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China – Competing More Effectively For Capital Through Effective Disclosure.

4 September, 2013

 

Legal News & Analysis – Asia Pacific – China – Capital Markets

 

How Best Practices In Transparency And Guidance Can Increase A Chinese Company’s Overall Success In The U.S. Capital Markets

 

The recent period has been extremely challenging for Chinese companies listed in the U.S. The group as a whole has been severely impacted by the global economic crisis, financial accounting scandals at various Chinese companies, and a host of short seller attacks that targeted difficult to understand and non-transparent Chinese businesses. Many of the Chinese companies trading on the NYSE and NASDAQ have seen their share prices fall sharply over the past two years. Even the best performing Chinese companies are having difficulty rebuilding investor trust and winning the intense competition for capital. 

 

With that as a backdrop, it is no surprise that some U.S. listed Chinese companies have given up trying to navigate the U.S. market. A number of companies are actively and aggressively seeking other options such as listing on different international exchanges or arranging to go private, temporarily or permanently removing themselves from the public markets. 


Yet on the other hand, there are many Chinese companies choosing to stay in the U.S. to brave the extremely challenging environment. However, with investor confidence in Chinese companies so badly shaken, how can these issuers attract shareholder interest and build confidence in their company as an investment? 

We believe that for those companies to succeed – to stand out from the pack, restore international investor confidence, and generate more acceptable valuations – they must enhance certain investor relations behavior and practices. Perhaps most importantly, they need to recognize and respond to the intense demand from the investment community for enhanced transparency and much more effective disclosure. 


In short, increasing transparency and expanding disclosure parameters are critically important for any publicly listed company looking to enhance its corporate reputation and increase valuation. The most successful companies go well beyond what is legally required, providing transparency in their communication processes, educating and informing the investment community, and providing accurate guidance that builds shareholder support for their investment proposition. This is sometimes not an easy task. However, in today’s environment it is most definitely one of the only things that will help a public company compete more effectively for capital.


Effective Disclosure is No Longer a “Nice to Have” – It is a “Must Have”


It is indisputable that investors are demanding ever greater transparency from public companies, as are regulators like the Securities and Exchange Commission (SEC) and U.S. exchanges such as the NYSE and NASDAQ. Short sellers are aggressively pointing out when a company appears to be “hiding something” and exchanges are going as far as temporarily halting or actually delisting stocks if a company is seen to be operating under a veil of secrecy.


The growing importance is real and it is also not going unnoticed by the public companies themselves. Many Chief Executive Officers, Chief Financial Officers, and Investor Relations Officers are making improved disclosure a priority for their company. In fact, as BNY Mellon has discovered in its Annual Investor Relations survey (2012), for the last three years providing effective disclosure has been a top priority for Investor Relations Officers both around the world and in Greater China.


Clearly, this means that the market has spoken and companies are listening. Effective disclosure and transparency are no longer something negotiable for issuers. It is a must have and companies that are interested in succeeding in the capital markets need to meet – or exceed – the rising standards.

 

Even So, Good Disclosure is an Art… Not a Science

 

While management teams know they need to focus on this, do they all know what good and effective disclosure actually is…. and is there a rule book they can follow?

 

We would argue that the definition of good disclosure is broad. There is no “one-size-fits-all” standard and in reality it is much more an art than a science. This of course leaves the path you need to take open to interpretation and this can be confusing to some. But on the positive side, it also gives companies the opportunity and a great deal of latitude to define what will work best for their own situation.

 

Nevertheless, at the core of good and effective disclosure is the concept of going beyond legal requirements of financial reporting. Following regulations and legal rules is critically important but if a company is only reporting earnings four times a year and only doing required financial filings, it will fall well short of investor expectations. Those who succeed are aware that in reality, best practices in disclosure combines a variety of important investor relations and financial communication initiatives

 

In short, a company that uses a comprehensive set of diversified communications strategies and tactics will be seen as more open, will more effectively broadcast its investment proposition, will reach more investors, will be better differentiated versus peers, and will almost certainly command a higher valuation than others.

 

What are the Barriers to Best Practices in Transparency and Guidance?

 

To be sure, communicating in a fully open and transparent fashion is not easy for any publicly listed company and there are many obstacles that may make this seem like an overwhelming – and perhaps disadvantageous – undertaking.

 

The barriers are many, particularly for Chinese companies listed in the U.S., and it would be naive to pretend that they don’t exist. What are the most common hurdles?

 

Competitive Risk Revealing too much can erode pricing advantage and threaten competitive edge. 
Macro Dynamics It is difficult to forecast accurately, particularly in the current market.
Cultural Differences  U.S. investors are used to the more forthright approach of U.S. companies.
Regulatory 
Environment
Regulations in China and the U.S. are different and seem to at times conflict, which is challenging.
Company Structure Access to full corporate information is a challenge for Investor Relations Officers in any market, and this may be particularly acute in China.

 

While they can’t be ignored, these challenges do not need to impair the effort to improve disclosure practices – and Chinese companies simply cannot afford to let these stand in the way. Further, if they do, the consequences can be dire, as outlined below.

 

What Can Go Wrong When You Fall Short of Best Practice…?

 

Given the challenges outlined above, it may feel easier to follow only the basic legal requirements of being public. Also, a management team may believe it needs to protect proprietary business information or disclose as little as possible in order to support its market position within its industry. However, for a public company this most usually leads to failure in a number of critical areas. 


If you are not doing your best to be open and transparent and provide the market with diversified operational and financial information, you will likely wind up with the following:

 

Constant Confusion  Investor uncertainty or misunderstanding about your business, financial and operating results, and future expectations.
High Skepticism Suspicion that you are hiding something.
Increased 
Vulnerability
 
Leave your company wide open for short attack or problems with the SEC or U.S. stock exchanges.
Low Valuation Trade at a discount to local and international peers.
Capital Flight  Investors will shift to more transparent and easier to understand peers.

 

…But What Can Go Right? What are the Tangible Benefits of Following Best Practices in Effective Disclosure?


We believe that there are significant benefits to a company that is transparent with the market, finds ways to be open and creative with disclosures, and effectively manages the investment community’s expectations.

Companies that look to improve their approach will most certainly achieve the following: 

 

Increase Understanding of their Business The right and varied disclosures and enhanced transparency make it easier for stakeholders to understand your business and your forward-looking strategy. 
Separate from the Pack Will separate from the mass of Chinese U.S. listed companies and be perceived as more attuned to needs of sophisticated investors.
Attract Better Investors More institutional investors will likely be interested in getting involved and trust you as a steward of their capital.
Generate Efficiencies  You will save time and your job will be easier.
Help Repair Reputation of the Group Will be doing your part to elevate the actions of and perception of Chinese U.S. listed companies that have been under severe pressure.

 

Developing a Roadmap for Improved Disclosure: What Should You Do?


If you have made the decision to improve your disclosure practices what should you do? In our view, there are some very simple steps you should follow.

  

• RESEARCH: Perform extensive research and know what you are dealing with.


• ANTICIPATE: Always work to anticipate what is coming and stay ahead of the investment community whenever possible.


• IMPROVE COMMUNICATIONS: Improve how you are communicating with the investment community by using better and more sophisticated materials and tools.


• DIVERSIFY DISCLOSURES: Improve what you are communicating by diversifying the types of disclosure you are using and always going well beyond regulatory requirements.


RESEARCH: Know What You Are Dealing With


Identify and Prepare to Defend Your Own Vulnerabilities 
Certainly no company is perfect and all businesses have areas of weakness that others will work to point out or leverage. For Chinese companies listed in the U.S., this became abundantly clear over the last two years as short sellers consistently exploited real, potential, or imagined weaknesses in numerous businesses – driving down stock prices and destroying many companies’ reputations. While these were extreme cases, they highlight how important it is for companies to know where they have weaknesses in any number of areas: business strategy, communications practices, corporate governance, the ownership structure, financial reporting practices or controls, etc. 


Because of this, we believe Chinese companies should perform an internal due diligence exercise, potentially in conjunction with a third party advisor, to discover potential areas of weakness that could be exploited by investors, the media, or peers. A company should then work to fix what is wrong or be prepared to explain to the public why the perceived vulnerability is not a real risk to investors. Importantly, all of this should be incorporated into all the key messages that a company uses. You should leave very little open for interpretation or exploitation.


Conduct Perception Audits
Periodic perception audits can be used to gauge the sentiment of analysts, investors, and the media and the information that is gathered provides insight into what stakeholders don’t understand or where a company needs to do more to satisfy them. Further, asking shareholders and analysts what other information they would like to obtain or would benefit their analysis is an easy way to figure out how to improve the level of information you are providing the market.


Benchmark Peer Disclosure
Knowing what key peers are doing and saying is a critical preparatory step and it is therefore advisable to do a full peer disclosure benchmarking analysis. The peer set should include publicly listed industry peers located in both China and the U.S. as well as leading international listed companies who are recognized as having good disclosure standards.

 

It is important to understand the types of information that other companies are disclosing, the metrics that peers use to measure their business, the kind of forward-looking guidance that is being provided, and the industry statistics that peers are providing to the market. Further, getting a sense for where these companies are speaking publicly, how frequently they are putting out press releases or doing investor conference calls, and what information they are posting on their website is helpful in assessing industry best practices.


Aggregating information of this nature is invaluable as it enables a company to understand what investors have access to elsewhere and shows where companies may be falling behind – and therefore where they need to make up ground.


ANTICIPATE: Stay Ahead of the Investment Community


Answer Questions Investors Have Before They Are Asked
If you know there are problematic issues or things to address, why avoid talking about them? There is rarely a good reason to wait to receive questions from investors rather than instead thinking very carefully about all that they need to hear in order to fully understand your business and your growth story, what may have gone wrong in the quarter’s business performance, and so on. Best practice disclosure includes anticipating all that investors need to know to make them comfortable with the company as an investment – and delivering that to them in a succinct, articulate way that makes a management team look smart, a business model seem simple, and a growth strategy appear exactly right.


Moreover, by monitoring peer news, market developments, and analyst coverage and having consistent interaction with top shareholders, a company is able to uncover misunderstanding, knowledge gaps, and issues that may need to be better addressed. All of this should then be proactively worked into key messaging, investor presentations, press releases, and conference call scripts. Investors will believe the company is being forthright and it will appear more transparent than if it leaks out bits of information slowly, and only after being asked repeatedly for more details.


Manage Expectations in Advance and Never Ever Surprise Investors
The idea of providing more information rather than less also applies when considering how to make sure investors understand “what comes next.”


It is now widely agreed that effectively managing expectations is key to successful investor relations. Some form of hard or soft “guidance” is usually required to keep the investment community engaged in the investment story and believing that the company will deliver a return to them over time. It is important to note that providing guidance no longer needs to mean that a company provides hard top and bottom line forecasts. Instead, it can provide information about indicative metrics, give a description of why industry changes will impact business results, or describe how “a year of investment” will help the company post stronger profitability in the subsequent period.


Related to this, investors hate to be surprised. Telling them what you generally expect to happen with your business ahead of time – and then executing that successfully – is the best way to keep investors calm and supportive of your stock. If on the other hand, you tell them very little about what will happen and/or overpromise on what you can deliver and then report a dismal quarter, they will react extremely badly and this is when stocks take major hits. Strong investor relations practices require consistent and careful disclosures that help investors understand where a business has been and where it is headed – but a company has to be comfortable being open and transparent to execute this well.


IMPROVE COMMUNICATIONS: Communicate More and Use Better Materials


Create Pristine Documents That Tell a Comprehensive Business Story
A strong set of well-articulated messages and visually appealing communications materials not only serves to differentiate a Chinese company from its domestic peers and global market competitors but also demonstrates to the market a commitment to open and transparent communications. To this end, we believe that many Chinese companies should be looking to upgrade the communications materials they are using. 


First, management teams should be making concerted efforts to create a solid set of messages that explain why the company is stronger than peers, what beyond the financial story is important for people to know, what the growth strategy is, and so on. 


Second, these messages should be pushed to the market through well written press releases, articulate and compelling investor presentations, detailed quarterly investor newsletters, etc. Doing only the minimum when it comes to the actual communications materials that you use is a missed opportunity. The companies that get noticed are using top of the line documents that have a look and feel similar to some of the largest global brands and publicly listed international companies. In order to stand out from peers, it is this calibre of materials that companies should strive to achieve.

  

Increase Pace of Communicating

In the wake of a series of profit warnings, auditor disputes, corporate governance scandals, and de-listings involving U.S. listed Chinese companies, this group of issuers needs to “overcommunicate” to re-establish credibility and trust. One way to accomplish this is to increase the pace of communicating with the market. Companies should aim to make more announcements about business updates between quarterly earnings announcements, use periodic investor newsletters to explain developments in the business, and consistently post new supporting information to their websites. 


Communication should be viewed as an ongoing tool that helps a company connect effectively with the owners of its stock and attract new potential shareholders – rather than something that happens only four times a year when earnings are reported. The more real and thoughtful news that investors hear from a company, the more they will view the management team as open and accessible.


Leverage Investor Relations Website to Reach and Teach Remote Investors
Corporate and investor relations websites enable companies to showcase management teams, operations, products, financial results, corporate governance, and key community initiatives to a wide group of investors. Also, for Chinese companies that are physically quite remote from some of their target shareholders, posting real-time, tailored information on a website can be a cost-effective way to resolve some of the information, distance, and time-zone concerns. The website can be used as a central place to post high standard digital communications materials such as product related videos orefficiently packaged interactive earnings materials and investor presentations. In an increasingly digitally-focused market environment, effectively leveraging this opportunity is a 
must.


DIVERSIFY DISCLOSURES: Go Well Beyond Regulatory Requirements


Tell More Than Your Financial Story
All too often, companies make the mistake of viewing disclosure as driven purely by financial and regulatory needs – a box that must be ticked, but nothing more. We believe this is short-sighted and the most successful companies are going well beyond only reporting their financial results four times a year. Rather, they are describing the whole of their overall corporate story and showing current and potential investors much more – describing who their customers are, what they are doing in their community, what new partnerships have been entered into, etc. 


Companies can also better leverage existing public relations initiatives that are ongoing in China, using them with international audiences in a way that will help give insight into competitive advantages and market position in China. For instance, companies can translate and internationalize existing Chinese press releases about company milestones, industry differentiators, and thought leadership commentary in order to tell a broader and deeper corporate story to international stakeholders.


Use a Variety of Communications Tools –Releases, Meetings, Events – to Connect with Investors
It is also important for management teams to remember that the best disclosure plans go well beyond relying only on press releases as the way to communicate. Instead, companies should create a diverse and robust set of activity to reach all of the most important stakeholders. This includes doing press releases, staying in contact with the top shareholders via periodic calls, setting up in-person meetings with prospective holders, hosting company-sponsored investment community events, etc. Diversity in outreach and engagement signals that a company is very focused on ensuring investors have many ways to gain access and get information from management. 

  

Use Media Relations as a Communications Tool

At a very basic level, media relations is a key investor relations tool in that it can help broadcast a company’s investment story efficiently to a very broad group of potential investors. Further, strategic media relations can help foster a strong public image, provide an independent platform from which to tell a company’s story, and generate valuable reputational capital and goodwill. A company’s investor relations and public relations communications teams should work closely together to identify opportunities to use the media to widely disseminate key aspects of both the corporate and financial story. 


Chinese companies can slowly introduce media relations to their disclosure process by first seeking media coverage of strong earnings results and then over time graduate to developing “hard news” stories about corporate strategy, the management team, new partnerships, M&A activity, and other business initiatives. Media relations is a very powerful and effective communications tool and should not be underestimated in the effort to improve disclosure practices.

  

Integrate Social Media into the Mix 

Investors are increasingly relying on social media platforms such as Twitter for up-to-the-minute market news and sentiment. It is no surprise then that these platforms have become increasingly important channels for communications between public companies and their shareholders. In response to this, in April 2013 the SEC released guidance to companies about the acceptable use of social media, such as Facebook or Twitter, to release company-related information. This guidance removes concerns that disclosures made through social media outlets may conflict with the SEC’s Regulation Fair Disclosure (Regulation FD). 


Although social media will never become the exclusive distribution mechanism for investor communications and it would be a mistake to view social media as a “silver bullet” solution in attracting investor attention and improving disclosure standards, companies can and should selectively leverage social media as an additional distribution channel.


Conclusion


In the current market environment, Chinese companies need to work harder than ever before to establish and sustain investor trust and confidence. At the same time, investors now demand more from publicly listed companies than ever before – more information, more access, more engagement. 


All of this means that Chinese companies who want to compete effectively for capital need to position themselves as transparent, open, and engaged with the investment community. 


Importantly, there is no simple “off-the-shelf” solution for this. Each company needs to develop a disclosure program to suit its own needs and meet the increasingly stringent demands of the investment community. It is essential that they review all aspects of their approach to disclosure and to the greatest extent possible aim to emulate international best practices and standards. 


With a cross-border team of investor relations professionals with deep, sector-specific expertise and more than 30 years of experience in financial communications and investor relations, FTI Consulting is ideally positioned to support companies in this effort.

 

 

For further information, please contact:


Cara O’Brien, FTI Consulting
cara.obrien@fticonsulting.com 

 

Martin Reidy, FTI Consulting 
martin.reidy@fticonsulting.com

 

Pui Shan Lee, FTI Consulting
ps.lee@fticonsulting.com

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