An Opportunity for Small-Caps Is On The Horizon

The past ten years have dampened the fun of being a small cap public company. Increased regulatory efforts, such as Sarbanes Oxley, have escalated the cost of being public. With the growing threat of litigation, the risk to management and directors has increased. Research and trading support, vital to gaining broad institutional support, has become rare. Even the ability for managers and owners to gain some liquidity has increasingly become burdensome and complicated given the regulatory and practical restrictions of insiders selling stock.

Still, in recent years being public did have some benefits mostly in perceived valuation benefits and the ability to use stock to raise capital, make acquisitions or attract key employees. Well, with the market meltdown a tough situation for public companies has become even worse.

Now, being a small cap public company can be downright disheartening. Stock prices have not just dropped with the rest of the market, but given the lack of liquidity in the small end of the market, many stocks have plunged and remain depressed. So, along with the cost and the risk of being public, small public companies are now faced with a valuation discount as well. In today’s market, I would argue that it is easier and cheaper for a privately held company to raise capital than it is for its comparable publicly held brethren to do so. Not that it is particularly easy or cheap for small private companies, but at least they can raise money whereas many public companies do not have the luxury and given the fact they are restricted by their “public” price they have very little incentive to do so.

Being a glass-half-full guy, I see an opportunity on the horizon for small cap companies. There is a very long list of successful small public companies with strong balance sheets and motivated owner/managers who have quickly reacted to the downturn to right the company size and remain cash flow positive. Increasingly my conversations with these companies are focusing not on surviving the tough times, but on how to take advantage of their relative strength to get ahead over the next few years. Get bigger, get private, get bought, get value – these are all potential opportunities that strong small cap companies should be examining and prioritizing now as to have a plan to get ahead before and during the recovery.

It has been a tough road to be public and it’s gotten even more arduous, but it would be a shame for the strong companies not to be proactive and improve their standing dramatically coming out of the downturn. A company with capital, a solid balance sheet, motivated owner/managers and a well thought out strategic plan can clean up over the next 24 months. It won’t happen by accident either.

Tim McMahon is a Managing Director at Covington Associates.  He can be reached at 617-314-3950 or ibankerblog@covllc.com.