Companies operate in the real world, but Wall Street prefers buckets when it comes to classifying businesses and determining research analyst coverage. Companies moving towards an initial public offering (IPO) would do well to develop their positioning early and agree upon the right mix of covering analysts with their underwriting banks. Here are a few considerations for companies to guide their thinking:
1. Traditional versus disruptive business models. Most companies operate traditional businesses that are easily understood and categorized by Wall Street. However, disruptive technology companies maintain dramatically different growth and financial profiles than legacy providers, which creates a challenge around cultivating appropriate Wall Street coverage. In many cases, the coverage conundrum often boils down to business models and end markets. Coverage from a business model perspective depends on factors such as the company’s revenue growth, margin profile, and key performance indicators (KPIs). Whereas, end market coverage emphasizes the company’s participation within an analyst’s defined industry coverage universe.
2. Multi-sector coverage. If your company’s business model and end markets straddle more than one Wall Street sector, you may wish to consider multi-sector research coverage. The upside to multi-sector coverage includes an expanded investor target universe, a deeper understanding of the company from different viewpoints, and the ability to accentuate parts of the story based on changing market sentiment. It also encourages industry analysts to reconsider valuation beyond the typical metrics and peers. Further, each analyst brings unique channel relationships that provide investors with additional insights. However, a mix of analysts also involves more complexity with varying peer sets, KPIs, and a range of valuation multiples and methodologies.
3. Joint coverage versus mixed coverage. With multi-sector coverage, is it better to have joint or mixed coverage (see Figure 1) among the underwriting group of your IPO? The benefits of joint coverage, which involves multiple analysts from the same bank, are the same as listed above in the prior point (i.e., expanded investor target universe, etc.), but factor in that a lead analyst almost always emerges. Therefore, it’s important to assess whether you’d be comfortable with either analyst from a bank becoming the primary (or possibly sole) voice on your stock depending on relevance over time.
Alternatively, companies may opt for mixed coverage. This entails coverage from the majority of analysts under one sector (e.g., internet) and then the balance of coverage from select banks with end-market analysts (e.g., consumer) who bring insight into industry dynamics. It should be noted that many high-growth companies favor coverage from tech analysts at IPO in anticipation of end-market specialists initiating coverage organically over time (see Figure 2).
Figure 1: Joint Coverage Versus Mixed Coverage
Figure 2: Evolution of IPO and Post-IPO Analyst Coverage
4. Valuation. Conventional wisdom holds that certain Wall Street sectors always command a premium multiple to others in a rigid form of hierarchy (i.e., tech over traditional). Our research suggests otherwise. We analyzed the sell-side estimates of four companies that were covered from both internet and consumer analysts at IPO (see Figure 3). The implied valuations based on initial price targets of consumer analysts were higher than internet analysts in three of the four instances. In fact, since their IPOs, these companies were valued at higher multiples by consumer analysts over 90% of the time. That said, since the COVID-19 pandemic, there has been a convergence of multiples between internet and consumer analysts; the difference between the two groups is currently 0.2x revenue, on average, compared to 0.6x revenue in early February.
Figure 3: Analysis of Sell-Side Estimates
5. What’s the bottom line? First, take an honest look at your company. How do you manage your business, and how do you gauge performance? Which public companies are most relevant and who do you compete directly against in the market? If you’d like to be positioned as a software company, but only a minority of your business is recurring software revenue, your profit margins lag the software peers, and you don’t benchmark against any common software measures, it will be difficult to make the case for software analyst coverage.
Second, meet with research analysts, bankers, and public institutional investors well ahead of an IPO to understand how you’re perceived and what KPIs they view as most relevant. Once you’ve benefited from the exposure and feedback, you’ll have a better handle on positioning and structuring analyst coverage for your company. Just bear in mind that it’s tough to pivot once you’re public, so take the necessary steps upfront to ensure you’re comfortable with how your story will be told for the long haul.