Shock waves have gone through the international stockbroking community since Merrill Lynch agreed to pay a US$100 million out of court settlement over charges of conflicts of interest among its analysts.
It raises the age-old question whether analysts work in the best interests of their investor clients or the investment banking division of their organisation.
There is a clear hierarchy in broking firms with investment bankers at the top, institutional dealers in the middle and retail advisers at the bottom. Analysts serve both institutional and retail clients but the investment bankers keep a close eye on them.
Analysts generally don't make negative recommendations on a client, or potential client, of their organisation's investment banking division. Analysts of big broking firms rarely make negative accredited comments because their investment banking department sees every company as a potential customer. This phenomenon is reflected in the huge number of media quotes from unnamed analysts.
Several Merrill Lynch analysts were accused of making positive recommendations on companies that were clients of its investment banking division when the analysts believed that these companies were complete duds.
This is not a big problem in New Zealand because of the low level of corporate activity. But it could be if there is an increase in activity, particularly new floats. In the mid-1980s, when there were 206 new floats in a five-year period, analysts wrote glowing reports on corporate clients even though most of these companies were utter rubbish.
Analysts will always tend to write positive reports because it is easier to gain access to senior management if one has made favourable comments on them.
Since the beginning of May three major broking firms have made 81 recommendations of which 42 (52 per cent) were buys, 34 (42 per cent) were holds and only 5 (6 per cent) were sell recommendations. Four of the sell recommendations were for Air New Zealand and the other was for Capital Properties.
It would be fantastic if market rises and falls were consistent with analysts recommendations but unfortunately this is not the case.
Disclosure
Another issue facing individual investors is the emphasis on positive information when a new company is raising money and the non-disclosure of some items when it is being taken over.
The second point was highlighted this week when GRD announced it had sold almost 2 million Otago Power shares for $6.5 million.
When GRD took over Macraes Mining at the end of 1998 this shareholding, which represents nearly 7 per cent of Otago Power, was not disclosed. In Monday's Stock Exchange announcement GRD argued that this shareholding had not been accounted for because the Otago Power co-operative constitution has historically made realising the values of the shares difficult.
There was some truth to this argument before Max Bradford's electricity reforms but after these reforms were passed, which was before the Macraes takeover, it became much easier to realise these shares. GRD has done very well from this shareholding having had a $1 million capital repayment before this week's sale.
This shareholding would have almost certainly been revealed if Macraes had come to the market with an initial public offering.
GDC Communications & CabletalkStuart Johnstone received a grilling from shareholders at GDC Communications' annual meeting. The chairman, who is also GDC's largest shareholder, was in an unenviable position because his company has failed to meet its prospectus forecast and the share price is well below its high of $5.11.
GDC's disappointing performance is consistent with Cabletalk, another listed company with similar operations.
The core business of the two companies is the maintenance of Telecom's network. Telecom has divided its network into 34 patches and has allocated these to GDC, Cabletalk, Downer Engineering and Alstom. These are three-year contracts, with Telecom having the right to extend them for a further two.
GDC has seven patches and Cabletalk six, all of which complete their initial three years in the next 12 months.
The profitability of these maintenance contracts depends on the operator's efficiency. Telecom does not want the contractors to become too profitable but at the same time it wants to have at least four strong companies tendering for its patch contracts when they come up for renewal.
GDC reported revenue of $42 million from its contracting division last year and a pre-tax profit of $2 million. Its non-contracting activities had sales of $25 million and a pre-tax profit of $3.1 million.
Cabletalk is much more reliant on its Telecom contracts and these operations are far less efficient than GDC. On April 15, Cabletalk announced that it would not achieve its forecast profit for this financial year.
Anticipated revenues of $46 million were in line with expectations but costs were $4 million above forecasts and the company is expected to report a loss of $1 million, after goodwill amortisation of $660,000.
The problem with Cabletalk, which gained listing through the New Capital Markets, is that the vendors were too greedy when they sold their businesses to the company for $15.35 million.
The consideration, which included $12.7 million of goodwill, was 21.7 million Cabletalk shares at 50c and $4.5 million cash. The cash payment was partly funded by a nine for one rights issue at 50c.
By contrast the GDC $1.50 a share issue raised $8.7 million for the company and this has been reinvested in its non-contracting division, particularly the new application service provider iVASP.
Johnstone was quizzed extensively on iVASP. He is extremely confident of its future and expects the new application to produce monthly profits from the third quarter.
GDC has a profitable contracting division but its share price performance will be strongly influenced by the success or failure of iVASP and other non-contracting activities.
Cabletalk is a long way behind GDC as it has yet to prove that it can make a satisfactory return from its contracting operations.
GDC: On a Sounder Footingfxtab5 20 15 25 15 25
Move comes after MP Takutai Tarsh Kemp died last month.