New York based small cap focused research firm, Sidoti & Company, Inc. recently filed to raise up to $35 million in an initial public offering. The IPO will be co-managed by WR Hambrecht & Co. along with Sidoti’s own investment banking arm.
Terms of the Offering
Last Thursday, Sidoti filed a Form S-1 Registration Statement with the SEC to raise up to $35 million in an initial public offering.
According to the filing, Sidoti generated $30.3 million in revenue in 2013, compared to $29.8 million in 2012, and net income of $800,000 for both years. For the first six months of 2014, Sidoti recorded $14.1 million in revenue and $300,000 in net income.
While terms of the proposed offer were not provided, we estimate that Sidoti will sell between 50% to 60% of the firm to the public if the offering is fully subscribed.
One interesting aspect of the offering is that Sidoti & Company’s own investment banking division will be running the IPO alongside WR Hambrecht & Co.
Background on Sidoti
Founded in 1999, Sidoti & Co. is a boutique research firm that produces and markets US small and micro-cap research to long only asset managers and hedge funds. The firm serves almost 500 institutional investor clients in the United States, Canada and the United Kingdom.
As part of this research offering, Sidoti provides research reports, institutional sales coverage, access to corporate management, and it allows buy-side clients to pay for its research via its trading desk. In recent years, the firm has started offering limited investment banking services.
Asset management clients have told us that the principal strength of Sidoti’s research services has been the knowledge that the firm’s analysts have of the companies they cover, the relationships they have had with company management, and the corporate access events they have offered. In addition, clients have also valued the fact that Sidoti analysts produce models for all the companies they cover.
In the past few years, Sidoti expanded its business from providing research coverage primarily on companies with a market cap of between $300 mln to $2.0 billion (small cap companies), to micro-cap companies (companies with a market capitalization of less than $300 million).
Rationale for the IPO
Sidoti’s planned IPO is based on a couple of factors. First, Sidoti’s core business, producing and selling small cap research to the asset management community, has flattened out in recent years. Equity commissions – the currency used to pay for equity research – have fallen over the last few years creating a difficult environment for growth. In addition, many long only asset managers have continued to cut costs in recent years as they have lost market share to ETFs, index funds, and other low cost investment products.
Ultimately, these trends have led Sidoti management to look to expand into other businesses which might be able to pick up the slack for flattening research sales. One obvious direction is to leverage their small and micro-cap research expertise to manage money themselves. Management highlighted this rationale in their S-1.
“We intend to leverage our established small- and micro-cap research brand to expand into the asset management business. We believe a unique opportunity exists to establish an asset management platform focused on the small- and micro-cap segments. We believe these segments are underserved by existing asset managers and that significant capacity exists to create such a platform. As we establish a track record of performance in this business, we intend to expand our reach and seek to attract assets from other institutions, high-net-worth individuals and other sources.”
Another reason we think Sidoti management decided to go public at this time is to help the firm attract top flight analytical, sales and money management talent. Sidoti has historically been known as a firm that refuses to overpay for talent. As a public firm, Sidoti will have the luxury of attracting qualified staff with equity, as well as cash compensation. We think this will be important to the firm as it tries to build out its asset management business, as well as hire high quality research analysts. Management explained this in their recent filing.
“We expect that our transition to a public company will enhance our ability to execute our growth strategies and meet our clients’ needs. As a public company, we expect to have greater visibility with clients, increased access to capital, and additional currency to explore strategic opportunities. Operating as a public company should also enhance our ability to attract and retain high-quality professionals by expanding our effort to offer equity-based incentives linked directly to the success of the business.”
Lessons for the Research Industry
The Sidoti IPO is the latest chapter for a research provider which has continually evolved. Originally an independent research firm, Sidoti added a trading desk early on in its existence in an effort to maintain some control over the amount of commission revenue buy-side clients were directing to the firm to pay for its research. Before setting up its own desk, Sidoti partnered with another broker-dealer for commission payments.
In the past few years, Sidoti added an investment banking arm in an effort to bolster its revenues as it decided to leverage its research capacity by partnering with other banks that did not have this capability to win small cap banking mandates.
Now the move into asset management. Clearly, Sidoti is not the first independent research firm that has decided to go into the asset management business (Argus Research, Thomas White International, and Ned Davis Research are just a few examples). Unfortunately, many other research firms have struggled with making the transition from purely producing and selling research to gathering sufficient assets to create a profitable asset management business.
Maybe this is why Sidoti decided to raise capital in the public market in order to hire the talent required to raise capital, as well as hire money management professionals who have built up an attractive track record. It will be interesting to see how Sidoti’s IPO fares, and how successful the business is in building its asset management division.