Sell calls vanish as analysts feather nests

By BRIAN GAYNOR

Rapid changes in the stockbroking industry are having a big impact on brokers' analysis and recommendations. These trends, which have been strongly criticised in the Northern Hemisphere, have had several effects:

* Brokers' research has become more sales-oriented.

* Analysts make few sell recommendations.

* They are unwilling to criticise poor management.

* Brokers analyse only the largest companies.

In the past two decades there has been a sharp reduction in commission rates, particularly for institutional investors.

As rates have fallen, the traditional broking area has become less profitable and stockbrokers have had to look elsewhere for profit growth.

Investment banking and corporate advisory work underwriting new floats, mergers and acquisitions are far more lucrative and analysts are being used to tout these services to large corporations.

A negative research report destroys any chance of procuring corporate advisory work.

According to Arthur Levitt, chairman of the US Securities and Exchange Commission, "the competition for investment banking business is so keen that analysts' sell recommendations on stocks of investment banking clients or potential clients are very rare."

An analysis of brokers' recommendations backs up this statement. At the end of last year, only 29 of 8000 research reports covering companies in the Standard & Poor's 500 index had sell recommendations. In other words, 99.64 per cent of these reports had either a hold, buy or strong buy recommendation.

Mary Meeker, the high-profile technology analyst at Morgan Stanley Dean Witter & Co who earned a reputed $US15 million in 1999, sustained a positive view on internet stocks as they nosedived last year. Most of the companies she still recommends are clients of Morgan Stanley's investment banking division.

Similar trends have developed in this country. Most analysts maintained a hold or buy recommendation on Brierley Investments as its problems increased. Fletcher Challenge Forests received few sell recommendations as its outlook deteriorated and share price declined.

Brierley Investments and Fletcher Challenge generate a huge amount of investment banking and corporate advisory work. The main brokers are reluctant to place a sell recommendation on existing or potential corporate clients because it could have a negative impact on their income from this activity.

Analysts are also afraid that senior management will not talk to them after a sell recommendation. This is important because access to a company is vital and an uninformed analyst is of little use to his or her employer.

There is also the problem of liquidity. A well-publicised and aggressive sell recommendation is self-defeating because the company's share price falls rapidly and few shares can then be sold. Brokers usually tell their best clients that an analyst has turned negative but this opinion is rarely published or widely distributed.

The usual strategy is for a broker to stop covering a company when its performance deteriorates. There is little point having an analyst committed to a company that has limited investor interest and no prospects of investment banking work.

At one stage Trans Tasman Properties, formerly Robt Jones Investments, was crawling with bullish analysts; now it is virtually friendless. Its recent annual meetings have attracted only long-suffering shareholders.

The internet boom was a perfect example of the false optimism of the broking community, particularly in the United States. Analysts invented new valuation criteria for stocks and hyped up share prices to unrealistic levels. Their corporate departments prospered as hundreds of new companies were sold to gullible investors.

Many of these investors have lost 80 per cent or more of the money they invested in the internet sector.

The internet boom was more subdued in this country but many of the same characteristics were evident. Most brokers covering the sector also provided them with corporate advisory services to internet companies.

Their analysts continued to maintain buy recommendations throughout last year's meltdown.

Analysts are quick to praise good managers but reluctant to criticise poor ones. Paul Anthony, the former chief executive of Contact Energy, Roderick Deane, previously at Telecom, and Greig Gailey, of Fletcher Energy, have been highly regarded and Michael Beard, of Tranz Rail, is one of the current favourites.

Much is expected of Mr Beard but Tranz Rail's share price has a long way to go before it reaches the original issue price of $6.19 a share.

In private conversation, brokers have been highly critical of the senior management of Brierley Investments and Fletcher Challenge but little of this has appeared in print. This is unfortunate because poor managers become entrenched if they are protected from criticism.

The investment public is also deprived of a critical assessment of one of the most important influences on a company's performance.

The recent announcement of the new board of directors of Fletcher Challenge Forests, Fletcher Challenge Building and Rubicon is a case in point. The appointment of all the former Fletcher Challenge directors to one of the new boards was greeted with dismay in the investment community.

It confirms that Fletcher Challenge is totally out of touch with shareholder sentiment but no criticism of these appointments has appeared in a publicly released report.

The three Fletcher Challenge companies could generate a great deal of investment banking income in future years. But one of the biggest problems facing investors is the reduced coverage of companies.

At one stage brokers covered a wide range of companies but reduced commissions and a heavy emphasis on overseas investors have reduced coverage to the more heavily traded stocks.

The electricity sector is a good example of this. Most stockbroking firms produce voluminous reports on Contact Energy. This is because it is the largest company in the sector, has high sharemarket liquidity and many overseas shareholders.

There is also the prospect of corporate advisory work if Edison International sells its 41 per cent stake or makes a full takeover offer.

By comparison, Horizon Energy, TransAlta (before its acquisition by Natural Gas), TrustPower and UnitedNetworks are sparsely covered. Yet all but Trans Power have substantially outperformed Contact Energy since its 1999 listing.

The Whakatane-based Horizon Energy has performed particularly well but few brokers have recommended the stock because it is too small for their analysts to cover.

Investors should not rely on brokers for sell recommendations and are best advised to do their own small-company research.

* * *

MONTANA - The debacle over the company, particularly the granting of a waiver by the Stock Exchange to Lion Nathan, is a huge black mark for the New Zealand sharemarket.

One big broker wrote from Wall St: "New Zealand will again rely on professionals who have no recollection of the past and no concept or belief in corporate governance to keep its listed sector alive.

"This is a vivid reminder to Lion Nathan shareholders, who thought they had a bid from Kirin at $5.40 per share only to find Doug [Myers] and his friends escape at never-to-be-repeated prices.

"Kiwi passports are being ceremonially burned on the New York desk in disgust, as our clients get taken to the cleaners once again in New Zealand."

What more can one add?

* * *

Paul Anthony is having his sharetrading activity scrutinised by the Securities Commission.

On August 28, he bought 20,000 Contact Energy shares at $2.51. Because it was less than two months before Contact's 30 September balance date, the trade took place outside the commission's safe-harbour period for buying and selling shares by directors.

Also on August 28, Edison Mission Energy, Contact's 40 per cent shareholder, started buying 4.4 million shares.

When Edison's purchases ended on October 18, Contact's price had risen to $2.78.

Chairman Phil Pryke said Contact had not adopted the commission's safe-harbour rules and Anthony's purchase did not breach the company's share trading regulations.

The commission will look at the timing of his purchase in relation to the profit announcement and whether he had any knowledge of the Edison purchase when he bought his shares.