Channel Check, MNPI

What is a Channel Check?

A channel check is a primary research method used by investment firms to collect data and information from a company’s distribution channels or chain of business. While there is always publicly available information available on a company, there is only so much information that can be gathered from financial statements, reports, announcements, etc. Distribution channel checks are a way to pick up details about a company’s operating practices – something that is not always publicly disclosed.

Distribution channels can include wholesalers, retailers, and distributors. Typically, investment analysts interview the distribution channel to pick up information like:

  • whether there are any product changes at the target company
  • whether there are any price changes to products or services
  • opinions on how competitive the target company’s product is in the current environment
  • opinions on how competitive the pricing is at the target company
  • pricing trends
  • understanding the targeted customer base
  • customer buying patterns
  • view into inventory levels
  • how successful marketing efforts have been by the target company
  • retailer and distributor opinions about competitors
  • local sales trends
  • perceived company value
  • seasonal and geographic variation

All of this information is then used by the analyst to perform channel checks as part of their due diligence before formulating an estimate for the target company’s sales revenue for the coming year, determining the valuation of a company, and making an investment recommendation regarding the target company’s stock.

How a Channel Check Works?

The obvious advantage and ultimate goal of the channel check is to uncover information about the target company that is not supplied by the actual company. The other advantage is that it gives the analyst insights into the company’s current health and prospective growth.

Logistics – Let’s say X, Inc. is the target company for an analyst.

  • the analyst wants to check on X’s clients and distribution channels to get an estimate of how many widgets will be ordered from X. This is so the analyst can project X’s revenue for the coming year
  • analyst calls a manager at X’s largest client
  • analyst asks manager about his own company’s plans for continuing business with X in the form of an anecdote or opinion on how competitively X is positioned in the widget market

Risks to Keep in Mind

Whenever an investment analyst speaks to industry contacts in search of information that may not be widely known by the public, there is a risk of receiving confidential or sensitive information that may constitute MNPI.

The following risks should be considered during the information gathering process of a channel check:

  • are you inducing any of the channel contacts for information? Inducement can be monetary in nature or as a non-monetary reward or gift. If the channel contact is incentivized to provide information they know should be kept private, is an inducement and a big risk
  • attempting to receive any information from a channel contact that may be in breach of any confidentiality agreements or fiduciary duty that is owed by that individual to his/her clients or employer. You should always check with the contact to ensure that the individual is not under any agreements that may prevent them from sharing information about a certain company, metrics, or specific topics
    • typically, these conversations occur without the target company’s knowledge or permission, heightening the risk
    • depending on what types of questions are asked and the level the individual is at the company, he/she may require written consent or permission from a C-level manager or owner to participate in the channel check
  • whether any MNPI was collected during the channel check that may be disseminated internally at a hedge fund where an investment decision was made based off of the non-public information. For this reason, analysts need to be careful in filtering out information gathered and quarantined
  • inquiring about the channel contact’s own business practices, profits, products, etc. vs. asking an opinion on a competitor, distributor or supplier. There is risk that too much information about a retailer’s own store sales comes close to the line of breaching confidentiality
  • what types of questions are being asked – are they quantitative in nature like actual sales, earnings, profits vs. qualitative information

Bottom Line

  • channel checks provide valuable input to an analyst’s mosaic that is not available in any public sources
  • legal and compliance risks need to remain at the forefront of any analyst’s channel research process to ensure that the information gathered from the industry is not in breach of any confidentiality obligations or insight that might constitute as MNPI
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