the U.S. mushroomed from about 4,000 to more than 10,000. We have all witnessed the rush to "hot IPOs." That hype has abated a bit, but IPOs still outnumber the companies closing their doors or being merged out.
As for demand, the last few years have seen vigorous and successful efforts by the Securities and Exchange Commission and stock exchanges to narrow the bid/asked spreads in stock trading, going from smaller fractions such as 32nds and 64ths to decimalization. While this is beneficial for stock owners and traders, these spreads are the gross margin of the brokerage business, and have had the effect of necessitating trading of significantly more shares to achieve the same, or even less, gross profit. Thus brokers and traders have, for the most part, focused mainly on stocks that trade millions of shares rather than ones that trade a few thousand -- perhaps like your company. Indeed, according to Bloomberg Financial Information Service, Microsoft Corp. has 58 analysts following its stock, Intel -- 62, and IBM Corp. - 43. Compare this to one or two small analyst firms (and sometimes none) following micro-cap stocks.
The stock-market boom has had a similar effect on money managers, who are responsible for portfolios that include many stocks. Many portfolios are now so huge that, rather than attempt to cover hundreds or thousands of stocks, managers have been forced to join the "bigness" parade by favoring larger-cap stocks. These trends have helped create the stock market "orphanage" your company lives in. Not that you are alone -- the median company in our database of 10,122 U.S. public companies had 1999 sales of just $74 million, leading to the conclusion that more than half of these public companies make do with much less in the way of stock-market analysis and support than would have been assumed as recently as 10 or 15 years ago. Of course there are a number of small-cap and micro-cap funds out there, and a few independent research firms such as Sidoti & Co. and the Red Chip Review that follow very-small-cap companies primarily for them. Getting plugged into this circuit can help, but it usually falls short of solving the basic problem. What more to do, then? Most companies in your situation aren't going to do much, if anything. After all, management is performing well, being paid well, and -- if there are no noisy stockholders or directors who have a hyper sense of duty to the voiceless herd of small shareholders out there -- the boat isn't likely to get rocked. To be fair, it's also true in most cases that there's not much that can be done other than plugging along and making steady progress toward a size level that will get you on the larger radar screens. Some companies, however, do lend themselves to strategic reconfigurations that can greatly increase shareholder value. Here are a few examples my firm has been involved in:
A specialty-chemicals company developed a cash-flow problem that stemmed from its continuing investment in a drug-delivery subsidiary that was completely overlooked. It accorded negative value by the two chemical-industry analysts who followed the company. We helped spin out the drug-delivery subsidiary as a separate public company, thus making its enormous potential recognizable -- although it's not yet profitable -- and the sum of the two securities has been as high as three times the price of the original host company's stock at the time we started.
A small, electronic-components manufacturer had a subsidiary that manufactured printers for several fast-growing applications. We found an underwriting firm willing to take public this spun-off division despite its relatively small size, and the sum of these two stocks were soon more than three times the host company's stock price before the split-up.
The CEO and board of a listed prototypical "old economy" company realized that its then-current portfolio of manufacturing operations was probably never going to catch the world's fancy, despite good current profitability and competent operating management. So far, one new division has been added in an area of faster growth potential and an on-going effort is being made to replace certain operating assets with others with a more dynamic future. We never know how successful efforts like these will eventually prove, but you never know until you try. It is always good to bear in mind that, as long as markets value different kinds of operations differently (as they always will), many companies have the potential, regardless of size, to improve their overall valuation by strategic reordering. If that means rocking the boat, maybe it will be worth it.
Thomas E. Dewey Jr. is a partner in the New York investment bank McFarland Dewey & Co.