Patience Pays Off
U.K. Bank Shuffle
Financial Engines CEO Diamond gets Barclays Maggioncalda finally crown, while Gulliver takes his company public restores order at HSBC
Power Broker
RBS banker Simon Wilde helps Hong Kong’s richest man get richer
OCTOBER 2010 WWW.INSTITUTIONALINVESTOR.COM
INSIDE The 2010 AllAmerica Research Team Page 35 Facebook for Finance Page 54
THE ANALYST IS SUE
The Mystery of Microsoft Page 58 Death of the IPO Page 62 Brazil’s Goldman Page 66
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FEATURES
CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE THE A N A LYS T ISSUE
OCTOBER 2010
58
54
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62
54 Facebook
INVESTMENT RESEARCH
35
35
THE 2010 ALL-AMERICA RESEARCH TEAM
for Finance BY LEN COSTA
Blogs, online networks and other social media web sites are creating new opportunities for investment research. 57 TWEETING FOR TRADERS Twitter is a popular tool for the Chicago exchanges.
Research & Rescue BY LESLIE KRAMER
66 Brazil’s Goldman BRAZIL
58 The Mystery
CORPORATE FINANCE
of Microsoft BY STEPHEN DAVIS
Why does Wall Street continue to treat Microsoft like yesterday’s news? Don’t blame the analysts who track the company — they’re getting a little tired of recommending it.
BY JASON MITCHELL
Former bond trader André Esteves wants to build BTG Pactual into the preeminent investment bank in the emerging markets. Here’s why the Brazilian banker may well succeed.
62 Death of the IPO
In a year when macro concerns overshadowed stock picking, these analysts came to the aid of investors at sea in the market turbulence.
CAPITAL MARKETS
BY JULIE SEGAL
How Eliot Spitzer’s 2003 Wall Street research settlement killed capitalraising in the U.S.
VOLUME XLIV, NO. 8 • AMERICAS EDITION
BLOGS
Web institutionalinvestor.com
Check out our breaking news on who is up and who is down and out in the world of asset management.
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RESEARCH
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WISDOM THE FUTURIST THE CHARTIST
CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOP
7
ETC
OPENING
Ticker Barclays and HSBC tap CEOs • Settling trades in renminbi — through New York • Hedge fund managers are shorting Obama •Lithium gets charged up • Five Questions For Burton Malkiel People Faces in Finance • This Month in Finance
18
20 DONE DEALS
26 ALTERNATIVES
BY IMOGEN ROSE-SMITH AND XIANG JI
BY IMOGEN ROSE-SMITH
Rich at Sea
The bankruptcy of a luxury resort divides opinion about its prospects.
BY XIANG JI
BY KATIE GILBERT
24 THE BUY SIDE CAPITAL
18
RAINMAKERS
Long Circuit
BY ALLEN T. CHENG
Simon Wilde connected Hong Kong’s richest man with the lights of London.
Investors are taking a look at funds of hedge funds that boast a quant bent.
28 GREEN SHOOTS
Private equity firms are turning to dividend recaps.
Change Agent A Down Under fund has charted a backdoor route to green improvements.
Crossing the Line
30 CEO INTERVIEW
Inflation or deflation? Investors hedge their bets.
BY MICHAEL PELTZ
BY LAURIE KAPLAN SINGH
25 THE BUY SIDE
The New Normal BY DAVID ADLER
Asset allocation after the crisis: Is this time different?
The 2010 All-America Research Team
In a year when macro concerns overshadowed stock picking, investors say these analysts offered a world of good advice.
Bring on the Geeks
22 MARKETS
Debt Done Gently
71
5 Inside II 104 Inefficient Markets 105 Unconventional Wisdom 106 The Futurist 108 The Chartist
Third Time Is the Charm
It took ten years for Jeffrey Maggioncalda to take Financial Engines public.
To see the latest on these stories or provide feedback, visit institutionalinvestor.com
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DIAMOND: ANDREW HARRER/BLOOMBERG NEWS
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www.institutionalinvestor.com EDITOR-IN-CHIEF William H. Inman AMERICAS EDITOR Michael Peltz INTERNATIONAL EDITOR Tom Buerkle ART DIRECTOR Nathan Sinclair MANAGING EDITORS
Thomas W. Johnson (Editorial) Tracy Tjaden (International, Online) LONDON BUREAU Loch Adamson (Chief) ASIA BUREAU Allen T. Cheng (Chief) WEB EDITOR James Johnson
WEB PRODUCTION/DESIGN Michelle Tom SENIOR WRITER Frances Denmark STAFF WRITERS Imogen
Neil Sen (London) REPORTER Xiang Ji
Rose-Smith, Julie Segal,
SENIOR CONTRIBUTING EDITOR Firth Calhoun SENIOR CONTRIBUTING WRITERS Pam Baker,
Hugo Cox, Claudia Deutsch, Katie Gilbert, Fran Hawthorne, Jonathan Kandell, Leslie Kramer, Scott Martin, Ben Mattlin, Craig Mellow, Virginia Munger Kahn, Rosalyn Retkwa, Cherry Reynard, Nick Rockel, David Rothnie, Harvey D. Shapiro, Henry Scott Stokes, Paul Sweeney, Stephen Taub SENIOR EDITORS Tucker Ewing, Jane B. Kenney (Editorial Research) ASSOCIATE EDITORS Denise Hoguet,
Fritz Owens (Editorial Research)
COPY EDITORS Monica Boyer, Ruth Hamel,
Catheryn Keegan, Patrick Sheehan
DEPUTY ART DIRECTOR Diana Panfil ART DEPARTMENT Alex Agius, Israt Jahan,
Bethany Mezick, John Miliczenko
EUROMONEY INSTITUTIONAL INVESTOR PLC CHAIRMAN Padraic Fallon DIRECTORS Sir Patrick Sergeant, The Viscount
Rothermere, Richard Ensor (managing director), Neil Osborn, Dan Cohen, John Botts, Colin Jones, Simon Brady, Diane Alfano, Christopher Fordham, Jaime Gonzalez, Jane Wilkinson, Martin Morgan, David Pritchard, Bashar Al-Rehany INSTITUTIONAL INVESTOR, 225 Park Avenue South, New York, NY 10003; (212) 224-3300; Fax: (212) 224-3171. www.institutionalinvestor.com London Bureau: Nestor House, Playhouse Yard, London EC4V 5EX, U.K.; (44-207) 303-1703; Fax: (44-207) 303-1710 Hong Kong Bureau: 27/F, 248 Queen’s Road East, Wan Chai, Hong Kong; 852-2912-8030; Fax: 852-2842-7011 © 2010 Institutional Investor, Inc. (ISSN 0020-3580) No statement in this magazine is to be construed as a recommendation to buy or sell securities. Neither this publication nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system, without the prior written permission of Institutional Investor magazine. For reprints and Web links, contact: Dewey Palmieri (212) 224-3675; Fax: (212) 224-3563; e-mail: [email protected]. Printed by Cadmus Specialty Publications, Richmond, VA U.S.A. For customer service inquiries please call (800) 945-2034; Overseas: (212) 224-3745; Fax: (615) 377-0525. FOUNDER Gilbert E. Kaplan INSTITUTIONALINVESTOR.COM
Street Smarts WILL ROGERS, UNSCHOOLED
and uncouth, was no sell-side analyst. But he had a certain financial wisdom, born of having lost his shirt more than once.“Don’t gamble,”he admonished readers of his newspaper column. “Take all your savings and buy some good stock, and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” The Oklahoma humorist’s observations, published just weeks after the market crash of 1929, were meant to satirize speculators who had insisted that investing was easy and risk-free, provided you bought the right stocks (that is, the ones they were selling). Nearly four decades would elapse before brokerage firms began to publish research — based on fundamentals, not speculation — to guide investors to the right stocks and steer them from the wrong ones. Each year for the past 39 years we have asked money managers to tell us which U.S. sell-side analysts have been their best guides to Wall Street, and the names cited most often are inducted into our annual All-America Research Team. Over the past 12 months, the
stock market has soared, plummeted, surged and then dropped in a nauseatingly wild ride that has frayed many an investor’s nerves. Perhaps it’s no surprise that voter participation in this year’s survey jumped 20 percent over last year, as more buy-siders sought to show their appreciation for the analysts who’d piloted them safely through the turbulence. Producing this ranking is unquestionably a team effort. Senior Editor Tucker Ewing manages the mammoth project, with invaluable assistance from Associate Editor Denise Hoguet and Data Quality Manager Tina — Will Rogers McKenna in confirming the data on scores of firms, hundreds of analysts and thousands of voters. With their hard work and dedication, they make an extraordinarily difficult task look easy — not unlike the analysts on the 2010 All-America Research Team (page 35).
“If it don’t go up, don’t buy it.”
— WILLIAM H. INMAN EDITOR-IN-CHIEF [email protected]
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OPENING
October 2010 News and views from the world of finance
Stuart Gulliver (left) and Robert Diamond Jr.
GULLIVER: KEREM UZEL/BLOOMBERG; DIAMOND: DANIEL ACKER/BLOOMBERG NEWS
U.K. BANK CEOS
Buckingham Palace. Well, the U.K.’s two leading banks have changed their stripes. Last month Barclays announced a seamless succession plan, while HSBC, caught off balance by the departure of chairman Stephen Green for a government post, didn’t seem to know who was running the shop for a few days. That both banks made their investment banking chiefs
CHANGE AT THE TOP BARCLAYS AND HSBC PUT INVESTMENT BANKERS IN CHARGE In the 1990s, Barclays almost needed a revolving door on its C-suite, so frequently was it replacing its CEO, whereas crosstown rival HSBC Holdings has customarily rotated its top management with the predictability of the changing of the guard at INSTITUTIONALINVESTOR.COM
CEO speaks volumes about the importance of the business to their bottom lines, even as a government-appointed Banking Commission looks into possibly separating investment and commercial banking as part of the U.K.’s response to the crisis. The news that Barclays’ president and investment banking boss, Robert Diamond Jr., 59, would succeed John Varley, who is retiring at 55 after seven years as CEO, underscored the dramatic transformation in the
bank’s fortunes over the past decade. While Varley revived Barclays’ U.K. retail and commercial banking franchise and expanded overseas, notably through the 2005 purchase of South Africa’s Absa Group, Diamond turned the bank’s Barclays Capital subsidiary from a second-tier fixed-income shop into a global bulge-bracket investment bank, capped by his bold acquisition of Lehman Brothers Holdings’ U.S. business after it went bankrupt two years
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“
We believe passionately that Barclays and the universal banking model are a strong positive for the U.K. —Bob Diamond Barclays
”
combination of so-called casino banking with a deposit-taking institution. With the Banking Commission considering that very issue, such views can’t be lightly dismissed. Yet in elevating Diamond, who will take over in March, Barclays is making a confident statement about its new profile. “We believe passionately that Barclays and the universal banking model are a strong positive for the U.K.,” Diamond tells Institutional Investor. The bank remained profitable throughout the financial crisis and didn’t need a government bailout, unlike U.K. rivals Royal Bank of Scotland Group and Lloyds TSB Group, he notes.
FOREIGN EXCHANGE
SETTLINGTRADES IN RENMINBI — THROUGH NEW YORK During the financial crisis several of China’s biggest banks unobtrusively opened swanky offices in Manhattan. Today their timing looks especially prescient. They’re ideally positioned to establish an important frontier for Beijing in its bid to internationalize the renminbi, on its terms. China’s second-largest bank, China Construction Bank Corp., has conducted more than $200 million worth of renminbi trade-financing and settlement transactions in New York (technically, the settlements take place in China) since
Diamond intends to continue expanding Barclays’ global footprint. The bank is well-positioned to benefit from growth in Africa through Absa, as well as from the weakness of many banking rivals in Europe. “The environment will be opportunity-rich,” he says. Not as rich for Diamond himself, though. The banker, who took home £34.7 million ($54.5 million) last year — much of it from the sale of Barclays Global Investors, in which he held shares — will receive a £1.35 million salary in his new role, with potential bonuses worth a further £3.4 million. In contrast to the smooth handoff at Barclays, HSBC stumbled after Green announced that he was leaving to become U.K. Trade and Investment minister. An uncharacteristic struggle
for the chairmanship broke out between nonexecutive director John Thornton and CFO Douglas Flint after it became clear the board would not allow CEO Michael Geoghegan to step into the job as his predecessors have done. HSBC initially denied that Geoghegan was threatening to quit, but soon afterward announced he would be retiring early, in January, and would be succeeded by investment banking chief Stuart Gulliver.“I came to a very quick decision that it was time to hand over to the next generation,” Geoghegan said. Gulliver, like Flint a longtime HSBC executive, received a £9 million bonus last year. He, too, will take a pay cut in his new position, to £1.25 million plus a bonus of up to £5 million. A well-traveled extrovert who has spent much of his career in Asia,
he will provide a complement to new chairman Flint’s U.K. experience and technocratic manner. Gulliver’s investment banking unit delivered half of the bank’s $11.1 billion in pretax profits in the first half of this year, but the business is geared toward emerging markets and isn’t as extensive as Barclays’. The 51-year-old banker was promoted to oversee all of HSBC’s banking operations in Europe and the Middle East earlier this year, grooming him for a wider role. Like Geoghegan, he will be based in Hong Kong. In promoting Flint, who will stay in London, HSBC emphasized his expertise in regulatory policy, something that will be important as the Banking Commission prepares to issue its report next year. — Tom Buerkle and Neil Sen INSTITUTIONALINVESTOR.COM
NELSON CHING/BLOOMBERG NEWS
ago. Barclays, which generated nearly 90 percent of its profits from the U.K. in the mid-’90s, today makes roughly two-thirds of its profits overseas. Barcap generated 48 percent of group revenues and 86 percent of pretax profits in the first half. The promotion of Diamond — an investment banker, and an American to boot — rankles some in the U.K. The government’s Business secretary, Vincent Cable, said the move underscored concerns about the
June, reports John Weinshank, head of trade finance and corporate banking for CCB in New York. “This business will grow in importance over time, and this is just the beginning,” he says. Weinshank sees the potential to increase CCB’s New York–based renminbi trade financing and settlement business to $1 billion a year in two years. Since June, when China’s central bank expanded its pilot renminbisettlement program worldwide, the U.S. has become a key venue. Chinese exporters are eager to settle in renminbi to guard against foreign exchange risk and to benefit from potential gains against the dollar. “It’s going to grow and be a significant business over time, and the renminbi will be an important currency for trade settlement,” predicts Daniel Scanlan, head of transaction banking for the Americas at Standard Chartered, one of several global banks vying with Chinese banks. HSBC estimates that $2 trillion in annual trade flows — or up to half of China’s total — might be settled in renminbi in three to five years. “China is now the second-largest economy in the world,” notes Wu Bin, general manager of Industrial and Commercial Bank of China’s New York branch. “So why would you bet against the renminbi?” — XIANG JI
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devoted Republiin the business community, this Point’s Dan Loeb. In his secondcans, like Caxton’s manager asserts. At the time, quarter letter to clients, Loeb Bruce Kovner and he called Obama’s pursuit of asserted that the Securities and Elliott Associates’ universal health care an “ego Exchange Commission suit against Goldman Sachs over Paul Singer, won’t exercise.” And though this mortgage-related activities was waver in their loymanager endorsed some of the a tipping point. Already shaky alty to the other side president’s financial reforms, investor confidence, he argued, of the aisle, either. he says that “the time wasted all but collapsed in the face of But what is and the uncertainty this caused worrisome new laws and regulainteresting is the businesses is unforgivable.” tions that many saw as intended degree of disillusionObama’s foreign policy more to redistribute wealth than ment with Obama also upset several hedge fund to promote growth, and to be among hedge fund managers who’d donated to Loeb: Not holding contrary to free-market ideals. managers who his campaign. They brand the his breath “Washington has taken regard themselves as push to rid the world of nuclear political free agents. weapons, talk to sworn enemies actions over the past months, POLITICS HEDGE FUNDS like the Goldman suit, that seem Not only have many such as Iran, and withdraw SHORT OBAMA from Afghanistan “naive.” designed to fracture the populace lost confidence in FORMER BOOSTERS One manager was stunned by pulling capital and power Obama, they’ve FEEL BETRAYED when last June Obama canceled from the hands of some and lost faith in the president George W. Bush’s putting it in the hands of others,” Democratic Party. plan to install a missile-defense wrote Loeb. In the same letter, For example, When he ran for president system in Poland and the Czech however, he also criticized “inept SAC Capital Advisors’ Steve in 2008, Barack Obama executives in regulated financial Cohen, who supported Obama Republic chiefly to safeguard enjoyed especially enthuinstitutions who bury their sharein 2008, recently hosted a fund- against attack from Iran. “This siastic support from liberals, raiser for Republicans. Sources was a shocking turn,” the hedge holders and then walk away with college kids and, surprisingly, say Cohen is alarmed about the fund manager said at the time. ill-gotten sacks of loot.” many hedge fund managers. nation’s swelling deficits. Loeb’s peroration would He was also upset by Obama’s But as the country gears up for Another very well-known have done Glenn Beck proud. “blowing off” Israeli prime one of the most crucial — and hedge fund manager became “Perhaps our leaders will minister Benjamin Netanyahu cantankerous — midterm elecdisenchanted when the awaken to the fact that free maron a White House visit. tions ever, several of the smartpresident tackled health care ket capitalism is the best system Perhaps the most outspoken money set who say they’re not head-on. The long and conten— and public — critic of Obama to allocate resources and create beholden to any party have tious debate over Obamacare innovation, growth and jobs,” among heretofore sympathetic pledged allegiance to the GOP. created too much uncertainty he told his clients.“Perhaps hedge fund managers is Third One household-name hedge fund manager who considers himself a “middle-of-the-road COMMODITIES guy” insists that “people who A JUMP-START FOR LITHIUM voted for Obama are disilLithium, the critical ingredient in the long-lasting batteries used to power hybrid cars, has lusioned.” As Kenneth Gross, been sparking interest among institutional investors. Launched on July 23, Global X a Skadden Arps partner who Management’s lithium exchange-traded fund attracted nearly $25 million in six weeks leads that firm’s political law — the fastest growth of any of New York–based Global X’s 14 commodity and country ETFs. practice, points out, “Hedge “What was surprising and very different about lithium,” says Bruno del Ama, Global X CEO, “was that we received a huge amount of inquiries [even before the launch], mostly funds tend to be more ideologifrom hedge funds.” cal, but even ideological money Lithium, of course, isn’t only for propelling energy-efficient vehicles. Lithium salts are the has moved away from the active ingredient of a mood-stabilizing drug. And because it is the lightest metal and has Obama Administration.” great energy-storage properties, lithium is a key element of batteries for laptops and cell To be sure, staunch phones. The bright prospects of hybrid vehicles are fueling heightened interest in the metal. Global X’s lithium ETF is not a pure play on the commodity. Half of its 20 constituents are minDemocratic supporters like ing and refining companies, such as FMC Corp., while the other half are such lithiumGeorge Soros and Avenue battery makers as Advanced Battery Technologies. As with many ETFs categorized as Capital Group co-founder green, “you have to be careful,” warns Deborah Fuhr, global head of ETF research for BlackMarc Lasry will probably Rock. “People think they’re buying a [pure] commodity exposure.” — FRANCES DENMARK remain Obama supporters. And INSTITUTIONALINVESTOR.COM
PAPER: RICHARD MEGNA; LOEB: DANIEL ACKER/BLOOMBERG NEWS
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KER OPENING FIVE QUESTIONS PEOPLE THIS MONTH IN FINANCE RAINMAKERS DONE DEALS MA Hedge Fund Politics
“
Just don’t spring [a tax hike] on me. I need time to make a plan. I’m not moving to the Caymans. —David Tepper Appaloosa Management
”
“doesn’t care” if he has to pay the president’s proposed tax hikes on “higher earners” if that would help the overall economy. Likewise, Appaloosa Management’s David Tepper recently said on CNBC that he would support Democratic proposals to tax carried interest (a share of profits in a partnership, such as a hedge fund) as ordinary income rather than capital gains — which could considerably increase Tepper’s tax bill — as long as he was given ample warning. “Just don’t spring it on me,” he said. “I need time to make a plan. I’m not moving to the Caymans.” — Stephen Taub
typical U.S. family went from 30 to 40 cents for every dollar of income to $1.30 to $1.40. In addition, our financial institutions got way overleveraged, and so did our government. America’s debtto-GDP ratio is projected to get to 80 to 90 percent. By contrast, FIVE QUESTIONS FOR BURTON MALKIEL China’s ratio is RANDOM WALKING just 19 percent. IN CHINA So with respect to balance sheets — and this is in With the publication of some sense a balance-sheet A Random Walk Down recession — China looks very Wall Street in 1973, Burton much better. Malkiel set off a debate on How would you passive versus active investing rank China among that still rages. More recently, emerging markets? the famous espouser of indexI’m very positive on emerging ing — a professor of econommarkets in general. But having ics at Princeton University said that, there’s no doubt in my — provocatively argued in mind that China is the best of his latest book, From Wall them. It has grown a lot faster Street to the Great Wall, that and is likely to continue to do so investors should devote a far larger proportion of their port- for at least the next decade. folios to China. Malkiel, who What about India? himself invests in China as a I wouldn’t want to live co-founder and CIO of Alphain any country that wasn’t Shares, discusses the case for a democracy like India. But China with Senior Contributthere’s a real advantage that ing Editor Firth Calhoun. China has over India. If China Did the financial crash wants to build a power plant, it make China more, or less, goes ahead and builds a power attractive to investors? plant. In India you try to build More attractive. First, China a power plant and somebody has had a much better ecosays,“Not in my backyard.”As a result, India has a power grid nomic performance. Exports that doesn’t work. fell off a cliff in China, as they did in all exporting countries, What about risks? but China was the first to The world has been recover. Second, the genesis caught up in a huge economic of this crisis was too much imbalance. Essentially, the debt. Consumer debt for the
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global economy was growing nicely because the U.S. was the consumer for the world — taking on more and more debt — and China and maybe India and Brazil were the producers. Well, that ain’t gonna work anymore. The U.S. consumer is tapped out. China has much too little consumption and much too much investment in terms of GDP. Chinese premier Wen Jiabao himself called this “unbalanced and unsustainable.” So China has got to consume more, and they will. The government has plans — and they usually carry out plans — to encourage more spending and less saving, including building a social safety net.
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Should pension funds and endowments invest more of their portfolios in China?
Institutional investors are underweighted in China. But determining the proper weight gets complicated. I’m an indexer, of course. So somebody might say,“Okay, why don’t you buy a world index?” Here’s the difficulty with that. Indexes are float-weighted. The peculiarities of China mean that a significant portion of the market value of Chinese equities is not in the float. If you do a float-weighted world index, China ends up at about 2 percent. But China is 7 percent of the world’s GDP at official exchange rates. So investors should have at least 7 percent of their portfolios invested in China. You’ve got the most rapidly growing country in the world, with lots of labor resources, and Chinese equities are extremely attractive on a price-toearnings-growth-ratio basis. So why would you ever want to be underweighted in China? INSTITUTIONALINVESTOR.COM
W.W. NORTON & COMPANY VIA BLOOMBERG NEWS
they will see the folly of generating greater deficits by ‘investing’ in programs that lead to corruption and distortions of the system. Perhaps too, a cloven-hoofed, bristly haired mammal will become airborne and the rosettelike marking of a certain breed of ferocious feline will become altered. In other words, we are not holding our breath.” Yet at least one well-known hedge fund manager who expresses deep disappointment in Obama says that he may not vote Republican in November. “I vote for the person who is better for the country at the time,” he says. By the same token, he insists that he
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OLIVER STONE ON WALL STREET; NEW MEXICO’S PENSION FLAP Investing in Africa may no longer be just for die-hard dogooders, but it probably still doesn’t hurt for most investors in the troubled continent to combine their capitalist instincts with charitable impulses. That very much appears to be the case for Bob Geldof, the wildhaired onetime lead singer of the Boomtown Rats , a passionate Africa activist. It was “Sir Bob” who in 1985 organized the Live Aid concert for famine relief in Ethiopia. But now he is reportedly trying to put together what might be called “Live Invest”: Geldof, 59, is seeking to raise as much as $1 billion from institutions to invest in Africa. Is he serious? Well, he is said to have approached well-connected fund-of-hedge-funds manager Arki Busson, who has a philanthropic bent, for help. — Imogen Rose-Smith
LONGS AND SHORTS OF GREG LIPPMANN
In late 2005 Greg Lippmann, then Deutsche Bank’s New York–based global head of asset-backed-securities trading, began looking for a standardized way to short mortgage-backed securities, which happened to be thriving at the time. Teaming up with bankers from other firms, Lippmann fashioned a suitable credit default swap. The idea was simply to provide another useful product, but Lippmann soon became alarmed by excesses in the MBS market. So in addition to pitching the short
to clients as a hedge, he took a proprietary position, starting at $1 billion, on behalf of Deutsche. It proceeded to lose money for the next 15 months. But then came 2007 and the start of the subprime meltdown. In a single day Lippmann’s Deutsche trade made a profit of more than $100 million, reports Michael Lewis in The Big Short. This spring Lippmann, 41, left Deutsche to co-found a hedge fund firm, LibreMax, with three of his old colleagues. They plan to trade mortgages and other ABS — betting that Lippmann can make money on the way up as well as on the way down. — I.R.-S.
‘MONEY’ NEVER SCHLEPS
It’s a wonder that so many large egos could fit into one room. But
there they were, crammed into Cipriani 42nd Street (housed in a converted bank) for an elegant after-party following the September 20 New York premiere of Oliver Stone’s Wall Street: Money Never Sleeps. What made this soiree so unusual was not the Hollywood celebrities, but the Wall Street heavyweights. There was Warren Buffett, swarmed by groupies; short-seller Jim Chanos, accompanied by a Lady Gaga look-alike; hedge fund impresario Anthony Scaramucci, schmoozing with folks from CNBC; and activist manager and art collector Dan Loeb (see page 8) soaking it all in from an aesthetic perspective. But then why shouldn’t they have been partying it up? All had cameo roles in the movie,
a sequel to Stone’s 1987 classic Wall Street. And most were consulted on what turned out to be a movie with a not exactly pro-capitalist message. Some Wall Streeters offered more than counsel. In the movie, Jake (played by Shia LaBeouf), the prospective son-in-law of a reprised and quasirehabilitated Gordon Gekko (Michael Douglas), works on a trading floor with dramatic views of surrounding Manhattan skyscrapers. In reality, the 25,000-square-foot space, though an authentic trading floor — one belonging to Knight Capital Group — is in Jersey City, New Jersey. Knight’s CEO, Tom Joyce, says a location scout for Fox approached him in late 2008 after shots of the trading floor INSTITUTIONALINVESTOR.COM
GELDOF: JASON ALDEN/BLOOMBERG NEWS; LIPPMANN: DEUTSCHE BANK VIA BLOOMBERG NEWS; STONE: COURTESY 20TH CENTURY FOX
BOB GELDOF’S AFRICA FUND?
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SIDE ALTERNATIVES GREEN SHOOTS CEO INTERVIEW COVER STORY INVESTMENT RESEARCH COR Counterclockwise from top left: Bob Geldof, Africa investor; Greg Lippmann, mortgagebacker; Oliver Stone, Wall Street commentator; Charles Ferguson, filmmaker; Brian Hyndman, marketmaker; Diane Denish, candidate.
the new exchange will bring greater transparency and liquidity to public markets by attracting orders that would otherwise have gone to “dark pools” — alternative off-exchange venues where buyers and sellers can trade anonymously. — Xiang Ji
FERGUSON: MARIUSZ CICHON/REPRESENTATIONAL PICTURES/COURTESY SONY PICTURES
LAND OF DISENCHANTMENT: NEW MEXICO’S PENSION FLAP
appeared in the Los Angeles Times. “The next thing I knew I was having lunch with Oliver Stone at the Capital Grill in Midtown,” he says. — I.R.-S.
INSIDE ‘INSIDE JOB’
It’s little wonder that filmmaker Charles Ferguson felt he had the street cred to chronicle the 2008 carnage on Wall Street — his 2007 documentary No End in Sight, was about the war in Iraq. Ferguson’s newly released Inside Job — the title tells all about his viewpoint — documents the financial crisis. The Wall Street executives responsible for the bomb that nearly destroyed the U.S. economy are as scarce in this film as the Republican Guard was in his earlier one. Instead, amid reams of charts and graphs, Ferguson features INSTITUTIONALINVESTOR.COM
mostly politicians and expoliticians, such as former New York governor Eliot Spitzer, interspersed with a few highpriced call girls who catered to Wall Streeters. But he swears that every senior investment banker on Wall Street talked to him behind the scenes. Ferguson, 55, who sold his software company to Microsoft in 1996, understood the mechanics of Wall Street before embarking on the project. And he got a crash course (as it were) from a good friend, economist Nouriel Roubini. Still, Ferguson was surprised by many of the goingson in the financial industry: “If somebody had told me that Goldman Sachs was selling securities that it was also designing to fail,” he says,“I would have said ‘No.’” — Julie Segal
NASDAQ: EVERYONE OUT OF THE POOLS
Brian Hyndman is a marketmaker in the most literal sense. As the senior vice president of Nasdaq OMX Group’s transaction-services division, the 41-year-old financial technology expert helped to establish Nasdaq OMX BX. Now he’s presiding over the launch this month of another new exchange — Nasdaq OMX PSX — that will be the first to place its emphasis not on the speed of trades but on their size. “Buy-side investors have been frustrated that they couldn’t always get to the front of the line” because of the size of their trades, explains Hyndman. “Now they can put up a larger order and get a larger portion of incoming liquidity.” He hopes
It was what political insiders call “bad optics” — an appearance, at the least, of impropriety. Bruce Malott, chairman of New Mexico’s Educational Retirement Board pension fund, borrowed $350,000 from the father of Mark Correra, a placement agent who had secured money management mandates for his clients with the $8.5 billion ERB fund. In September, Malott, who had been appointed by Democratic Governor Bill Richardson, quit the ERB while insisting that though he did borrow the money, he’d done nothing wrong. He says he wasn’t aware of Mark Correra’s role at the ERB until last year. Democratic lieutenant governor Diane Denish, who hopes to succeed Richardson, declared in a written statement: “Obviously, Mr. Malott knew this was a clear conflict that should have been disclosed. He should have disclosed it and resigned a long time ago.” Speaking of disclosure, Denish’s statement neglected to mention that Malott’s accounting firm was until July treasurer of her campaign. Investigators from the FBI and SEC are looking into payto-play at New Mexico’s public pension funds. — I. R.-S.
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• More than 30 public funds, including the San Francisco Employees’ RetireTHIS MONTH ment System, the IN FINANCE BUDGET New Hampshire SHORTFALLS; Retirement System SRI BOOST and the New Mexico Public Employees Retirement MONEY MANAGEMENT Association, have awarded • Budget shortfalls in Illinois and roughly $2.6 billion in smallKentucky have forced public cap mandates this year. That’s pension plans there to sell off an increase of $800 million assets to meet obligations. over all of last year. Although officials at the funds The goal is to further diversify downplayed the moves, they portfolios and tap existing conceded that if their underpotential for growth in global funded status and benefit liabili- equities, specifically in small ties continue into next year, they caps, says David Kehler, retiremight have to reconsider their ment administrator for the funds’ investment strategies and Tulare County (California) shift out of illiquid investments. Employees Retirement AssociaAlthough it’s difficult to detertion. Other industry officials mine how widespread the probsay turnover is another driver lem may be, observers note that behind the trend.“The financial with many states facing budget crisis has seen a number of active woes, it’s conceivable that many managers struggle given a nummore pension funds will begin ber of factors, including the junk selling assets to meet liabilities. [bond] rally,” says Paul Harte, Pension funds have routinely vice president at San Francisco’s sold assets as part of a normal Strategic Investment Solutions. investment cycle. But problems “I suspect some of these manarise when they must sell more agers have underperformed — and sooner — than planned. severely and are being replaced.” Five Illinois plans will do both, — Money Management Letter selling 10 percent of their total MUTUAL FUNDS assets in 2011. Next door, the • Alternatives firm Altegris Kentucky Employees RetireAdvisors is planning to enter ment System is selling $30 milthe regulated mutual fund lion of its holdings, slightly business — turning many of the below 1 percent of total assets. strategies it runs in the private “If your unfunded liability placement space into retail approaches 70 percent, you’re funds and ramping up marketheaded for a bad time,” says ing campaigns to get the word David Urbanek, public infor-
out. “The more there’s been a difficult period for stocks, the more people are striving for returns [and] it’s more likely that alternative return streams are being put into portfolios,” says executive vice president Richard Pfister. La Jolla, California–based Altegris plans to fill the demand for returns with the noncorrelated managedfutures mutual fund it launched in September, as well as others it has in the works. Many of the broker-dealers and investment advisers with which Altegris works have requested access to the firm’s strategies for their nonaccredited investors, Pfister says. “It’s a demand thing — they’ve not had a lot of choices that are of this quality,” he asserts. Up next: The firm is looking at launching
long-short equity and fixedincome funds, as well as an event-driven fund and possibly a diversified strategy. Theo Gallier, CIO of advisory firm Private Ocean, says his firm does not invest in hedge funds as a matter of policy. However, he adds, it is interested in alternative investments in mutual or exchange-traded fund formats. “We do believe strongly in the diversification effect of managed futures and other socalled alternatives in ETFs and mutual funds where there is
not a high correlation to stocks and bonds,” he says. “And we are always on the lookout for additional funds.” — Fund Action
INTERNATIONAL FINANCE
• MetallRente Pensionfonds, the multiemployer pension plan for the German metals industry, has decided to invest only in shares of companies that fit socially responsible investment criteria. A plan official says ethical, social and environmental aspects are now very important to all equity investments. The defined contribution scheme strategically allocates about 80 percent to equity and 20 percent to fixed income. It offers three different asset mixes to its members. For members under 55, most assets are allocated to equity. For members between 55 and 58, up to 50 percent of assets are invested in equity, while for members over 58 all assets are allocated to fixed income. MetallRente was created in 2001 by Gesamtmetall, the engineering industry employers’ association, and IG Metall, the metal industry trade union. It manages €1.7 billion ($2.2 billion) worth of assets. — Global Money Management Finance industry news briefs compiled by Institutional Investor’s Newsletters division. INSTITUTIONALINVESTOR.COM
ANDERS WENNGREN
mation officer for the Illinois Teachers’ Retirement System, which has a 52.1 percent funded ratio. — Money Management Letter
Cubist Pharmaceuticals, Inc.
Creating Shareholder Value by Addressing Unmet Needs Interview with David W.J. McGirr, Senior Vice President and CFO For those who may not be familiar with Cubist, how would you summarize the company’s position? Cubist’s goal is to become the leading global company focused on discovering, developing and commercializing therapies for acutely ill patients. Our ability to navigate the continually evolving acute care environment is producing results for our successful IV antibiotic CUBICIN® (daptomycin for injection), which is used to treat serious skin and bloodstream infections, and paving the way for success with new treatments. We have been profitable for more than four years — quite an achievement for an emerging mid-cap biopharmaceutical company. We pay close attention to operating income as we continue to support CUBICIN while making progress with our clinical pipeline. Today we are particularly excited about the opportunity represented by CXA-201, an asset with CUBICIN-like commercial potential, now in Phase 2 clinical trials. At a time when many pharmaceutical companies were reducing or eliminating their antibiotic discovery and development programs, Cubist developed CUBICIN and launched it in the US in 2003. Your revenue guidance for 2010 is $627-$652 million and you’ve stated that CUBICIN is on track to achieve at least $1 billion dollars in peak annual revenues. What accounts for this success? Number one, I’d cite the strength of our scientific team, whose critical, insightful research allowed us to move forward with CUBICIN. Next, I would include the determination of many parts of the Cubist organization as we worked with external infectious disease opinion leaders as well as regulators in designing and executing a first-of-its-kind study of CUBICIN as a treatment for very serious Staphylococcus aureus bloodstream infections. The success of this study provides CUBICIN with a well-differentiated position in the market. Finally, I’d point to Cubist’s acute-care commercial and medical affairs teams deployed across the United States, who provide the support needed to ensure that appropriate patients have access to CUBICIN. I should add that our projection of $I billion in peak sales for CUBICIN assumes a positive outcome in the Hatch Waxman-related patent litigation underway. Cubist is now taking a portion of its revenues from CUBICIN to advance additional programs in clinical trials. What guides you in these investment decisions? Our thinking is driven by our overarching goal of building long-term shareholder value. In the business model we are building, R&D would ideally represent about 25 percent of revenues—which is significantly higher than the R&D spending of other established biopharma companies. We will get there only by carefully managing our investment in other areas. Striking the right balance presents challenges, of course, and puts a healthy tension in the system.
You indicated that one of Cubist’s leading agents in development, CXA-201, has “CUBICIN-like potential,” meaning potential for peak annual sales of $1 billion. Can you describe the market opportunity that supports this projection? CXA-201 is being developed to treat serious infections caused by Gram-negative bacteria, including Pseudomonas aeruginosa, which is a particularly dangerous pathogen, notorious for its resistance to antibiotics. We see a peak annual sales opportunity for CXA-201 of $1 billion in the US and EU combined. Do you plan a continued focus on antibiotics for serious infections? This will always be a core interest, but not the only one. Our focus is on addressing unmet medical needs in acute care, which is where hospital patients are generally first diagnosed and treated. Our preclinical work includes collaborations investigating new therapies to treat acute pain as well as certain viral infections. With CUBICIN, Cubist created its own sales and marketing organization in the US and out-licensed the drug to other, larger pharmaceutical companies for markets outside the US. Would you do that again? Perhaps. Clearly, we would leverage the proven commercial organization we already have in place in the United States. As other clinical programs advance toward approval and launch, we will make the strategic and financial decision whether to outlicense or create our own ex-US commercial organization. Cubist has built a healthy cash position—more than $563 million in cash, cash equivalents and investments as of June 30—as well as $300 million of debt. Why is debt part of the capital structure, and what are your plans for use of cash? Cubist’s outstanding debt consists of $300 million of 2.25 percent convertible subordinated notes that mature in June of 2013. We believe that for a revenue-generating, cash-positive company, some debt is an appropriate element of the balance sheet. We will use our cash to grow the company through investment in R&D and by acquiring late-stage assets. Our cash position puts us in a strong position to act quickly when our diligence suggests that an external asset has both the scientific and unmet-need/commercial-opportunity merits that would make it a good fit for us. CONTACT INFORMATION
Eileen McIntyre Senior Director, Corporate Communications 781-860-8533 [email protected] www.cubist.com
Sponsored Statement • October 2010
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TICKER FIVE
RBS’s Wilde: “London needs good power”
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Electric have good experience operating power plants in Hong Kong and are well qualified.” The deal was monumental in more ways than one: It was Cheung Kong’s biggest overseas investment, and it was RBS’s biggest deal as a sole adviser. It was also a personal victory for Wilde, 40, a managing director and co-head of RBS’s energy and resources team for Europe, the Middle East and Africa. The Cambridge graduate with a master’s in economics and law first alerted Cheung Kong executives to EDF’s desire to sell its U.K. subsidiary in early 2009. He had worked on the sale of another EDF subsidiary in 2002 and was familiar with longterm power contracts, having worked at RBS when it participated in the sale of Gatwick Airport, which involved renegotiation of an electricity contract. As a result, Wilde was well positioned to help Li’s team value EDF’s long-term contracts, present an offer and restructure the company’s debt load once the deal was accepted in July. (EDF’s board approved the sale on September 7.) Wilde gained solid experience doing energy deals — as well as a strong reputation — when he advised Spanish energy producer Iberdrola on its 2007 purchase of U.S. power comSimon Wilde connected pany Energy East Corp. Hong Kong’s richest man Before joining RBS he spent with the lights of London. nine years with the M&A BY ALLEN T. CHENG team at ABN Amro Group. “Simon has extensive knowledge of the energy industry and has very good knowledge of how to address clients’ needs for any specific transaction,” says Pedro Azagra, Iberdrola’s head of corporate development.“He was always available when we needed him. That made a key difference in our successful bids.” Hong Kong’s Superman — Li’s nickname in Asian business circles — almost didn’t get the U.K. power company, says Wilde, who, along with his team of 25 bankers and lawyers from RBS’s London and Hong Kong offices, worked around the clock for days before submitting a final winning bid on July 26. “One of the key elements was a new business plan for this new company,” says Wilde. “We needed to come up with a plan that was best in class. We needed to explain many details, including capital expansion, the organizational structure of the business and how it will be run day to day.” ••
Long Circuit
HEIKO PRIGGE
LI KA-SHING, HONG KONG’S RICHEST MAN, WILL SOON BE
in charge of keeping the lights on at Buckingham Palace. The royal residence is a client of the electricity franchise surrounding London that Li, thanks to some deft deal makers on his side, acquired last month for a hefty £5.8 billion ($8.9 billion). A mergers and acquisitions advisory team from Royal Bank of Scotland Group, led by Simon Wilde, helped Li outmaneuver Australian rival bidder Macquarie Group and its partners, the Abu Dhabi Investment Authority and the Canada Pension Plan, to buy EDF Energy Networks’ power grids from Électricité de France (also known as EDF Group). EDF Networks distributes electricity to 8 million customers in Britain’s eastern and southern regions, including Buckingham Palace, the Channel Tunnel Rail Link and the University of Cambridge. The acquisition bolsters Li’s U.K. infrastructure portfolio. His Cheung Kong Infrastructure Holdings already controls the utility company Cambridge Water, while Hutchison Whampoa, another Li company, has assets including mobile phone provider 3 Group and some port facilities in Britain. The missing piece? Power. “London needs good power and lots of power, so if you need to invest in a high-profile, prestigious asset, this is a great project,” says Wilde, who heads the team that advised Li’s consortium, which consisted of Cheung Kong Infrastructure, Hongkong Electric Holdings and the Li Ka Shing Foundation. “If you make a mistake, it will be very high-profile, but Cheung Kong Infrastructure and Hongkong INSTITUTIONALINVESTOR.COM
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Rich at Sea
The bankruptcy of a luxury resort divides opinion about its prospects.
BY IMOGEN ROSE-SMITH AND XIANG JI
T
HE RICH, AS F. SCOTT FITZGERALD
might have said, are very different from you and me — they have better holiday destinations. Among the best of them is Sea Island. The luxury Georgia resort and spa boasts a spectacular seaside golf course, a private beach club, elegant rooms (with rates starting at $395 a night), gourmet dining (buttermilk-fried Maine lobster tails in a Jack Daniel’s honey glaze for just $52) — and a bankruptcy. On August 10 the resort’s owner, Sea Island Co., and its subsidiaries filed for Chapter 11 protection in U.S. bankruptcy court, weighed down by debt of more than $550 million. The good news for Sea Island and its vacationers is that a so-called stalking-horse agreement — an offer to buy the resort out of Chapter 11 — is already in place in the form of
a deal proffered by distressed-debt experts Avenue Capital Group and Oaktree Capital Management. The $18 billion-in-assets New York– based Avenue and Los Angeles–based Oaktree, with $76 billion, have said they would pay $197 million to purchase the resort, which includes two luxury hotels, three golf courses, the Cloister Spa and Fitness Center and the Sea Island Beach Club, according to court documents. The property is being shopped around by bankers from Goldman Sachs Group, who declined to comment. One hedge fund manager whose firm looked at the deal says he worries about the ability of Sea Island to make money, pointing out that, according to Goldman’s analysis, the hotel has not turned a profit in well over a decade. Sea Island was a family-owned company founded by industrialist Howard Coffin in 1911, when Coffin, a frequent vacationer on the southern coast of Georgia and part of the upper class that Fitzgerald chronicled so well, purchased 20,000 acres on Sapelo Island. In 1928, Coffin, who made his money in the automobile industry, opened the Cloister hotel. With just 46 rooms, it was known as a “friendly little hotel,” David Bansmer, Sea Island’s president and COO, testified in bankruptcy court. By 2007, Sea Island had opened a redeveloped Cloister and the beach club and spa, and begun work on the Frederica Golf Club and residential development. The company planned to sell condos to a new class of well-heeled vacationers, many of whom frequented Sea Island. That’s where the real money was to be made — not on the resort itself. To finance its continued development, Sea Island took out a $100 million term loan in 2007, on top of its existing $96 million term loan, and increased a $200 million revolving loan to $235 million. Interest rates on the loans were between 4.65 and 6.5 percent, according to court documents. Like many such developments at the time, Sea Island’s expansion was furnished through debt, which was easy to raise. But as Deborah Jackson, executive managing director of Weiser Realty Advisors, the real estate advisory arm of New York real estate accounting firm WeiserMazars, notes, many of the hotelto-condominium conversions or hotel-condominium developments from that era have struggled since 2008.With the market not expected to recover until at least 2011, the pain has continued.“Unless you have deep pockets, you are going to be in a difficult situation,”Jackson says. Both Oaktree president Bruce Karsh and Avenue chairman and CEO Marc Lasry have vacationed at Sea Island for years. In August, Lasry told Institutional Investor that he stands to get Sea Island at a great price, especially given the almost $600 million the resort cost to develop. “It is a unique asset with great potential,” he says. “The fact that we knew the property and people there better than anybody else afforded us unique insights.” According to a source close to both firms, Avenue and Oaktree view Sea Island as more than a real estate play; it is about taking advantage of a turnaround that may hit the luxury complex and high-end vacation destination market. Oaktree and Avenue aren’t the only interested parties. Sea Island had to file a copy of its complete financials with the court by September 23, and a court auction is set for October 11 — leaving just enough time for interested buyers to take a quick reconnaissance jaunt to Georgia. •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
SEA ISLAND COMPANY
Sea Island will soon have new owners
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EALS CAPITAL MARKETS THE BUY SIDE ALTERNATIVES GREEN SHOOTS CEO INTERVIEW COVER ST
Debt Done Gently Private equity firms are cautiously turning to dividend recaps to bolster liquidity. BY XIANG JI
M
ICHAEL PSAROS
loathes the idea of being a seller these days. The co-founder and managing partner of New York turnaround investor KPS Capital Partners says the traditional exit channels — that is, the selling of private equity deals — remain singularly unattractive. Even after a three-year slump, the sector shows few signs of a turnaround. A number of KPS’s portfolio companies, such as East Alton, Illinois–based Global Brass and Copper, are well positioned to fetch a handsome price once the economy comes back, he says. A few years back, KPS, which has $2.6 billion under management, created GBC from a carve-out of Olin Corp.’s metals division for $400 million in cash. Intent on getting a good price and gaining some liquidity, Psaros, now 43, turned to a maneuver known as dividend recapitalization. Dividend recaps occur when a company takes on new debt to pay out a special dividend to private investors or shareholders. The upside is the payout; the downside is the high leveraged debt, which increases the chance of bankruptcy. In August, GBC issued $465 million of new debt, of which $102 million was used to issue a cash dividend to shareholders — KPS is the majority shareholder and together with company management holds 100 percent of GBC — and the rest to refinance its outstanding debt. Earlier this year, GBC issued a $100 million dividend funded directly from GBC’s cash flow. With the two dividend distributions, KPS has returned its equity investment plus a tidy profit, says Psaros. “While we wait to sell our portfolio companies, dividend recap is a great way to provide incremental liquidity to our limited partners and our fund,” he adds. Psaros declined to provide specifics. Dividend recaps have become a viable means of adding liquidity as private equity firms face a prolonged dry spell. Blackstone Group, Madison Dearborn Partners and D.E. Shaw & Co. are among the
many firms that have obtained liquidity through such deals. In total, dividend recap volume rebounded to $10.5 billion during the first two quarters of 2010, compared with $900 million in 2009 and $2.7 billion in 2008. To be sure, dividend recaps kept many deals in motion, given that realized exits for private equity firms during the first two quarters of this year were just $48.6 billion, according to data tracker Dealogic. Compared with those done at the peak of the equity bubble, today’s dividend recaps are tamed lions. Aside from a number of deals leveraged at more than 5 times ebitda, or earnings before interest, taxes, depreciation and amortization — the most leveraged deal: Blackstone’s AlliedBarton Security Services’ $111.5 million recap done in August, leveraged at 6.1 times — the vast majority of the 50 or so deals this year are modestly leveraged at below 5 times ebitda. Moreover, most dividend recaps are financed by the bank loan market, with strict covenants, rather than the loosely structured pay-in-kind notes used three years ago.“Deals are done at a leverage ratio that makes more sense,” says Rod Miller, a partner at New York–based law firm Weil, Gotshal & Manges, who has worked on more than a dozen dividend recap deals in his 17-year career. “Since most of this recent batch of deals has been financed with first lien bank debt, private equity owners have to make calculated decisions to balance the risk and their liquidity needs.” In comparison, private equity firms were able to claw back their investments through dividend recaps much faster during the boom. Many of those companies ended up dangerously leveraged at 7 to 8 times ebitda after recap deals, and some didn’t survive. There’s no doubt dividend recaps increase the chances of restructuring, says Weil’s Miller. But KPS’s Psaros argues that appropriately leveraging companies — many of which — Michael Psaros, co-founder, KPS salvaged from bankruptcy KPS Capital Partners with zero or little debt — shields the companies from huge tax bills. Philip Canfield, principal at GTCR Golder Rauner in Chicago, an $8 billion-in-assets private equity firm, agrees. “When there has been significant value creation in a company,” he says, “dividend recaps can be ideal to leverage it up to an appropriate level.” GTCR, it should be noted, hasn’t done a dividend recap deal in the past three years. None of the firm’s portfolio companies are sufficiently “mature and seasoned,” says Canfield. Wise words. ••
“
Dividend recap is a great way to provide incremental liquidity.
”
Comment? Click on Banking & Capital Markets at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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KETS CAPITAL THE BUY SIDE ALTERNATIVES GREEN SHOOTS CEO INTERVIEW COVER STORY INVES
T
THERE’S A DEBATE IN ECONOMICS THESE
days as to whether inflation or deflation will drive the future of the U.S. economy. On one side, experts point to a confluence of trends — a weak economic recovery, high unemployment and overcapacity — driving down wages and prices. On the other, some economists maintain that inflation, as a result of the vast expansion of the money supply, is the bigger risk. For money managers, the challenge is to prepare portfolios for both scenarios. The U.S. Federal Reserve Bank has boosted excess reserves in the banking system from about $2 million before the financial crisis to $1.2 trillion at the February 2010 peak. Many economists believe that inflation will reignite as soon as the money sitting on bank and corporate balance sheets begins to circulate. “The investment-grade correal question is when we cross the divide,” says porate bonds. While economists debate inflation, Ronald Muhlenkamp, manager of the nearly “Corporations have investors seek quality and yield. $1 billion Muhlenkamp Fund. done a very good job BY LAURIE KAPLAN SINGH Not any time soon, says Anthony Crescenzi, of reducing expenses a market strategist and portfolio manager at while keeping top-line fixed-income giant Pacific Investment Managerevenues stable,” Palment Co. Crescenzi’s forecast for near-term frey notes. disinflation is keeping Pimco’s allocation to He is finding addiTreasury Inflation-Protected Securities relatively low. In their place, tional yield in structured products such as asset-backed and he’s emphasizing high-quality senior corporate bonds with high commercial-mortgage-backed bonds and foreign bonds. The fund’s underlying recovery rates.“These issuers generally have hard assets, largest foreign allocations are to the countries poised to do best in such as gas pipelines and metals manufacturing facilities, which can the eventual global recovery, including Canada, Mexico and New be sold in the event of default,” he explains. His firm also believes Zealand, which hold relatively strong fiscal positions and show it can enhance returns by moving money into foreign government promising growth. bonds, targeting Brazil, Egypt and some North African countries Muhlenkamp, for his part, is playing the markets cautiously. with strong economic growth. “Interest rates are as low as they can go,” he says. His concerns about Peter Palfrey, co-manager of Loomis, Sayles & Co.’s $364 million the risk of near-term deflation and longer-term inflation have caused Core Plus Bond Fund, takes a similar view. Loomis Sayles is forecast- him to build up cash reserves to 30 percent of assets. Remaining assets ing disinflation — a moderation or slowing of inflation — but not are invested in the stocks of companies expected to benefit from outright deflation. Palfrey believes the best strategy is to have excess enterprise spending. Consumers are overleveraged, but “corporate yield in the portfolios. His fund currently yields about 4.5 percent, balance sheets are in pretty good shape,” he says. compared with a 2.65 percent yield on the Barclays Capital U.S. In the face of economic headwinds, the focus should be on Aggregate Bond index, its benchmark. bottom-up securities selection, says Vanguard Group’s Joseph Davis. He’s been able to achieve the incremental yield by shifting assets The no-load mutual fund giant is forecasting a muted, U-shaped out of U.S. government securities, which he says have become recovery with high-quality earnings in both equity and fixed-income too expensive after all the government support during the crisis. portfolios.“In a tepid recovery,” says Davis,“the difference between He’s rechanneled the bulk of the proceeds into high-yield and the top and bottom performers is going to be wide.” •• INSTITUTIONALINVESTOR.COM
BRIAN CAIRNS
Crossing the Line
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ESTMENT RESEARCH CORPORATE FINANCE CAPITAL MARKETS BRAZIL THE 2010ALL-AMERICA RESE
The New Normal Asset allocation after the crisis: Is this time different? BY DAVID ADLER
T
HE GREAT RECESSION THAT
continues to rattle global stock markets has fundamentally changed the asset allocation rule book for institutional investors, and those who fail to adapt do so at their clients’ peril, say leading financial experts. “The dislocations of the financial crisis have a permanent component,” Carmen Reinhart, economics professor at the University of Maryland, tells Institutional Investor. “If you compare the decade after a crisis to the one that preceded it, you find lower GDP growth, higher unemployment and lower real housing prices. Leveraging unwinds.” Reinhart, best known for her book This Time Is Different, a history of financial crises written with Harvard University economics professor Kenneth Rogoff, has extended her analysis of a crisis to the ten years preceding it and the ten years that follow. The resulting report, “After the Fall,” written with Reinhart’s husband, Vincent Reinhart, resident scholar at the American Enterprise Institute for Public Policy Research in Washington, and unveiled at the Federal Reserve Bank of Kansas City’s economic conference in Jackson Hole, Wyoming, in late August, contends that financial crises have unusual aftereffects that last ten years. Shrinking household and bank balance sheets, as well as disruptions in credit markets, leave a permanent mark on growth and employment, Reinhart says; economic trajectories change after a financial crisis, and the aftermath doesn’t last a few years but closer to a decade. GDP growth drags significantly, unemployment continues, and median housing prices remain 15 to 20 percent lower during the 11 years after a crisis, Reinhart found. “I know it’s not uplifting, but at Jackson Hole the import of the message was taken home,” she says. “People were not saying we were off our rockers.” Edward Keon Jr. certainly wasn’t. “The impact of the crisis has changed the way we do things,” says the portfolio manager and INSTITUTIONALINVESTOR.COM
head of asset allocation at Prudential’s Quantitative Management Associates. The primary effect has been on investors’ appetite for risk. Keon’s model found there was a regime shift by investors resulting in lower risk tolerance and reducing equity valuation. “We have adjusted our tactical asset allocations as a result,” he says. Keon is neutral or underweight U.S. equities because of investors’ pronounced risk aversion and overweight emerging markets because of their favorable demographics compared with Western economies, which have hefty pension entitlements. Another way of incorporating this increased risk aversion is to allocate more capital to high-yield bonds. Says Keon,“Investors are favoring fixed income, and high yield has the potential for attractive returns compared to the riskier parts of the stock market.” But not all investors agree with Reinhart’s thesis that this time things are different. Jeff Applegate, CIO of Morgan Stanley Smith Barney, believes this is just another business cycle. “Our methods for reaching an overweighting of an asset class haven’t changed,” he says.“Though the downturn was unusually severe, the way markets have recovered has been quite normal, cyclically. It is comparable to prior business cycles.” In 2008, Applegate believed that the economy would start improving by April 2009, so he increased his allocations to small-caps, which tend to strongly reflect economic cycles. This proved to be the correct call. In June of this year, having captured the excess returns in the sector, he reduced his allocation to small-caps and added to emerging equities. “Fundamentally, we don’t have a — Carmen Reinhart different assessment today than in University of Maryland April 2009,” says Applegate. Striking a postcrisis middle ground is ING Asset Management’s Paul Zemsky, who agrees that this time around a few things have changed. “The size of our tactical moves is smaller because the tail risk is higher,” he notes, adding that the dispersion of potential economic outcomes means uncertainty is higher than ever. A double dip is possible but not likely, he says. “In general, we have been overweight equities with the belief that the fundamentals are still improving.” Not everyone is convinced the stock market will come back.“You had a bubble, and bubbles don’t come back,” says Stanley Kon, director of research for fixed-income manager Smith Breeden Associates, based in Durham, North Carolina. “We have experienced many structural changes in the economy, and because of these structural differences, asset allocation must change as well.” He argues for a greater focus on alpha versus beta risk budgeting. Reinhart, the most outspoken believer in the new normal, begs off making precise allocation recommendations. “There are sectors that can thrive in low growth,” she says, “and sectors that need a boom.” ••
“
The dislocations of the financial crisis have a permanent component.
”
Comment? Click on Asset Management at institutionalinvestor.com.
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SIDE CAPITAL ALTERNATIVES GREEN SHOOTS CEO INTERVIEW COVER STORY INVESTMENT RESEA
B
ACK IN THE 1990S AT THE
now $21 billion alternative-investment manager D.E. Shaw & Co., Benjamin Appen ran a $600 million fund of hedge funds for the firm. D.E. Shaw is famous for its highly quantitative investment style. Given that fund-of-funds managers tend to be viewed as good old-fashioned talent pickers at their best — and, at their worst, as glorified marketers whose returns are derived from access to key managers — a fund-of-funds business seemed like an odd fit for the firm. So it was hardly surprising when D.E. Shaw, which marketed Appen’s fund exclusively in Japan, shuttered the product in 2000. At the time, there was little interest in blending hedge fund Benjamin Appen investing and quant know-how. (left) and James A decade later the reputation of funds of hedge funds has deteHall teamed up to riorated. First came the market collapse of 2008, when, instead form Magnitude of providing protection through diversification, the average fund of funds performed worse than the invest in more-complex hedge overall hedge fund industry. Then came fund strategies. For its first five the dramatic discovery at the end of that Investors are taking a look at funds of years, Magnitude had less than year that Bernard L. Madoff Investment hedge funds that boast a quant bent. $700 million in assets, but by the Securities was a massive Ponzi scheme, BY IMOGEN ROSE-SMITH end of 2007 assets had reached whose key investors included several $2 billion. Like most hedge fund well-known fund-of-hedge-fund firms. As a result, the fund-of-hedge-funds managers, Magnitude had a rough year in 2008; its fund was industry shrank from $798.6 billion in down 21.6 percent. Magnitude assets under management at the end of 2007 to $571.3 billion two years later, according to Chicago-based ended 2008 with $2.9 billion, and assets had dropped below $1.7 billion by mid-2009 as a result of redemptions. But performance more Hedge Fund Research. But it’s far from over for funds of hedge funds. As the global econ- than bounced back, returning 25.7 percent in a year when the average omy continues to sputter, more institutional investors will tap hedge fund of hedge funds was up 11.47 percent. The fund’s total assets funds in the search for returns, and many of them will opt for the under management now top $2.2 billion. According to investors, the bundled approach. In 2002, not long after D.E. Shaw closed his fund, firm returned 1.2 percent in the first six months of this year, beating the Appen teamed up with James Hall to launch Magnitude Capital. As HFRI fund-of-funds composite index, which was down 0.55 percent. global head of UBS’s hedge fund business, Hall helped oversee a $2 bilAs investors come back to funds of hedge funds, many of them lion quantitative global macro hedge fund; he had begun his career as will look for evidence that their managers really are adding value, an options floor trader for O’Connor & Associates. and this should bode well for Magnitude. Daniel Celeghin, a partner Magnitude’s adherence to quant principles is evident in the tech- with consulting firm Casey, Quirk & Associates, says funds of hedge niques it uses to construct portfolios and in the way it evaluates hedge funds will thrive — if the industry changes its ways. “To justify asset management fees, as opposed to consulting or advisory fees, funds fund managers’ strategies and risk management. The firm’s evaluation of managers includes analyzing a fund’s of hedge funds need to be more than allocators, access providers or underlying risk and return trends and benchmarking performance risk measurers,” he says.“They need to generate returns. One way to against its peer group. The firm also places a huge emphasis on risk convince investors they can deliver those returns is by employing a management, modeling how funds will perform in times of stress.“As systematic process with clear inputs, decision accountability and a an options trader, you get used to thinking about risk in a complex way to measure the effectiveness of manager selection over time.” •• way,” says Hall. “You get used to thinking about portfolios and Comment? Click on Hedge Funds/Alternatives situations where there are hidden risks.” The quant backgrounds at institutionalinvestor.com. of the Magnitude partners are also reflected in their willingness to INSTITUTIONALINVESTOR.COM
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Change Agent A Down Under fund has charted a backdoor route to green improvements. BY KATIE GILBERT
A
S GOVERNMENTAL FOOT-
dragging on climate-change issues continues to delay the implementation of new measures, such as a federal cap-and-trade system in the U.S., it has helped spur another novel idea — using investors’ clout to impose on companies the climate-related regulations that governments have yet to introduce. In mid-July, Australian Ethical Investment, the A$640 million ($609 million) investment firm that introduced socially responsible investing to Australia more than 20 years ago, launched the Climate Advocacy Fund. Heralded as the first of its kind in the world, the new fund promises to turn the traditional approach to SRI on its head. Rather than simply refusing to invest in companies it considers harmful to health or the environment, the fund will work with these companies through a formalized process to effect the changes it wants to see. By tracking the S&P/ASX 200 index, the Climate Advocacy
Fund pulls into its portfolio many of the companies that Australian Ethical has never touched before. Once the new fund invests in companies with which it finds fault, it will use its shareholder muscle to present formal resolutions at their general annual meetings. For the first few years, the fund will focus primarily on climate-change issues and largely on disclosure — for example, writing resolutions that would require a company to publish a report about its carbon emissions. James Thier, executive director of Australian Ethical and the brains behind the fund, says that in the absence of governmental implementation of the kinds of climate regulations he believes are needed — such as cap and trade and mandatory emissions reporting — the country’s large investors must take a more active role.“One of the reasons we formed the fund is that we think individuals need to act if government doesn’t,” Thier, 54, tells Institutional Investor. In Australia, too, a cap-and-trade system recently fell by the wayside, with then Prime Minister Kevin Rudd dropping the plans in April, citing insurmountable political and public opposition to the idea. But the idea for the Climate Advocacy Fund was in the works long before that. In 2006, Thier received Australia’s Churchill Fellowship, which he used to research ways to make SRI a better change agent. He traveled to the U.S. and Europe in his search for answers and ended up with a hybrid fund that borrows from some of the SRI models but has its own twist. With the Climate Advocacy Fund, Thier has developed a new type of shareholder advocacy. It’s not an original concept in the world of SRI, but two things set Thier’s fund apart: First, it will be writing and submitting its own resolutions, with the help of a roundtable of about 20 scientific, environmental and social advisers. Although there are a few other funds that formulate their own resolutions, those documents are typically used to spark a private conversation between the fund and the board. After some sort of agreement is reached, the resolution is often withdrawn. “The resolution itself is usually seen as simply a wedge to get in the door to negotiate,” says Thier. The second difference relates to the formal process adopted by the Climate Advocacy Fund. It doesn’t intend to just submit a resolution with the idea of quickly withdrawing it and moving into a discussion behind closed doors.“This needs to be more than simply sitting around a table and having a discussion,”Thier notes.“This is a more formalized, more rigorous process, set within the legal and regulatory structures.” Leslie Lowe, who recently left her position as director of the environment program at the New York–based Interfaith Center on Corporate Responsibility, which sponsors shareholder resolution discussions, is encouraged by Thier’s new fund — though she says it’s too early to say whether the structure will catch on as a trend. If it does, investors need to watch carefully to be sure that SRI firms aren’t adopting the structure just to boost returns by getting around the pesky limitations that negative screening can present. “If you really are an advocacy fund, what did you do to change Exxon and Chevron?” she says. “And can you demonstrate that to me?” •• Comment? Click on Green Investing at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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IVES CAPITAL GREEN SHOOTS CEO INTERVIEW COVER STORY INVESTMENT RESEARCH CORPORA
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UY SIDE ALTERNATIVES GREEN SHOOTS
CEO INTERVIEW COVER STORY INVESTMENT RE
I
IN THE SPRING OF 2000, AS THE
Nasdaq composite index was soaring to record highs amid investor euphoria over anything Internet, Financial Engines CEO Jeffrey Maggioncalda assembled his troops at the company’s Palo Alto, California, headquarters. He was preparing to take the venture public, he told them. Within days, however, the Nasdaq began to free-fall, eventually dropping about 80 percent. Financial Engines, which at the time provided investment advice for 401(k) and other retirement plan participants over the Internet based on the theories of Nobel Prize–winning economist William Sharpe, never did file that S-1 IPO registration form. During the next few years, as many web-based companies struggled and more than a few went bust, Financial Financial Engines’ Engines hunkered down. In search Maggioncalda: A web CEO with patience of extra revenue, Maggioncalda and his team came up in 2004 with the idea of offering professionally man- It took ten years for Jeffrey Financial Engines’ March IPO was one of this year’s most aged accounts to retirement plan par- Maggioncalda to take successful; its shares jumped nearly 44 percent the first day ticipants using the same investment Financial Engines public. of trading, to $17.25 (they have since slid to just under $14, engine that powered the company’s BY MICHAEL PELTZ as of late September). online advice service. The new busiFor Maggioncalda, the $83.2 million offering was a mileness took off: In 2007 professional stone in a journey that began 14 years ago when Financial management represented nearly half Engines’ founders, then–Stanford University finance profesof Financial Engines’ $63.4 million in revenue.The following April, Maggioncalda instructed his investment sor Sharpe, Stanford law professor Joseph Grundfest and Silicon bankers to prepare a new IPO registration form — only to shelve it Valley lawyer Craig Johnson, hired him at 27 to be the company’s first employee — and CEO. Grundfest, who proposed to Sharpe when the financial crisis hit that summer. So it’s no wonder that Maggioncalda jokes, “by the time we that they start a firm to capitalize on Sharpe’s theory for constructdrafted the most recent S-1 [in December 2009], we were worried ing portfolios with the highest expected return for a given risk, had that we were going to precipitate the next financial crisis.” Instead, known Maggioncalda when the Stanford Business School graduate
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OOTS CEO INTERVIEW COVER STORY INVESTMENT RESEARCH CORPORATE FINANCE CAPITAL MAR
was working at Cornerstone Research, which did analysis for business litigation. Despite his lack of specific computer programming or portfolio management expertise and his relative youth, Maggioncalda, 41, is today an experienced chief executive known for his strategic vision, rapport with employees and sense of mission.“Jeff is good at recognizing his own limits,” says Christopher Jones, Financial Engines’ CIO and one of the first employees.“He has been good at recognizing how to complement those limitations by bringing in really good people, who have strengths where he has comparative weaknesses, and then letting them do what they are good at.” That approach seems to be working. In the second quarter, Financial Engines’ revenue grew 32 percent year over year, to $25.6 million, thanks largely to a 60 percent increase in sales of professional management services. Assets under management soared 51 percent, to $29.4 billion. Maggioncalda recently spoke with Americas Editor Michael Peltz about running, at long last, a publicly traded company.
“Once we came up with the managedaccount program, we started investing pretty aggressively. We had to spend because we saw this business was going to be a winner.”
Institutional Investor: What did you learn from your first two attempts to take Financial Engines public? Maggioncalda: Part of the story here is that you’ve got to be pretty
patient. Because oftentimes the trends go against you, and you’ve got to be resilient enough to say: “Okay, we’re going to retrench for now. We’ll be back another day.” With your Silicon Valley roots, was there any thought of trying to ride the wave of web excitement, or was there always a longer-term vision?
There’s a long-term vision that’s predicated on demographics. That’s far more enduring and inevitable than any kind of technology trend. Demographics really was the cornerstone of our vision — that is to say, “Look, we’ve got a whole generation of people approaching an important point in their lives where they need to think about retirement, at a time when public policy has shifted all of the responsibility for retirement onto their shoulders.”And then we knew that we had Bill Sharpe — a Nobel prize winner — so that’s another pretty core asset to get started with. [Sharpe, director emeritus of Financial Engines, is spending the bulk of his time now doing research on postretirement economics.] Still, were you able to leverage the enthusiasm for the Internet?
We absolutely harnessed it in the form of fundraising. Between 1996 and 2000, when the spigot shut off in Silicon Valley, we raised about $130 million. After 2000 you could not raise as much money as we had done — the door slammed shut — and then we used the money to grow our customer base and to develop our managed-account program. All that money lasted us through a very difficult period of a recession and 9/11 and the shakeout of the whole dot-com industry. How were you able to conserve money and still attract and retain talent?
It was quite challenging. When we entered 2000 we had about $100 million of cash in the bank, and we became cash flow positive around 2003. But once we came up with the managed-account program, we started investing pretty aggressively. We had to spend
because we saw that this business was going to be a winner. So that money basically had to last us nine years. We scaled back our expenses. We changed our compensation structure to take more equity instead of cash. As to your point on retention, I’d say that the fundamental requirement is that people had to believe. That’s why a hallmark of the company is that it was founded with a noble purpose, something that employees could feel good about — helping people save for retirement. But employees also had to have a belief that it’s going to pay off. How important was the decision to manage money?
It’s the key. What’s interesting about it is that it is the same underlying technology in terms of the engines; it’s the same target customer, which is the employee in a 401(k) plan; it’s the same distribution strategy, which is through the workplace. It actually is all the same — 90 percent of our basic strategy — but we just didn’t have the killer app that everybody wanted. And frankly, the way we came up with the managed accounts is we were scratching our heads, saying, “Why aren’t more people using online advice?” So we went out and started interviewing people, and they basically said, “I don’t really want to go online and do this.” So we said, “Well, what if we take all the same engines and methodology and everything else but create a version of the service where we’ll take care of this for our customers.” So that’s what we did. Why did you decide to try for a third time to do an IPO?
We started the process in the fourth quarter of 2009. Part of what was really challenging was the mind-set shift in the market: It went from nuclear winter and total survival mode going into ’09 to a growth mind-set when the markets came racing back in the second half of the year. We immediately had to say,“Okay, let’s start investing again.” Is there a difference being CEO of a publicly traded company?
My job as a CEO comes down to three things. No. 1 is to get the strategy right. I’ve seen so many companies execute on the wrong strategy, and they can do a brilliant job and work really hard, but the fundamental insight that was driving their execution just wasn’t right. So you have to have a good strategy that plays to your strengths. The second thing is to set the right culture and alignment within the company. The third piece is the team: I have to hire really good people. So as I think about those three fundamental pieces of being a CEO, I don’t know that my job is that different from what it was before. What has changed is I’ve got a new audience who cares about the story and who I need to care about. My current investors have been, for the most part, investors for over a decade. My newer investors probably aren’t going to have average holding periods that long. Some of them have average holding times of days or weeks. So making sure I have the story really clear and being really consistent about what we’re saying and what we’re doing is important. The tolerance for error in terms of surprising somebody is much lower. •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
URALSIB CAPITAL
New Life in Russia’s OFZ Market When the financial crisis hit in mid-2008, leading countries had to adopt emergency plans to boost economic recovery. Russia was no exception, and its government approved one of the largest anti-crisis packages relative to GDP. The other problem facing Russia was a sharp drop in commodities prices, but before there was a price collapse Russia was able to accumulate a significant cash cushion in its Reserve and National Wellbeing funds. For the anti-crisis programs, the government is using the Reserve Fund only, which dropped significantly from $142 billion on Sept. 1, 2008 to $40 billion on Sept. 1, 2010. The federal budget deficit rose to 5.9 percent of GDP in 2009 after nine years of surplus. This year’s federal budget deficit is officially forecast at 5.4 percent of GDP. In July 2010, Ministry of Finance (MinFin) officials announced that the government’s new debt program was being developed, focusing mainly on domestic borrowings as opposed to reserve fund usage or external debt.
More Emphasis on the Domestic Market MinFin’s forecast of external and domestic borrowings, $bn 2012E
2011E
2010E
54.8 48.3
32.1 20.7
17.8
25.0
20.0
10.6 5.0 Original
Revised
Original
7.9
4.8 Revised
5.9
Original
Revised
● External Debt ● Domestic Debt Source: MinFin
In April, Russia returned to the external markets for the first time in 10 years and placed $5 billion of sovereign eurobonds. According to the new program, no more foreign currency placements are due this year. The MinFin’s initial plan included borrowing $17.8 billion on the external market and $10.6 billion on the domestic market in 2010, but the updated policy now allows $32.1 billlion to be borrowed domestically in addition to the $5 billion of external debt already sold. The government expects total debt/GDP to reach 11.5 percent in 2010 and 16.3 percent in 2013, so the local bond market is set to develop quickly. On the back of increased primary supply from both the government and corporates in 2009, the local bond market surpassed the external market in total size for the first time in Russia’s recent history.
In 2009 the Local Market Became the Primary Venue to Trade Russian Debt External Public Debt Vol., $bn 175 150 125 100 75 50 25 0
94.2
103.8
23.4 12.8
47.8
42.8
02
03
49.0
99.4
102.9
04
40.5
44.8
05
38.5
06
34.7
07
31.9
08
Local Bond Market has Potential for Expansion Size of local bond markets of Russia and its EM peers, $bn Russia 600 500 400 300 200 100 0
Brazil 134
31.9
09
34.4
10ytd
5250 4500 3750 3000 2250 1500 750 0
2526
2624
207
10.3%
424
238
● Government Bonds ● Non-government Bonds ● Local Bonds % GDP (right axis) Source: Bloomberg,Reuters
The lower inflation rate in the past eight months was a consequence of crisis-environment specifics such as low demand, capital outflows, and global deflation. We expect the CPI rate to accelerate to 7.5 percent by the end of the year. Meanwhile, drought and panic on food markets brought additional inflation pressure to Russia’s economy, but as we see no monetary factors behind rising inflation, we do not expect the CBR to change its monetary policy and raise the refinance rate from its current 7.75 percent. The ruble exchange rate will be determined by Russia’s trade balance, A stronger ruble will be the main and as a consequence, by commodity and most effective prices. The monthly trade balance surplus instrument against exceeds $10 billion this year, and we as- the current sume moderate ruble appreciation by the inflation risks end of the year if the global recovery continues. The government always named low inflation as a leading point in its economic strategy, and a stronger ruble will be the main and most effective instrument against the current inflation risks brought by the drought that Russia now faces. Offering a premium over inflation, Russia’s market in federal notes, or OFZ’s, becomes more attractive and more liquid with the government’s goal of developing and concentrating its activity on this part of the domestic bond market. We expect the larger supply of OFZs to increase segment liquidity rather than to bring higher yields. Ruble bond yields are higher than pre-crisis, with the OFZ curve’s slope at their steepest since 2005. And key money-market rates are now below their pre-crisis levels, providing lucrative carry-trade opportunities. We recommend three-to-five year duration OFZs due to their good combination of substantial duration and trading liquidity. OFZ yields hedged into dollars generally correspond to Russian sovereign dollar yields, so the ruble curve does not look expensive compared to dollar risk. All-in-all, unlike past years, trading local government debt appears to be rewarding.
1470
1603
09
10ytd
1257 268 160 315
02
03
481 876
1144
722
1047
558 04
05
06
07
08
● Government ● Municipal ● Corporate Source: Cbonds
Russia’s local bond market has strong potential to expand relative to emerging market peers as well as the global market. The local
60% 50% 40% 30% 20% 10% 0
49
902
217
51.5%
32.9%
1812
109
Mexico
98.2
Domestic Public Debt Vol., RUBbn
63.1
4.0
bond market currently amounts to only 10 percent of GDP, versus 33 percent in Brazil and 52 percent in Mexico.
Contact Information URALSIB Capital 8, Efremova Street, Moscow, 119048, Russia www.uralsibcap.ru
Sponsored Statement • October 2010
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© 2010 Prudential Investment Management, a Prudential Financial, Inc. company. PRUDENTIAL, PRU and the Rock logo are registered service marks of The Prudential Insurance Company of America, Newark, NJ and its affiliates. 1 As of 3/31/2010. 2 As of 12/31/2009, Prudential Financial was ranked the 12th largest institutional manager, which includes the assets managed by Prudential Investment Management. Pensions & Investments ® is a registered trademark of Crain Communications, Inc. PIM-2010-0073 Ed. 7/10
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COVER STORY
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THE A N A LYS T ISSUE S ON
Michael Gam bardella
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James Co vello
A.M. (Toni) Sacconaghi Roderick Bourgeois
Deborah Weinswig
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Robert Drbul Andrew Lazar Meredith Adler
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Zelman & Associates
Empirical Research Partners
Wolfe Trahan & Co.
ISI Group
Goldman, Sachs & Co.
Deutsche Bank Securities
Citi
Morgan Stanley
Sanford C. Bernstein & Co.
UBS
BofA Merrill Lynch Global Research
Barclays Capital
J.P. Morgan
ALL-AMERICA FIRST-TEAMERS, BY FIRM
The centerpiece of our first annual Analyst Issue is the 2010 All-America Research Team (page 36), but also check out Facebook for Finance (54), a look at how social media are reshaping research; The Mystery of Microsoft (58), an analysis of the world’s most-followed and least-appreciated stock; Death of the IPO (page 62), a report on how the 2003 Wall Street research settlement killed capital raising; and Brazil’s Goldman (page 66), a profile of investment bank BTG Pactual. INSTITUTIONALINVESTOR.COM
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THE 2010ALL-AMERICA RESEARCHTEAM
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THE ANALYST ISSUE
By Leslie Kramer PHOTOGRAPHS BY CHRIS BUCK
In a year when macro concerns overshadowed stock picking, these analysts came to the aid of investors at sea in the market turbulence.
F
INDING WINNING STOCK PICKS
is a challenge even when the economy is expanding and the stock market is rising; identifying safe havens can be equally tricky when conditions take a turn for the worse. Sell-side equity analysts who track U.S. companies were called upon to do both over the past year, as the Standard & Poor’s 500 index shot up 18.7 percent from its low point in the fourth quarter of 2009 to late April, plunged 16 percent through early July and then rebounded 10.3 percent by early August — only to fall 7 percent through the end of that month. The shaky U.S. economy was repeatedly rattled by overarching events both foreign and domestic: drawn-out, partisan debates on health care and financial reform in Congress; sovereign debt crises, first in Dubai and then in Europe; a disastrous oil-rig explosion in the Gulf of Mexico; and more. Analysts had to keep on top of developments in all of these issues as they sought to guide anxious clients through tumultuous times. “The market was driven by macro events, and analysts needed to understand and interpret those events to provide perspective on which sectors and stocks would outperform,”
INSTITUTIONALINVESTOR.COM
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Scott Davis Morgan Stanley Electrical Equipment & Multi-Industry
“There is light at the end of the tunnel.”
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“People are saying, ‘I don’t want to be caught not knowing.’”
Lisa Gill J.P. Morgan Health Care Technology & Distribution
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THE 2010ALL-AMERICA RESEARCHTEAM
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THE LEADERS TOTAL TEAM POSITIONS
RANK 2010
2009
1
2
2
1
FIRM
FIRST TEAM
SECOND TEAM
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2009
2010
2009
2010
2009
J.P. Morgan
46
44
15
15
12
11
Barclays Capital
43
46
12
12
10
14
8
11
THIRD TEAM 2010
2009
7
8
5
9
RUNNERS-UP 2010
2009
12
10
16
11
13 explains Thomas Schmidt, J.P. Morgan’s New York–based head of 4 5 Credit Suisse 34 31 0 0 6 4 10 13 18 14 Americas equity research. 5 4 UBS 29 33 3 5 4 2 8 5 14 21 As Stephen Haggerty, who directs coverage of North and South Ameri6 6 Sanford C. Bernstein 25 28 10 10 4 4 7 7 4 7 & Co. can equities for BofA Merrill Lynch 8 7 9 Morgan Stanley 24 16 8 1 5 4 3 3 8 Global Research in New York, observes: “It’s been a tough year to 8 7 Citi 23 27 3 5 5 5 5 5 10 12 be a sell-side analyst.” 9 10 Deutsche Bank 18 13 1 2 1 1 2 3 14 7 True enough, but the past year’s Securities market and macro economic 10 8 Goldman, Sachs & Co. 10 17 1 1 1 2 4 2 4 12 extremes offered analysts an 10 11 ISI Group 10 9 7 6 2 1 0 1 1 1 opportunity to prove they were up to the challenge, and the ones who impressed investors the most can be found at J.P. Morgan, which count by eight, to 24. Even more striking: The number of Morgan rises from second place to take top honors for the first time in the Stanley analysts ranked No. 1 in their respective sectors catapults All-America Research Team, Institutional Investor’s annual ranking from one last year to eight this year. Only three firms claim more top of the nation’s best sell-side equity analysts. J.P. Morgan captures 46 positions than Morgan Stanley: J.P. Morgan, BarCap and Sanford C. Bernstein & Co. (see “The Leaders,” above). total team positions, two more than last year. Down a notch to second place is the research squad that has domiProfiles of the analysts and teams in first place can be found nated this ranking for the past seven years, five as part of Lehman in Research & Rankings, beginning on page 71; complete Brothers and the past two at Barclays Capital. (The researchers results, including profiles of analysts and teams ranked second moved en masse after Barclays acquired the North American opera- and third and the list of runners-up can be found on our web site, tions of Lehman Brothers Holdings in September 2008.) The BarCap institutionalinvestor.com. Survey results are based on responses from nearly 3,500 portfolio managers and other investment procrew takes 43 positions this year, down from 46. BofA holds steady in third despite having picked up five more fessionals at some 970 firms that collectively manage an estimated positions, bringing its total to 42. Rounding out the top five are Credit $10.2 trillion in U.S. equities (see “Picking the Team,” page 89). Suisse, which rises one rung after adding three more positions, for a “The events of this year reiterate that analysts need to be more total of 34; and UBS, which slips one notch after losing four positions, focused on what is going on around the globe and how it can affect leaving it with 29. their coverage universe,” says Schmidt. “But the core, fundamental Morgan Stanley is the biggest upward mover among the top firms, work that analysts do on specific companies has not changed.” rising from ninth place to seventh after boosting its team-position One thing that has changed: “Clients have increased the demand 3
INSTITUTIONALINVESTOR.COM
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BofA Merrill Lynch Global Research
42
37
3
7
12
6
19
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THE 2010ALL-AMERICA RESEARCHTEAM
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THE ANALYST ISSUE
they are putting on sell-side research departments to explore new opportunities,” he says. To keep up with this demand, J.P. Morgan has added three analysts over the past year, bringing its total to 58 senior researchers who follow a whopping 1,135 U.S. companies — 50 more than last year and the highest number of any firm — and Schmidt says they will initiate coverage on an additional 20 to 30 stocks over the next 12 months. BarCap has 65 senior analysts this year — that’s one less than last year — but they added coverage of 15 stocks, for a total of 965. Stuart Linde, the firm’s New York–based head of global equities research, says the firm will be expanding its coverage more aggressively, with a goal of tracking 1,100 companies by 2012. He has no plans to
“The events of this year reiterate that analysts need to be more focused on what is going on around the globe.” — Thomas Schmidt, J.P. Morgan
increase his senior-analyst head count but may hire more junior analysts to help with the increased workload. With macro concerns dominating investors’ minds, BarCap is deploying its resources more strategically, focusing on global and equity-linked products that span asset classes. “Our clients want any kind of incremental insights that will help them generate greater returns for their portfolios,” Linde explains. “What we’ve tried to do is ensure we have an integrated approach within and outside equities. As a result, the look and feel of our reports is significantly improved.” BofA expanded its research operations by roughly 9 percent, to a staff of about 80 senior analysts, Haggerty says, and their coverage
universe grew by about 20 percent, to 950 companies. “We wanted to drive stock coverage and increase the firm’s equity analyst base, in line with client interest,” he says. Morgan Stanley’s rise in the ranking can be attributed at least in part to the firm’s renewed commitment to the U.S. market. Stephen Penwell, New York–based director of North American equity research, has brought 14 analysts on board over the past year, for a total of 62, and plans to add seven to ten more by year-end 2011. “We expect the department to grow modestly over the next year, as we fill a couple of important coverage holes and continue to develop our best internal talent,” he says. Morgan Stanley researchers follow 755 stocks — an increase of more than 120 companies over the past year — and will have initiated coverage of about 50 more by December. “We felt our footprint, in terms of analysts and stocks covered, was too small to be competitive as a top firm in the U.S. equity markets,” Penwell explains. IT’S AN INTERESTING TIME TO DOUBLE DOWN ON THE U.S.
market, as many investors still fear a double dip. The so-called Great Recession officially ended in June 2009, after 18 months — the longest downturn since World War II — the National Bureau of Economic Research reported last month. Even so, real gross domestic product growth is anemic and the unemployment rate remains above 9.5 percent, with some 15 million Americans out of work. “The market has traded sideways in a relatively broad range, as market participants have vacillated between betting on growth and betting on a double-dip recession,” Penwell observes. “Equity volumes have been subdued as a result of the lack of clear direction.” Of course, it’s clear direction that investors need most when uncertainty abounds, and few segments of the American economy have been as shrouded in uncertainty in recent years as the financial services sector. As long ago as March 2008, when the Federal Reserve Bank of New INSTITUTIONALINVESTOR.COM
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Derik de Bruin UBS Life Science & Diagnostic Tools
“There was lots of money hiding out in life sciences.”
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Alexia Quadrani J.P. Morgan Publishing & Advertising Agencies
“No one anticipated such a strong recovery.”
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“MLPs had a terrific run in the first half of 2010.”
Gabriel Moreen BofA Merrill Lynch Global Research Master Limited Partnerships
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THE 2010ALL-AMERICA RESEARCHTEAM
Jamminder (Jimmy) Bhullar J.P. Morgan Insurance/Life
“Sentiment on the group is extremely negative.”
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Jay Gelb Barclays Capital Insurance/Nonlife
“Earning power is going to be somewhat compressed.”
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Paul Cheng Barclays Capital Integrated Oil
“There is still too much uncertainty on the economic front.”
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York helped arrange the shotgun marriage of JPMorgan Chase & Co. and Bears Stearns Cos. to prevent the latter from a bankruptcy that many believed would devastate the nation’s financial system, legislators began talking about reforming the way Wall Street conducts business. The conversation continued through the bailouts of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp., the collapse of Lehman Brothers and the rescue of insurance behemoth American International Group. They were still discussing the subject when Merrill Lynch & Co. was sold to Bank of America Corp., Morgan Stanley and Goldman Sachs Group were converted to bank holding companies, and Congress passed the controversial, $700 billion Emergency Economic Stabilization Act of 2008. It was not until July 2010, when President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, that the contentiously debated regulatory reforms became law. While legislators were wrangling over how extensive an overhaul of the nation’s financial system was required and the form it should take, investors were dependent on analysts to keep them apprised of every development, proposal and even rumor, for all had the power to move the markets. Money managers were especially impressed with Sanford C. Bernstein’s Kevin St. Pierre, who finishes in first place for the first time in Banks/Midcap. “I find Kevin’s work valuable because of the detailed financial analysis he does of the industry and of the companies he follows,” says one client.“His work has been particularly useful in light of the raft of regulatory and legislative changes.” Those changes had a“huge impact”on his sector, St. Pierre notes — but there was an even bigger issue: the turn in the credit cycle.“A year ago banks were furiously building their reserves and raising capital, but fast-forward to right now — banks are doing the opposite,”he explains. “They are releasing reserves, drawing down their reserve coverage, and some are even beginning to think about how to use their excess capital.” INSTITUTIONALINVESTOR.COM
Loan-delinquency rates, which had been surging throughout much of last year, began to slow in the fourth quarter, indicating that the peak would be significantly lower than many people had feared, he notes. St. Pierre had been urging clients to underweight their holdings in his sector, but last fall he changed course and advised them to overweight midcap banks — especially those whose valuations had fallen the farthest. “There is a price for every asset, and we felt those stocks had drifted significantly below even a worst-case scenario, in terms of losses,” he says. In April, when the shares had corrected to what he saw as appropriate valuations, he declared it was time to take profits. “We told investors they should migrate toward safer, moreprofitable names that had already repaid their loans from the Troubled Asset Relief Program and were building capital, as opposed to eroding it,” he explains.
“Our clients want any kind of incremental insights that will help them generate greater returns.” — Stuart Linde, Barclays Capital
St. Pierre says it’s too soon to tell what the long-term effect of the Dodd-Frank reforms will be.“We’ve only just begun to see how it will impact the banks’ ability to generate revenue,” he notes. Nonetheless, he is confident they will adapt to defend their margins. For instance, the new law imposes restrictions on banks’ use of overdraft fees on debit cards, which had been a major source of income for many issuers, but some lenders will offset that lost revenue by charging higher account-maintenance fees. “The banks are trying to backfill some of what is going to be
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Anthony DiClemente Barclays Capital Entertainment
“It’s a temporary reversal based generally on macroeconomic concerns.”
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eliminated, so I think that, yes, it’s going to be a hit to profitability, but not as large as some fear,” he says. Disproportionate fear has also hammered the insurance industry, but not because of financial reform, according to the analysts whom investors say do the best job of providing coverage: J.P. Morgan’s Jamminder (Jimmy) Bhullar, who wins the top spot for the first time in Insurance/Life; and BarCap’s Jay Gelb, a first-time first-teamer in Insurance/Nonlife. The AIG debacle — in which the troubled insurer was forced to seek an $85 billion lifeline from the federal government, owing to a lack of liquidity — rendered other outfits in the group guilty by association, at least in the minds of many investors. After all, if a company that was ranked among the world’s 25 largest by revenue in 2007 could suddenly find itself without enough cash on hand to meet its obligations, couldn’t the same fate befall a smaller institution? “Sentiment on the group is extremely negative,” says Bhullar. “Our stocks are trading at 80 percent of book value and only seven times next year’s earnings.” That negativity remains, he says, despite the improvements in life insurers’ fundamentals and balance sheets that are thanks in part to the loosening of credit. A similar phenomenon is affecting nonlife companies. Many property and casualty insurers and reinsurers — Ace, Arch Capital Group and Travelers Cos. among them — have strong financial positions and excess capital, and given their relatively low valuations, one would expect investors to gobble up the shares, Gelb says. But macro concerns are creating headwinds for the industry. Weak auto and home sales have slowed new-policy growth, as has the low rate of business start-ups. Some insurers have raised premiums to help make up for the decline in sales, and many have undertaken cost-cutting initiatives to streamline profitability and boost excess cash, which they are INSTITUTIONALINVESTOR.COM
using to buy back shares and buoy investor confidence.“But earning power is going to be somewhat compressed by such a low interest rate environment, and until you get a sustained economic recovery, top-line growth should be somewhat weak,” Gelb says. Just last month the Federal Reserve Board opted to keep its benchmark overnight lending rate at a historically low 0.25 percent, and that does not bode well for insurers in the near term, Bhullar notes. “The recent sector pullback has been due to fears of a double-dip recession and concerns about the possibility of sustained low interest rates,” which could prompt some outfits to lower their earnings estimates, he says. Should that happen, clients know that Bhullar will keep them informed.“Jimmy is very conscientious about calling me both before and after earnings releases to give me updates on his stocks,” says one pension fund manager. “I find his approach very helpful.” Gelb’s backers are similarly supportive. “Jay is all about the hustle,” says one. “He is on top of everything and was the first to quantify the BP oil-rig loss on insurers, at a time when there was very little information.” The explosion of the London-based global oil-and-gas company’s Deepwater Horizon drilling rig in the Gulf of Mexico, in April, claimed 11 lives and resulted in one of the worst environmental catastrophes of all time. It also sent shock waves through a sector about which investors had already been uneasy owing to wildly erratic oil prices over the past couple of years. Gelb’s BarCap colleague Paul Cheng, who is No. 1 in Integrated Oil for the first time, had been negative on the sector since the start of the year, primarily because of low oil prices. “Over the last ten months, energy has been one of the worst-performing sectors,” he notes, adding that he expects oil to remain trading at $70 to $80 a barrel for the rest of the year and into the first quarter of 2011. “There is still too much uncertainty on the economic front — we
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WEIGHTING THE RESULTS This table shows the top firms if a rating of 4 is assigned to a first-teamer, 3 to a second-teamer, 2 to a third-teamer and 1 to a runner-up.
don’t expect oil to break out of this narrow trading range just yet,” states Cheng. That said, low valuations make this the ideal time for investors to stock up. “We have probably seen the worst, and market expectation is low enough that we suggest clients gradually raise the portfolio weighting in the integrated-oil shares over the coming months,” he says. He believes growth will resume by the second quarter of next year, but much will depend on what happens in Washington with regard to the Obama administration’s attempts to ban deepwater offshore drilling. In May the president called for a six-month moratorium in response to the BP disaster, but that ban was overturned by a federal judge in June. The following month, after the administration had lost on appeal, the Department of the Interior responded with a second moratorium, which is scheduled to end next month. But many analysts and market observers fear it may be extended. “The outcome will impact the thinking we have about companies with a large exposure in the Gulf of Mexico,” Cheng says. That view is shared by Morgan Stanley’s Ole Slorer, who makes his first appearance in the top spot in Oil Services & Equipment. “A situation where the lifting of the moratorium takes a full election cycle would be the worst-case scenario, and it definitely introduces some uncertainty,” he says.“The permitting of new exploration wells in the deepwater Gulf of Mexico will be a slow process, in any case.” Companies in his coverage universe that did not perform well were those with connections to offshore drilling and construction, prompting investors to look elsewhere. Slorer knew just where to point them, because “he is always in tune with global issues and how they affect the sector, and he knows a good opportunity when he sees one,” says one longtime client. “The biggest development in the sector this year has been the
RANK BY WEIGHTED FORMULA
RANK IN LEADERS TABLE
1
1
J.P. Morgan
122
2
2
Barclays Capital
104
3
3
BofA Merrill Lynch Global Research
79
4
6
Sanford C. Bernstein & Co.
70
5
7
Morgan Stanley
61
6
4
Credit Suisse
56
7
5
UBS
54
8
8
Citi
47
9
10
ISI Group
35
10
9
Deutsche Bank Securities
25
WEIGHTED TOTAL
FIRM
emergence of unconventional natural-gas drilling activity in North America and how it has transformed the pressure-pumping and stimulation markets,” he explains. “Pressure-pumping companies have therefore seen a big pricing cycle at a time when consensus had left this subsegment for dead.” The analyst believes that the cycle peaked in August and that the next six months will likely be challenging.“It will be difficult to make money in the absence of a clear direction of global GDP growth, which drives energy demand and the need to drill more and produce more energy,” Slorer says. However, a ban on offshore drilling could provide a boost to master limited partnerships, observes Gabriel Moreen, who lands in that sector’s winner’s circle for the first time.“The moratorium may mean additional capital spent onshore, in which case MLPs could benefit from the need for additional onshore energy infrastructure,” the BofA researcher says. At a time when many analysts are cautious, Moreen is positively INSTITUTIONALINVESTOR.COM
We didn’t create the leading ETF provider. You did.
At iShares, we believe the value of leadership isn’t measured by numbers. Otherwise, our ten years of experience, 200-plus ETFs and status as the world’s leading ETF provider1 would be enough. More important is what it means to you as an institutional investor—deep resources dedicated to finding smart solutions for your needs. Let’s create something together. Call our dedicated Institutional Team at 1-800-743-9285 or visit iShares.com/institutional.
iShares has been serving the institutional market for 10 years and holds a 47% AUM market share.2 800
US ETF $AUM
700
iShares $AUM
$789
$618
AUM ($Billions)
600
$542 500 $432 400 $311
300 $236 200 $157 100 0
1
70 $ 8
$87
$106
$18
$31
$58
‘00
‘01
‘02
‘03
$
$114 ‘04
$171 ‘05
$251
‘06
$329
‘07
$372 $258
‘08
‘09
Source: Global ETF Research & Implementation Strategy Team, BlackRock, Bloomberg, as of 12/09. Based on number of ETFs, AUM and market share. Source: FactSet, Bloomberg and BlackRock, as of 12/09.
2
Call 1-800-iShares to request a prospectus, which includes investment objectives, risks, fees, expenses and other information that you should read and consider carefully before investing. Investing involves risk, including possible loss of principal. The iShares Funds are distributed by SEI Investments Distribution Co. (“SEI”) and advised by BlackRock Fund Advisors (“BFA”). BFA is a subsidiary of BlackRock Institutional Trust Company, N.A. (“BlackRock”), neither of which is affiliated with SEI. ©2010 BlackRock. All rights reserved. iShares® is a registered trademark of BlackRock. All other trademarks, servicemarks or registered trademarks are the property of their respective owners. iS-2802-0710
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WHAT INVESTORS REALLY WANT Participants in the 2010 All-America Research Team were asked to rate, on a scale of 1 to 10, the importance they place on a dozen sell-side equity research attributes. For a 13th consecutive year, respondents said they consider industry knowledge to be the most vital attribute. Earnings estimates was deemed the least important attribute. RANK BY U.S. EQUITIES UNDER MANAGEMENT OVERALL RANK
ATTRIBUTE
$75 BIL- $30 BILLION $10 BILLION $5 BILLION $1 BILLION LION TO TO TO TO LESS THAN OR MORE $74.99 BILLION $29.99 BILLION $9.99 BILLION $4.99 BILLION $1 BILLION
1
Industry knowledge
1
1
1
1
1
1
2
Integrity/professionalism
1
2
2
2
2
2
3
Accessibility/ responsiveness
3
3
3
3
3
3
4
4
4
5
5
4
6
5
5
4
4
5
5
6
8
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7
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11
11
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12
12
12
12
12
ebullient about his sector’s 4 Special services (company potential. “MLPs had a terrific visits, conferences, etc.) run in the first half of 2010, 5 Written reports delivering an almost 20 percent 6 Local market knowledge/ total return,” he says. Portfolio country knowledge managers that flocked to partnerships in search of yield were 7 Management access (one-to-one) rewarded with high dividends. “It is one of a few equity sectors 8 Useful/timely calls & visits that deliver the holy grail of high up-front tax-advantaged yields 9 Financial models with growth at rates greater 10 Idea generation than inflation,” he says. Moreen remains bullish. 11 Research delivery (entitlement, technology “Our mantra is, ‘If the corpo& customization of buy-side needs) rate bond market continues to stay strong, it bodes well for 12 Earnings estimates MLP performance,’” he notes. Investors are likely to take heed.“Gabe stands out, given his broad coverage of not only MLPs but also the closed-end funds that are the dominant owners of this sector,” explains one fund manager. “Perhaps the boldest call made by any MLP analyst over the past year was his series of upgrades this past May, amid a broader market correction and especially within this space, when he upgraded a number of MLPs — and he was right.” Bold calls also helped propel J.P. Morgan’s Lisa Gill to the top spot for the first time in Health Care Technology & Distribution. “I like her independence,” declares one supporter. “She is willing to challenge the big names and so provides us with a sort of second opinion on our trades.” Drawn-out partisan debate over health care reform caused every
bit as much anxiety as the prospect of a financial system overhaul, but Gill alerted clients to an upside. She reassured investors as the debate was ongoing that her sector was relatively immune from its effects, in that most of the companies in her coverage universe do not participate in government programs such as Medicare and Medicaid, the expansion of which was one of the most contentious issues among sparring legislators. After the Patient Protection and Affordable Care Act was enacted in March, Gill informed investors that the sector could see a modest boost. “Obamacare provides for incremental increased coverage for individuals, which could increase the amount and frequency of doctor visits and the use of drugs such as statins through continued on page 89 INSTITUTIONALINVESTOR.COM
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INVESTMENT RESEARCH
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THE ANALYST ISSUE
ILLUSTRATION BY BARRY FALLS
Finance
Blogs, online networks and other social media web sites are creating new opportunities for investment research. By Len Costa
I
F INFORMATION “WANTS TO BE
free,” as one half of the famous aphorism goes, somebody forgot to tell Wall Street. This fall a federal appeals court in New York will weigh in on a long-running and widely watched legal dispute pitting Barclays Capital, Bank of America Merrill Lynch and Morgan Stanley against Theflyonthewall.com, a New Jersey–based web site that publishes sell-side analyst recommendations before the market opens — and often before the firms can distribute their own research to clients. The firms contend this hurts their commission revenue. This past spring a lower court judge ordered Theflyonthewall. com to delay publication of the firms’ stock calls until one half hour after the opening of the New York Stock Exchange, among other restrictions.The web site countered with an appeal and won a temporary stay. Even if the brokerage firms prevail in their battle against Theflyonthewall.com, winning the war to preserve the primacy of their investment research won’t be easy. Bolstered by the low cost of online publishing and
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the rising popularity of blogs, discussion forums and commenting, the ranks at a big firm: “You’re talking about members of the same a growing number of niche web sites are creating opportunities for club — similar schools, similar background, working at the big Wall new forms of investment analysis to emerge — and for buy-side pro- Street firms, quoted in the major media.” But these days, he contends, fessionals, even those at rival firms, to collaborate and learn directly “that model is totally broken.” from one another. These social media web sites are supplementing, For every form of investing, to tweak Apple’s catchphrase,“there’s and in some cases supplanting, the traditional Wall Street informa- a blog for that.” Naked Capitalism, which specializes in financial and tion ecosystem that transmits sell-side investment research and economic commentary, is overseen by Yves Smith, the nom de plume stock calls to the buy side. The sites’ popularity has been fueled by of a former Goldman, Sachs & Co. and McKinsey & Co. executive, the limitations and shrinking coverage universe of sell-side research and is widely read by hedge funds. Footnoted.org, launched by and the failure of establishment experts — from Wall Street analysts journalist Michelle Leder, reports on the things that companies try and strategists to the credit ratings agencies to the financial news to bury in their Securities and Exchange Commission filings and was recently acquired by Morningstar. And Jeff Matthews Is Not Making media — to call the credit crisis. “The sell side can often be slow to twist and turn with where the This Up, written by the founder of Greenwich, Connecticut–based market is going,” says David Jackson, a former Morgan Stanley hedge fund RAM Partners, delivers blunt analysis of everything from technology analyst and the founder and CEO of Seeking Alpha, the sources of revenue growth at Hewlett-Packard Co. under former a leading investment blog backed by blue-chip venture capital CEO Mark Hurd to Wall Street’s earnings coverage. firms Accel Partners, Benchmark Capital and DAG Ventures. The explosion in socially generated investment analysis is both But crowd-sourcing investment ideas, he says, has its benefits: a blessing and a curse, especially when you consider the volume of Throughout the rise and crash in the price of oil in 2007 and 2008, short messages containing financial content that are transmitted the unraveling of the housing market and the implosion of Bear every day via Twitter, the microblogging service that is especially Stearns Cos. and Lehman Brothers Holdings, Jackson’s more than popular among active traders (see sidebar, opposite). To manage 3,000 handpicked contributors and vocal readers were “uncannily what traders might call the high “signal-to-noise ratio” of public web on topic in terms of what was driving the market — at a macro level sites, at least three private online communities now cater specifically to professional investors: Value Investors Club and Distressed Debt and an individual stock level.” In mid-August, as part of the U.S. Treasury Department’s ongoing Investors Club, which were founded in 2000 and 2009, respectively, outreach to the financial blogosphere, seven bloggers were invited and each cap their membership at 250 investors, who are anonymous to a private meeting with a small group of senior officials, including to fellow users; and SumZero, which launched in 2008, combines Treasury Secretary Timothy Geithner, to discuss financial reform. As user-generated investment research with social networking features four of the seven bloggers regularly contribute to Seeking Alpha, the and now boasts a membership of more than 4,000 buy-side analysts meeting was a nod to the site’s growing influence. and portfolio managers. Finance pros have taken notice. According to audience tracker All three sites are rivals of sorts but share some members. GenerNielsen Co., Seeking Alpha, which launched in 2004, now attracts ally speaking, they screen applicants based on the quality of a sample more financial professionals than any other major financial web investment thesis and require members to post write-ups on securities site. The site recently hit 540,000 registered users, and its opinion and regularly rate other community members’ ideas. The sites may and analysis pieces, which are free, are read by more than 2.8 mil- also offer incentives to encourage participation; Value Investors lion people a month. Nielsen data suggest that more than 385,000 Club, for example, awards a weekly prize of $5,000 for the best idea. of these individuals are professionals: money managers, sell-side SumZero is betting that scale, transparency and Facebook-style analysts, investment bankers, financial advisers, business leaders, networking features will set the site apart from its two smaller entrepreneurs and sophisticated retail investors. Morgan Stanley’s rivals. “The dynamic is that the bigger the idea database gets, the sell-side research, by comparison, goes out to more compelling it becomes to contribute to,” roughly 250,000 institutional investors, though says co-founder and CEO Divya Narendra, a the firm’s reach is much broader when you factor 28-year-old former analyst at Boston-based in its retail network of 18,000 financial advisers hedge fund Sowood Capital Management who and their clients. is running the site while pursuing law and busi“Blogging is absolutely democratizing the ness degrees at Northwestern University. investment business,” says Barry Ritholtz, who Networks are something that Narendra is CEO and director of equity research at indehas spent a lot of time thinking about. As an pendent quant research firm FusionIQ, and undergraduate at Harvard University, he cowho writes The Big Picture, a well-regarded founded social network ConnectU, and he blog about macro investing themes. A Wall remains locked in a long-running legal battle — David Jackson, Seeking Alpha with Facebook and its co-founder Mark ZuckStreet veteran and the former chief market erberg, a Harvard classmate whom Narendra strategist at New York boutique investment accuses of stealing his idea. SumZero’s name bank Maxim Group, Ritholtz says that 20 years ago the typical Wall Street strategist had an and tagline,“The opposite of zero sum,” suggest economics degree, went to one of a half dozen a Facebook-like zeitgeist. It’s a cheeky riff on the leading MBA programs and came up through idea — which seems out of place in the cutthroat
“The sell side can often be slow to twist and turnwith where the market is going.”
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Tweeting for Traders Twitter is a popular tool for the Chicago exchanges
T
he spectacular rise of Twitter has been a marketing boon for techsavvy A-listers and big consumer brands alike, from pop diva Lady Gaga and President Barack Obama to Starbucks, the NBA and JetBlue Airways. Financial services firms have mostly sat this revolution out. But there are two notable exceptions: the Chicago Board Options Exchange, which boasted 763,030 Twitter followers as of mid-September, and CME Group, which had 759,892 — enough to place both exchange operators among the top 300 most-followed Twitter accounts worldwide. What explains this micro blogging success story? In brief: traders’ need for speed. Twitter’s rapid-fire, 140-character messages have proven ideal for squeezing a lot of actionable information into a tiny space, including shortened links to pertinent articles and web pages. That makes Twitter the perfect medium for commodities, futures and options traders
looking to share breaking news, swap ideas with likeminded investors and source data before it hits the wires, whether it’s a Midwestern farmer tweeting about crop yields or a currency strategist commenting on a move in the dollar-yen exchange rate. That’s where the Chicago exchanges come in. They have carved out a niche on Twitter by adding to the real-time flow of conversation. Allan Schoenberg, director of corporate communications at CME Group, personally mans the exchange’s Twitter account, @CMEGroup, which was set up in August 2008, and sends anywhere from a handful to a dozen tweets a day. He says the microblogging platform is useful for promoting his brand, tracking issues of importance and even fielding customer feedback. By understanding the Twitter audience’s needs, he says, “you can build value for your community that reciprocates into value for your company.” The exchanges are surprised by their own success. “Like many new to the social media arena, CBOE launched this effort with fairly modest expectations,” says Cynthia Elsener, vice president of marketing and educational services, who oversaw the creation of the @CBOE account in March 2009. “The rapid expansion of followers has been quite a revelation.” Both exchanges’ Twitter presences have gotten a boost from
world of money management — that investors can create value for one another by openly collaborating and sharing ideas. And they are. James Kilroy, a portfolio manager at Gainesville, Georgia–based Willis Investment Counsel, which oversees about $1 billion in institutional and high-net-worth assets, joined SumZero when it was a third of its current size. He says that he often posts a detailed investment thesis to the site after completing his research and building a position. His goal is to stress-test his ideas — “I want to understand how I can be wrong,” he says — and to share them with an influential community that is prepared to act on a persuasive argument. “You want to be early and first,” explains Kilroy, a former Bear Stearns analyst who covered multi-industrials, “but ultimately you need other investors to share your point of view for the stock to go up.” Kilroy likes the fact that SumZero members must disclose whom INSTITUTIONALINVESTOR.COM
StockTwits, an online community that organizes tweets about investments. The web site popularized the use of the dollar sign in Twitter messages to designate ticker symbols for stocks, currencies and options and futures contracts, making it easier for traders to swap information about their most popular products, such as the CBOE volatility index ($VIX) and CME Group’s E-mini S&P 500 contract ($ES_F). Traders say Twitter is addictive — and indispensable. Joe Donohue, an early investor in StockTwits who is based in Morristown, New Jersey, and manages $7 million in separate accounts for high-net-worth individuals, began using the microblogging platform a few years ago to share trading ideas and track the real-time flow of information. “If I’m long or short Apple, I can look at that stream and somebody out there in the hinterland has found something and put it on Twitter,” he explains. “I’ve never had an experience where that wasn’t valid information.” Donohue, who has worked on Wall Street for 25 years and cofounded a hedge fund firm now called YA Global Advisors, tweets using the handle upsidetrader (the name of his blog) and has amassed more than 9,000 followers. “The only way to be more current is to spend $25,000 to have a Bloomberg terminal on your desk,” he contends.
This point underscores what may be Twitter’s most important legacy in the financial world: its potential to level the playing field for different types of investors — big and small, novice and professional — by providing easy and inexpensive access to realtime information and a soapbox for previously undiscovered investment talent. Coronado, California–based StockTwits, whose mission is to help investors find and track the best tweets about investments, is hastening this revolution. “We believe in new faces,” says cofounder and CEO Howard Lindzon. “It’s a more distributed model of leadership.” Nonetheless, there’s at least one aspect of Twitter at which the pros still have an advantage: using software to scour the more than 90 million tweets broadcast every day to uncover trading signals. Mark Palmer, CEO of Lexington, Massachusetts–based StreamBase Systems, which helped pioneer technology capable of processing thousands of information sources in real time, says that roughly a fifth of the firm’s 75 money management clients are using his product to analyze digital content. Thanks to an enhancement introduced last year, the software is now capable of analyzing tweets. Buying on the rumor and selling on the news has never been easier — or more scientific. — L.C.
they work for and the type of funds they manage. “It forces you to a higher level of accountability,” he adds. Access to contrarian investment thinking is also a key driver of investor interest in these social media sites. Jackson credits Seeking Alpha’s success to the diversity of viewpoints expressed by the site’s writers and commentators, who create a wide-angle view of a stock that he says is unmatched by traditional Wall Street research. SumZero’s Narendra agrees. “Somebody might put up a thesis [on SumZero] where a stock trades at $2 and the target is $10,” he says. “That’s the kind of stuff that the investment community needs — a divergence of viewpoints, as opposed to herd thinking.” Still, investors must proceed with caution. In a 2007 study of 340 buy and 160 sell recommendations posted on Seeking Alpha, Veljko Fotak, a Ph.D. student in finance at the University of Oklacontinued on page 91
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CORPORATE FINANCE
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THE ANALYST ISSUE
Why does Wall Street continue to treat Microsoft like yesterday’s news?
Don’t blame the analysts who track the company — they’re getting a little tired of recommending it.
By Stephen Davis ILLUSTRATIONS BY DIANA PANFIL
M
ICROSOFT CORP. HAS HAD A LONG HISTORY OF
acquiring any software technology it deems necessary to compete in the marketplace — beginning with DOS, the computer operating system it purchased in 1981 from a Seattle company and then licensed to IBM Corp. to run the original IBM PC. But the Redmond, Washington, giant’s $44 billion bid for Internet rival Yahoo!, unveiled in February 2008, was different. Thanks to economies of scale, the gap between the Internet’s winners and losers was widening fast, Microsoft CEO Steve Ballmer warned in his letter to Yahoo!’s board of directors. Tacitly but unmistakably pointing to Google, he wrote, “Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition.”What Ballmer coveted most about Yahoo! was not its technology but its popularity among Internet users. That’s why Ballmer is happy with the way things turned out. After three months of talking to Yahoo! and failing to agree on a price, the Microsoft chief withdrew his offer. A year later Microsoft CEO Steve Ballmer (left) has long had the support of the company’s co-founder and former chief, Bill Gates (right), but investors in recent years have preferred Apple CEO Steve Jobs
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a new management team at Yahoo! agreed to a ten-year partnership deserves the most credit for adding “software tycoon” to America’s whereby users who type in a search query on Yahoo!’s sites will be lexicon. The company’s 1986 initial public offering was the über-IPO handed off to Microsoft’s search engine; the two companies can then for a generation of Silicon Valley entrepreneurs, venture capitalists share the real bonanza: advertising made more lucrative by all those and ordinary Americans, the archetype for how technology’s winners additional Yahoo! users.“Success in search requires both innovation are rewarded — even nerdy ones. Microsoft’s shares turned Gates and scale,” Ballmer said in a statement on July 29, 2009, asserting the into the richest man on the planet in 1995, while making “Microsoft complementary strengths of Microsoft and Yahoo!, respectively. In millionaires”out of thousands of the company’s employees and invesBallmer’s view, the partnership promises to give Microsoft’s search tors worldwide. But since the tech bubble burst in 2000, Microsoft’s business the popularity boost it needs to earn competitive advertising MSFT ticker has traded flat, mostly in the mid-$20 range; on a splitrevenue and stay in the technological race with Google — without the adjusted basis, the stock has lost more than 50 percent of its value since risks of what would have been by far Microsoft’s largest acquisition. Ballmer took over as CEO. Whereas Microsoft’s stock price outpaced Wall Street hasn’t exactly been impressed. “They got 80 to 90 the company’s profits in the 1990s, today — to the astonishment of percent of what they wanted,” concedes Citi Investment Research & anyone who remembers the go-go years — its price-earnings ratio lags Analysis analyst Walter Pritchard, one of the many analysts following that of the Standard & Poor’s 500 index. Mister Softee’s diminished Microsoft who opposed the original acquisition bid. Pritchard saw stature was certified in May with the news that Apple had overtaken that deal as too large and potentially disruptive, given that Microsoft Microsoft as the world’s most valuable technology company, as didn’t need all the Yahoo! assets. measured by market capitalization. Investor criticism has been harsher. Where Ballmer sees strategic Few would assert that Microsoft has had as good a decade as Apple. progress and future profits, investors see billions spent in a losing But Mister Softee’s below-average valuation is baffling to many, not sideshow. In the past three years alone, Microsoft’s online services least of which are the three dozen Wall Street analysts who cover unit, which includes Bing and the MSN collection of sites that com- Microsoft.As with their predecessors last century, many of the current pete with Yahoo!, among others, has posted more than $5.3 billion generation of analysts have had a buy on the stock more often than not: in losses. Meanwhile, Google’s share of the world’s search markets This summer, 28 out of 38 tracked by S&P rated the stock either a buy or a buy/hold. (Nine of the other ten rated it hold, has grown to more than 64 percent in the U.S., up from 56 percent in 2007; during the same and one rated it“weak hold.”There were no sells.) REVENUE BREAKDOWN 2001 period, Yahoo! and Microsoft’s combined share Indeed, many top software analysts have recfell from more than 34 percent to 29 percent. 19% ommended the stock for most of their careers. 33% Desktop Worse still, for many observers, the Yahoo! Enterprise But this century that recommendation hasn’t software & applications services (Office) partnership fits a pattern of Microsoft futilely worked out so well. For many on Wall Street, (SQL Server, spending big to catch up with successful first- tools) Microsoft has become a paradox: a high-tech movers — after all, MSN was launched as an leader with the valuation of a low-tech laggard. AOL-killer in 1995 and has been unprofitable “In Microsoft you have a stock that’s overcovever since. Wired magazine, a savvy judge of ered but underfollowed,” says Morgan Stanley Silicon Valley credibility and cachet, summed up software analyst Adam Holt, who’s led his firm’s 38% Desktop this viewpoint with a graphic showing Microcoverage since 2002. platforms 8% 2% soft and Yahoo! as overlapping circles in a Venn The company is hard to follow, but analysts (Windows XP) diagram. The caption for the intersecting area: don’t blame Microsoft’s investor relations. Windows ecosystem “STILL NOT GOOGLE.” “They provide investors with a lot of access,” Consumer software, services and devices (MSN, Xbox) Under Ballmer, who took the CEO reins from notes Holt, adding that over the past year and Consumer commerce investments (Expedia) a half, Microsoft’s accessibility to Wall Street Bill Gates in January 2000, the world’s largest software maker has become perhaps the most has been as high as he’s seen during his career. REVENUE BREAKDOWN 2010 underappreciated large-cap name in investment (Holt, the top-ranked software analyst on circles today. Using a strategy for coping with disthis year’s All-America Research Team, has 28% 30% ruptive technological change that Gates forged in covered technology stocks since 1997.) Long Business Operating (Office) systems the 1990s, Microsoft faces an almost entirely difconsidered a standout in the tech sector for its (Windows 7, Internet ferent lineup of competitors from a decade ago, outreach efforts, Microsoft, under IR director Explorer) let alone two decades ago. Yet, while its current Bill Koefoed, has added nondeal road shows to competition has gained investors’ admiration, the already full schedule of meetings and conferMicrosoft battles the perception that it is a dim 24% ences it regularly hosts or attends. Sell-side anaplodder — despite mounting evidence that its Server lysts surveyed by Institutional Investor voted & tools strategic plotting has been consistently shrewd. (Exchange) the company’s investor relations the best in its 1% 4% 13% On Ballmer’s watch, Microsoft’s revenue has sector (Institutional Investor, February 2010). grown by 172 percent; earnings per share have And the days when private audiences with execWindows ecosystem tripled. But over the same period, the company’s utives were arranged for certain analysts, such Online services (MSN, Bing) stock has been dead money. “Mister Softee,” as as Goldman, Sachs & Co.’s longtime AART first Entertainment and devices (Xbox) Unsegmented revenue teamer Rick Sherlund — who squired Gates the shares are known on the Street, probably
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around Wall Street when Goldman brought customers say Microsoft’s infamous take-no-pristhe company public — are long gone. (Sherlund oners sales and marketing culture has survived quit sell-side research in 2007 and now runs his the scrutiny of trustbusters. One IT executive own private fund.) recently involved in shutting down a failed hedge “There’s no one who’s family anymore,” says fund groans over the“pointlessly legal”demands Citi’s Pritchard, a ten-year Street veteran who Microsoft placed on the firm to prove that it was like most Microsoft analysts today has covered no longer using licensed software. the company only since Ballmer became CEO. As for its prominence in the American psyche, “It’s just been democratized.” In recognition the company’s position seems as entrenched of Regulation FD, which prohibits companies as ever. Google’s unofficial corporate motto, from selectively disclosing material informa“Don’t be evil,” for example, carries an implied tion, Microsoft has opened events like its financorollary that’s understood by millions of cial analyst meeting — a daylong affair held Americans, and not just Silicon Valley–types: annually in Redmond — to anyone with an “Don’t become Microsoft.” But the past decade has seen important shifts in the public’s image Internet connection. of Microsoft. To be sure, Gates’s company has But unraveling the mystery of Microsoft attracted envy, resentment and even hatred from requires more than an Internet connection. It the outset, but ridicule of Microsoft became requires command of a company that seeks to a mainstream phenomenon during the 2000s make money using a variety of business models, some confounding and even contradictory, thanks to products that became punch lines while competing against rivals that succeed using rather than hits: operating system Vista, media yet other models, which might differ from the player Zune and smartphone Kin. Microsoft ones their founders started with, in markets that fans may find some solace in the fact that the didn’t even exist a few years earlier. Except, that company contributed to one of the decade’s — Peter Klein, Microsoft is, when these same rivals are not competing at cultural touchstones, Apple’s popular “I’m a all: Currently, Microsoft counts among its bitterMac/I’m a PC” ad campaign (which chaffed est competitors such past partners as Apple, IBM Microsoft without even naming it — another and Sony Corp. — and, yes, even Yahoo! (Another reason that Ballmer, sign of the company’s continued prominence, at least). But the jeers who declined to speak with II for this story, is probably happy about of the generation that came of age this century are unlikely to draw not buying Yahoo! is that three months of negotiations convinced him laughter in Redmond. (Sample joke among today’s teenage geeks: that melding the two companies’ cultures would have been difficult.) “The day that Microsoft starts making things that don’t suck will be By most financial measures, Microsoft appears healthy, and its the day it starts making vacuum cleaners.”) juggernaut across the tech sector has been relentless. Earnings for its Analysts aren’t laughing, either. For Wall Street researchers, Microlatest fiscal year handily surpassed the Street’s expectations, and it soft has become something of a shaggy-dog story: long, complex and posted a profit margin that rivals in other industries can only dream full of woolly detail, with — worst of all — a letdown at the end.“We of: just under 40 percent. That’s about twice IBM’s and well above spend more time on Microsoft than on any other company [in our the profit margin of every large-cap name in tech, including Apple (30 universe],” says Citi’s Pritchard. “It’s bigger, more complicated, in percent) and Google (35 percent). Among its fellow members of the more markets than the rest.” For example, Microsoft breaks out its Dow Jones industrial average, which Microsoft joined in 1999, only financial results for its five business divisions (down from seven, after drugmaker Merck & Co. coins it at a higher rate. And Microsoft’s a 2008 reorganization), each of which “is like a company in itself,” latest results are no fluke. Over the past five years, despite the recent notes Sarah Friar, who took over Sherlund’s Microsoft coverage at recession, operating margins never strayed outside a band of 34 to 37 Goldman in 2007.“You have to delve into a lot of minutiae to be able percent; over the past ten years, they’ve averaged 35 percent — two to tell a client something worthwhile about Microsoft,” Friar sighs. points above the 33 percent average achieved from 1986 to 1995, “There are maybe 20 percent of my [portfolio manager] clients who Microsoft’s first decade as a public company. want that kind of minutiae — and 80 percent who just don’t care.” Nor has the company shown any backtracking from its larger Another challenge for analysts stems from all the bumping mission. The corporate motto that Gates himself says he fashioned in around that goes on in the tech sector. Wall Street usually groups Microsoft’s earliest days — “A computer on every desk and in every Microsoft with enterprise software companies like Oracle Corp. home, all running Microsoft software” — is still chiseled in stone on and SAP that compete with it for corporate clients; also included in the company’s Redmond campus. (Gates stepped down in 2008 to the typical software analyst’s universe are companies that have sucpursue the work of his charity; he remains chairman of the board.) The ceeded by carving out niches in the desktop market, such as Intuit, company boasts that in the past decade it has created no less than eight the maker of QuickBooks, and Symantec Corp., which provides new product lines with sales of more than $1 billion each, ranging from security and storage management solutions. But the competition that’s weighed heaviest on Microsoft’s stock this the Exchange and SharePoint server systems that help workers send e-mail and collaborate on documents to Xbox, the gaming console that decade hasn’t come from this universe. Instead, Microsoft’s analysts continued on page 94 Microsoft pits against Sony’s PlayStation and Nintendo Co.’s Wii.And
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“In the long run, customer satisfaction is probably the single biggest leading indicator of our financial performance.”
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eachyear in the U.S., according to accounting and consulting . This past decade, however, an average of 126 companies went 76 percent decline, despite two bull markets and strong GDP ht). Couple the lack of IPOs with the natural attrition in stock er of publicly traded companies in the U.S. has shrunk by more it peaked in the mid-1990s. ormation in the U.S. is on life support,” warns David Weild IV, ital markets group at Grant Thornton and is the founder and estment bank Capital Markets Advisory Partners in New York. a critical part of a capital markets ecosystem that includes analysts, investment bankers and venture capitalists. A healthy st rates and product innovations combine to provide the rich le IPO market. And with the maturation of Internet companies, merce, widespread adoption of computers and the resulting t to mention aging baby boomers to consume new biomedical hould have been an ideal time for companies to be formed and tivity wof August. Weild calculates tas threadbare. ithin tof August. Weild calculates the ecosystem itself. Public een dependent on quality equity research. Investment banks id for that research, and the analysts who produce it, through vestors commissions and earning the difference between a prices, or spread). But beginning in the mid-1990s, regulatory anging from the rise of online brokerage to order-handling tion, reduced the profitability of trading — and undermined ives for firms to create in-depth investment research. When er support research with commissions and trading revenue, ent banking, butof August. Weild calculates tof August. Weild ent conflicts of interest eventually attracted the attention of cians. ew York State attorney general Eliot Spitzer unwittingly lar of economic support for investment research by prohibitinvestment banking revenue to underwrite the work of their ering thousands of public companies. Although the motives of ly pure — to protect mom-and-pop investors from Wall Street tocks that they secretly thought were dogs — his actions have equences. In the wake of the landmark Global Research Analyst treet has decoupled research from its primary funding source, e dropped coverage of all but the largest U.S. companies. As a nd midcap companies are in the penalty box, unable to attract Street even as demand from investors has grown, and many een discouraged from pursuing IPOs. should live in infamy,” says Charles Newhall III, co-founder m New Enterprise Associates, which in the past three decades n 650 companies, including 165 that have gone public. “There n sof August. Weild calculates tof August. Weild calculates
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By JULIE SEGAL
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Initial public offerings, those sweet harbingers of economic growth, are on the rise. General Motors Co., once the world’s most influential carmaker, is returning to the market next month in what may be the largest IPO ever. Hulu, the popular video web site, is planning an IPO that has investors daydreaming of dot-com riches.
Death of the IPO
ONAL INVESTOR OBITUARIES OCTOBER 4, 2010
CAPITAL MARKETS
ccompanies were born eachyear in the U.S., according to co ing firm Grant Thornton. This past decade, however, an a in went public every year — a 76 percent decline, despite tw w GDP growth (see chart, right). Couple the lack of IPOs wi G sstock st t listings, and the number of publicly traded compan b more than 40 percent since it peaked in the mid-199 by “Today capital formation in the U.S. is on life supp IV, IIV V who heads up the capital markets group at Grant Tho aand an n CEO of boutique investment bank Capital Mark New York. N IPOs have been a critical part of a capital markets eentrepreneurs, en n equity analysts, investment bankers an healthy h he e economy, low interest rates and product innovat the tth h rich soil needed for a fertile IPO market. And with th ccompanies, co o growth in online commerce, widespread ad the tth h resulting productivity gains, not to mention aging ba new biomedical creations, the 2000s should have been an n ne to o be formed and go public. Yet IPO activity was thread The reason lies within the ecosystem itself. Public dependent on quality equity research. Investment bank d de for fo o that research, and the analysts who produce it, thr iinvestors in n commissions and earning the difference betwe prices, or spread). But beginning in the mid-1990s, regul p pr r ranging from the rise of online brokerage to order-han ra ization, reduced the profitability of trading — and un incentives for firms to create in-depth investment resea no longer support research with commissions and tradi to investment banking, but the inherent conflicts of inte the attention of regulators and politicians. In 2003 then–New York State attorney general E destroyed the last pillar of economic support for investm ing firms from using investment banking revenue to und armies of analysts covering thousands of public compani of Spitzer were seemingly pure — to protect mom-andStreet analysts promoting stocks that they secretly th actions have had unintended consequences. In the wake Research Analyst Settlement, as Wall Street has decoupl mary funding source, brokerage firms have dropped cove U.S. companies. As a result, many small- and midcap co box, unable to attract attention from Wall Street even as has grown, and many entrepreneurs have been discoura “Spitzer’s name should live in infamy,” says Charles of venture capital firm New Enterprise Associates, which has funded more than 650 companies, including 165 “There was good research in small companies, even if
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n if some got tainted in the speculative fervor of the bubble.” surely had its low point in the 1990s, as analysts appeared on s networks touting sky-high price targets for companies that bringing public. But the best analysts allowed good ideas to anies — and good companies to turn into good investments. he market makers would commit capital, research analysts had the salespeople would get on the phone and they would find a ho spent 14 years at Prudential Securities in senior investment apital market positions, including co-chairman of the firm’s mmittee for equity research, investment banking, institutional hat kept people honest was the great competition for ideas. an analyst would cover 15 stocks, and he didn’t have to tout search, investment b over another.” nt, research staffs have been slashed, pay has been cut, analysts dge funds and other investment firms, and capital and sales e for all but the biggest stocks. To be sure, large-cap stocks still of research analysts. That’s where the trading volume is and . Nearly 50 percent of publicly listed companies, however, have an $350 million, well below the radar of most sell-side firms. entrepreneurs and venture capitalists who want to take their wenty years ago the median IPO was $10 million. In 2009 it imilarly, from 1991 through 1997, 80 percent of IPOs were ion. Since 2000 just 20 percent of IPOs have fallen in that range. ital markets for financing innovation in the U.S. are virtually e knows it has happened,” says Newhall, one of the deans of ndustry. “Nasdaq [with its population of technology-heavy, the goose that laid the golden eggs for the American economy.” ,823 in 1997, the number of publicly traded companies had the end of August. Weild calculates that 360 new listings are st to replace exiting companies. If the U.S. wanted to expand ted companies at 3 percent annually — about equal to GDP ave to add 520 new public companies every year, a far cry from t. Weild calculates tof August. Weild calculates tarkets are today. ly American problem. IPOs outside the U.S. are humming. n Tokyo rose 28 percent from 1997 through 2008; listings in Hong Kong, 65 percent in Sydney and 11 percent in Toronto, hornton. Listings in Germany and Italy for the same period rose rcent, rof August. Weild calculates tespectively. ts, who closely follow public companies and know the ins and ls and strategies, play an important role in the capital-raising companies to the attention of investors, drum up excitement Without them, companies can have difficulty finding takers. icly traded companies feel abandoned,” says Robert Mancuso, ing partner of private equity firm Dellacorte Group. “You h report a year, but that’s not coverage.” Mancuso has directly e of the IPO over a 34-year career that began with a stint at ard Frères & Co. and included three years as CEO of Merrill rs, overseeing Merrill’s first private equity fund. ment banks provide research on what their clients want — and . The heads of research at several major banks say their firms ercent of the dollar value of their clients’ holdings. Those same ish research on only a tiny fraction of the total number of U.S. gan, fof August. Weild calculates tor example, which has the erse, puts out research on 1,135 U.S. companies. e U.S. IPO market have had a dramatic impact on the venture ture capitalists, which Weild calls the “Johnny Appleseeds” have little choice but to pursue alternatives to going public. of venture capital exits now are done through mergers and lly, large companies buying small players.“Venture capitalists their portfolios and saying, ‘It’s been so long since one of my lic that I may want to see these firms get acquired,’” says Mark the National Venture Capitalcompanies were born eachyear g to accounting and consulting firm Grant Thornton. This r, an average of 126 companies went public every year — a 76 ite two bull markets and strong GDP growth (see chart, right). Os with the natural attrition in stock listings, and the number mpanies inof August. Weild calculates t the U.S. has shrunk by t since it peaked in the mid-1990s. ormation in the U.S. is on life support,” warns David Weild IV, ital markets group at Grant Thornton and is the founder and estment bank Capital Markets Advisory Partners in New York. a critical part of a capital markets ecosystem that includes
companies were born eachyear in the U.S., according to accounting and consulting firm Grant Thornton. This past decade, however, an average of 126 companies went public every year — a 76 percent decline, despite two bull markets and strong GDP growth (see chart, right). Couple the lack of IPOs with the natural attrition in stock listings, and the number of publicly traded companies in the U.S. has shrunk by more than 40 percent since it peaked in the mid-1990s.
growth in online commerce, widespread adoption of computers and the resulting productivity gains, not to mention aging baby boomers to consume new biomedical creations, the 2000s should have been an ideal time for companies to be formed and go public. Yet IPO activity was threadbare. The reason lies within the ecosystem itself. Public offerings have long been dependent on quality equity research. Investment banks have traditionally paid for
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Then there’s Skype, the company that allows free calls over the Internet, looking to raise $100 million. Rumors abound that social media juggernaut Facebook may soon decide to go public, in a deal that could rival Netscape Communications Corp.’s 1995 offering, which boldly ushered in the Internet era. Indeed, this is shaping Spitzer’s 2003 research settlement up to be the best year Eliot with Wall Street sealed the IPO’s fate for capital raising since 2007. As of September 24, some 90 companies had gone public, raising $13.6 billion, compared with just 64 companies for all of 2009. All told, 192 companies have filed to go public
speculative fervor of the bubble.” Equity research surely had its low point in the 1990s, CNBC and other news networks touting sky-high price t they’d had a hand in bringing public. But the best analys turn into good companies — and good companies to tur “In the old days, the market makers would commit c had an opinion, and then the salespeople would get on th find a buyer,” says Weild, who spent 14 years at Prude investment banking and equity capital market positions of the firm’s strategic planning committee for equity resea institutional sales and trading.“What kept people hones tion for ideas. At any point in time, an analyst would cove have to tout one over another.” Since the settlement, research staffs have been sla analysts have scattered to hedge funds and other inve tal and sales support is largely gone for all but the big large-cap stocks still garner the attention of research a trading volume is and thus the commissions. Nearly 50 companies, however, have market caps of less than $35 radar of most sell-side firms. Size matters for entrepreneurs and venture capit their companies public. Twenty years ago the median I 2009 it was $140 million. Similarly, from 1991 throu IPOs were smaller than $50 million. Since 2000 just 2 fallen in that range. “I think our capital markets for financing innovatio destroyed, and no one knows it has happened,” says N of the venture capital industry. “Nasdaq [with its po heavy, smaller listings] was the goose that laid the golde economy.” From a peak of 8,823 in 1997, the number of publicl fallen to 5,107 as of the end of August. Weild calculates needed every year just to replace exiting companies. If th the number of its listed companies at 3 percent annuall growth — it would have to add 520 new public compa from where the markets are today. This is a decidedly American problem. IPOs outsid Corporate listings in Tokyo rose 28 percent from 199 increased 92 percent in Hong Kong, 65 percent in Sy Toronto, according to Grant Thornton. Listings in Ge same period rose 36 percent and 26 percent, respectivel Research analysts, who closely follow public compa outs of their financials and strategies, play an important r process. They call the companies to the attention of in ment and create liquidity. Without them, companies ca takers.“CEOs of small publicly traded companies feel a Mancuso, founder and managing partner of private equit “You might get one research report a year, but that’s not directly witnessed the decline of the IPO over a 34-year stint at investment bank Lazard Frères & Co. and inclu of Merrill Lynch Capital Partners, overseeing Merrill’s f To be sure, investment banks provide research on w and are willing to pay for. The heads of research at sever firms cover more than 80 percent of the dollar value o Those same firms, however, publish research on only a number of U.S. companies. J.P. Morgan, for example coverage universe, puts out research on 1,135 U.S. com The troubles in the U.S. IPO market have had a venture capital industry. Venture capitalists, which Appleseeds” for the IPO market, have little choice but t going public. Close to 90 percent of venture capital exit mergers and acquisitions — typically, large companie “Venture capitalists today are looking at their portfolio long since one of my companies went public that I may get acquired,’” says Mark Heesen, president of the N Association, who has advocated for the venture industry just 25 percent of venture transactions were M&A dea typically took 4.3 years for a venture-backed company t time had more than doubled, to 10.3 years. IPOs aren’t just a way for investors to potentially get to cash in. They are engines of job creation, as newly publ periods of high growth and robust hiring. In fact, accor
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this year, compared with 119 in 2009. Market experts are declaring that the IPO is back. But they’re wrong. As the media, investors and investment banks swarm around companies selling shares to the public, what’s lost is that this year’s 90 completed IPOs is a paltry figure when viewed in historical terms. From 1991 to 2000 an average of 530 public companies were born each year in the U.S., according to accounting and consulting firm Grant Thornton. This past decade, however, an average of 126 companies went public every year — a 76 percent decline, despite two bull markets and strong GDP growth (see chart, right). Couple the lack of IPOs with the natural attrition in stock listings, and the number of publicly traded companies in the U.S. has shrunk by more than 40 percent since it peaked in the mid-1990s. “Today capital formation in the U.S. is on life support,” warns David Weild IV, who heads up the capital markets group at Grant Thornton and is the founder and CEO of boutique investment bank Capital Markets Advisory Partners in New York. IPOs have been a critical part of a capital markets ecosystem that includes entrepreneurs, equity analysts, investment bankers and venture capitalists. A healthy economy, low interest rates and product innovations combine to provide the rich soil needed for a fertile IPO market. And with the maturation of the Internet, growth in online commerce, widespread adoption of computers and the resulting productivity gains, the 2000s should have been an ideal time for companies to form and go public. Yet IPO activity was threadbare. The reason lies within the ecosystem itself. Public offerings have long been dependent on quality equity research. Investment banks have traditionally paid for that research, and the analysts who produce it, through trading (charging investors commissions and earning the difference between a stock’s bid and offer prices, or spread). But beginning in the mid-1990s, regulatory and other changes, ranging from the rise of online brokerage to order-handling rules and decimalization, reduced the profitability of trading — and undermined the economic incentives for firms to create in-depth investment research. When banks could no longer support research with commissions and trading revenue, they turned to investment banking, but the inherent conflicts of interest eventually attracted the attention of regulators and politicians. In 2003 then–New York State attorney general Eliot Spitzer
unwittingly destroyed the last pillar of economic support for investment research by prohibiting firms from using investment banking revenue to underwrite the work of their armies of analysts covering thousands of public companies. Although Spitzer’s motives were seemingly pure — to protect momand-pop investors from Wall Street analysts promoting stocks that they secretly thought were dogs — his actions have had unintended consequences. In the wake of the landmark Global Research Analyst Settlement, as Wall Street has decoupled research from its primary funding source, brokerage firms have dropped coverage of all but the largest U.S. companies. As a result, many small- and midcap companies are in the penalty box, unable to attract attention from Wall Street even as demand from investors has grown, and many entrepreneurs have been discouraged from pursuing IPOs. “Spitzer’s name should live in infamy,” says Charles Newhall III, co-founder of venture capital firm New Enterprise Associates, which has funded more than 650 companies, including 165 that have gone public. “There was good research in small companies, even if some got tainted in the speculative fervor of the bubble.” Equity research surely had its low point in the 1990s, as analysts appeared on CNBC and other news networks touting sky-high price targets for companies that they’d had a hand in bringing public. But the best analysts allowed good ideas to turn into good companies — and good companies to turn into good investments. “In the old days, the market makers would commit capital, research analysts had an opinion, and then the salespeople would get on the phone and they would find a buyer,” says Weild, who spent 14 years at Prudential Securities in senior investment banking and equity capital market positions, including co-chairman of the firm’s strategic planning committee for equity research, investment banking, institutional sales and trading. “What kept people honest was the great competition for ideas. At any point in time, an analyst would cover 15 stocks, and he didn’t have to tout one over another.” Since the settlement, research staffs have been slashed, pay has been cut, analysts have scattered to hedge funds and other investment firms, and capital and sales support is largely gone for all but the biggest stocks. To be sure, large-cap stocks still garner the attention of research analysts. That’s where the trading volume is. Nearly 50 percent of publicly listed companies, however, have market caps of less than $350 million, well below the radar of most sell-side firms. Size matters for entrepreneurs and venture capitalists who want to take their companies public. Twenty years ago the median IPO was $10 million. In 2009 it was $140 million. Similarly, from 1991 through 1997, 80 percent of IPOs were smaller than $50 million. Since 2000 just 20 percent of IPOs have fallen in that range. INSTITUTIONALINVESTOR.COM
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“I think our capital markets for financing innovation in the U.S. are virtually destroyed, and no one knows it has happened,” says Newhall, one of the deans of the venture capital industry. “Nasdaq [with its population of technology-heavy, smaller listings] was the goose that laid the golden eggs for the American economy.” From a peak of 8,823 in 1997, the number of publicly traded companies had fallen to 5,107 as of the end of August. Weild calculates that 360 new listings are needed every year just to replace exiting companies. If the U.S. wanted to expand the number of its listed companies at 3 percent annually — about equal to GDP growth — it would have to add 520 new public companies every year, a far cry from where the markets are today. This is a decidedly American problem. IPOs outside the U.S. are humming. Corporate listings in Tokyo rose 28 percent from 1997 through 2008; listings increased 92 percent in Hong Kong, 65 percent in Sydney and 11 percent in Toronto, according to Grant Thornton. Listings in Germany and Italy for the same period rose 36 percent and 26 percent, respectively.
want — and are willing to pay for. The heads of research at several major banks say their firms cover more than 80 percent of the dollar value of their clients’ holdings. Those same firms, however, publish research on only a tiny fraction of the total number of U.S. companies. J.P. Morgan, which has the largest coverage universe, puts out research on 1,135 U.S. companies; Barclays Capital, which acquired the North American research group of Lehman Brothers Holdings in September 2008, covers 965 companies; and BofA Merrill Lynch Global Research follows 950. The troubles in the U.S. IPO market have had a dramatic impact on the venture capital industry. Venture capitalists, which Weild calls the “Johnny Appleseeds” for the IPO market, have little choice but to pursue alternatives to going public. Close to 90 percent of venture capital exits now are done through mergers and acquisitions — typically, large companies buying small players.“Venture capitalists today are looking at their portfolios and saying, ‘It’s been so long since one of my companies went public that I may want to see these firms get acquired,’” says Mark Heesen, president of the National Venture Capital Association. In 1993 just 25 percent of UNDERWRITING THE ECONOMY: WITHOUT A HEALTHY IPO venture transactions were M&A deals, he adds. Back MARKET, THE U.S. WILL STRUGGLE TO REDUCE UNEMPLOYMENT then, it typically took 4.3 years for a venture-backed 10.0 company to go public. By 2009 the time had more than 800 doubled, to 10.3 years. IPOs aren’t just a way for investors to potentially get 700 9.0 rich or for entrepreneurs to cash in. They are engines Number of IPOs of job creation, as newly public companies often enjoy 600 8.0 periods of high growth and robust hiring. In fact, U.S. unemployment rate according to Grant Thornton, because of the dearth of 500 IPOs, 22 million potential jobs were not created during 7.0 the past decade. That’s roughly 3 times the 7.3 mil400 lion jobs that were lost during the Great Recession of 6.0 2007–’09 — unpleasant statistics for a country that is 300 hoping to avoid a double-dip recession. 200
5.0
WALL STREET INVESTMENT RESEARCH traces its roots back to the 1960s, when growing pen4.0 100 sion funds, mutual fund complexes and other big institutional investors started looking to their brokerage 0 3.0 firms to help them in the labor-intensive task of assess1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ing stocks. Donaldson, Lufkin & Jenrette was one of the (through August) Source: Grant Thornton pioneers in the field, exchanging good ideas in return for executing trades, and underwriting its growing ranks Research analysts, who closely follow public companies and know of analysts with the riches from commissions and trading spreads. the ins and outs of their financials and strategies, play an important Soon every brokerage firm followed suit and Institutional Investor role in the capital-raising process. They call the companies to the got into the game, launching its first All-America Research Team attention of investors, drum up excitement and create liquidity. ranking of top equity analysts in 1972. Three years later, Congress deregulated brokerage commissions, Without them, companies can have difficulty finding takers.“CEOs of small publicly traded companies feel abandoned,” says Robert a move that unleashed a wave of discounting among firms. In the Mancuso, founder and managing partner of private equity firm wake of deregulation and increased competition, smaller players Dellacorte Group. “You might get one research report a year, but were acquired by big shops that had enough volume to offset lower that’s not coverage.” Mancuso has directly witnessed the decline of commissions. Paine Webber snapped up Mitchell, Hutchins & Co., the IPO over a 34-year career that began with a stint at investment and Drexel Burnham Lambert bought William D.Witter, to name two bank Lazard Frères & Co. and included three years as CEO of Merrill such deals. Research survived, though the changes started chipping Lynch Capital Partners, overseeing Merrill’s first private equity fund. away at firms’ lush profit margins. Around that time, investment continued on page 98 To be sure, investment banks provide research on what their clients INSTITUTIONALINVESTOR.COM
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Brazil’s PHOTOGRAPHS BY GUTO SEIXAS
Former bond trader André Esteves wants to build BTG Pactual into the preeminent investment bank in the emerging markets. Here’s why the Brazilian banker may well succeed.
By Jason Mitchell
A
NDRÉ ESTEVES BEGINS HIS
working week on Sunday evening.The youthful chief executive officer of BTG Pactual, Brazil’s largest independent investment bank, invites half a dozen or so of the bank’s senior partners to his apartment in the upscale Jardins neighborhood of São Paulo. Over water and coffee they discuss strategy, plan activities for the coming week and occasionally make decisions on major deals. At a Sunday night meeting in May, for instance, the partners agreed to acquire Rede D’Or, a leading network of private hospitals in Rio de Janeiro. The firm didn’t disclose the amount, but it was a typical BTG Pactual deal, using both the partners’ own money and capital from third-party investors. “We have a hard-working culture at Pactual,” the banker says in English with a strong Brazilian accent. “The harder you work, the more luck you have.” Esteves, 41, has worked harder — and enjoyed more luck — than most. In 1989 the Rio native joined the Pactual banking boutique as an intern fresh out of university,
CEO André Esteves: “I am still hungry and desperate to get richer” INSTITUTIONALINVESTOR.COM
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BRAZIL
and he quickly proved himself a talented debt trader and corporate financier. Within a decade he led a cadre of young bankers in taking control of Pactual from its founder, then in 2006 he sold the bank to UBS in a deal that made him one of Brazil’s wealthiest men. When massive subprime losses pushed the Swiss bank deep into the red, he bought back Pactual and merged it with his start-up asset management firm, BTG Investments. Over the past year, Esteves has pushed the new BTG Pactual into the front ranks of investment banking in Brazil, building a major equities and M&A franchise and a growing fixed-income business. The ambitious banker is only getting started. Esteves aims to turn BTG Pactual into the preeminent investment bank of Latin America and one of the most important asset managers in the emerging markets. “I think we can build a fantastic institution, the largest emergingmarkets investment bank and investment firm,” says Esteves, who punctuates his comments with a broad, boyish smile.“Our ambition is big, but it is long term. I think we will have achieved something fantastic within ten years.” Roberto Sallouti, BTG Pactual’s chief operating officer, who has worked with Esteves for 16 years, echoes his boss’s aspiration.“Why can’t Brazil have a global investment bank?” he asks.“The U.S. and Switzerland have them.” Esteves’ vision is bold but not foolhardy. His astonishing track record combined with Brazil’s newfound dynamism give him and his team a solid chance of success. The financial crisis has shifted the tectonic plates of the global economy. While the U.S. and Europe struggle with a huge debt overhang and sputtering economies, Brazil and other emergingmarkets countries are resurgent. Brazil’s economy is expected to grow by just over 7 percent this year, according to the International Monetary Fund, one of the fastest rates in the EM world after China and India. Brazil faces a presidential election this month, an event that in years past has often sparked financial turmoil, but both the leading candidates — Dilma Rousseff of President Luiz Inácio Lula da Silva’s Workers’ Party and her center-right rival, José Serra of the opposition Brazilian Social Democracy Party — are committed to maintaining the liberal economic policies that have seen the country prosper over the past decade. Brazilian outfits like mining company Vale, aircraft maker Empresa Brasileira de Aeronáutica and Itaú Unibanco Holding have become major players beyond Brazil. The country boasts the most-vibrant capital markets in Latin America; a fourfold surge in equity prices over the past decade and a rash of major IPOs have created an abundance of wealth. Esteves is determined to take advantage of those trends and make BTG Pactual a regional, and global, player. As the biggest country in Latin America and the Caribbean, and a magnet that attracts the largest share of the region’s foreign direct investment, Brazil provides an ideal springboard for Esteves’ ambition. The firm is off to a hot start. Since obtaining its banking license in September 2009, BTG Pactual has participated in 11 initial public offerings that raised a combined $24.5 billion. The deals included last October’s $8 billion offering of Banco Santander’s Brazilian subsidiary, the world’s largest IPO in 2009. In the same period the bank has advised on 13 mergers and acquisitions, valued at a total of $12.5 billion. BTG Pactual advised Cosan, a Brazilian
THE ANALYST ISSUE
sugar and ethanol producer, on a $4.9 billion ethanol joint venture with Royal Dutch Shell in February. As of late August the bank ranked third this year in equity capital markets in Brazil, with a 14.9 percent market share, trailing only Itaú Unibanco and Bank of America Merrill Lynch, according to data provider Dealogic. It also ranked third in
M&A, behind Credit Suisse and Morgan Stanley, advising on 21 deals worth $20.9 billion, in total. In August the bank advised Tam Linhas Aéreas, a Brazilian airline, on its $2.7 billion merger with Chilean carrier Lan Airlines, a deal that will create Latin America’s biggest airline. In his expansion effort, Esteves’ first priority is to build out BTG Pactual’s investment banking platform across Latin America. The region “is in very good shape,” he says. “Mexico, Colombia, Peru, Chile — they all have very good markets, very good macro numbers. They have independent central banks and floating exchange-rate regimes. Their economies have not suffered any economic disasters recently, and they have become much more stable.” The bank is extending its research and equity coverage and aims to cover all of Latin America within two years. BTG Pactual has roughly 50 analysts and ranks second in research in Brazil, behind Itaú Securities, according to Institutional Investor’s 2010 All-Brazil Research Team. It also ranks sixth in Latin American research. The bank has also been reaching out to other local investment banks in
“I think we can build a fantastic institution, the largest emerging-markets investment bank and investment firm.” —André Esteves, BTG Pactual INSTITUTIONALINVESTOR.COM
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José Miguel Vilela (left) heads equity sales, and former central bank president Persio Arida spearheads the growth of asset management
the region for possible deals. In August, for example, Esteves was the keynote speaker at a seminar on Brazil in Santiago, Chile, organized by LarrainVial, a leading independent investment bank in Chile, with $12 billion in assets under management. “We may make some niche acquisitions of some investment banking boutiques in other countries in the region, or we may make strategic partnerships with other groups if we find the right people,” says Esteves. BTG Pactual also aims to capitalize on the current trend in favor of emerging markets to transform itself into an international player in money management. The bank’s asset management subsidiary already manages 53.7 billion reais ($31.1 billion), the bulk of it for Brazilian institutional investors. The bank also has a wealth management arm that manages R26.3 billion for private clients. Although it has scale, the bank’s money management business is a very local operation: Roughly 90 percent of assets are from Brazilian clients. Esteves sees no reason why BTG Pactual, with its deep experience in Brazil, can’t compete for international mandates with global players like London-based Ashmore Investment Management, a leading EM investor, with some $35 billion under management. The firm has raised $1 billion this year for a global emerging-markets fund run by a team of five senior portfolio managers and 40 investment professionals from offices in São Paulo, London and New York. “I think we can equal Ashmore Investment within two years, probably sooner,” says Esteves. “Its key holding is in Brazil. The country is strongly weighted in many global emerging-markets funds. We already have a large sum of assets under management, but that is INSTITUTIONALINVESTOR.COM
mostly Brazilian money. I think we can raise the same amount again, if not more, internationally.” One of the biggest challenges Esteves faces in trying to grow his empire is the burgeoning competition. Buoyant economies and capital markets in other key emerging markets are fueling the rise of other local champions with big ambitions, but Esteves believes his firm has several important advantages over potential rivals. China’s Citic Securities Co., for example, enjoys a leading position in equity underwriting in China, the world’s biggest source of IPOs, but that bank is a state-controlled institution whose managers lack the entrepreneurial freedom of BTG Pactual’s executives, he says. Russia’s Troika Dialog and Renaissance Capital are based in a country where the economy is heavily dependent on energy. “In many ways, Brazil is more developed than the other BRICs,” says Esteves. “It has greater liquidity, and market institutions are more advanced. The country’s political institutions are more solid, and there is more transparency. Its rule of law has a stronger basis than in the other BRICs. This is an advantage for Brazil — and for BTG Pactual.” Esteves has more than the BRICs to contend with, meanwhile. The Brazilian market, like emerging markets generally, are attracting plenty of attention from global bulge-bracket firms, which are looking for new growth areas to offset sluggishness in the U.S. and European markets. Bank of America Merrill Lynch, Credit Suisse, HSBC Holdings, JPMorgan Chase & Co., Morgan Stanley and Santander are among the international banks looking to build on their already-strong presence in Brazil, while the country’s two leading retail and commercial banks, Itaú Unibanco and Banco do Brasil, are expanding their investment banking arms. Esteves isn’t daunted by the competition.“BTG Pactual’s big advantage over the big international banks is the fact that we are from the emerging markets,” says Esteves.“It is part of our DNA. You must understand the culture of emerging markets. It is easier to understand what is happening in Kazakhstan being based in Brazil than in New York. We lived through all the periods of economic volatility in Brazil, and we appreciate that that can happen in other emerging markets. We know how to navigate it.” BTG Pactual’s other big challenge is scale. The bank expects to have net income of about $750 million this year, on revenue of $1.4 billion. It has a lofty tier-1 capital ratio of 18 percent. The bank has net equity of just $3.9 billion, though. Its small capital base threatens to hold back growth, especially in fixed-income markets. The bank ranked a modest tenth in Brazil’s debt capital markets this year, as of late August, having participated in five deals, valued at a combined $1.1 billion, according to Dealogic. Santander, HSBC and Banco do Brasil held the top three places. Already there are strong market rumors that Esteves is looking for international investors. Sources close to the bank say BTG Pactual is in talks with a group of investors including Government of Singapore Investment Corp., the $185 billion sovereign wealth fund, about continued on page 101
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“There is a price for every asset.”
Kevin St. Pierre Sanford C. Bernstein & Co. Banks/Midcap
The 2010 All-America Research Team
In a year when macro concerns overshadowed stock picking, investors say these analysts offered a world of good advice. Page 72
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO
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Longtime followers of the All-America Research Team, now in its 39th year, will notice some changes to the profiles that appear on the pages that follow. In years past all ranked analysts and teams, from first place through runner-up, were listed in the sectors in which they placed. This year we feature only those analysts and teams at No. 1 in their respective sectors, in expanded profiles that give a greater voice to the portfolio managers and buy-side analysts on whose opinions this ranking is based. Profiles of those in second and third place, whose write-ups have been similarly expanded, can be found on our web site, institutionalinvestor.com, along with a wealth of related data: the runners-up in each sector; the Next Generation, a roster of top analysts who’ve been publishing research for three years or less; Who’s the Best, which identifies analysts who surpass their peers in certain research attributes; and more. The site’s revamped archives also let subscribers see how these analysts, teams and firms have fared in years past. Take a look. — Thomas W. Johnson
Managing Editor Thomas W. Johnson Senior Editors Tucker Ewing Jane B. Kenney Associate Editors Denise Hoguet Fritz Owens
Cover photo by Chris Buck
THE 2010 ALL-AMERICA RESEARCH TEAM
The Best Analysts of the Year
By the end of August, the stock had raced to $65.83, for a gain of 9.8 percent that breezed past the sector by 17.8 percentage points. “He really knows his companies well and is focused on the key stock drivers,” declares one buy-side backer.
and relatively low utilization at the time.” His call was right on the money: The stock shot up to almost $70 in early April before falling to $42.49 by the end of August but nonetheless managed a 7.9 percent gain that outperformed the sector by 7.3 percentage points.
METALS & MINING
PAPER & PACKAGING
BASIC MATERIALS
Michael Gambardella George Staphos J.P. Morgan CHEMICALS
P.J. Juvekar
The buy side says: “Mike is a solid analyst and an excellent resource.”
Citi The buy side says: “He has great industry knowledge, right down to the product level for each of the companies he covers.”
iti’s P.J. Juvekar, 43, finishes in first place for a second consecutive year. “The analyst makes timely calls, provides excellent written research and knows the industry better than his peers,” insists one portfolio manager. Juvekar upgraded PPG Industries to buy in January, at $59.97, telling clients that the Pittsburgh-based producer of coatings for industrial, architectural and auto markets would benefit from increased auto production, as inventories had been depleted in 2009 because of the Car Allowance Rebate System, better known as the cash-for-clunkers program. Juvekar also believed the company would reap benefits from rising industrial production, to which PPG’s earnings are highly correlated.
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ichael Gambardella, who sits atop the sector for a third year running, “has been covering this space for 25 years or more — I believe that is the right number — and he offers an unparalleled perspective, given his history with these companies and his relationships,” according to one satisfied client. The 53-year-old J.P. Morgan analyst reiterated his buy rating on Pittsburghbased U.S. Steel Corp. in November, at $39.37. Gambardella made the case that even a modest increase in demand would drive steel prices higher than the consensus anticipated. “Domestic supplies were tight from low imports and inventories, and competitors were already running at high utilization rates, with cost inflation from higher input prices such as scrap and iron ore,” the analyst explains. “The company was a leveraged play on these themes, given its high fixed-cost base
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BofA Merrill Lynch Global Research The buy side says: “George is a strong analyst who has been covering the packaging space longer than anyone I know.”
eorge Staphos of BofA Merrill Lynch Global Research is No. 1 for a third straight year. Staphos, 45, “does excellent work and is a solid resource,” according to one longtime client. In February the analyst upgraded AptarGroup — a producer of pumps, aerosol valves and other dispensing systems for the food and beverage, fragrance and pharmaceuticals industries — from neutral to buy. Staphos believed that the Crystal Lake, Illinois–based company was on the heels of a strong earnings report and that customers’ orders and interest levels in new product launches were rebounding. He also liked the company’s low debt level. The stock had jumped from $37.61 to $41.65 by the end of August, a gain of 10.7 percent that outperformed the broad market by 13.4 percentage points.
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LINA CHEN
A NEW FORMAT FOR A FAMILIAR TEAM
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ONAL WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE
CAPITAL GOODS/ INDUSTRIALS
AIRFREIGHT & SURFACE TRANSPORTATION
from neutral to overweight, at $56.24, arguing that the Eden Prairie, Minnesota–based logistics provider’s improving volume would more than offset demand softness. Right again. The stock jumped 15.6 percent, to $64.99, and trounced the sector by 18.3 percentage points, through August.
Thomas Wadewitz J.P. Morgan AEROSPACE & DEFENSE ELECTRONICS
Joseph Nadol J.P. Morgan The buy side says: “His views move the stocks more than any other analyst covering the sector.”
.P. Morgan’s Joseph Nadol, 38, takes top honors for a second year running. In September 2009, Nadol highlighted his long-standing overweight rating on Precision Castparts Corp., at $98.39, telling clients that the Portland, Oregon–based aerospace parts supplier would increase its market dominance through its acquisition of Carlton Forge Works, an enginecomponents manufacturer headquartered in Paramount, California; the deal was concluded that month. PCC’s stock surged 15 percent, to $113.18, and outperformed the sector by 12.7 percentage points, through August. An August 2008 downgrade from overweight to neutral on General Dynamics Corp., at $88.85, largely on declining sales of its combat systems, also proved prescient. Shares of the Falls Church, Virginia–based militaryvehicle provider had plunged 37.1 percent, to $55.87, by the end of August 2010; during the same period the sector fell 17.4 percent. “Joe is more knowledgeable and has better ideas than anyone else in the space,” asserts one impressed investor.
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The buy side says: “If we had to use only one analyst, Tom would be it.”
epeat first-teamer Thomas Wadewitz continues to wow investors with “top-notch recommendations,” as one fund manager puts it. In September 2009 the J.P. Morgan researcher upgraded United Parcel Service from neutral to overweight, at $52.49, betting on the Atlanta-based courier’s earnings growth. He was right: UPS’s shares soared to $69.71 in May before slipping to $63.80 by late August, delivering a 21.5 percent rise while the sector advanced 15.3 percent. In April, Wadewitz, 43, raised C.H. Robinson Worldwide
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BUSINESS, EDUCATION & PROFESSIONAL SERVICES
Andrew Steinerman J.P. Morgan The buy side says: “Andrew dominates the space and only gets better over time.”
t’s six years in a row at No. 1 for J.P. Morgan’s Andrew Steinerman, 42. “Andrew publishes incredibly thoughtful and timely proprietary surveys of the services subsectors,” observes one satisfied client, who empha-
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sizes Steinerman’s “Education Services Data Book,” a quarterly primer launched in January (it was an annual compendium in previous years), and the “Steinerman Staffing Study,” a monthly look at temp-hiring trends based on interviews with staffing professionals. In November the analyst reiterated his overweight rating on Robert Half International, when the Menlo Park, California–based staffer’s shares dipped to $21.85. Steinerman argued that temp help would pick up before overall employment. The stock catapulted to $31.81 in April before slumping to $21.58 by late August, but it still managed to lead the sector by 3.2 percentage points over the period. “Andrew is one of the last of the stock-picking analysts. He knows his industries stone cold and isn’t afraid to make an out-of-consensus call on an individual stock — we need more like him,” avers one buy-side supporter.
OVERALL RESEARCH STRENGTH To determine which brokerage firms have the greatest overall research clout, we combined the results of the All-America Fixed-Income Research Team (Institutional Investor, September 2010) with those of this poll. Here are the results. RANK 2010 2009
FIRM
TOTAL TEAM POSITIONS
TOTAL EQUITY POSITIONS
TOTAL FIXEDINCOME POSITIONS
101
46
55
1
2
J.P. Morgan
2
1
Barclays Capital
92
43
49
3
3
BofA Merrill Lynch Global Research
82
42
40
4
4
Credit Suisse
40
34
6
5
5
Goldman, Sachs & Co.
34
10
24
6
6
UBS
31
29
2
7
9
Deutsche Bank Securities
28
18
10
8
7
Citi
27
23
4
9
10
Morgan Stanley
26
24
2
10
8
Sanford C. Bernstein & Co.
25
25
0
ELECTRICAL EQUIPMENT & MULTI-INDUSTRY
Scott Davis Morgan Stanley The buy side says: “Scott’s reports are must-reading.”
organ Stanley’s Scott Davis ascends one level to make his first appearance in the winner’s circle, which for the past ten years had been occupied by Jeffrey Sprague. (Sprague left Citi in February to start his own firm, Vertical Research Partners of Stamford, Connecticut.) Davis, 42, receives high marks for his
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO January launch of a quarterly equipment-distributors survey and daily e-mail updates. Other boosters single out a February upgrade of Caterpillar from underweight to overweight, at $50.13, citing rising revenue. By late August shares of the Peoria, Illinois–based manufacturer of power-generating systems, engines and turbines had catapulted 30 percent, to $65.16, and blown past the sector by 25 percentage points. Davis, who graduated from Bethlehem, Pennsylvania’s Lehigh University in 1990 with a bachelor’s degree in economics, joined Morgan Stanley in 1996 after stints at Merrill Lynch and Capital Analysts. “Scott provides unbiased research, focusing on what truly makes companies prosper over the long term,” says one aficionado.
emerging economies would rapidly boost commodities prices and therefore mining demand. Sure enough, earnings rose — and the stock catapulted to $72.32 in April 2010 before settling to $57.49 in late August, for an eye-popping 399 percent gain that outperformed the sector by an incredible 371.7 percentage points. Kaplowitz “hits management with the right questions” and “provides impeccable service, with lightning-fast callbacks — day or night,” say two more supporters.
The buy side says: “David is the cream of the Wall Street crop!”
t’s ten straight years on top for David Raso, 40. The ISI Group analyst earns points for sticking with a buy on Deere & Co. since he reinitiated coverage in December 2008, at $38.69, citing the Moline, Illinois–based tractor maker’s strong balance sheet. Through August 2010 the stock soared to $63.27, advancing 48.2 percent in the preceding 12 months alone while the sector gained just 25.5 percent. In July, Raso upgraded United Rentals from hold to buy, at $8.83, on valuation and rising demand for the Greenwich, Connecticut–based rental company’s construction equipment. The stock had leapt 27.4 percent, to $11.25, by the end of the following month. “David’s fieldwork gives him an
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The buy side says: “Andrew is hands down the best analyst covering the group.”
ndrew Kaplowitz, 37, leads the pack for a second straight year. The Barclays Capital analyst “is able to put himself in my shoes and think like a buy-sider,” asserts one constituent. In March 2009, when the shares of South Milwaukee, Wisconsin–based mining-equipment manufacturer Bucyrus International dipped to $11.52, Kaplowitz underscored his overweight rating, arguing that rebounding
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Robert Drbul Barclays Capital The buy side says: “Robert is the go-to guy in his sector.” AIRLINES
Jamie Baker
amie Baker of J.P. Morgan makes it a hat trick, capturing top honors for a third year in a row.“He gives you tons of details, and he’s very thorough,” says one investor. In a September 2009 report,“Fundamentals on the Mend, Profits in the Distance,” the 42-year-old analyst turned bullish on the sector, arguing that the worst of the recession was over and that the airlines industry was poised for prosperity in 2010. Since then the sector outpaced the broad market by 31.9 percentage points, through August. Among the stocks Baker urged clients to buy was Chicago’s UAL Corp., parent company of United Air Lines, at $6.45. By late August the stock had flown to $21.20, a jawdropping 228.7 percent advance.
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ISI Group
Barclays Capital
APPAREL, FOOTWEAR & TEXTILES
The buy side says: “Jamie times the industry trends better than anybody in his peer group.”
David Raso
Andrew Kaplowitz
CONSUMER
J.P. Morgan
MACHINERY
ENGINEERING & CONSTRUCTION
information edge over his peers,” observes one investor.
“ANDREW KAPLOWITZ IS THE BEST ANALYST COVERING THE GROUP.”
obert Drbul returns to the winner’s circle for a third consecutive year — and for the seventh time in the past nine years. The Barclays Capital analyst impresses clients with his broad coverage and years of experience that “enable him to see industry trends across the food chain,” according to one portfolio manager. In August 2009 the 39-year-old Drbul recommended Phillips-Van Heusen Corp., citing improved inventory management and expectations of lower costs. He reiterated his recommendation in March, when the New York–based apparel company, which owns and markets the Calvin Klein, Izod and Sean John labels, among others, announced that it would acquire Tommy Hilfiger in a cash-and-stock deal worth approximately $3 billion (the takeover was completed in May); Drbul believed that the acquisition would provide a boost to Phillips-Van Heusen’s revenues. He pounded the table again in August, after the company reported stronger-thanexpected growth in the second quarter. By the end of that month, the stock had stitched up gains of 33.4 percent since Drbul first recommended it, rising from $34.24 to $45.68. During the same period the sector gained 23.8 percent.
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AUTOS & AUTO PARTS
Himanshu Patel J.P. Morgan The buy side says: “Himanshu is as hardworking an analyst as you will find.”
imanshu Patel, 35, of J.P. Morgan cruises to No. 1 for a fourth straight year. “He will tell you where the industry is headed in the next few years, not just the next quarter,” says one client. Patel upgraded TRW Automotive Holdings Corp. of Livonia, Michigan, in June 2009 from neutral to overweight, at $9, on improved prospects for auto production and sales opportunities for its vehicle-safety components. The stock had raced to $34.76 by late August 2010, an astonishing 286.2 percent gain that left the sector’s otherwiseimpressive 55 percent advance eating its dust.
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Known as a “real pro” who is not afraid to ask management tough questions, Faucher impressed investors with his coverage of Coca-Cola Co. this year. In January the 41-yearold analyst downgraded the Atlanta-based soft-drink manufacturer’s stock from buy to neutral, at $54.24, on valuation. In early August, after the shares had inched up only 4 percent and trailed the sector by 2.6 percentage points, Faucher upgraded them to buy, at $56.41, dubbing the stock a bargain relative to its peers after months of underperformance. So far the upgrade appears to have been premature, however; Coke’s share price was mostly flat in August, closing the month at $55.88, as the sector slipped 1.4 percent.
The buy side says: “Ali has the deepest knowledge of the sector.”
li Dibadj of Sanford C. Bernstein & Co. rules the roost for a second consecutive year. “His research is remarkably detailed,” marvels one U.K.-based money manager. In a massive tome published in March, the 36-year-old Dibadj pointed to Procter & Gamble Co. as an at-risk stock, given the Cincinnati-based personal-careproducts manufacturer’s history of targeting upscale shoppers in an atmosphere that called for lower prices and more aggres-
A J.P. Morgan The buy side says: “John doesn’t become wed to his stocks and so is willing to change his ratings.”
olding on to the top spot for a second straight year is J.P. Morgan’s John Faucher.
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GAMING & LODGING
Joseph Greff J.P. Morgan The buy side says: “He is everything a sell-side analyst should be.”
FOOD COSMETICS, HOUSEHOLD & PERSONAL CARE PRODUCTS
Sanford C. Bernstein & Co.
John Faucher
sive marketing to cost-conscious consumers. He reaffirmed his neutral stance, at $62.64, and by late August, P&G’s share price had slumped to $59.67, a 4.7 percent drop that was just 1.5 percentage points ahead of the sector. Dibadj “is exemplary among a particularly strong group of analysts,” cheers one investor.
n first place for a fifth straight year is J.P. Morgan’s Joseph Greff. Fans credit the 40-yearold analyst with leading the pack in urging clients to buy Las Vegas Sands Corp. Greff issued an outperform rating in May, at $21.65, one month before the Nevada-based casino operator opened its newest property, the Marina Bay Sands resort in Singapore. The recommendation proved to be a jackpot for investors, as the stock had surged to $28.33 through August, a gain of 30.9 percent that trumped the sector by 27.7 percentage points. Clients also applaud an industry conference Greff hosted in Las Vegas in March, as well as his quarterly field trips to gaming hot spots Macau and Singapore — and what one money manager call his “excellent grasp” of industry numbers. “His models are phenomenal; the information is very deep and relevant — not arcane facts but data that really drive stock prices,” cheers one portfolio manager.
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BEVERAGES
JOSEPH GREFF “IS EVERYTHING A SELL-SIDE ANALYST SHOULD BE.”
call repeatedly since, citing improving margins and robust earnings growth. Shares of the Northfield, Illinois–based concern rose 12.2 percent year-todate through August, from $26.66 to $29.91. During the same period the sector advanced only 4.2 percent.
Andrew Lazar Barclays Capital The buy side says: “Andrew is by far the most thoughtful analyst in the space.”
ndrew Lazar captures the crown for an eighth consecutive year, thanks in part to consistently impressing investors with his detailed knowledge and broad view of the sector. The Barclays Capital analyst “is very good at taking a step back and looking at the big picture, trying to tie together threads across different companies,” explains one buy-side enthusiast. Lazar, 44, named Kraft Foods, the nation’s largest seller of beverages, confectionery and food, his top pick back in May 2009 and has highlighted the
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO that Ivy brings to the table is the depth, breadth and quality of her network — she’s got a golden Rolodex,” marvels one booster.
ing. The stock skidded 28.7 percent, from $34.11 to $24.33, through August.
HOMEBUILDERS & BUILDING PRODUCTS
RETAILING/BROADLINES & DEPARTMENT STORES
Ivy Zelman
Deborah Weinswig
Zelman & Associates The buy side says: “Ivy is the queen of homebuilding.”
vy Zelman reclaims the crown that she held from 1999 through 2004 and in 2006 and 2007 while at Credit Suisse, before opening her own firm, Zelman & Associates, in 2008. The 44-year-old analyst, who spent the past two years in second place, has become famous for her bearishness, prompting one money manager to quip: “If she ever becomes positive on the sector, people will pay attention.” Zelman hasn’t turned positive yet, but investors are paying attention — and cheering her recommendations. In August 2009 she downgraded Chicagobased building-materials manufacturer USG Corp. from neutral to sell, at $15.94, citing the slowdown in the nonresidential construction market, on which the company depends for roughly half of its revenue. In July, after the stock had tumbled 23.2 percent, to $12.24, Zelman elevated it to hold, on valuation. By the end of August, it had barely moved, closing the month at $12.17. Another winner: Back in April 2008, Zelman downgraded Standard Pacific Corp. from neutral to sell, at $5.41, on the belief that the Irvine, California–based homebuilder’s high valuation was “not sustainable.” It sure wasn’t. By late August 2010 the share price had plunged 35.5 percent, to $3.49. “One thing
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Citi RESTAURANTS LEISURE
John Glass
Robin Farley
Morgan Stanley
UBS The buy side says: “Robin is my go-to analyst for the cruise lines.”
obin Farley holds on to her crown for a ninth consecutive year. The UBS analyst highlighted her buy rating on Miami-based Carnival Corp. throughout the second half of last year, on expectations that the company would resume dividend payments — a development that Farley had predicted in July 2009 and which the company confirmed in January. Farley, 40, reiterated her bullish stance in March, at $36.73, as spring bookings looked promising. The stock sailed as high as $43.60 in late April before hitting troubled waters roiled by global economic concerns; by late August it had sunk to $31.18. Farley remains positive, with a target price of $43. “Because she’s so keyed into the management teams at the cruise lines and has great contacts at the travel agencies, she gives me real-time insights that I can use,” explains one loyalist. Farley’s May reiteration of her neutral stance on Harley-Davidson proved more successful. She told investors that the Milwaukeebased motorcycle maker’s improved year-over-year sales did not constitute the turnaround story that she was seek-
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The buy side says: “John is the best analyst in the space.”
organ Stanley’s John Glass reclaims the top spot after having dropped to third place last year. The 46-year-old analyst, who is based in Boston, “does everything well, from modeling, relationships with management, informative reports to being responsive to incoming calls,” insists one backer. Glass upgraded Chipotle Mexican Grill from sell to buy in January, at $86.43, citing an expected rebound in same-store sales, as well as strong growth prospects for the Denver-based chain of casual restaurants. The stock had bolted to $150.83 by late August, serving up a 74.5 percent gain that made the sector’s 13 percent rise seem like merely an appetizer.
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MEREDITH ADLER MAKES “QUICK READS ON TRENDS AND THEIR IMPACT.”
The buy side says: “She is a treasure trove of data.”
eborah Weinswig holds the top spot for a seventh straight year; the Citi analyst is also ranked third in Retailing/ Food & Drug Chains. Weinswig “has a fantastic way of synthesizing data into real-time actionable items,” cheers one backer. In December the 40-year-old researcher recommended Dollar General Corp., at $23.60, telling investors that the Goodlettsville, Tennessee–based discount retailer stood to gain from an increase in cost-conscious shoppers as the U.S. economy languished and unemployment remained high. By late August the stock had risen 15.7 percent, to $27.31, and led the sector by 13.6 percentage points.
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RETAILING/FOOD & DRUG CHAINS
Meredith Adler Barclays Capital The buy side says: “She stands head and shoulders above her peers.”
t’s nine straight years at No. 1 for Meredith Adler, who “draws on lengthy experience to
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ONAL WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE make quick reads on situations and evolving trends and their impact on companies and the industry as a whole,” extols one satisfied client. Case in point: The Barclays Capital analyst urged investors to buy NBTY, a Ronkonkoma, New York– based nutritional-supplements manufacturer that markets its products via its web site, as well as through drug and general merchandise stores. Adler, 56, recommended the stock in late April, at $39.04, on the belief that the company stood to gain from the medical community’s growing support of nutrient supplements. By mid-July, when Adler suspended coverage owing to BarCap’s involvement in the Carlyle Group’s $3.8 billion buyout of NBTY, the stock had advanced a very healthy 37.7 percent, to $53.74. During the same period the sector slid 9.5 percent.
retailers, telling clients that any recovery in the housing market would prove choppy and shallow; therefore, he argued, the stocks were already fairly priced. Among the names included in his report was Lowe’s Cos., a Mooresville, North Carolina–based chain with stores in all 50 states. By late August the stock had inched up only 4.9 percent, from $19.33 to $20.28; the broad market was flat during the same period.
RETAILING/SPECIALTY STORES
Brian Tunick The buy side says: “Brian is very much in the flow of information on all of his stocks.”
.P. Morgan’s Brian Tunick captures the crown for a fifth consecutive year. The 36-year-old analyst highlighted his buy rating on Ulta Salon, Cosmetics & Fragrance in September 2009, at $15, telling clients that the Bolingbrook, Illinois–based beauty-products retailer’s recent expansion efforts were leading to strong sales growth and rising market share and that the chain of beauty superstores was attracting a more-affluent clientele. The stock had shot to $22.70 by the end of August, a stunning 51.3 percent gain that left the sector’s 1.2 percent advance desperately in need of a makeover. Tunick “has a long history with the names he covers and has a good sense of their valuation ranges,” declares one client.
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Colin McGranahan Sanford C. Bernstein & Co. The buy side says: “Colin brings his knowledge to bear in every research piece he publishes.”
olin McGranahan of Sanford C. Bernstein & Co. is crowned the best in his sector for a fourth year in a row and for the fifth time in the past six years. “Nobody understands the practical perspective of running a retailer like Colin,” applauds one satisfied buy-sider. Last November, the 40-year-old McGranahan issued a neutral rating on home improvement
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David Adelman Morgan Stanley The buy side says: “David is the elder statesman of the sector.”
t’s eight straight years on top for Morgan Stanley’s David Adelman, who wins praise from clients for “thinking beyond the quarters” and for being “the first call on tobacco.” The 44-year-old analyst reiterated his overweight rating on Philip Morris International in February, at $45.03, making the case that the New York–based cigarette manufacturer would continue to enjoy solid revenue streams. By the end of August, the shares had risen to $51.36, a gain of 14.1 percent that led the sector by 4 percentage points.
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TOBACCO
work in a sector that trades very much on fluctuating sentiment,” explains one impressed client. Shah urged investors to buy China’s ReneSola in March, at $5.61, on the belief that demand for solar wafers would remain strong for the remainder of the year. So far, he’s been right. By late August, ReneSola’s share price had lit up gains of 56.3 percent, to $8.77, compared with the sector’s 16.2 percent decline. “Vishal does a great job focusing on the fundamentals in a market where data points are constantly changing, and his deep industry contacts allow him to be ahead of the curve when predicting stock moves,” explains one faithful supporter.
ELECTRIC UTILITIES
Daniel Ford ENERGY
Barclays Capital The buy side says: “If I really need to know the nuts and bolts about a particular issue, I call Dan.”
or four years running, Daniel Ford has held the pole position. The Barclays Capital researcher raised Alliant Energy Corp. from neutral to buy in September 2009, at $25.82, believing that investors were needlessly abandoning the stock after the Madison, Wisconsin–based utility ran afoul of local politicians and community activists by requesting a 13.8 percent rate hike. In April, after the stock had sizzled up 33.9 percent, to $34.57, and outperformed the sector by 35.9 percentage points, the 43-year-old analyst down-
F ALTERNATIVE ENERGY
Vishal Shah Barclays Capital The buy side says: “Vishal produces clear, concise, easy-to-follow models.”
epeating in first place is Vishal Shah, 34, of Barclays Capital. “Vishal provides a strong and meaningful frame-
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO graded it to neutral, on valuation. By the end of August, the stock had crept up only 1.3 percent, to $35.02. Ford, who is based in Wells, Maine, “has extensive knowledge on the industry. He not only knows most of the management teams very well, he is also well connected to the regulators, politicians and consumer advocates,” applauds one buy-side backer.
the past couple of years.” Cheng, 46, earned an MBA in finance and international business at New York University Stern School of Business in 1988 and worked at Kidder, Peabody & Co. before joining Lehman Brothers in 1994. Barclays acquired the North American operations of Lehman Brothers Holdings in September 2008.
NATURAL GAS
Ronald Barone UBS The buy side says: “Ronald Barone is my encyclopedia for the natural-gas sector.”
allas-based Ronald Barone finishes in first place for a fourth year running, but that doesn’t begin to describe the UBS analyst’s track record: He has ranked in this sector and its predecessor every year since 1975. Barone has “greater insight into what moves the stocks than other analysts,” insists one investor. That insight was on display last October, when the 67-yearold researcher recommended Questar Corp., telling clients the Salt Lake City–based company would spin off its high-growth (and deregulated) exploration-and-production operations so it could focus on its core natural-gas business. In April, when Questar announced it was considering doing just as Barone had predicted, Questar’s stock surged. By late August it had shot up 28.7 percent since Barone’s prediction, from a
post-spin-off adjusted price of $12.65 to $16.28, and outperformed the sector by 29.9 percentage points. “Ron so thoroughly knows the industry, the players and the mechanics of the business that his insight is invaluable, and he never loses sight of the fact that the job is to make stock calls — not to just build relationships with managements,” declares one enthusiast.
D MASTER LIMITED PARTNERSHIPS INTEGRATED OIL
Paul Cheng Barclays Capital The buy side says: “Paul understands what drives earnings.”
aul Cheng, who rises from No. 2 to claim first-place honors for the first time, “is always accessible — he calls me back whenever I need a quick answer,” says one portfolio manager. Last October the Barclays Capital researcher underscored his sell rating on refinery stocks, including Alon USA Energy of Dallas, at $9.30, and San Antonio–based Tesoro Corp., at $16.18, on the belief that the companies’ profits would be squeezed because, even though emerging-markets countries had not fully developed their refining capabilities, global supply would continue to outpace demand. Since the reiteration the stocks had fallen 41.7 and 30.6 percent, respectively, to $5.42 and $11.23, by the end of August. During the same period the sector declined 12.5 percent. One long-time client says he’s grateful that the analyst “kept me out of the refining sector for
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Gabriel Moreen BofA Merrill Lynch Global Research The buy side says: “He is not afraid to say what he really thinks — that’s an all-too-rare quality among sell-side analysts.”
ast year, when this sector was added to the survey, Gabriel Moreen landed in the No. 2 spot. This year the BofA Merrill Lynch Global Research analyst captures top honors, thanks in part to his “willingness to embrace controversy and go against the grain,” says one client. In December, Moreen upgraded Western Gas Partners of the Woodlands, Texas, from neutral to buy, at $17.45, arguing that the companies in the partnership had much stronger balance sheets than their peers. By late August the stock had shot up to $24.08, gaining 38 percent at a time when the sector advanced 13.8 percent. Moreen, 33, earned an A.B. at Princeton University in 2001; he joined Merrill Lynch in 2005 from J.P. Morgan, where he worked as a junior analyst covering the natural-gas sector.
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GABRIEL MOREEN “IS NOT AFRAID TO SAY WHAT HE REALLY THINKS.”
OIL & GAS EXPLORATION & PRODUCTION
Benjamin Dell Sanford C. Bernstein & Co. The buy side says: “Benjamin Dell consistently produces the most thoughtprovoking research.”
n first place for a third year running is Benjamin Dell of Sanford C. Bernstein & Co.; the 33-year-old analyst is also ranked third in Natural Gas. Dell, whose “research is thorough and meticulously detailed,” in the words of one investor, elevated Houstonbased EOG Resources to top pick in January, at $95, on his belief that its “unique approach to onshore oil production would give it a cost advantage.” The shares had risen 7.9 percent, to $102.51, by early August, when Dell suspended coverage on all of his stocks and became coleader, with Neil McMahon (who is ranked third in Integrated Oil), of AllianceBernstein’s newly created direct energy investment team.
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FINANCIAL INSTITUTIONS
damentals and valuation in the industry, whereas most other analysts seem to have only one or the other — or neither.”
OIL SERVICES & EQUIPMENT
BROKERS, ASSET MANAGERS & EXCHANGES
Ole Slorer Morgan Stanley The buy side says: “Ole adds a buy-side mentality to his sell-side research.”
fter spending the past three years in second place, Ole Slorer of Morgan Stanley climbs the final rung to finish on top for the first time. The 46-yearold analyst “understands what drives a company’s stock; sometimes the fundamentals are bad, but a stock can go higher. He’s a good stock picker who knows how to make money,” insists one portfolio manager. In August 2009, Slorer highlighted his valuation-based buy recommendation on pressure-pumping companies, including RPC, at $8.53. In mid-August 2010, after shares of the Atlanta-based outfit had gushed an incredible 104.6 percent, to $17.45, and bested the sector by a whopping 98.1 percentage points, Slorer downgraded the stock to hold, deeming the shares to be fully valued. RPC’s stock ended that month down 6.5 percent, to $16.31. Slorer “has a good feel for what’s going on with companies. He covers a ton of stocks and is always in the loop — he knows a ton of people,” notes one longtime client. Slorer earned a master’s degree in shipping, trade and finance at London’s City University Business School (Sir John Cass Business School) in 1989 and worked as an analyst covering the oil-services sector at NatWest Securities in London before joining Morgan Stanley in 1998.
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Charles (Brad) Hintz BANKS/LARGE-CAP
Sanford C. Bernstein & Co.
Matthew O’Connor Deutsche Bank Securities The buy side says: “Matthew’s work is accurate and relevant.”
atthew O’Connor of Deutsche Bank Securities marks his third straight appearance at No. 1, thanks in part to “good calls on regional banks early in the year — a very outof-favor group at the time, but he was one of the few people who was pounding the table on them,” recalls one money manager. One example: O’Connor’s upgrade of BB&T Corp. from hold to buy in midDecember, at $25.42, on the premise that the Winston-Salem, North Carolina–based holding company for the regional Branch Banking and Trust Co. was undervalued, primarily on overblown concerns about its potential real estate losses. In May, after the stock had rallied 33.2 percent, to $33.86, and beat the sector by 9.1 percentage points, the 35-year-old analyst downgraded it back to hold, on valuation. By late August it had tumbled to $22.12. Grateful clients also point to daily voice mails and periodic happy hour get-togethers for providing an extra degree of customer service. “I placed only one vote this year, and it was for Matt,” confides one of his buy-side counterparts. Adds another: “Matt seems to have a deep knowledge and understanding of both fun-
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BANKS/MIDCAP
Kevin St. Pierre Sanford C. Bernstein & Co. The buy side says: “Kevin provides valuable insights with a focus on valuation.”
fter two years at No. 2, Kevin St. Pierre rises to the top. “He knows the banks he follows incredibly well,” cheers one buy-side champion. In September 2009 the Sanford C. Bernstein & Co. analyst issued valuation-based upgrades from neutral to outperform on Regions Financial Corp. of Birmingham, Alabama, and Milwaukee’s Marshall & Ilsley Corp., at $6.10 and $8.05, respectively. In April, after the stocks had soared to $8.79 and $9.91 — gaining 44.1 and 23.1 percent at a time when the sector climbed 33.8 percent — he dubbed the shares fully valued and downgraded them to hold. By the end of August, they had slid to $6.43 and $6.55. “He provides the most in-depth fundamental insight into longerterm economics in the bank sector — beyond the ‘quarterly noise’ that many other analysts overly focus on — and provides more-quantified and longerterm analysis,” avers one buyside supporter. St. Pierre, 43, earned an MBA at New York University’s Stern School of Business in 1997 and worked at Booz Allen Hamilton before joining Bernstein in 2000.
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The buy side says: “Investors that listen to him make a lot of money.”
eturning to the No. 1 position, after having spent last year in second place, is Charles (Brad) Hintz, 60. As one portfolio manager observes: “The brokerage industry has suffered from a lack of good and broad coverage compared with other parts of the financial services sector, and Brad Hintz has done a good job filling that void. His background and extensive industry knowledge have made him an invaluable source for someone looking at the industry for investment opportunities.” In January 2009 the Sanford C. Bernstein & Co. researcher highlighted his buy rating on Morgan Stanley, on a price dip to $16.76, making the case that the New York–based investment bank’s earnings would revive thanks to its recently announced joint venture with Citigroup’s Smith Barney retail brokerage. He was right. By late August 2010 the stock had rebounded 47.3 percent, to $24.69, and had pulled ahead of the sector by 14.4 percentage points. “Brad does some of the best work looking at longer-term investment themes and issues for his sectors; combine this with indepth company analysis, and you have the perfect combination for our needs,” explains one grateful client.
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CONSUMER FINANCE
Bruce Harting Barclays Capital The buy side says: “Bruce Harting has clear, unbiased views.”
ruce Harting, 52, finishes in first place for a sixth consecutive year. The Barclays Capital analyst provides “a valuable perspective born of his many years’ experience,” affirms one loyalist. In August 2009, Harting upgraded American Express Co. from equal weight, where it had been since October 2007, to overweight, at $32.07, projecting that the New York– based credit card issuer’s high delinquency rate had peaked. He was right, and by late August 2010, Amex shares had surged 24.3 percent, to $39.87, and outperformed the sector by 9.1 percentage points.
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oriented and responsive to requests; plus, he really knows his companies well and, importantly, is focused on the key stock drivers,” proclaims one backer. Bhullar, 33, who earned a bachelor’s degree in finance and accounting at Southern Methodist University in Dallas in 1999, joined J.P. Morgan in 2000 after a brief stint at PaineWebber. The analyst upgraded Torchmark Corp. from neutral to overweight in February, at $43.84, judging concerns about the McKinney, Texas–based middle-market insurance carrier’s capital reserves to be overblown. Three weeks later management announced a share buyback, and the stock catapulted to $56.06 in April before settling down to $49.35 in late August, gaining 12.6 percent since the upgrade while the Standard & Poor’s 500 life and health insurance index advanced only 4 percent. Bhullar “makes timely calls, provides excellent written research and knows the industry better than his peers,” insists one backer.
The 39-year-old analyst, who holds an MBA from Bentley University of Waltham, Massachusetts, which he earned in 1999, initiated coverage of Berkshire Hathaway in April with an equal weight rating, at $120,465. Gelb questioned the Omaha, Nebraska–based investment management firm’s short-term earnings potential, and so far his caution appears to have been justified: The stock had slipped 1.5 percent, to $118,675, by the end of August. During the same period the broad market fell 12.3 percent. “When Berkshire was added to the Standard & Poor’s 500 index, there was a dearth of coverage for the conglomerate; Jay dived in and provided the muchneeded coverage,” says one impressed follower. Gelb worked at Prudential Securities before joining Lehman Brothers in 2005; Barclays acquired the North American operations of Lehman Brothers Holdings in September 2008. Gelb “works hard, communicates his ideas clearly and always picks up his phone to answer questions,” applauds one faithful client.
leader of the Merrill Lynch crew in 2008; Sakwa, 43, moved to ISI the following May. “I was skeptical of Sakwa’s move from bulgebracket Merrill to ISI: Would he get the same level of resources? Would he have the same level of corporate access? Fortunately the answer was ‘yes’ to both questions,” declares one longtime client. The ISI team upgraded Public Storage from hold to buy in February, at $81, on its earnings growth. By the end of August, shares of the Glendale, California–based storage-space renter had grown 21 percent, to $98.02, and bested the sector by 8.4 percentage points. In early July the analysts upgraded Boston Properties from hold to buy, as a bargain at $69.08. About three weeks later, after the Massachusetts-based office developer’s stock had catapulted 18 percent, to $81.54, they reduced it back to hold, on valuation. By late August it had barely moved, ending that month at $81.40.
Jay Gelb
REITS
BIOTECHNOLOGY
Barclays Capital
Stephen Sakwa & team
Mark Schoenebaum
ISI Group
The buy side says: “Mark has a knack for spotting trading opportunities that make money — sometimes a lot of money — for his clients.”
HEALTH CARE
INSURANCE/NONLIFE INSURANCE/LIFE
Jamminder (Jimmy) Bhullar J.P. Morgan The buy side says: “Jimmy provides the gold standard in client service.”
amminder (Jimmy) Bhullar moves up one notch to claim first-place honors for the first time. “Jimmy is very service-
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The buy side says: “Jay is what you wish every sell-side analyst could be.”
dvancing to the winner’s circle for the first time is last year’s No. 2 analyst, Jay Gelb of Barclays Capital. “Jay is extremely thorough; he doesn’t miss anything in his space,” insists one buy-side fan.
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The buy side says: “They provide the best REIT coverage, bar none.”
atapulting from runnerup to first place is the ISI Group quartet conducted by Stephen Sakwa, who last appeared atop the sector as
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ISI Group
lthough the sector handily outperformed the broad market this year — the New York Stock Exchange Arca bio-
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ONAL WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE technology index surged 12.6 percent, compared with a 5.9 percent loss for the Standard & Poor’s 500 index, year-to-date through August — top analysts had to dig harder to replace old favorites that had been knocked off the map because of mergers and acquisitions. Six-time sector king Mark Schoenebaum juggled that mandate while moving from Deutsche Bank Securities to ISI Group, which he joined in June. The 37-yearold analyst earns acclaim for a June buy rating on Genzyme Corp., at $53.38, as the Cambridge, Massachusetts–based protein-drug maker was being wooed for takeover by SanofiAventis. Genzyme’s stock had shot up a very healthy 31.3 percent, to $70.11, by the end of August, when the company announced that it had rejected an $18.5 billion buyout bid from the French pharmaceuticals giant. “Schoenebaum knows more about these companies than anyone else in the world,” insists one buy-side enthusiast.
stein, 38, expanded his coverage universe last October to include medical-device manufacturers while continuing to highlight his long-term overweights on favorite names such as Universal Health Services; shares of the King of Prussia, Pennsylvania– based operator of specialty surgery centers rose 7.4 percent in the 12 months through August, compared with a 3 percent gain for the sector. Clients continue to profit from Feinstein’s buy rating on HCP, a Long Beach, California–based real estate investment trust that invests in health care facilities. First recommended way back in February 2008 and reiterated repeatedly since, HCP’s shares jumped 31.4 percent, from $26.80 to $35.22, in the year through August.
age in December with an overweight rating, at $42.19, telling clients that even though the stock had vaulted 71.6 percent while she was on the sidelines, plenty of upside remained. The share price shot above $53 in June before drifting back down, ending August at $42.60 — but still ahead of the sector by 7.3 percentage points. “She is indefatigable and always accessible,” marvels one constituent. Gill, 41, earned a BBA in accounting at Loudonville, New York’s Siena College in 1991 and worked at Coopers & Lybrand (now PricewaterhouseCoopers) and Ernst & Young before joining J.P. Morgan in 1998.
MANAGED CARE
John Rex J.P. Morgan The buy side says: “John’s is the definitive voice on managed care.”
Derik de Bruin HEALTH CARE TECHNOLOGY & DISTRIBUTION
Lisa Gill J.P. Morgan
Adam Feinstein Barclays Capital The buy side says: “He has become very aggressive in getting his ideas out onto the Street.”
or a sixth year in a row, Adam Feinstein of Barclays Capital captures the crown, thanks in part to his “brilliant and detailed analysis of what health care reform really means for these companies,” as one money manager puts it. Fein-
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n a year when health care reform moved from a relatively dim prospect to a fait accompli, the buy side turned to seven-time sector champion John Rex of J.P. Morgan to understand what Washington would do to the insurance industry — or even whether managed care would survive at all. “This was the ultimate binary event year, but he gave us all the scenarios on the way in and ultimately made the right call,” explains one London-based fund manager. In November the 48-year-old analyst decided that the sector was no longer in danger of being legislated out of existence and that Cigna Corp. of Philadelphia looked undervalued at $30. President Obama signed the final bill some four months later, and by the end of August, Cigna’s shares had advanced 7.4 percent, to $32.22. During the same
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LIFE SCIENCE & DIAGNOSTIC TOOLS
HEALTH CARE FACILITIES
De Bruin believed the Billerica, Massachusetts–based contract research organization was showing promising signs of revenue recovery. In late February, Germany’s Merck agreed to buy the company for $7.2 billion, or $107 per share. “They earned our vote right there,” says one grateful investor. Merck completed the Millipore acquisition in mid-July.
The buy side says: “She has a thorough knowledge of trends in the sector and how they affect stock prices.”
isa Gill, who spent the past two years at No. 2, rises the final rung to capture the crown for the first time. The J.P. Morgan analyst is “indispensable when it comes to the pharmacy benefit managers,” insists one longtime supporter. Gill had to suspend coverage on Express Scripts in April 2009 because her firm helped underwrite the St. Louis–based PBM’s $4.7 billion acquisition of WellPoint’s NextRx. She reinitiated cover-
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UBS The buy side says: “He provides old-fashioned, no-fluff models on companies that are sometimes hazily covered.”
erik de Bruin of UBS debuts in the top spot in this new sector, which inched up 1.7 percent in the 12 months through August (and trailed the broad market by 1.1 percentage points). The 46-year-old analyst — who earned a Ph.D. in molecular biology from Cornell University in Ithaca, New York, in 1993 and worked as a life-sciences analyst at Salomon Smith Barney and then Credit Suisse before joining UBS in 2002 — upgraded Millipore Corp. from neutral to buy in May 2009, at $64.48.
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO period the Standard & Poor’s 500 managed health care index gained 3.8 percent.
conviction remained supremely grounded in the fundamentals and the macro story,” explains one appreciative investor. A pension fund manager concurs: “Medtronic was a real heartbreaker, but he really pounded the table against it!”
numbers, but he is a master at figuring out how profitable these drugs are,” says one fan.
MEDIA
CABLE & SATELLITE MEDICAL SUPPLIES & DEVICES
PHARMACEUTICALS/SPECIALTY
Craig Moffett
Michael Weinstein
Aaron (Ronny) Gal
Sanford C. Bernstein & Co.
J.P. Morgan
Sanford C. Bernstein & Co.
The buy side says: “Michael outshines all others when it comes to understanding these companies.”
The buy side says: “Ronny excels at stock picking.”
The buy side says: “Craig is a fearless intellectual who provides brilliant, in-depth analysis.”
.P. Morgan’s Michael Weinstein makes it four in a row in the top spot, thanks in part for being “a really nice guy — but reliably no-nonsense. If a company or even his entire universe is in trouble, he will not mince words. That’s the most precious thing of all, as far as we are concerned: true honesty and clarity,” as one fund manager puts it. In a dismal year — the sector fell 11.4 percent in the 12 months through August and lagged the broad market by 14.2 percentage points — the 40-year-old analyst issued valuation-based downgrades on some longtime favorites, including Boston Scientific Corp. of Natick, Massachusetts, and Minneapolis-based Medtronic. Boston Scientific, a maker of cardiac-rhythmmanagement devices, he lowered to neutral in March, at $7.78, and by late August the stock had tumbled 33.3 percent, to $5.19. Medtronic, which manufactures defibrillators and other instruments, he cut to neutral in August, at $37.43, and by the end of the month, it had dropped 16 percent, to $31.45. “These were hard calls for us and, I suspect, for him — but his
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Timothy Anderson Sanford C. Bernstein & Co. The buy side says: “He takes a long-term view but doesn’t overlook short-term opportunities.”
imothy Anderson, 42, repeats in first place, thanks to his “insight into the patent cliff that is not only profound but also profoundly actionable. He’s the best at keeping us upto-speed on expiries and pipeline replenishment,” insists one buy-side counterpart. Another cites his “work on putting U.S. big pharma in a global context.” Back in January the Sanford C. Bernstein & Co. analyst, who works out of San Francisco, flagged the probability of offpatent competition for SanofiAventis’ blood-clot medication Lovenox, which had global sales of $3.9 billion last year. A generic formulation received clearance from the U.S. Food and Drug Administration in July, and by late August the French pharmaceuticals giant’s American depositary receipts were down 20.8 percent for the year, from $36.13 to $28.61, and trailed the sector by 11.8 percentage points. “Margins! Anyone can poll doctors and come up with potential revenue
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hat one fund manager calls an “unassailable franchise where the aesthetic markets are concerned” helps propel Aaron (Ronny) Gal, 43, to the No. 1 spot for a second year running. The Sanford C. Bernstein & Co. analyst initiated coverage on Medicis Pharmaceutical Corp. in April 2009 with a buy rating, at $13.05, after the Food and Drug Administration approved its wrinkle smoother, Dysport, a Botox rival. Last October, after shares of the Scottsdale, Arizona– based company had skyrocketed 69.6 percent, to $22.13, and led the sector by 47.3 percentage points, Gal urged clients to take profits. He upgraded the stock to buy in July, on a price dip to $21.80, and by the end of August, the shares had climbed 26.1 percent further, to $27.50.
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TIMOTHY ANDERSON IS “THE BEST AT KEEPING US UP-TO-SPEED ON EXPIRIES.”
raig Moffett rules the roost for a fifth year running; the 48-year-old analyst is also ranked third in Telecom Services. Hailed by one investor for his “spot-on predictions on share gains at cable companies,” the Sanford C. Bernstein & Co. researcher urged clients to buy Time Warner Cable way back in July 2008, well ahead of its spin-off from parent Time Warner. He reiterated his stance in April 2009, at $27.06, citing the New York–based cable TV, Internet and phone service provider’s improving cash flow, broadband technological advantage and debt-reduction strategy. In May 2010, after the stock had flown to $48.90 — a stunning 80.7 percent gain that outpaced the sector by 42.1 percentage points — he finally pulled the plug, on fears of price regulation by the Federal Communications Commission. He may have tuned out too soon; TWC’s stock continued to rise, ending August up 5.5 percent higher, at $51.57. As one backer notes, however: “Craig is not afraid to have a nonconsensus view of the world. He has accurately predicted declines in business at telecom companies and the path of regulation that is currently being pursued by the FCC.”
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ONAL WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE worked as a media analyst at Stern Stewart & Co. before joining Lehman Brothers in 2001; Barclays acquired the North American operations of Lehman Brothers Holdings in September 2008.
ENTERTAINMENT
Anthony DiClemente Barclays Capital The buy side says: “Anthony has the intuition of a buy-side investor.”
lients say “great shortterm and long-term stock calls,” such as an “early but welltimed call on Disney,” help Anthony DiClemente rise the final rung to secure his first-ever appearance at the top of the ranking. “Anthony made great stock and industry calls going into the 2008 downturn and into the 2009 recovery,” observes one buy-side enthusiast. The Barclays Capital analyst upgraded Walt Disney Co. from neutral to buy in early May 2009, at $22.89, telling investors that the Burbank, California– based company was ahead of its peers in developing and marketing digital content and that revenues at its signature theme parks had stabilized. The call proved to be a bit premature — the stock moved little over the next few months; but by late that July, the share price had begun to gain momentum, surging 42.2 percent, to $32.54, and outdistancing the sector by 11.8 percentage points, by the end of August 2010. “Anthony’s bullish call on cyclical media was dead right as the economy improved. He’s a source of industry knowledge and is willing to stick his neck out on controversial names,” observes one buy-side advocate. The 34-yearold DiClemente, who earned a bachelor’s degree in finance at University of Virginia in 1998,
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earnings estimates and organic growth,” and is also “very good at ranking the relative investment potential of the names in her coverage universe,” notes one money manager. Quadrani, who earned an MBA at New York University Stern School of Business in 1993, worked as a beverages analyst at Smith Barney and then covered advertising agencies at Bear, Stearns & Co., which was acquired by JPMorgan Chase & Co. in June 2008.
cent, from $34.87 to $57.61, and shot past the sector by 57.7 percentage points. Bourgeois “digs deeper into the companies and industries he covers than most other analysts do, and his analysis is heavy on facts, with the appropriate level of skepticism,” observes one buy-side supporter. Adds another: “He has an ability to formulate a near-term view on a stock without losing the forest for the trees — which is a problem many sellside analysts have.”
TECHNOLOGY PUBLISHING & ADVERTISING AGENCIES
Alexia Quadrani J.P. Morgan The buy side says: “No one does a better job of keeping us informed and up-to-date.”
lexia Quadrani, who spent the past six years in second place, climbs the final step to finish on top for the first time. The J.P. Morgan analyst “has a deep understanding of the advertising business, based on her years of coverage, good management access and media contacts, and detailed analysis,” cheers one buy-side champion. Case in point: Quadrani, 43, reiterated her buy recommendation on Interpublic Group of Cos. last October — she began recommending the company two years earlier — on the belief that the New York–based holding company for global advertising, marketing and media relations agencies would report better-than-expected third-quarter earnings. She was right. The stock had bolted 40.8 percent, from $6.06 to $8.53, by the end of August; during the same period the Standard & Poor’s 500 publishing and printing index fell 9.5 percent. “She does a great job anticipating directional changes in
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Mark Mahaney COMPUTER SERVICES & IT CONSULTING
Roderick Bourgeois Sanford C. Bernstein & Co. The buy side says: “He is the gold standard in the sector.”
anford C. Bernstein & Co.’s Roderick Bourgeois leads the pack for a fifth year running. Bourgeois, 41, is “uniquely insightful with regard to nearterm tactics, long-term industry structure and competitive dynamics,” declares one money manager. Clients continue to profit from the analyst’s take on Cognizant Technology Solutions Corp. of Teaneck, New Jersey, which he elevated to top pick back in January 2009, anticipating rising demand for the consulting firm’s outsourcing services. Bourgeois has reiterated his recommendation repeatedly since. In the 12 months through August, Cognizant’s shares soared 65.2 per-
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Citi The buy side says: “Mark knows how to ask the tough questions that get to the core of an issue.”
iti’s Mark Mahaney, 44, is No. 1 for a third straight year. “He has high conviction in his ideas and does deep analysis on the stocks he covers,” proclaims one impressed investor. The San Francisco–based analyst upgraded Akamai Technologies from neutral to buy in December, making the case that, thanks to a rebound in Internet advertising, shares of the Cambridge, Massachusetts– based developer of online content-delivery applications were attractively valued at $23.77. In June, after the stock had skyrocketed 86.4 percent, to $44.30, and pummeled the sector by 96.4 percentage points, Mahaney downgraded it to hold, on valuation. The downgrade appears to have been premature, however, as
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO Akamai’s stock continued to rise, albeit more slowly; it had climbed 4 percent higher, to $46.07, by the end of August. “He’s got a very good grasp of the macro trends that cut across the sector and is very well connected to the West Coast community, which gives him an advantage in understanding some of the potential competitive issues and trends impacting the group,” according to one portfolio manager.
SEMICONDUCTOR CAPITAL EQUIPMENT
James Covello
covering semiconductor devices, and he presents his case in a clear and interesting way,” says one money manager. This view is echoed by another buy-side supporter: “Whether one agrees or disagrees with his assessment of the cycle at any point in time, at least with Jim you will clearly understand why he is positioned the way he is.”
The buy side says: “Adam is quite knowledgeable, thoughtful and also great with responding to requests.”
The buy side says: “He has a good grasp of the big picture, without losing sight of the details.”
A.M. (Toni) Sacconaghi Sanford C. Bernstein & Co. The buy side says: “Nothing gets by Toni — absolutely nothing.”
.M. (Toni) Sacconaghi, who takes the No. 1 position for a ninth consecutive year, “is the most detailoriented analyst in the hardware sector — he gets all the industry and corporate data, scrubs it multiple ways and reaches valuable, investable conclusions,” according to one devoted buy-sider. The Sanford C. Bernstein & Co. analyst reiterated his outperform rating on Apple in February, at $195.96, underscoring the Cupertino, California–based consumer-electronics company’s robust cash flow and high cash balance of $40 per share. By the end of August, the share price was up a juicy 24.1 percent, to $243.10, and was ahead of the sector by 24.7 percentage points. Sacconaghi, 45, remains bullish.
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JAMES COVELLO “HAS A GOOD GRASP OF THE BIG PICTURE.”
organ Stanley’s Adam Holt, who rises from second place to capture his firstever first-team finish, “does a good job of combining fundamental analysis with solid channel work,” declares one buy-side supporter. One example: Observing that Intuit, a Mountain View, California– based developer of accounting and tax-preparation programs, was ahead of its peers in transitioning from an off-the-shelf sales approach to moreprofitable online delivery, Holt upgraded the company’s shares from neutral to overweight in May, at $36.09, citing strong growth prospects and improving profitability. The stock had zipped to $42.74 by the end of August, a gain of 18.4 percent that eclipsed the sector by 32.6 percentage points. “Many sell-side analysts myopically focus on calling a company’s next quarter, but Adam balances that with a broader, long-term and strategic perspective on the company’s secular prospects — and in the long run, the latter carries the day,” declares one impressed investor. Holt, 36, earned a bachelor’s degree in religious studies and a certificate in African-American studies at Princeton University in 1995; the analyst, who is
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Adam Holt Morgan Stanley
Goldman, Sachs & Co.
ames Covello of Goldman, Sachs & Co., who repeats in the top spot, “is very detailoriented, does good channel checks and sticks with his convictions,” avers one backer. The 37-year-old analyst downgraded FormFactor from neutral to sell in April, at $16, saying continued weakness in the dynamic random access memory market would put pressure on margins, but the company could not restructure operations quickly enough to increase its supply of products in greater demand. By the end of August, shares of the Livermore, California–based maker of cards used to test DRAM, flash memory and similar devices had plummeted 56.3 percent, to $7, and trailed the sector by 32.5 percentage points. “Jim brings an important perspective to the equipment outlook that comes from
SOFTWARE
SEMICONDUCTORS
Christopher Danely J.P. Morgan The buy side says: “His client service is second to none.”
n his fourth straight appearance in the winner’s circle, Christopher Danely continues to impress clients with his customer service and strong analytical skills. The J.P. Morgan researcher, who is stationed in San Francisco, “has solid contacts on the ground in Asia, and this helps keep him up-to-speed on the incremental movements in demand throughout the channel,” asserts one buyside backer. Danely, 39, upgraded Linear Technology Corp. of Milpitas, California, from neutral to overweight in July, at $27.64, on its growing market presence, among other factors. Shares of the company, which designs, manufactures and markets a line of high-performance analog and mixed-signal integrated circuits, were trading above $32 by the end of that month but had drifted back to $28.62 by late August, for a gain of 3.5 percent that nonetheless led the sector by 10.8 percentage points.
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ONAL WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE based in San Francisco, joined Morgan Stanley in 2008 after working as a credit analyst at Union Bank of California and an e-commerce analyst at Hambrecht & Quist, which was acquired by Chase Manhattan Corp. in 1999. The latter outfit merged with J.P. Morgan the following year.
TELECOMMUNICATIONS
DATA NETWORKING & WIRELINE EQUIPMENT
Ehud Gelblum Morgan Stanley The buy side says: “Ehud often comes up with interesting analyses based on what at first glance appear to be uninteresting, dead-end data from companies.”
hud Gelblum lands on top for a fifth consecutive year; the Morgan Stanley analyst is also No. 1 in Telecom Equipment/Wireless, for a fourth year running. Gelblum, 41, initiated coverage on Cisco Systems in late March with a neutral rating, at $26.51, warning investors that demand would continue to decline for the San Jose, California–based maker of modems, routers and other networking devices. He was right. The stock had slumped to $19.99 by the end of August, falling 24.6 percent as the sector gained 2.1 percent. Gelblum “digs deeper than his peers to deliver unique insights,” marvels one buy-side admirer, who adds, “He also has a great sense of humor — there are not enough guys like Ehud in our business.”
TELECOM EQUIPMENT/WIRELESS
Ehud Gelblum Morgan Stanley The buy side says: “Ehud discusses the issues in a plain-English way and doesn’t get caught up in the hype of technology.”
n first place for a fourth consecutive year is Ehud Gelblum of Morgan Stanley; the 41-yearold analyst is also on top in Data Networking & Wireline Equipment, for a fifth straight time. “He always seems to back up his views with strong numbers and a unique spin,” declares one backer. Gelblum reiterated his overweight call on Qualcomm in late June, at $32.97, on the premise that the San Diego–based supplier of chipsets used in Android handsets would surge as demand for those phones increased. He was right. The stock had rung up gains of 16.2 percent by late August, to $38.30, beating the sector by 12.3 percentage points.
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neously with hardware sales, instead of deferring them as separate, not-yet-realized items. This modification, he argued, would likely increase the revenues reported and thus buoy the stock prices of affected companies, which also include Redmond, Washington–based Microsoft Corp. and Dell of Round Rock, Texas. FASB approved the rule change two weeks later, and by the end of August, Apple’s shares had jumped 42 percent, from $171.14 on the day Senyek published his report to $243.10.
MACRO
ECONOMICS
Ed Hyman ISI Group The buy side says: “Ed’s insights are precise and easy to digest.”
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numerous good calls,” says one investor, citing as example the analyst’s January reiteration of his overweight rating on Savvis, an information technology services provider headquartered in Town & Country, Missouri. “We saw an attractive valuation and the potential for improved revenue performance,” says Flannery, 48. In late April, after the stock had advanced 20.1 percent, from $15.42 to $18.52, and outpaced the sector by 25 percentage points, the analyst issued a valuation-based downgrade to neutral. By the end of August, the shares had slipped to $17.48.
ACCOUNTING & TAX POLICY
Christopher Senyek ISI Group
TELECOM SERVICES
Simon Flannery Morgan Stanley The buy side says: “Simon has great insight into the competitive dynamics for the companies he follows.”
imon Flannery, who spent the past three years in second place, rises one rung to finish on top for the first time since this sector was created through the 2007 merger of Telecom Services/Wireless and Telecom Services/Wireline; the Morgan Stanley analyst led the latter sector for five years, from 2002 through 2006. “Simon has made
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The buy side says: “Few people on the Street understand the issues as well as Chris.”
hristopher Senyek of ISI Group repeats in first place. Praised by one portfolio manager for his “clear explanations of changing rules and their implications,” the 35-year-old Senyek published a report in September 2009 detailing how Cupertino, California–based Apple would be one of the prime beneficiaries of an expected change by the Financial Accounting Standards Board that would allow hightechnology companies to claim subscription revenues simulta-
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or a record 31 consecutive years, Ed Hyman of ISI Group takes top honors. With the aid of an expanded staff of bottom-up, fundamental sector analysts, the 65-year-old economist is “continuing to create a world-class organization from the rubble of Wall Street’s oncevenerated sell side,” observes one portfolio manager. Many clients favor his frequent industry surveys — of staffing companies, manufacturers and so forth — for “a timely read on business sentiments,” notes one grateful reviewer. Investors also appreciate Hyman’s willingness to admit when he’s wrong, as he was in May, when global government stimulus efforts and an upturn in business inventories prompted him to declare a turning point in
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO the economy. The following month he reversed his position, largely because of the worsening debt crisis in Europe and its impact on the U.S. stock market; the Dow Jones industrial average reported its worst May performance since 1940. “When the data changed he reflected it in his outlook rather than stubbornly holding on to the earlier forecast, as others might,” proclaims one loyalist.
known as Equity Derivatives. It was rechristened this year as Equity-Linked Strategies to reflect the broader, more comprehensive approach that many firms are taking with regard to hybrid debt securities. Boosters cheer the BarCap team for its March 2009 recommendation that they implement a buy-write strategy, purchasing certain volatile stocks, which changed monthly, and simultaneously selling their call options, thus earning income through the option premiums. Through August 2010 the strategy returned 49.3 percent, Deshpande says, while the benchmark buy-write monthly index advanced just 25.2 percent. In November they urged investors to buy the 4 percent 2034 convertible bonds of Chevy Chase, Maryland’s CapitalSource, on the strength of the corporatefinance firm’s capital reserves. By the end of August, the hybrid bond had posted a total return of 22.5 percent.
Research) strategist, who also captures second-place honors in Quantitative Research, warned clients in early May that the market had peaked for the year, and he urged them to minimize their exposure to stocks, especially financial and technology shares, and seek safety in bonds. His reasons: dwindling federal stimulus money and an expected turning point in the leading economic indicators. He was right. The Standard & Poor’s 500 index, which had swelled 4.6 percent year-to-date before his warning, fell 10 percent through August, with its financial and tech sectors plunging 19.6 and 13.2 percent, respectively. “François helped us avoid some of the worst of the sell-off,” observes one investor.
Tree of Chesapeake, Virginia. The stocks had bolted 40.7 and 21.2 percent, respectively, by the end of August; during the same period the broad market fell 8 percent. (Brazil’s Gerdau bought the remaining shares of AmeriSteel for $1.6 billion, or $11 per share, in late August.) “Mike is that rare quant who ties together the macroeconomic context with bottom-up stock selection, which is useful for our investment decisions,” observes a grateful ally.
SMALL COMPANIES
Steven DeSanctis BofA Merrill Lynch Global Research The buy side says: “Steve is a solid resource.”
his year marks the third straight appearance at No. 1 for Steven DeSanctis of BofA Merrill Lynch Global Research, who impresses clients with his responsiveness. “He will have even customized data back to me in minutes,” marvels one supporter. DeSanctis, 42, downgraded small-cap industrials from overweight to neutral in May, and at the same time he reduced small-cap basicmaterials companies from neutral to underperform, deeming shares of outfits in those sectors to be overpriced. The industrials sector, which had advanced 1.9 percent year-todate at the time of the downgrade, subsequently slid 6.6 percent, through August. Materials, which had already been down by 4.1 percent for the year, tumbled 6.2 percent further. During
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Michael Goldstein Empirical Research Partners The buy side says: “Michael is the best in the world at what he does.” PORTFOLIO STRATEGY EQUITY-LINKED STRATEGIES
Maneesh Deshpande, Evren Ergin, Venu Krishna & team Barclays Capital The buy side says: “These analysts dig deep and drill down to the core.”
aneesh Deshpande, 42, Evren Ergin, 39, and Venu Krishna, 44, lead the Barclays Capital crew of six to the top spot for a fourth consecutive year in the sector formerly
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François Trahan Wolfe Trahan & Co. The buy side says: “If you followed his advice, you would have made a fortune.”
n first place for a third straight year — and for the fifth time in six years — is François Trahan, 41, who left ISI Group to join forces in February with Edward Wolfe (who is ranked second in Airfreight & Surface Transportation). The 41-year-old Wolfe Trahan & Co. (formerly Wolfe
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ichael Goldstein lands in the winner’s circle for a fourth straight year; the Empirical Research Partners analyst is also ranked second in Portfolio Strategy. Using proprietary modeling tools, the 55-year-old Goldstein identified distressed stocks in March that he believed were likely to benefit from market turmoil and outperform in the near term. Among the companies he named were Torontobased steel producer Gerdau AmeriSteel Corp. and discount variety store operator Dollar
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ICBC
A Fast-Growing Bank with a Sustainable Business Model Industrial and Commercial Bank of China (ICBC) continues to enjoy vibrant and sustainable growth in spite of the uncertainties in the global and Chinese financial markets. In the six months to June 30 2010, ICBC’s after-tax profit was RMB85 billion ($12.5billion) – up 27.3 percent from the previous year. Impressive in any circumstances, this is particularly striking because ICBC had also reported growth in the first half in 2009, when many Chinese banks were experiencing a decline in profit. ICBC’s record speaks to the stability and sustainability of the bank’s profit growth. It has become increasingly clear that the ICBC business model and development strategy are succeeding in ICBC has a countering economic fluctuations. backdrop of The bank has achieved this profit solid asset growth against a backdrop of solid asset quality. The quality. The first half of 2010 was the first half of 11th consecutive year in which both 2010 was the balance and ratio of non-performing the 11th loans declined. The NPL ratio stood consecutive at just 1.26 percent on June 30, 2010, year in which down 0.28 percentage points from both the the end of 2009, while the provision balance and coverage ratio rose 25.4 percentage ratio of nonpoints to 189.81 percent. ICBC’s performing provision balance stands at close to 1.9 loans times the NPL balance. The numbers declined. demonstrate a capacity to withstand risk and economic shock along with a foundation for further growth. Continued strong performance will prove exceptionally important at a time when many people have raised doubts about loans to local government financing and the real estate industry. Throughout the economic boom years, the financial crisis and the stimulus-led recovery in China, ICBC has strictly adhered to credit approval criteria when lending. It has taken timely and effective measures to control potential risks, and the quality of credit assets has been well maintained. In its real estate loans, for example, ICBC’s support has been concentrated on housing development projects and owneroccupied residential property mortgages. First-time home buyers account for 94 percent of the ICBC mortgage book; consequently the NPL ratio for property loans is only 0.8 percent, and for individual mortgage loans, 0.44 percent. On the local government side, most ICBC loans went to provincial and municipal financing platforms and high quality urban infrastructure projects. These are remarkably healthy, with an NPL ratio of just 0.02 percent. Despite this prudence, loan growth continues in an orderly way. Domestic RMB lending increased by RMB524.1 billion ($77.2 billion), or 9.9 percent, in the first half of 2010, although it is notable that this rate of growth is 1.7 percentage points lower than the industry average. Careful monitoring of the loan
book has helped ICBC’s yield increase to a net interest margin of 2.37 percent, helping to drive consistent profit growth. Of the new project loans, 95 percent were to projects that are under construction or in development; very little is loaned out to new projects. ICBC has aligned its policy with the government’s macro-economic control position, yet has retained support in the national interest, lending to key infrastructure projects, vital industries and emerging industries of strategic importance. Also, small business loans and trade financing business have been a priority. The increase in these loans in the first half of 2010 exceeded that for the whole of 2009. ICBC has also seen robust growth in other important lines of business. Net fee and commission income reached RMB36.9 billion ($5.4 billion) in the first half, up 33 percent on the previous year; this intermediary business now accounts for more than 20 percent of ICBC operating revenue. Investment banking, which brought in RMB8.67 billion ($1.3 billion), was up 21.3 percent, wealth management by 43 percent, and corporate wealth Net fee and management 87.1 percent. Corporate commission customer settlement business, RMB income rose settlements, custody and credit cards 33 percent all grew dramatically. ICBC is now one in the first of the biggest banks in Asia by asset half of 2010, custody, with over RMB2 trillion ($297 investment billion) in this area, and is the fourth banking largest credit card issuer in the world, was up with over 40 million card holders. A 21.3 percent, sign of sophistication is that more than and wealth half of bank business was conducted management by 43 percent. through electronic banking. The next step is international. ICBC has been expanding in 2010, opening branches in Malaysia and Hanoi, commencing trial operations in Abu Dhabi, and completing the acquisitions of BEA Canada and Thailand’s ACL Bank. ICBC is no longer a domestic bank: it has 181 branches and offices in 22 countries and regions, with a global network and service chain covering five continents on a unified technological platform. Both at home and overseas, ICBC is well placed to grow fast but sustainably. CONTACT INFORMATION
ICBC 55 Fuxingmennei Avenue, Xicheng District, Beijing, China www.icbc.com.cn www.icbc-ltd.com
Sponsored Statement • October 2010
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AZIL RESEARCH THE 2010 ALL-AMERICA RESEARCH TEAM INEFFICIENT MARKETS UNCONVENTIO the same period the broad market dipped 2.3 percent.
TECHNICAL ANALYSIS
Jeffrey deGraaf ISI Group The buy side says: “Jeff has guided us through this tumultuous market.”
effrey deGraaf of ISI Group, who takes No. 1 for a sixth year running, wins cheers from investors in part for his multimedia work. In January his
J
“Weekly Survival Guide” began including a link to a ten-minute online video clip of the 42-yearold analyst explaining a series of slides and graphs. “It’s a terrific way of clearly describing what he’s seeing in the market,” applauds one viewer. Other backers point to deGraaf’s February prediction of an imminent rally, based on market volatility. The very day deGraaf made his prediction, the Standard & Poor’s 500 index ended its three-week, 8 percent drop and began to rise, gaining 15.2 percent by late April before a sell-off (which deGraaf did not see coming, as he admits) sent it reeling. Clients also praise the analyst’s February 2009 bullish call on gold producers as likely beneficiaries of equity volatility, as investors sought a safe haven.
USPS Statement of Ownership, Management and Circulation (Required by 39 U.S.C. 3685)
Through August 2010 the sector had catapulted 41.6 percent.
WASHINGTON RESEARCH
Thomas D. Gallagher & team ISI Group The buy side says: “They do a great job handicapping legislation.”
he ISI Group duo led by Thomas D. Gallagher takes first-team honors for an eighth straight year. “They’re accurate
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and objective,” says one buy-side fan. In January the team warned that any financial reform bill would include a proposal set forth by former Federal Reserve Board chairman Paul Volcker, a member of President Obama’s Economic Recovery Advisory Board, to restrict banks from proprietary trading in speculative investments. The so-called Volcker Rule became the focus of spirited and highly contentious debate in Congress, but a modified version of the proptrading ban was included in the final Dodd-Frank Wall Street Reform and Consumer Protection Act that the president signed into law in July. Gallagher, 56, left ISI Group last month to join Scowcroft Group, a Washington-based political and economic consulting firm. ••
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continued from page 52 pharmacy benefit
management,” she explains. While keeping one eye on developments in Washington, the analyst also kept investors apprised of another issue with farreaching consequences: the expiration of patents on many drugs and a shortage of new, protected formulations. “There have not been as many new drugs developed by pharmaceuticals as in the early 1980s and ’90s, and fewer new patents have been issued,” she points out. The so-called generic-drug wave began in 2006, when patent protection on Merck & Co.’s cholesterol-lowering drug Zocor and Pfizer’s antidepressant Zoloft expired, and will continue through 2015, by which time an estimated 80 percent of the market once held by brand-name pharmaceuticals will be taken over by generics, Gill explains. So, even though health care reform will result in a greater number of Americans having health insurance and thus more people will probably be taking prescription medication, many of those drugs will be generics for which insurance companies pay less, and pharmacy profit margins will be squeezed. As a result, investors have become increasingly pessimistic about the sector’s future and are questioning its potential for growth, she says. “We’ve gotten to the point where people are saying, ‘I don’t want to be caught not knowing what will happen in the future,’” Gill says. She remains bullish, however, and predicts that the specialty-pharmaceuticals industry, which includes biologics and selfinjectables, will see annual sales expand from $60 billion to $70 billion currently to $100 billion by 2015. A lot can happen between now and then — indeed, well before then. Some Republicans, anticipating a return to congressional power in next month’s midterm elections, INSTITUTIONALINVESTOR.COM
have raised the possibility of repealing at least some provisions of health care reform. Those elections are already causing anxiety elsewhere in health care markets, according to Derik de Bruin, who debuts at No. 1 in Life Science & Diagnostic Tools, a sector added to the survey this year. “There was already growing concern over possible reductions in government funding to academic labs, in the wake of European austerity measures,” the UBS analyst says.“Now there are worries that if the Republicans win big in the midterm elections, then discretionary spending for non-defense-related R&D programs could face budget cuts.” De Bruin has been doing his best to allay investors’ fears, reminding them that “the National Institutes of Health, the biggest source of funding for U.S. academic labs doing biomedical research, has friends on both sides of the aisle.” He notes that his sector served as a relatively safe haven in the volatile health care landscape — “there was lots of money hiding out in life sciences” — and even though it too
PICKING THE TEAM
experienced a sell-off recently, he continues to pound the table and sees opportunities for tremendous growth. “Three years ago it cost well over $1 million to sequence a whole human genome, and now the price is down to about $10,000 and still falling, so there has been tremendous progress,” de Bruin says. Mounting legal challenges to the validity of gene patenting have stemmed some of the optimism, because “the technology is moving faster than the legal framework was prepared for,” he adds. Investors are confident that de Bruin can keep pace with such a rapidly evolving sector. “He is very good at translating the science into actionable investment recommendations,” says one pension fund manager. “We know that he knows what these technologies are worth and, more importantly, which ones are actually new and exciting and which ones are just an old business dressed up with confusing new technology.” Federal legislation — albeit of a much different sort than health care reform — had a positive impact on Electrical Equipment
To select the members of Institutional Investor’s 39th annual All-America Research Team®, we started by sending questionnaires covering ten categories and 66 investment sectors to the directors of research and the chief investment officers of major money management firms. Those polled included firms featured in the II300, our ranking of the biggest asset managers in the U.S., and other significant U.S., European and Asian institutional investors. In addition, we contacted institutional investors from client lists submitted by Wall Street research directors and sent questionnaires to analysts and portfolio managers at many top institutions. Several changes were made to this year’s survey. One new sector was added: Life Science & Diagnostic Tools. In addition, Equity Derivatives was expanded, and its name changed to Equity-Linked Strategies, to reflect the broader, more comprehensive approach that many firms are taking with regard to hybrid debt securities. Sectors are organized within broad categories: Basic Materials, Capital Goods/Industrials, Consumer, Energy, Financial Institutions, Health Care, Media, Technology, Telecommunications and Macro. Rankings were determined strictly by using numerical scores. We took the number of votes awarded to each analyst and weighted the votes based on the size of the institution responding and the place it awarded to that analyst (first, second, third or fourth). For research sectors where team efforts are the norm — Equity-Linked Strategies, Real Estate Investment Trusts and Washington Research — we combined the votes for all the analysts covering a sector at each firm; in the commentary, though, we highlight the team leaders. Teams and individuals were designated runners-up when their scores fell within 35 percent of the third-teamers’ scores. Analysts who changed firms after July 2, 2010, are cited at their previous organizations. We keep confidential the identities of the survey respondents and their firms to ensure their continuing cooperation. We consulted nearly 3,500 individuals at some 970 firms, including more than 90 of the 100 biggest U.S. equity managers. Our respondents manage an estimated $10.2 trillion in U.S. equities. The ranking was compiled by Senior Editor Tucker Ewing, Associate Editor Denise Hoguet and Researchers Billo Wu and Ying Zhang, under the guidance of Managing Editor Thomas W. Johnson. Senior Contributing Writers Pam Baker, Katie Gilbert, Hillary Jackson, Leslie Kramer, Scott Martin and Paul Sweeney wrote the sector reports.
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THE 2010ALL-AMERICA RESEARCHTEAM
& Multi-Industry, according to that sector’s top-ranked researcher, Scott Davis. The Morgan Stanley analyst, in his first appearance at No. 1, notes that the American Recovery and Reinvestment Act of 2009, the $787 billion economic stimulus package that Congress approved in February of that year, provided a much-needed boost to many of the companies in his coverage universe. “Even small improvements in revenue growth are leading to very nice earnings surprises,” says Davis. “After two tough years the fact that people can talk about order books getting better means there is light at the end of the tunnel.” The best may be yet to come, he points out. “It typically takes at least a year to get projects approved and the engineering work done,” Davis explains.“It’s been a year and a half, and we are now seeing real money being pumped into infrastructure projects such as water, wastewater and railways.” He expects the trend to continue and is bullish on the sector. “Positive surprises could come from later-cycle markets such as construction and power generation, which have been severely depressed for several years now,” Davis adds. Growing interest in environmentally friendly products has also been good for the sector, he says. Some of that can be attributed
Obama was elected, there was a lot of chatter that some sort of tax on carbon would be introduced in the form of cap and trade or even in a simpler form of increased subsidies for clean energy,”says Davis.That has not happened — at least, not yet — and thus the wind-power business has been extremely weak.“Visibility on a recovery here is low,” he notes. Not so the recovery in ad markets. Just ask J.P. Morgan’s Alexia Quadrani, who rules the roost for the first time in Publishing & Advertising Agencies. “I was most surprised this year by how quickly the advertising market grew, from turning in its worst performance in almost a century to becoming one of the most robust,” she says. “No one anticipated such a strong recovery.” Newspapers took a beating last year, as the recession stoked concerns about the industry’s viability over the long term. But aggressive cost-cutting measures and a rebound in advertising helped bring many of them back from the brink, she adds, noting that newspaper stocks have more than doubled off their May lows and are up approximately 50 percent from one year ago. “Many companies refinanced their debt, pushed out maturities and are now seeing better revenue,” Quadrani says.
“The outlook for U.S. companies is better than for the U.S. economy overall.” — Stephen Haggerty, BofA Merrill Lynch Global Research
to stricter environmental regulations and HVAC — heating, ventilating and air conditioning — efficiency standards, which set off a need for equipment upgrades. “Air-conditioning regulations have created a fair amount of business, and lots of energy-saving products are selling well now,” Davis says. Much of the environmentalupgrade cycle is being driven by companies’ desire to cut energy costs and operate in a more environmentally responsible fashion, but there is another benefit: “Payback periods for environmental investments have decreased considerably over the past several years, and now even simple upgrades like lighting, HVAC and motors can have a payback of less than two years,” he explains. Not all companies in the sector have benefited equally, however. “When President
Advertising agencies, by contrast, weathered the recession better than most other media companies because “they operate in many different businesses and geographies, which reduces their exposure to any one area that may be hit hard by the downturn,” she explains. This is one segment of the economy in which next month’s elections are a cause for optimism, in light of January’s court ruling that set aside provisions of the Bipartisan Campaign Reform Act of 2002 limiting corporate spending in federal contests. “The Supreme Court’s overturn of part of the McCain-Feingold Act should cause an increase in political advertising dollars spent during election season,” Quadrani notes, with newspapers and local TV stations the likeliest beneficiaries.
Clients who have known Quadrani for some time were not surprised that she was able to navigate the abrupt turnaround in her sector’s outlook. “She moved from Bear Stearns to J.P. Morgan a couple of years ago without missing a beat,” recalls one money manager. “And she has consistently added value in what has been a tumultuous couple of years.” The recovery in advertising also provided a boost to companies in the Entertainment sector, in which BarCap’s Anthony DiClemente leads the ranking for the first time. “Profitability across the board for most major ad buyers on a national level rebounded, and as a result, big U.S. multinationals have had the ammunition to spend more on advertising and marketing,” he explains. That sent the sector soaring — until April, when it started to fall to earth. “It’s a temporary reversal based generally on macroeconomic concerns over housing, unemployment and consumer confidence,” DiClemente says: People began cutting back on their spending on fears of a double dip. The downturn may only be temporary, but some changes may last far longer. For instance, cost-conscious Americans are not buying as many DVDs as they once did, and may never again. “The presence of DVD rental companies has shifted consumer behavior away from DVD sales and more toward rentals, which are lower-priced transactions and therefore less profitable for the movie studios,” DiClemente says. Video piracy remains a major problem, cutting into studios’ profitability, but “if companies find a way to sell movies and TV shows globally in a secure way, they could make up in volume what they are giving up in price,” he adds. Relying on higher-volume sales rather than higher prices may be a strategy that companies in all sectors adopt as the economy remains sluggish, because “balance sheets are flush with cash, and companies are cutting costs,” observes BofA’s Haggerty. “The outlook for U.S. companies is better than for the U.S. economy overall.” Identifying which of those companies are likely to triumph is what the best analysts do, and the members of the 2010 All-America Research Team have proved that they are up to the challenge. •• Comment? Click on Research at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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INVESTMENT RESEARCH
continued from page 57 homa, found that
the stock picks exhibited some value and market impact, as measured by returns in the 20 trading days after publication, but that the quality of the investment advice varied. He found scant evidence of any factors that could predict the quality of a blogger’s recommendations. Size may be the enemy of the good. Wesley Gray, an assistant professor of finance at Drexel University in Philadelphia and a co-founder of Empirical Finance, a recently seeded $50 million quantitative hedge fund, has studied the investment write-ups posted to Value Investors Club, whose founders, Joel Greenblatt and John Petry — longtime partners at New York hedge fund firm Gotham Capital — strictly enforce the 250-member cap. Gray’s analysis, which formed the basis of his Ph.D. dissertation at the University of Chicago Booth School of Business, found that stocks recommended on the site delivered an average one-year buy-and-hold return of 9.52 percentage points above the predicted return, after controlling for risk. Gray and his colleagues performed a similar, unpublished analysis of recommendations on the SumZero web site, which has a much larger user base and a shorter track record, and found no statistical evidence that the ideas posted there were, on average, market-beating. That comes as no surprise to the Value Investors Club founders, who admit just one in 15 applicants.“If every member of the buy side joins SumZero, over time you’re going to have the aggregate return of the market,” says Petry. Blogs, online communities and crowdsourcing platforms like Twitter may hold promise for investors, but their reach is still limited, especially among more-seasoned professionals. “Most portfolio managers over 35 are ignoring this stuff,” says Steven INSTITUTIONALINVESTOR.COM
Goldstein, co-founder and CEO of Alacra, a New York–based content aggregator that helps investment firms track information published on blogs, social media sites and other online sources. Tapping into the right networks can be a Herculean task. “Yes, there is a proliferation of information and a lot of debates happening on social networking sites, but I think if anything it obfuscates the issues,” says Barry Hurewitz, chief operating officer of investment research at Morgan Stanley. He contends that good sell-side analysts, thanks to their own professional networks, are better equipped to define the debate and understand market expectations.“They tend to have the conversations with investors that matter the most,” says Hurewitz. The proponents of online communities and social networking have no delusions of grandeur, but they are firm in their belief that these new online tools will ultimately change the way investors conduct research and vet new ideas. “I don’t want to sound ridiculous,” says SumZero’s Narendra, who positions his site as an alternative source of information that complements existing sources, such as sell-side research, 10-Ks and investors’ own proprietary models. Still, the entrepreneur can’t help but ponder the possibilities. “If we get to the stage where there are 10,000 to 20,000 buy-side analysts all in one community,” he says, “I think that’s really, really powerful.” THEFACTTHATPROFESSIONALMONEY
managers share investment ideas online is perplexing to academic economists. After all, in an efficient and competitive market, money managers should be inclined to keep valuable insights private so that they can exploit the information advantage to outperform their rivals and attract greater sums of investment capital. In practice, though, sharing has long been one of the most important ways that fund managers discover new investment ideas. Private “idea” dinners and gatherings like the twice-annual Value Investing Congress, launched by Whitney Tilson and John Schwartz, have long been a staple of the business. In a 1988 academic paper, written back when social networking meant working the cocktail party circuit rather than friending somebody on Facebook, Yale University economist Robert Shiller and then–Harvard
economist John Pound found that roughly 53 percent of the institutional investors they surveyed attributed their initial interest in a stock to another investment professional.When the inquiry was limited to a small sample of stocks that had experienced rapid price increases, 75 percent of the investors traced the origins of their ideas to fellow fund managers. Sharing good ideas with competitors, it turns out, is an entirely rational undertaking. Drexel’s Gray cites three reasons: the collaboration argument (originally put forward by another academic, Harvard economist Jeremy Stein), which holds that managers will share information if doing so provides access to constructive feedback; the diversification argument, which holds that sharing is rational when it gives managers access to a wider pool of high-quality ideas; and the awareness argument, known more pejoratively as “talking your book,” in which a manager profits by persuading other investors to buy, thus bidding up the price. The speed and scope of information sharing among investment professionals got a big boost in the late 1990s with the rapid adoption of instant messaging on Wall Street. With IM, brokers and traders — much like the teenagers who popularized the technology — found that they could share information with multiple individuals simultaneously and that sending an IM was more real-time than e-mail and more convenient than the telephone. Sensing an opportunity, Reuters and Bloomberg introduced their own instant messaging platforms in 2002 and 2003, respectively, marking an important turning point. Unlike most consumer IM platforms at the time, both companies offered investment firms security, auditing and privacy controls, helping compliance officers get comfortable with the technology amid growing scrutiny by the SEC and other regulators that oversee brokerage firms. As Reuters and Bloomberg terminals became ubiquitous in the investment business, they emerged as linchpins in what might be deemed Wall Street’s formal network for the distribution of research and stock calls to the buy side. Today, once an analyst releases a research report, it is typically published to the firm’s passwordprotected web site for clients and distributed simultaneously to entitled customers via Thomson Reuters (as the company is now
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INVESTMENT RESEARCH
known), Bloomberg or other third-party distributors, such as Capital IQ. Brokers and traders also e-mail research to clients, disseminate the substance via IM and host private conference calls or webcasts to discuss the investment opinions. Thomson Reuters and Bloomberg are themselves working to build on strengths in instant messaging to create new opportunities for investment professionals to share and collaborate online — but in a way that affords firms ample control over who can see their content and how their employees share research and other proprietary information. Both companies’ flagship data products allows users to create profiles, follow updates from individual users and share charts and data, along with comments. “Bloomberg built systems to meet our customers’ networking needs before the concept of social media even existed,” says Jean-Paul Zammitt, Bloomberg’s head of core terminal products and services. Even a Wall Street lawyer could love this kind of networking: As Eran Barak, Thomson Reuters’s global head of community strategy, puts it, the goal is to “bring the power of community and collaboration into financial professionals’ work flow,” while giving IT departments and compliance officers “all the tools to be compliant with regulation and perform risk management.” Outside of this formal distribution network, socially generated investment opin-
earnings guidance/smoothing game.” With the stock trading at $54 in mid-September, investors who bought on the dip were up nearly 40 percent. “When you submit a good idea to Value Investors Club or SumZero, others get on board,” says Alan Axelrod, a member of both sites and a former managing director at Ziff Brothers Investments, who now oversees $50 million in separately managed longshort domestic equity accounts. “You can immediately see some volume change plus the stock going up on a long you might suggest or down on a short.” THERE IS NO DOUBT THAT INVEST-
ment recommendations posted to social networks, however exclusive they may be, can be subject to biases. The 2007 paper by Fotak of the University of Oklahoma found that the stock picks from bloggers on Seeking Alpha tended to focus on large-cap names with recent abnormal returns and trading volumes. Long picks were consistent with contrarian strategies, he found, while shorts reflected momentum strategies. Conversely, stock picks posted to Value Investors Club and SumZero are more likely to be small-cap stocks or special-situations opportunities, according to Drexel’s Gray. He noted in his Ph.D. thesis that the median market cap of long ideas, which make up the vast majority of recommendations on both sites, was $393 million for Value Investors
“The technology keeps morphing. That’s the challenge on the regulatory side.” — Margaret Paradis, Baker & McKenzie
ion is for now less heavily regulated, but potentially very lucrative, for those who can tap into the right source. Value Investors Club, the most exclusive of the online venues aimed at pros, is seen as a particularly fertile source of high-quality ideas. In early May, for example, user “cxix” recommended shares of NBTY, the world’s largest maker of vitamins and supplements, then trading at $39 a share. The company, cxix wrote, was “a better business than it’s generally given credit for” and prone to “blowups” — such as the one in the previous week, when shares fell 20 percent intraday — because management “doesn’t play the
Club and $559 million for SumZero. Most users of both sites are themselves employed by small and midsize firms. Based on an analysis of SumZero’s membership, Gray found evidence that larger fund managers were less willing to share new ideas than smaller managers were. (His interest isn’t just academic: Gray’s hedge fund trades in part on quantitative models that analyze the flow of information through social networks like SumZero and Value Investors Club.) Apart from discovering and vetting new investment ideas, these specialized social media sites — the ones that don’t permit anonymity, at least — also provide crucial
networking opportunities. Narendra says that SumZero is in many ways an extension of the information provided by services like Bloomberg. He points out that a Bloomberg terminal can be used to find out the names of firms that are 5 percent holders of a company’s stock, but not the names of the analysts at those firms who actually cover the company. On SumZero, however, users can search for a 5 percent holder and find out which of its analysts is covering the company. Users can also figure out who they know in common, whether they both used to work at Goldman Sachs or even whether they attended the same business school. “We’ve taken elements from social networking and [online encyclopedia] Wikipedia and applied them to the buy side in a way that nobody really has in the past,” says Narendra. Over time, social networking may reduce the advantage that more-sophisticated asset managers with deeper pockets enjoy over smaller firms. “You’re gaining an extension of your own staff of smart people to render an opinion,” says money manager Axelrod. Although he generally prefers anonymity when connecting with peers online, he hasn’t hesitated to take advantage of the networking opportunities afforded by SumZero, using the site to identify fellow investors with whom to strategize.“It provides avenues for what social media is all about: relationships,” says Axelrod. “Not frivolous relationships but very valuable points of access.” Alexander Rubalcava, founder of Los Angeles–based wealth management firm Rubalcava Capital Management, agrees. He recently posted on SumZero an analysis of offshore oil exploration and production company ATP Oil & Gas Corp., which has substantial operations in the Gulf of Mexico. As the BP oil spill dragged on, the web site “helped me keep track of all the changes proposed by the government,” says Rubalcava, a former analyst at Santa Monica, California–based venture capital firm Anthem Venture Partners.“Keeping up with that was beyond any one firm, but a lot of people were exchanging their findings on SumZero.” The market for online investment opinion is helping some firms reach new clients. Chicago-based independent equity research firm Applied Finance Group, which typically serves institutional investors and large bank trust departments, publishes a daily investment thesis on a proprietary blog INSTITUTIONALINVESTOR.COM
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called Value Expectations and regularly contributes ideas and analysis to Seeking Alpha. Co-founder Rafael Resendes says the exposure has helped introduce his firm to registered investment advisers and brokerage teams that haven’t typically been big buyers of independent research. “Who knows how this will change the client landscape,” he says. The Big Picture’s Ritholtz also attributes business wins to his blog. His firm, Fusion IQ, runs an asset management business that has attracted more than $300 million in assets, primarily through word-of-mouth referrals. “I suspect there’s a comfort level thanks to my blog,” says Ritholtz.“It makes the process of someone validating you that much easier.” Networking and information exchange may be especially valuable in niche areas of the market. A case in point is Distressed Debt Investors Club, the brainchild of a credit analyst who goes by the handle “Hunter” and has eight years of experience on the buy side. Hunter, who declines to reveal his real name or the name of his employer, says that about three quarters of the roughly 200 investment ideas on the web site are distressed-debt and eventdriven plays, with the remainder split between equity and special-situations opportunities. “A lot of people on the site have either formal credit training or a leveraged finance background, so people understand the bankruptcy and restructuring process,” explains Hunter, who says his site marries the best of Value Investors Club and SumZero. (He is a member of both.) “On other sites or in sell-side reports, you might not have people well versed enough to understand the implications of, say, a fraudulent conveyance ruling.” Still, money managers trolling for new investment ideas must proceed with caution. Academic studies of retail investors have found strong evidence that stock message boards lead to confirmation bias. Studies of professional investors’ offline behavior suggest that they are prone to the same temptations. With the balkanization of online information sources and the rise of the number of networking sites for professionals, myopia is a hazard. “You run the risk of reading just the people who agree with you,” says Ritholtz. Conflicts of interest are another danger. Seeking Alpha differentiates itself with a contributor policy that requires its bloggers, INSTITUTIONALINVESTOR.COM
who range from hobbyist investors to professionals, to provide the site’s editors with their real names for verification purposes, even if they blog anonymously, and to disclose positions in the securities they write about. Still, compliance with the policy is not policed by the site and thus depends on contributors acting in good faith. The founders of private buy-side communities that permit anonymity say that they too know everyone’s identity, even if fellow users don’t, and that their sophisticated, highly vetted user bases assume that people are writing about positions they already own. “It’s preselected for people who will see through pump-and-dump,” says Value Investors Club’s Greenblatt. Will these nascent social networking sites for financiers flourish — or will they remain a pursuit for just a narrow slice of the investment community? There are challenges to growth. For starters, regulators
a different model. Rather than pursuing advertising, Narendra and his partners are considering strategies for selling or licensing to third parties the investment selections and recommendations that are featured on the site. Back on Wall Street, many of the major brokerage firms say they aren’t yet ready to discuss how they might deploy social media tools to extend the reach of their investment research. But at least one firm is taking a page from the digital media playbook. In August, Morgan Stanley became the first Wall Street firm to launch iPad and iPhone apps allowing institutional clients to search and browse its research. According to research COO Hurewitz, the firm has already begun streaming research presentations on video. And in a world awash in information, Morgan Stanley is helping its analysts validate their investment theses by leveraging a three-year-old internal custom research
“We’ve taken elements from social networking and Wikipedia and applied them to the buy side.” — Divya Narendra, SumZero
and compliance departments alike are still trying to figure out how to adapt existing rules on disclosure, supervision and recordkeeping to the unruly world of social media communications. Many firms are ordering employees to steer clear, and in some cases they are simply blocking social media sites from office computers. “The new technology keeps morphing,” says Margaret Paradis, a partner in the investment fund and asset management practice at law firm Baker & McKenzie in New York.“That’s the challenge on the regulatory side.” Making money is another hurdle. Some sites, like Value Investors Club, will no doubt continue to be run as quiet side projects for a select few. But other sites, such as Seeking Alpha and SumZero, aim to become profitable businesses. Seeking Alpha relies primarily on advertising, but in October the site will launch a platform featuring more than 20 applications for stock and exchange-traded-fund research as well as screening and charting tools, says CEO Jackson. SumZero is contemplating
group called AlphaWise, which uses tools like quantitative market research and data mining to uncover primary evidence on any topic, from casual dining trends in the U.S. to equity issuance in India. By strengthening its research with proprietary data sources and delivering the content through new digital channels, such as apps that enable the firm to control access with a log-in, these initiatives are consistent with the firm’s protective stance in its case against Theflyonthewall.com, but at odds with the open, collaborative and freewheeling nature of the social web. Whether these two approaches to creating professional-quality investment opinion can coexist in the information age, or whether they will ultimately converge as they have in other industries, remains to be seen. •• Len Costa is the director of innovation and emerging media at CFA Institute, a global association of investment professionals. Comment? Click on Investment Strategies at institutionalinvestor.com.
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continued from page 61 have been obliged to assess the latest smartphones and tablets from Research in Motion and Apple, hardware vendors that are outside their regular purview. Likewise, most sell-side firms assign two other perceived threats, salesforce.com and Google, to an Internet analyst, who’s typically not the same person who leads Microsoft coverage. (Citi’s separate software industry and Internet research teams recently joined forces for a “deep dive” study of the Microsoft-Yahoo! partnership.) When it comes to covering Microsoft, says Katherine Egbert, a software industry analyst at Jefferies & Co.,“there are just unlimited things to know.”
A GENERATION BEFORE APPLE’S
iPhone App Store opened many eyes to the benefits of a software-centric ecosystem, Microsoft pioneered the concept with its migration from the DOS operating system to Windows. Though not the first operating system with a graphical interface, Windows became the easiest and cheapest way for most PC users to discover this user-friendly technology in the 1990s, thanks to Microsoft’s prodding the industry on all fronts. Some of its efforts to tip the market in Windows’ favor were criticized, leading to a series of high-profile antitrust actions, but others were welcomed. For example, the company made sure that developers had the support and tools they needed, such as Visual Basic (a coding kit that debuted in 1991). The benefits that Microsoft reaped from leading this migration quickly became obvious. In 1991 then–Sanford C. Bernstein & Co. analyst Mike Kwatinetz coined the term “Wintel” for the emerging PC standard that combined Windows with Intel Corp.’s microprocessor hardware.“I named it that because IBM had lost control,” recalls the former II-ranked software analyst, who currently works in venture capital. Microsoft’s mas-
tery over Windows enabled its applications programs, led by the spreadsheet Excel and word processor Word, to vault past competitors and dominate their markets. At the same time, with Windows NT (launched in 1993), Microsoft began to add networking capabilities comparable to those offered by Novell’s NetWare; Novell’s domination of the PC networking market, in turn, vanished. Wall Street took notice. Kwatinetz says Microsoft was his top stock pick for his entire nine-plus years on the Street, from 1991 to 2000. Early in 1993, Microsoft’s market capitalization overtook IBM’s. Over the course of the decade, Mister Softee showered investors with gains averaging nearly 60 percent a year, or a cumulative return exceeding 9,300 percent. By the end of the 1990s, nine out of every ten PCs were sold with Windows. Hundreds of millions of users, and nearly every IT supplier of any kind, whether in hardware or software, from coders to chip makers, were building their efforts around it. In addition, while Microsoft’s applications programs ruled users’ desktops, the company was using its Windows NT beachhead to expand into corporate data centers, first with products like BackOffice Server and Exchange and later with server systems marketed under the Windows brand. Meanwhile, with Visual Basic and its 1997 successor, Visual Studio, Microsoft remained the dominant supplier of tools required by Windows coders, both those working within the company itself and those operating independently, whose efforts completed the virtuous circle. Such is the ecosystem that Microsoft has been defending over the past ten years. So where’s the shagginess in all this? The answer: There isn’t any. During the 2000s the three business units through which Microsoft manages the Windows ecosystem accounted for about 84 percent of the company’s revenue, which totaled $439 billion, and all of its profits, a cool $155 billion. Microsoft’s Windows-related businesses account for less of the company’s total revenue today than they did at the beginning of the decade, but this shift has been slight, dropping from an average of 85 percent over the first half of the decade to about 83 percent in the second half (see chart, page 44). The trouble is, too many of today’s investors see potential weakness instead of strength in this carefully tended, walled-in garden.The
longer Microsoft stretches out Windows’ annuitylike income stream, the more investors seem to view it as a vulnerability. In their simplified view, anything that threatens the primacy of the Windows PC becomes nothing less than an existential threat to Microsoft. Take the iPad, the tablet computer that has become a popular hit for Apple this year. In the same way that smartphones like RIM’s BlackBerry and Apple’s iPhone demonstrated that users don’t need a PC to keep up with e-mail — in particular, corporate e-mail managed by Microsoft’s widely used Exchange system — the iPad points to a future in which ever more tasks that today require a Windows PC will be handled without one. Thus investors seem to have concluded that tablets can mean only one thing for Microsoft: “The iPad comes out in April, and by summer people are predicting the death of Microsoft,” observes Egbert. Such thinking is not new, of course. Microsoft famously faced its first existential challenge even as it was leading the migration to Windows during the 1990s, with the rise of the Internet, marked in particular by the web browser pioneered by Netscape Communications. In 1996, a year after Netscape’s wildly successful IPO, venture capitalist Roger McNamee gave a talk to an industry panel titled “Why Intel and Microsoft Don’t Matter Anymore.” By then, Gates had fully grasped the threat and directed his people to redesign Microsoft’s entire product line with web connectivity (“Net awareness”) in mind. Microsoft started by offering Internet Explorer as a free add-on to purchasers of Windows 95, and the so-called browser wars began. Forced to give its browser away for free too, Netscape eventually fell behind both financially and technologically. By mid2000, IE’s share surpassed 80 percent. Microsoft called its strategy for ensuring Windows’ relevance to the Internet“embrace and extend.” By offering IE as a free add-on to Windows, the company sought to make Internet browsing part of Windows’ standard feature set. Microsoft’s success in vanquishing Netscape led some wags to add a third “e” to this Internet strategy — “and extinguish.” It also gave impetus to what would become the second existential challenge Microsoft would face during this period: the series of antitrust actions filed against the company in the U.S. and Europe. The U.S. Department of Justice and 20 U.S. states sued the INSTITUTIONALINVESTOR.COM
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company for antitrust violations in 1998 and eventually produced a court order that would have split it in two. (That decision was reversed on appeal in 2001.) In the final settlement, accepted in 2002, Microsoft agreed to unbundle IE in future Windows licensing deals. Provided that Microsoft remains in compliance with these and other terms of the settlement (which by all accounts it has), judicial oversight of the company in the U.S. is set to expire in May 2011. Financially, the impact of Microsoft’s long-running antitrust saga has been immaterial. The stock dipped in response to some of the headline-grabbing charges, but never for long. But with the benefit of hindsight, many observers attribute the company’s recent sluggishness to its antitrust headaches. Company insiders refer to the first half of the past decade as the “dark ages of Microsoft,” reports IR director Koefoed, who himself joined in 2004 from Pricewaterhouse Coopers Consulting, where he specialized in high-tech strategic planning. When Jefferies analyst Egbert added Microsoft to her coverage universe in 2006, she found a company besieged. “When you have 90 percent of the world’s governments on your back,” she observes, “it’s very hard to innovate.” Egbert credits Microsoft’s stellar past to its success as a “fast follower” rather than as an innovator per se.“Microsoft’s best growth came as they adopted technologies, mostly invented by others, to the mass market,” she wrote in a July note to clients following the company’s fiscal year 2010 earnings release. “They are in the early innings of mass adaptation of products developed by others — this time for tablet PCs, a mobile phone OS, cloud computing and online search.”Egbert’s advice to frustrated investors: “Stop expecting from Microsoft innovation à la Apple and start expecting low-cost mass market adaptations of popular technologies, à la China.” Even analysts who agree that adaptation, rather than innovation, is Microsoft’s core competency worry that the company has yet to demonstrate that it has emerged from its postantitrust stupor, let alone that it has recovered its 1990s mojo.“It feels like they’re being hit by these waves and letting them wash over themselves before they react,” says Citi’s Pritchard. “They want to do it right, and so they end up with a long-term plan. But it takes longer than anyone expects, and many investors just don’t want to be along for the ride.” INSTITUTIONALINVESTOR.COM
For Microsoft investors, this year’s chief anxiety producer has been the popularity of tablet computers like Apple’s iPad. A July report produced by Goldman Sachs’ IT research team named Microsoft the primary loser in this nascent trend, asserting that a significant part of the stock’s underperformance this year “has been due to the risk from iPad traction and lack of a satisfactory offering for this emerging and popular form factor.”Goldman’s report predicted that Windows will power just 13 percent of tablets sold next year and that in the long run the tablet category “represents a threat to Microsoft’s dominance of the PC world as users choose non-Windows tablets as an incremental device, instead of a Windows-enabled notebook or netbook.” But other analysts, though concerned by Microsoft’s late arrival to the tablet party, see the situation less grimly. For one thing, the growth prospects for the PC ecosystem are enhanced by the continuing decline of hard-
everybody knows, you can buy two netbook PCs for the price of one iPad,” he said. INVESTORS PERCEIVE ANOTHER ILL
wind for the Windows ecosystem in the trend that lately goes by the name of — appropriately enough — cloud computing. In this scheme, instead of using software that’s been paid for up front and installed in a corporate data center or office PC, customers fetch the programs and data they need from an outsider’s “cloud” — that is, from software hosted on a vendor’s remote facilities and accessed via a network (typically, but not always, the Internet). Web-based e-mail is a simple example. All that’s needed to access a Microsoft Hotmail or a Google Gmail account, for example, is an Internet connection and a web browser — which could be running on a Windows PC, a smartphone or a tablet. Companies like salesforce.com and Google offer more-sophisticated cloud-
“You have to delve into a lot of minutiae to be able to tell a client something worthwhile about Microsoft.” — Sarah Friar, Goldman, Sachs & Co.
ware prices; as desktop PCs approach $500 or less, they’ve become affordable to the burgeoning middle classes of Brazil, China and India. For another, Microsoft has managed to embrace new form factors, like netbooks, despite being absent at their creation. The first wave of netbooks was powered by the Linux operating system, but the devices were returned in droves after users found them incapable of running Office applications like Excel. Today more than 80 percent of netbooks sold run a specially designed version of Windows. Besides, says Jefferies’s Egbert,“Microsoft knows how to compete against Apple.”With tablets, many analysts see the two longtime rivals following the same playbooks they used in the 1980s, when Apple attracted the premium-paying customer with advanced technology and Microsoft tagged along later but won the masses. At Microsoft’s annual meeting for financial analysts this summer, Ballmer declined to say what he expected Windows tablets to look like or when they would appear on the market. But he seemed certain that price would be a key differentiator of Windows-powered tablets.“As I think
based apps, ranging from spreadsheets to sales management systems, and argue that for customers the cost savings over traditional IT solutions are compelling. After a couple of years of indecisiveness, Microsoft last year released a cloud framework of its own called Windows Azure.“The cloud is the future of IT,” chief financial officer Peter Klein stated unequivocally in his address at the company’s annual analysts’ meeting on July 29, 2010. He added that Microsoft believes this shift would increase its revenue and profits, not shrink them as some observers fear, for three reasons. First, via the cloud, Microsoft will be able to offer more — and more expensive — products to customers who lack the resources or expertise to run them on their own premises. Second, it will be harder for customers to pirate software that runs on Microsoft’s facilities rather than the customers’ own. That’s not insignificant for a company that estimates that one of every two copies of Office currently in use, and one of every four copies of Windows, is unlicensed. Last, Microsoft believes that by controlling the hardware as
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well as the software that customers use, its products will simply run better than they do today. “And in the long run,” Klein told his audience,“customer satisfaction is probably the single biggest leading indicator of our financial performance, obviously.” For investors, the only trouble with Microsoft’s migration to the cloud is that it’s likely to be gradual. The resulting revenue boost is unlikely to move the needle of total revenue, or the stock price, several analysts say. “They’ve laid a really good groundwork,”says Jefferies’s Egbert. Unfortunately, she adds,“they get zero credit [for this] in the stock.” By comparison, Wall Street has no trouble giving credit to salesforce.com. One of the few pure plays in cloud computing, the company’s shares are up more than 700 percent since its 2004 IPO, including a 300 percent rise in the past 18 months alone. Wall Street has acknowledged Microsoft’s efforts in phones and search; unfortunately, it hasn’t been the kind of recognition that
way today in the technology sector: the mass migration from basic, keypad-centric cell phones to Internet-savvy smartphones with graphical, touch-sensitive screens. By distributing its Android operating system to developers, telecommunications carriers and handset makers — in most cases for free — Google is positioning itself at the center of an emerging ecosystem that may eventually rival Microsoft’s in importance. Unit sales of Android-powered handsets (there are at least 50 models) this spring collectively caught and now surpass those of the early touchscreen market leader, Apple’s iPhone. It’s no wonder that Microsoft’s current smartphone ambitions are met with skepticism. After halting development of its nontouch-capable phone operating system in 2006, Microsoft has been focusing on its next-generation phone OS, Windows Phone 7, which is expected to show up on handsets this holiday season. A developer’s package
“We spend more time on Microsoft than on any other company. It’s bigger, more complicated, in more markets than the rest.” — Walter Pritchard, Citi Investment Research & Analysis
management in Redmond is seeking. Analysts say spending in both areas amounts to a drag on the stock. Without apologizing for any of the spending, Ballmer has publicly acknowledged that Microsoft isn’t where he’d like it to be in either area. Yet Microsoft’s problems are not merely a matter of its own performance. To the contrary, an even bigger problem for the company is what its competitors have done in its absence. None of Microsoft’s competitors is more formidable than Google. Among its resources: total domination of a rarefied but fast-growing, highly profitable and global business; hundreds of millions of active, even passionate, users; thousands of the world’s smartest engineers; and billions in cash. Plus, Google has a visionary management willing to pour current profits into money-losing projects aimed at exploiting long-term technology trends. Sound familiar? When it comes to phones, the resemblances between Google and Microsoft are even more apparent. Stealing a page from Microsoft’s 1990s playbook, Google is leading the most important trend under
was distributed last summer, and in July the company announced that it intended to give a Windows Phone 7 handset to all 89,000 of its employees as soon as the first models become available, in an effort to spur app development for the new platform. “It’s really hard to figure out exactly how the company achieves their goals in the smartphone area,” Citi’s Pritchard said during an appearance on CNBC in late July. The view from inside the Windows ecosystem is less skeptical but still cautious. “Microsoft totally dropped the ball [when it discontinued development of its previous phone operating system],” says one longtime Windows loyalist, Michigan-based smallbusiness systems specialist Amy Babinchak. Recently recognized as a Microsoft “partner of the year” at the company’s annual gathering for independent resellers and consultants, Babinchak says she has outfitted her own firm with iPhones and recommends them to clients. Still, she expects it won’t be long before she’ll also be plugging Windows 7 phones: “When Microsoft sets their sights on something, they have yet to fail.”
Microsoft’s hope is that it’s still early days for smartphones — and indeed, the enterprise-computing garden hasn’t been ripped up utterly yet, either by iPhones or Android devices. According to New York–based independent developer Jonathan Westfall (another ecosystem member “recognized” by Microsoft), Microsoft’s forthcoming phone operating system will support unique integration capabilities with its enterprise server systems, making possible handsets that “play better” with Exchange and SharePoint, for example, than ones based on Android. “Microsoft has the potential to be the best at Exchange integration,” Westfall says. No one in the industry is counting Microsoft out just yet. But investors are close to doing so. In its July earnings call, management stressed that all five of its business divisions had delivered double-digit top-line growth. Sales for the Windows unit grew 24 percent year-on-year, twice the division’s average for the decade; for the fourth quarter, year-on-year growth shot up 44 percent. Although that bounce follows a recession, the company cited independent research showing that in laptops, the fastest-growing category in the U.S. PC market, Windows’ market dominance had recently risen. All told, Microsoft had sold 175 million licenses of Windows 7, CFO Klein told listeners on the earnings call, making it the fastest-selling operating system by any company, ever. The market, however, was unimpressed. In after-hours trading following the call, Microsoft’s stock fell 12 cents. “I don’t have a good reason for the stock not to be up,” Goldman’s Friar told the Seattle Times. Clearly, investors and management value Microsoft’s assets differently these days. In Redmond some refer glumly to a “conglomerate tax” slapped on Microsoft by the market. “I don’t think people understand the breadth of the company,” observes IR director Koefoed, adding that “it’s particularly interesting how much we leverage our assets across our properties.” Unlike a cloud-computing specialist such as salesforce.com, Microsoft can spread the costs of the huge server farms required for its cloudcomputing buildout across other businesses, such as search and Xbox Live. Koefoed says the company’s Office unit is busy working on porting Office apps to the forthcoming Windows 7 phone platform.“The combination of all those things is really unique,” he INSTITUTIONALINVESTOR.COM
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says.“That’s why we feel so [convinced] that bigness is an asset.” Many analysts think the way for Microsoft to rouse investors is by first exciting its customers. The trouble is, the days when people lined up at midnight to purchase an operating system are long past. Outside its own ecosystem, Microsoft and its engineers have never received the credit they deserve for getting Windows to embrace the innovations of others — which sounds a lot easier than it really is. Though the latest Xbox should dissuade anyone who thinks bigness has smothered Microsoft’s ability to innovate, the company’s living room business isn’t large enough to change its numbers for investors. “They’re no longer perceived as a growth company,” says Egbert, who figures Microsoft has about a 12- to-18-month window to become relevant again. Or else — what? Prospects for deal making on the order of the Yahoo! bid have since dimmed, analysts say. Some saw a chance for Ballmer to buy his way into the smartphone race when Palm, whose latest phone operating system was designed from the ground up for touch, announced it was putting itself up for sale last spring. (Hewlett-Packard Co. purchased the beleaguered handset maker in April for about $1.2 billion.) But Microsoft’s dark reputation in Silicon Valley serves to dampen enthusiasm for such deals, and value-oriented investors would rather see Microsoft spend its cash — $37 billion at last count — on boosting its dividend or buying back stock. An indication of just how important such financial engineering is to investors came when shares of Mister Softee jumped 5 percent on heavy volume one afternoon last month (their largest gain this year) after a wire service reported that the company would finance its dividend and buyback program with new debt. But the shares gave back much of that gain a week later after Microsoft announced that it was increasing its dividend by 23 percent (investors evidently were hoping for more). One solution that has been bandied about since Bill Gates’s reign as CEO is the U.S. Justice Department’s proposal to break Microsoft into multiple companies. Supporters of the breakup remedy, ranging from Apple CEO Steve Jobs (who voiced his support for such a step as early as 1994) to Forbes blogger Victoria Barret (in a post this summer), would probably agree that a voluntary vivisection under Ballmer is unlikely. INSTITUTIONALINVESTOR.COM
But one can’t help observing how many of Microsoft’s problems such a move might solve. Consider if Ballmer were to divide his domain into three separate companies: one focused on platforms (Windows, including Azure and an operating system for mobile devices, servers and Xbox); one on applications (Office, phone- and Azure-based apps, games and developer tools); and one on the web (Bing and MSN). The first two combine enough profitable business lines to stand on their own, and they’d be motivated as never before to open the Windows ecosystem to competitors’ innovations. As for the third, Ballmer could make it viable by first buying Yahoo! — these days the company could probably be had for half the $44 billion he offered in 2008 — and then merging it with this unit. Yahoo! would get the part of Microsoft it needs (search technology), without the part it seems to fear and loathe (Ballmer himself). Ballmer, and the new platforms and apps units, would get what they really need: a company with the resources to provide genuine competition to Google. (In the bargain, Yahoo! would get a purpose — something most analysts think it needs.) Granted, there’s no real precedent in the tech industry for such a move. Unlike IBM’s spin-offs of its PC and printer lines, the aim would not be to rid Microsoft of businesses no longer valued by senior management. A more apt precedent might be Standard Oil Co., which created more wealth for John D. Rockefeller and his fellow shareholders in pieces than it ever did as a single, monopolistic entity. Similarly, the goal of breaking up Microsoft would be to show the world what it’s really made of — to expose the assets that Ballmer and company (but not enough others) see, for the benefit of Microsoft’s employees, customers, competitors and investors. The engineering and management talent trapped within Ballmer’s behemoth would be unlocked; the competitive landscape of technology would be transformed from one in which Microsoft’s sluggishness slows the pace of innovation within its own vast ecosystem to one in which smaller, hungrier companies, including the Microsoft spin-offs, have a chance to compete in other ecosystems, not just Windows, and be rewarded for their success in doing so. By embracing competition in this way, Microsoft might even rid itself of its Evil Empire designation once and for all.
The platforms company would put its phone and tablet project in high gear or suffer the wrath of shareholders. The apps company might build products that people want to use instead of ones they have to build because everyone else does. Unleashed, one of the new mini–Mister Softees might even endear itself to Wall Street. Sure, the breakup would be a little messy (imagine trying to figure out how to allocate Microsoft’s sales and marketing force of 25,000-plus, more than the total employee ranks of Google). But nothing like — well, nothing anyone could call shaggy, exactly. In fact, plotting the restructuring of Microsoft has long been a popular parlor game on Wall Street. Newly profitable Xbox, seen as an outlier for its hardware expertise and focus on the consumer, has been drawing the most attention from investors this summer, with speculation ranging from a spin-out to perhaps a tracking stock, analysts say. And high-profile jobs landed by Microsoft senior executives — including ex-CFO Chris Liddell, who became General Motors Co.’s CFO early this year, and ex–business division head Stephen Elop, who took over as Nokia Corp.’s CEO last month — serve to remind investors of the deep bench at the ready in Redmond. But the latest speculation persists not because analysts and investors believe any such plan is in the cards — to the contrary, most believe it’s a nonstarter — but rather because assessing the behemoth’s breakup value provides a quantifiable way of determining just how underappreciated the stock has become. For its part, management in Redmond has consistently refuted the logic behind any breakup speculation by arguing that the company’s assets are complementary and worth more intact than in pieces. Which means that analysts are likely to have a shaggy-dog story in Microsoft for some time to come. The bullish case for the next couple of years has the company’s revenue growing about 6 to 9 percent annually. For a megalarge-cap stock like Microsoft, that kind of growth is nothing to scoff at — though it doesn’t mean investors won’t. The bearish case, of course, leaves Mister Softee looking like a plain old dog. •• Comment? Click on Global Markets at institutionalinvestor.com.
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continued from page 65 banking boutiques
Hambrecht & Quist, Montgomery Securities and Robertson Stephens sprang up in San Francisco to focus on venture-backed companies in nearby Silicon Valley, while Alex. Brown & Sons — the first U.S. investment bank — started doing the same for small start-ups in the mini–venture capital alley between Baltimore, Washington and northern Virginia. These firms, dubbed “the Four Horsemen,” were all later gobbled up by big commercial banks. Deregulation of commissions was only the beginning of the changes. In an effort to protect investors and level the playing field, the Securities and Exchange Commission implemented the Manning and Order Handling Rules in 1996 and 1997, respectively. Under the Manning Rule, brokers couldn’t trade before the interests of their clients. The Order Handling rules required brokers to
tunities in the markets. These players send thousands of trades into the market every minute, primarily on the largest, most liquid stocks. The challenge to the brokerage firms was to produce more insight into the biggest companies, while catering to the short-term traders that generate the most commissions. Beginning in the 1980s, as commission rates shrank dramatically, and gaining steam in the 1990s with the other market structure changes that eroded profits, investment banking became the new patron of research. Analysts frequently brought in new business, joined bankers on IPO road shows and were paid directly out of banking profits. “The joke was that the analysts were bankers in research clothing,” says Weild. Then, on December 20, 2002, just as another bull market was about to unfold and a thriving IPO market might have taken root, Spitzer dealt his crushing blow against capital raising, announcing that ten big firms had agreed to settle charges that they had been publishing tainted investment research in hopes of winning banking business. The Global Research Analyst Settlement, which was finalized in April 2003, incorporated different agreements with Bear, Stearns & Co.; Citigroup; Credit Suisse First Boston; Goldman, Sachs & Co.; J.P. Morgan Securities; Lehman Brothers; Merrill Lynch; Morgan Stanley; U.S. Bancorp Piper Jaffray; and UBS Warburg. The firms were to pay $1.4
“The buy side has become less excited about sell-side research as senior people have left.” — George Shapiro, Access 342
display all client limit orders publicly when they were at or better than the national best bid or offer. In 2001, following yet another SEC rule change, the Nasdaq Stock Market and the New York Stock Exchange began trading in decimals rather than fractions. The new trading rules and decimalization put downward pressure on bid-offer spreads, further eroding the once-thriving economics that underpinned IPOs and a healthy aftermarket for stocks. With skinnier spreads, there was no choice but to automate trade execution. This set the stage for high frequency traders and hedge funds to develop computer algorithms and programs to try to detect anomalies and arbitrage oppor-
billion in fines to fund restitution, education and independent research. In addition, for five years the firms had to provide clients with independent research alongside their own assessments. Spitzer believed that investors would be able to assess the quality of their brokerage firms’ research by comparing it against research provided by third parties. The settlement also prohibited the practice of paying analysts from banking revenues, and analysts and bankers could no longer talk without a compliance person in the room. Wall Street responded swiftly and decisively. Firms cut the ranks of their analysts, dramatically reduced their pay, fired their support staff and made each researcher
follow far more companies, shrinking the depth of their coverage. Investment research became a cost center — and a potential legal liability. The Street even began outsourcing some number-crunching tasks to low-cost countries like India. Many of Wall Street’s most respected analysts balked under the new restrictions that traced their every move. Firms began monitoring e-mail and sent out lengthy legal disclosures every time an analyst spoke to the press. Hedge funds and other money management firms were only too happy to snap up analysts at relative bargain-basement salaries. In the early years after the settlement, several All-America top-ranked analysts left the Street, including Morgan Stanley insurance researcher Alice Schroeder and Judah Kraushaar, who covered brokerages and asset managers at Merrill Lynch. The analyst exodus continues today, as do the layoffs. “The buy side has become less excited about sell-side research as senior people have left,” says former Citi analyst George Shapiro, whom II ranked No. 1 in Aerospace & Defense for seven years. Citi laid off Shapiro at the end of 2008, when the bank said it was cutting the number of companies it covered by 7 percent; in June 2009 he joined Access 342, a Stamford, Connecticut–based independent research firm. U.S. sell-side equity research expenditures are expected to decline from $4.9 billion in 2006 to $4.0 billion by 2011 — an 18 percent decrease, according to Integrity Research Associates, a New York–based firm that matches investment managers with research products. Although Spitzer’s settlement with Wall Street was aimed to ensure that individual investors could compete more evenly with institutions, the markets, ironically, have become less efficient because of the falloff in research. As a result, the cost of capital for smaller, emerging companies has risen. “Historically, there is a pretty clear tie between getting research coverage and getting sufficient liquidity and trading in your name,” says Michael Mayhew, founder and chairman of Integrity Research. “If you’re a large-cap company and you have 18 analysts covering you, you’ll have a lower cost of capital than a small-cap company in the same industry that has two or three analysts.” Boutique firms like JMP Securities in San Francisco were founded specifically to fill INSTITUTIONALINVESTOR.COM
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the gap.“The bulge-bracket firms are saying a company isn’t a good IPO prospect until it has $100 million in revenue or $400 million to $500 million in potential market cap,” says Carter Mack, president and director of investment banking at JMP.“We believe that there are viable companies at $50 million in revenue and $150 million to $300 million market cap, if they have good growth characteristics and large addressable markets.” Both independent research and buy-side research have grown as investment banks have retrenched, but this is hardly replacing what’s been lost on the sell side. Furthermore, money management firms greatly depend on sell-side research to augment their own resources.“The buy side wholeheartedly uses research from the sell side,” says Craig Huber, who at Barclays was the All-America team’s top-ranked Advertising & Publishing analyst for four years before joining Access 342 in November 2009.“Buy-side analysts are covering so many subsectors and stocks that the smart ones figure out who the best sell-side analysts are and get them on the phone.” The changing face of independent research includes the emergence of expert networks that allow investors to talk to suppliers and other experienced professionals in the field of the target company.“The overall research budgets are declining, but the dollars are being spent on alternative sources of data,” says Unni Narayanan, CEO of Mountain View, California–based Primary Global Research, an expert network. “People are now looking at satellite images of clouds in their research. But what you lose is focused coverage on these smaller companies.” WHAT WILL IT TAKE TO REVIVE THE
IPO market? Obviously, there must be companies, but the U.S. has them. Since 2005 some 6,100 privately held companies have received venture capital funding, according to the NVCA and Pricewaterhouse Coopers, and this has created a rich pool of IPO candidates. In addition, the rebound in Wall Street’s fortunes since spring 2009 has boosted investment banking, which is expected to become a bigger part of bank profits given the new restrictions on proprietary trading. At the same time, smaller companies should benefit from U.S. monetary policy, as the Federal Reserve Board has said that it expects to keep interest rates near zero for the foreseeable future. INSTITUTIONALINVESTOR.COM
What’s missing for most of these companies, even if they eventually manage to go public, is high-quality equity research — the capital markets glue, so to speak. Putting in place economic incentives for investment banks to produce that research will require re-creating a U.S. regulatory environment that is friendlier to IPOs. Going back to the future is no small feat, and perhaps impossible: It demands that commissions be raised and trading spreads widened. Grant Thornton’s Weild proposes that an alternative stock market be established by Nasdaq OMX, NYSE Euronext or even a venture-backed company. Issuers would voluntarily list on the market and be actively supported by market makers and specialists, in an arrangement not unlike the old floorbased exchanges. Electronic communication networks would be prohibited from trading in the stocks listed on this new market, which would have minimum spread and commission levels and require market makers to
turn.“We’re recommending higher costs on a per-trade basis, and that is anathema to the ideology that has gripped the SEC for the last decade,” Weild says. Weild isn’t the only capital markets veteran who believes such a radical step is necessary. “We need to consciously take a risk for capital formation,” says Michael Halloran, a partner at Haynes and Boone who splits his time between the law firm’s Washington and Silicon Valley offices. From 2006 to 2008, Halloran was deputy chief of staff and counselor to then–SEC chairman Christopher Cox — experience that gives him insight into how markets really work. “You could fix spreads or commissions; when you go public, your underwriter and you would make that decision,” he explains. “By doing that, you would bring back sales support and the economics for equity research. You’re turning back the clock voluntarily.” The solution could come from the banks themselves, but that’s unlikely because most
“Our capital markets for financing innovation are virtually destroyed, and no one knows it has happened.” — Charles Newhall III, New Enterprise Associates
provide research that would also be held to a minimum standard. Weild, a former Nasdaq vice chairman, testified in June before the SEC and the U.S. Commodity Futures Trading Commission on the reasons for the May 6 “flash crash.” He told the regulators, “We have called for an alternative market system to reinvigorate primary capital formation and the fundamentally oriented ecosystem of research, sales and liquidity provision that is essential to support companies that need capital to build plants, buy equipment and put people to work.” Sources say SEC chairman Mary Schapiro is incorporating some of Weild’s thinking on job creation and capital formation into the agency’s stances on market structure and other regulatory issues. Brokers that participate in Weild’s alternative market would have decent revenue from trading and commissions and could once again afford to produce equity research. But such a market would need the blessings of regulators and would require officials to admit that all their well-intentioned reforms had perhaps taken a wrong
big investment banking firms don’t believe there is a problem. The biggest banks say they already cover almost as many companies as they did before the global settlement, even if it’s now with a smaller staff. “Because of the data-gathering power of the Internet, the time spent searching for data has been reduced, which enables more time for indepth analysis,” says David Bleustein, head of U.S. equity research at UBS. Thomas Schmidt, head of Americas equity research at J.P. Morgan, says his firm was one of the first to ramp up its research coverage of small- and midcap stocks over the past few years. “It was clear to us that the segment lacking was small- to midcap names,” he says, adding that about 35 percent of J.P. Morgan’s coverage now focuses on large-cap companies. The bank does provide some coverage of companies with market caps of $200 million to $400 million, but, Schmidt says,“we may be more nimble there, including a willingness to drop coverage if clients no longer show interest in a company.” Schmidt believes the economics of the equity business have changed in the past
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decade, independent of the research settlement. “We just faced the cold, hard facts that the top line for the entire equity business had slowed,” he explains. J.P. Morgan, like most of the big banks, is doing more with less.“We used to have an eight- or nineperson team covering each sector,” Schmidt says. “They would write 50 pages ten years ago, but the market didn’t want that. Clients want analysts’ thoughts, assumptions and information on what their contacts are telling them in real time, with only the occasional 50-page report that goes in-depth on the entire sector.” In addition, American investment banks are increasingly focusing on burgeoning nonU.S. markets for new business. Most derive almost half of their profits from overseas. Therefore, the U.S. economy can hardly depend on American investment banks for a solution to the IPO problem in the U.S. Meantime, the IPO problem and its effect on markets and job creation rears its head
every day. Larry Tabb, founder and CEO of research firm TABB Group and a longtime market observer, says IBM Corp.’s acquisition last month of privately held Blade Network Technologies, a Santa Clara, California–based company that makes networking switches for data centers, is just one example in a long line of many. Ten years ago a company like Blade would have gone public and aggressively competed against IBM, he says. Now it’s cheaper for IBM to raise capital for an acquisition of Blade than it is for the smaller company to go public. “Instead of creating more jobs, you create the synergy effect: IBM fires anybody who is redundant,” says Tabb. The growing populism in the U.S. that is foiling politicians and regulators in their efforts to get the economy jump-started again — think of the debate on taxation and the federal stimulus plans — clearly has its roots in the mortgage crisis. But it also has sprung up because Wall Street is no longer
intricately connected to Main Street via the IPO market and jobs. Wall Street has stopped raising money for all those Main Streeters. “The dream was for many years to found a business and take it public,” says Dellacorte’s Mancuso. “Now, unless you’re a very big company, the costs of being public and the liabilities outweigh the rewards of seeing your stock go higher.” What does Eliot Spitzer think of all this? The former New York governor, who on October 4 began his new career as co-host of a nightly news program on CNN, tells Institutional Investor that Wall Street can hardly blame him for the problems in the IPO market.“If people say that a prohibition on lying in the market is hurting the market for IPOs, there is a deeper problem than I thought,” he says. •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com.
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continued from page 69 the possible sale of a
stake. Brazilian media have suggested that the bank could sell a 16 percent holding for some $2.4 billion. Such an alliance would make sense. GIC has been shifting the financial services portion of its portfolio from Western banks to emerging-markets institutions, while BTG Pactual is eager to grow its limited presence in Asia. Neither GIC nor BTG Pactual would comment on the reports, but Esteves makes it clear that he would welcome deep-pocketed shareholders. “We may realize an IPO within five years,” he says. “What is more likely is that within one or two years we undertake a high-quality private placement and raise around $1.5 billion.” However the bank goes about raising capital, Esteves insists that he intends to remain in control this time.“One thing I can
banking, and James Oliveira, who is head of asset management in Brazil, are among the most-dynamic bankers in Brazil. Many of them have worked with Esteves from Pactual’s early days and are personal friends. Huw Jenkins, the managing partner in charge of BTG Pactual’s London office, is a former chief executive officer of UBS Investment Bank. “BTG Pactual is a fantastic shop,” says the CEO of a leading investment banking boutique in Latin America, who asked not to be named.“It has a global reach with very strong local knowledge. It has top people.” THE RISE OF ANDRÉ ESTEVES AND
BTG Pactual reflects Brazil’s ascent in the world. Esteves, an only child, was brought up in Tijuca, a middle-class neighborhood of Rio de Janeiro. He studied computer science at Rio’s Federal University. Upon leaving university in 1989, he joined Pactual, an investment banking boutique founded by banker Luiz Cezar Fernandes six years earlier. Although hired as a mere intern to fix back-office computers, Esteves’ drive was evident from the start: He used to sleep in Pactual’s office in the modest Lapa neighborhood of Rio de Janeiro so that he could get more work done. Within a year he was a member of the bank’s foreign debt trading team, and within
“We have the capability to take very fast decisions. At UBS the decision makers were very far removed from you.” — Guilherme Paes, head of investment banking
rule out is sale to an international house, not after Pactual’s previous experience.” As he looks to grow, Esteves can build on a strong management team. The bank boasts a cadre of accomplished and well-connected bankers, beginning with Esteves himself. In addition to climbing to the top of the ladder at the old Pactual, the CEO served as global head of fixed income at UBS between August 2007 and June 2008, when he left to create BTG. Persio Arida, the bank’s global chairman of asset management, is a former president of the Brazilian central bank and served as a board member of Itaú, the country’s dominant retail bank, between 2001 and 2008. Sallouti and such other key Brazilian partners as Guilherme Paes, who is head of investment INSTITUTIONALINVESTOR.COM
two he was managing IPOs and M&A deals. In 1992 his trading skills helped the bank to post a 59 percent return on capital. In recognition he was made a partner the following year. In 1999, Esteves and four other junior partners effectively took control of Pactual from Fernandes by demanding his final 14 percent stake in the bank in exchange for loans to prop up his other failing businesses. It was a crucial period for the bank. At the time the bank’s old guard, led by Fernandes, wanted to take the firm into retail banking and compete with the likes of Itaú and Banco Bradesco. But Esteves and his partners prevailed with a different strategy. “What happened was that the younger generation of partners at the bank believed that it should
follow the fully fledged investment banking model, and that ended up being the winning strategic proposal,” he says. Winning, indeed. Pactual profited enormously from Brazil’s economic takeoff this decade, and in 2006 it became a highly prized target of UBS, the Swiss bank then jockeying for global investment banking leadership. That December, UBS bought Pactual for $2.6 billion plus a $500 million retention package for some 80 employees, including Pactual’s 33 partners. The deal made Esteves, who owned a 30 percent stake in Pactual, a very wealthy man. The Swiss bank promptly made Esteves chairman and CEO of its overall Latin American business. The ink had barely dried on the sale agreement, however, when UBS began running into serious difficulties. Losses were piling up at Dillon Read Capital Management, a hedge fund arm run by former investment banking chief John Costas that invested heavily in subprime mortgage securities. In May 2007, UBS said it would wind down Dillon Read.Two months later the bank abruptly announced the departure of then-CEO Peter Wuffli because of the mounting losses. Esteves saw opportunity in the crisis. He lobbied investment banking boss Jenkins to appoint him as UBS’s global head of fixed income, citing his understanding of how flawed riskassessment models had led the bank to underestimate its subprime valuations. In August 2007 the bank’s board followed Jenkins’s recommendation and appointed Esteves to the role, and he moved to London. Two months later the bank put him in charge of UBS’s currency and proprietary trading units, as well. What Esteves inherited wasn’t pretty. By year-end the bank was reeling. UBS took the first of what would total some $50 billion in write-downs on mortgage-backed securities; it posted a loss of Sf4.4 billion (then worth $3.9 billion) for 2007 and would go on to lose Sf23.6 billion more over the following two years. The bank would ultimately need a big capital injection from the Swiss government to survive. “I was there at the peak of the stress,” he says. “Personally, it was a very constructive experience — but not something I would want to repeat.” In June 2008, Esteves left the bank.With 30 former UBS employees, including 25 traders and portfolio managers, he set up BTG in September of that year under a strict“no compete”legal arrangement.The terms meant that
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BTG could focus only on asset management and private equity, a frustration to Esteves and the other partners, who wanted to engage in a full range of investment banking activities. In April 2009, with UBS looking to retrench and raise capital, Esteves and his partners agreed to buy Pactual back from UBS for $2.5 billion and embarked on their campaign to restore the firm to prominence as a full-fledged investment bank. Some 15 of the original directors at UBS Pactual are now partners at BTG Pactual. Many, such as COO Sallouti, have been with Esteves since the early days at Pactual. Others have been recruited from UBS. In April, Jenkins lured Roberto Isolani, a former co-head of global capital markets at UBS, to join him in BTG Pactual’s London office as the managing partner responsible for client business across asset management and investment banking. The bank also recently hired Igor Hordiyevych, UBS’s former head of debt capital markets for Central and Eastern Europe, the Middle East and Africa, to develop its business in Central and Eastern Europe. Currently, BTG Pactual has about 1,000 employees, with 53 partners and 48 associates. It expects to double its head count within three years. Other key partners include CFO Marcelo Kalim, who joined Pactual 14 years ago and served as chief investment officer at UBS Pactual with Esteves, and Simeon Schwartz,
in a modern building in the São Paulo neighborhood of Faria Lima, an unassuming district of broad thoroughfares and gray tower blocks that is emerging as the city’s new financial district. The office is open plan, which fosters interaction and allows even junior staff members to talk directly with partners. Esteves has his desk in the middle of the trading floor, which accommodates 150 people. Arida, who in many ways is his right-hand man, sits beside him, and Sallouti is in the row behind them. “Culture is one of the big differences between BTG Pactual and the old UBS Pactual,”says Paes, the investment banking chief, who has worked at Pactual for 16 years.“We have the capability to take very fast decisions. If a client wants us to grant them a $400 million loan, we can make a decision within two days. At UBS the decision makers were very far removed from you. You had to explain to them how things worked on the ground.That did not help to run the business.” Esteves compares BTG Pactual with Goldman Sachs Group when it was a partnership. He says the flat, lean structure creates efficiency, and he believes the bank can continue to operate in its current fashion with as many as 5,000 employees.“Think big but keep the structure flat,” he says. The meritocratic model is central. Halfjokingly, Esteves says the partners are
“Lots of people want to be entrepreneurs and to be rich.You have to come work for us. We have no problem recruiting.” — Roberto Sallouti, chief operating office
who heads the bank’s New York office. He spent 11 years at UBS, most recently as global head of derivatives, government securities and commodities, before leaving in 2008 to help Esteves set up BTG. Renato Cohn and Rogério Pessoa are co-heads of wealth management and have worked with Esteves for more than a decade. Cohn signed on with Pactual in 1999 and joined UBS Pactual as head of products and services in wealth management. Pessoa joined Pactual in 1998 and was the partner responsible for private banking. BTG PACTUAL PRIDES ITSELF ON ITS
entrepreneurial, meritocratic culture. The bank’s headquarters occupies three floors
divided into two groups: the rich and the poor. The rich ones provide the capital for the bank and help to incentivize the poor ones. Esteves’ own rise inspires many partners and junior staff.“I love him,” says Paes. “He is so dynamic and knows so much about everything, whether it is the trading side, potential M&A deals or potential IPOs, macroeconomics. He is a very complete guy.” The rags-to-riches ethos runs throughout the firm. “Many partners at BTG Pactual, including myself, represent the Brazilian dream,” says Sallouti.“We started from humble positions. Lots of people want to be entrepreneurs and to be rich. You have to come work for us. We have no problem recruiting.
People know that we are entrepreneurial.” Esteves boasts that he likes to hire people with doctoral degrees. “Ph.D.s are poor, hungry and desperate to get rich,” he says. “I am no longer as poor as I used to be, but I am still hungry and desperate to get richer.” Esteves doesn’t sleep at the office these days, but he does log long hours. He usually arrives as early as 6:30 a.m. and does not leave before 8:00 p.m. He often calls partners together for meetings as late as 10:00 p.m. Esteves travels frequently, visiting the London and New York offices once a month and Hong Kong occasionally. When he is in São Paulo, he usually takes one risk call a day and has a meeting with an institutional client. The bank has three divisions: investment banking, asset management and wealth management. The investment bank employs about 100 bankers, mostly in Brazil, but it is expanding overseas and has eight bankers in London and New York. Notable recent hires include Alexander (Sandy) Severino, a former head of fixed income for Brazilian companies at Citigroup, who came on board in New York in July to head the bank’s international fixed-income business. BTG Pactual is expanding its capital markets operation at a time when the Brazilian market is showing some signs of softness. The IPO market has slowed during the past two years, although secondary offerings are still significant. In February, Multiplus of São Paulo, the frequent-flier unit of Brazil’s biggest airline, raised R724 million when it went public, one third less than it had wanted; and in March real estate developer BR Properties had to scale back its IPO to R1.1 billion, also about one third less than it had intended. One of the biggest problems in the IPO market has been the number of underwriters. At the height of the financial crisis, Brazilian commercial banks extended important credit lines to companies on the condition that if they went public or made secondary stock offerings the banks would be included as book runners. “A company must get the underwriting right,” says Paes. “No proper book building has taken place, because some of the underwriters do not really know the deal. That has led to unrealistic valuations.” BTG Pactual’s equity business has benefited from a surge in trading volume, though. The Bovespa, or Bolsa de Valores de São INSTITUTIONALINVESTOR.COM
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Paulo, is the world’s seventh-largest stock market, with a total capitalization of some $1.2 trillion. Trading volume has exploded by roughly 20-fold over the past decade, to an average of about R6 billion a day currently. In May the Bovespa ranked BTG Pactual No. 1 by trading volume, with a total of R20 billion for the month. Roughly 45 percent of that trading is done with Brazilian clients; the U.S. generates a similar amount, and Europe chips in 10 to 15 percent, says José Miguel Vilela, the bank’s head of equity sales and trading. “Brazilian investors are becoming more important, especially following the international financial crisis,” he says. The bank has senior sales teams and trading desks in São Paulo, New York and London. The latter office covers Asia for now, but the bank plans to establish an Asian sales and trading team in Hong Kong. BTG Pactual’s asset management division has grown strongly during the past year. The bank moved up one place, to seventh, on the Brazil 20, II’s ranking of the country’s top money managers. The business is split into three parts: a long-only business, which manages R48.4 billion in Brazilian equities and fixed income; global-macro hedge funds, which manage R2.8 billion; and merchant banking or private equity, which manages R2.5 billion. The long-only business is a purely domestic affair at the moment, investing exclusively in Brazilian stocks and bonds and marketed only to Brazilian institutional and retail investors. At the core of the business are two fund families: Pactual High Yield, a fixed-income portfolio that has produced a cumulative return of 110 percent since July 1996; and Pactual Hedge, a fixed-income and equities portfolio that has produced a cumulative return of 127.5 percent since October 1995. The two funds have a total of R14.2 billion in assets. The bank does have international ambitions in this area: It plans to launch a mutual fund for European retail and institutional investors based on its long-only equities fund. The hedge fund business, which has R2.9 billion in assets, has grown steadily since the bank launched its flagship Global Emerging Market and Macro Fund in February 2009, mostly with the partners’ own money. The dollar-denominated fund, which currently has $940 million in assets, posted a 16 percent return from January to the end of August this year, making it one of bestINSTITUTIONALINVESTOR.COM
performing funds in the global emergingmarkets category. The bank has been actively marketing GEMM to foreign institutions this year, and Esteves believes it could attract as much as $5 billion within two years. “This is a fantastic alternative investment for global investors,” says Esteves. “There is so much interest in the emerging markets now. I think we will attract many international investors.” The bank has also launched a fund investing in distressed U.S. mortgage securities. It has raised $150 million of a goal of $200 million, with BTG Pactual’s partners committing $90 million.“The fact that partners have invested so much in this fund gives clients a lot of confidence,” says Sallouti. In September 2009 the firm launched its merchant banking business, a private equity–style operation that uses the bank’s own capital and money from outsiders to make long-term investments. The business
its record low of 8.75 percent since April; the rate is well above the Federal Reserve Board’s policy rate of 0.25 percent and the European Central Bank’s 1 percent rate. “Brazil is a paradox in one sense,” says Arida. “Investors are very sophisticated, but the lending and trading horizons are very short term. People want very liquid instruments.” BTG Pactual is also emerging as one of the most important wealth managers in Brazil. Big retail banks such as Itaú Unibanco, Bradesco and Banco do Brasil have been expanding successfully at the lower end of this market, thanks to their massive branch networks and huge pools of existing customers they can mine for potential private clients. BTG Pactual is focusing on ultra-high-networth individuals, or clients with at least R10 million to invest, putting it in competition with the likes of Goldman Sachs. In common with most top wealth managers in Brazil, BTG Pactual usually offers its big-
“Pactual has avery long track record, with very consistent performance and high levels of capital preservation. That helps us attract clients.” — Renato Cohn, co-head of wealth management
has three main focuses: special-situations funds, infrastructure and real estate. In addition to the Rede D’Or hospital group, the division’s portfolio includes a 51 percent stake in Derivados do Brasil, a gasand-service stations operator, which was acquired in December 2008; a 50 percent stake in car-parks operator Estapar, bought in May 2009; and minority stakes in Suzuki Motors do Brasil and Mitsubishi Motors Corp. do Brasil, purchased in March of this year. The bank doesn’t disclose the amount of those investments. BTG Pactual plans to start marketing soon for a private equity fund investing in Brazil, and an infrastructure fund is likely to follow. Arida says Brazilian investors are still heavily tilted toward fixed-income products and short-term instruments, mainly because of the country’s comparatively high interest rates. On July 21 the central bank raised the benchmark Selic rate by 50 basis points, to 10.75 percent, in a bid to contain inflation, which stood at 4.49 percent in August. The central bank has been pushing the Selic rate up from
gest clients exclusive funds, akin to separately managed accounts, that can invest in other funds or individual assets. Some 60 percent of private clients have this type of fund. “Pactual has a very long track record, with very consistent performance and high levels of capital preservation,” says Cohn. “That helps us attract clients.” Cohn says that the wealth management team learned a lot from working at UBS. For example, they have emulated UBS’s idea of having a dedicated M&A team within the wealth management division to assist highend clients that want to make acquisitions. Esteves and his team have plenty to do to fulfill their goals, but the CEO points to Brazil’s emergence as an economic powerhouse that he and his partners can imitate at BTG Pactual. “It’s not about the money, although results are important,” he says. “I want to build something special, something to be proud of. It’s a long-term ambition.” •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com.
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INEFFICIENT MARKETS UNCONVENTIONAL WISDOM THE FUT
Poststeroid Economics
Two years ago The U.S. economy is like a the Great Recession marathon runner who runs too Government bailouts and waltzed in — to the hard and pulls a hamstring, fiscal stimulus during the great surprise of but finds himself with another Great Recession have created homeowners, the race to run. So he’s injected challenges for investors. Fed and the banks with some industrial-strength BY VITALIY KATSENELSON — and everyone dis- steroids, and away he goes. As covered that house the steroids kick in, his pace prices don’t always accelerates as if the injury go up. The financial never happened. He’s up and sector, the lifeblood running, so he must be okay — of our economy, this is the impression we get, started to drown in judging from his speed and his progress. What we don’t see the sea of bad debt. is what is behind this athlete’s As the troubles in terrific performance: the that sector began steroids, or, in the case of our to spill into the real economy, the stimulus. economy, the govDURING THE ’80S Obviously, we can keep our ernment felt it had no choice and ’90s, ignorance fingers crossed and hope the but to step in, and the bailouts was bliss. The global and stimuli began. runner has recovered from his economy was growing Today it is hard to take a injury, but there are problems nicely, and analyzing it walk through our economy with this thinking. Let’s address (or even paying attenand not meet a friendly Uncle them one by one: • Serious steroid intake exagtion to market cycles) seemed Sam; he is everywhere. He’s gerates true performance. like a waste of time, as the econ- buying long-term bonds and Economic stimulus creates an omy came in only three flavors: thereby keeping long-term appearance of stability and good, great and awesome. Even interest rates artificially low. if you misread the flavor, the Since he took over the defunct downside was that you’d just (for all practical purposes) make a little less money. Value Fannie Mae and Freddie investors prided themselves on Mac, he is the U.S. mortgage being bottom-up-only analysts, market, because those orgafocused on scrutinizing indinizations account for the bulk vidual stocks, while top-down of mortgages originated. Of analysis — making investment course, he is also on the hook decisions by looking only at for their losses. the macro picture — became Our dear Uncle Sam rolls unfashionable, viewed as marin style; he doesn’t know how ket timing. to bail out or stimulate on the growth, but a lot of it is teeterProlonged and virtually cheap. U.S. government debt ing on a very weak foundation uninterrupted growth brought (at least, the debt that is on the balance sheet) leapt from about of government intervention. complacency, excesses and • Steroids are addictive; once 60 percent of GDP before the debt. Bottom-up-only analysis we get used to their effects, it Great Recession to more than worked until it stopped workis hard to give them up. When ing, as investors discovered 100 percent in 2010. The party during the recent crisis that the of overleveraged consumers has the first home-buyer tax credit expired, it was extended for global economy can come in been crashed by an overleveranyone with the patriotic additional flavors: bad, horrible aged government. ambition to buy a house. It and downright nasty. Today the To understand the conseis hard to give up stimulus, cost of misreading the economy quences of the Great Recesbecause the immediate conseis much higher. sion, consider this analogy:
“ ”
Stimulus creates an appearance of growth.
quences are painful, but longterm gain has to be purchased by short-term discomfort. • The longer we use steroids, the less effective they are. Take
Japan, which was on the stimulus bandwagon for more than a decade. With the exception of tripled government debt, Japan has nothing to show for its efforts; the economy is mired in the same rut it was in when the stimulus started.
• Steroids damage the body and come with significant side effects. In the case of the econ-
omy, the side effects are higher future taxes and increased government debt, which brings on higher interest rates and thus below-average economic growth. The hopes that we’ll transition from government steroid injections back to an economy running on its own are overly optimistic. So what does this mean for investors? When we purchase a stock, we are buying a stream of future cash flows. By doing only bottom-up analysis, investors implicitly assume that external factors (the winds and hurricanes of the global economy) have no impact on these cash flows. That is a brave and careless assumption, especially in a poststeroid world. Instead, investors should take a more holistic approach, mixing bottom-up insights with topdown analysis. ••
Vitaliy Katsenelson is the director of research and a portfolio manager at Investment Management Associates in Denver, and the author of Active Value Investing. Comment? Click on Global Markets at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
LINA CHEN
MERICA RESEARCH TEAM
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INEFFICIENT MARKETS
UNCONVENTIONAL WISDOM THE FUTURIST THE CHARTIST C
LINA CHEN
The Myth of the Midterm
those had DemoThe stock market is less partisan crats replacing Republicans as the than you might think, but midterm elections can have an majority party in one or both chamimpact on certain sectors. bers of Congress. BY TOM GALLAGHER Taking a closer look at presidentialcongressional combos shows that market performance is best under Democratic presidents and Republican Congresses. But there have been only eight THE MOST IMPORyears since 1945 featuring this tant thing about the mix, and six occurred between midterm elections is 1995 and 2000, during the tech not who wins but sim- stock bubble. ply that they are being Why this partisan indifferheld. Although studies ence? The time period we’re linking market responses to looking at includes a big part of presidential election surprises the third year of a presidential show that stocks respond well term, and as students of the to Republican wins and bonds presidential cycle know, this is do well following Democratic the most robust year for stocks. victories, the magnitudes of the The argument goes that stocks moves are small. GOP presiden- do well in the third year in tial wins boost stocks just 2 to anticipation that incumbents 3 percent, on average, the day will generate a good economy after the election. in their final year to maximize What about partisan their reelection odds. I’ve control of Congress? When I always thought this notion was head of the Washington worked better in practice than research team at ISI Group, in theory. we looked at the performance Stocks often don’t generate of the Standard & Poor’s 500 partisan preferences, even over index from October 1 of midshorter periods. U.S. equities term election years through fell for a month after the GOP the following September 30. landslide in 1994 under Bill Clinton before rallying when Gains were robust, averaging 25 percent, compared with an the end of the Federal Reserve average of 9 percent for the rest Board’s rate-hike cycle domiof a presidential term. What nated the election results. In was striking was that the gains 2000, after the U.S. Supreme seemed independent of the Court decision ended the presioutcomes. In fact, the top three dential election uncertainty, years all came after Democrats stocks fell because the emerging made big gains under Repubrecession trumped George W. lican presidents, and two of Bush’s victory. Scott Brown’s INSTITUTIONALINVESTOR.COM
January win in Massachusetts, which deprived Democrats of their Senate supermajority, produced just a one-day stock rally. Though markets care about election outcomes, they are usually overwhelmed by other factors. For this election, the extent to which deleveraging dominates the economic data, and the Fed’s response to it, will tell the tale for the market. The election takes place November 2, and the Federal Open Market Committee meeting concludes the very next day. The Fed, not the composition of Congress, will be the policy driver for the market over the next year. I’ve often found that elections matter more for sectors than for the overall market. Looking ahead to November, traditional energy companies may have the most at stake, as
“ ”
Stalemate seems to be the order of the day. a Republican Congress would try to block funding for the Environmental Protection Agency’s efforts to regulate greenhouse gases. Health care companies would likely benefit, partly as a knee-jerk reaction to the prospect of Republican efforts to reverse health care reform. Financial stocks may also benefit in a similar kneejerk fashion, but it’s unlikely that Republicans would make a material effort to roll back financial reforms.
The real impact of the midterm election on financial markets will come as a result of policy actions taken by Washington. That in turn will depend on a complicated game of chicken played by Democrats and Republicans as they choose which issues to confront each other on. Two recent presidents lost their congressional majorities — Clinton during his first term and Bush in his second. The former offers a better guide to President Obama’s choices, as first-termers have greater incentives to cooperate with an opposition Congress, hoping to show results in their reelection drives. After the aggressive tactics of the then-resurgent Republicans failed in 1995– ’96, they reached agreement with Clinton on a series of secondary issues in mid-1996. It’s not hard to see the two sides, faced with a weakening economy, agreeing on a payroll tax cut. But barring a genuine double-dip recession, it’s easier to contemplate stalemates on near-term stimulus and longterm deficit reduction issues. In fact, stalemate seems to be the order of the day on most issues. It’s worth thinking about what that might mean for the higher stakes in 2012. •• Tom Gallagher recently joined Washington business advisory firm Scowcroft Group as a principal. Before that he led ISI Group’s Washington research team and ranked first in II’s AllAmerica Research Team for the past eight years. Comment? Click on Risk/Tech/Regulation at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIV
Is Financial Innovation Over?
The sitting Fed chairman, Ben Bernanke, concurred during recent The creativity that brought congressional tesus disastrous derivatives is timony, conceding, looking for a new outlet. “Financial innovation is not always BY JEFFREY KUTLER a good thing.”The upshot of the recent wave of creativity, he said, was too often “to take unfair advantage rather than to create a more efficient market.” The climate has turned hostile FOR FORMER toward financial innovation. Federal Reserve Board And yet, amid the slow-paced chairman Paul Volcker, recovery, economists, corporate this year’s landmark executives and politicians alike financial legislation hail innovation — broadly was mildly disappoint- defined — as a job- and wealthing. The bright-line separation creating engine that should be of traditional banking from stoked by tax breaks, capital riskier trading activities that he expenditures and research and had been stumping for — the development. Volcker rule — got watered Is there no role for the chastened financial industry in this down. But if that contribution doesn’t secure for the venerable hoped-for revival? Or don’t economist a permanent niche in its would-be innovators have the bank regulatory pantheon, a contribution to make to the then his rhetorical flourishes greater cause? certainly should. The answers, alas, are not as Most memorably and point- simple as Volcker’s well-aimed edly, Volcker proclaimed the but unnuanced zingers. The automated teller machine the ATM was an electromechanical invention of engineers, not greatest financial industry innovation of recent decades. bankers. Modern financial Dismissing much of the products are intangible, and inventiveness that produced although the crash did their image no good, there have securitizations and derivatives in their many flavors, been true breakthroughs over automated market mechanisms the years: financial futures and an explosion of investment and money market funds, for choices, Volcker groused in a example, not to mention a long London speech last December, list of quantitative algorithms “I wish someone would give me and business processes that the one shred of neutral evidence U.S. government has seen fit to grant patent protection. that financial innovation has It seems no more logical to led to economic growth.”
close off R&D in this or any other industry than it would have been to shut down the U.S. Patent and Trademark Office, as one of its directors supposedly suggested in the 19th century in anticipation of an end to inventions. What may have ended is anything on the order of the quantum advances in information technology and the Internet that fueled the last boom. “Don’t look for a new wave of IT,” advises Ronald Ruckh, a lead financial services industry consultant with LECG in New York.“It’s hard to see a million new products being developed, and derivatives are out the window. But IT can provide tools to be innovative, which means
“
I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth. — Former Fed chief Paul Volcker
”
introducing something new that is repeatable, solves a problem and adds value.” Charles Wendel, president of New York–based Financial Institutions Consulting, who works closely with business lenders, says the innovation-associated qualities of growth, experimentation and creativity are “not at a premium.”They are most
visible at big, profitable banks and in areas where technology investments yield an identifiable payoff, such as corporate cash management services. What Wendel sums up as “product innovation on the margins” won’t move markets or economies. Steven Spear, senior lecturer at the Massachusetts Institute of Technology’s Sloan School of Management and the author of a new book, The High-Velocity Edge, says two ingredients in tandem have that power: “constant discovery and innovation.” A postrecessionary environment “demands that companies be innovative,” says Spear. “But it’s not just a matter of spinning the wheel faster.” Firms and their customers are emerging into changed circumstances that have to be understood and translated into growth opportunities. One financial player that has had “no letup in the push to constantly innovate” is the International Securities Exchange, says Thomas Ascher, its chief strategy officer. ISE opened ten years ago as the first fully electronic U.S. options market; today it pursues transaction speeds and efficiencies with graphical processing units, a high-performance technology first proved in video games. The name of ISE’s game is market structure innovation, and it has seen no recessionary pause. •• Jeffrey Kutler is editor in chief of Risk Professional magazine, published by the Global Association of Risk Professionals. Comment? Click on Exchanges & Trading at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
LINA CHEN
UNCONVENTIONAL WISDOM
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WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE TH
INDEX OF ADVERTISERS Banco do Brasil . . . . . . . . . 21
I Shares . . . . . . . . . . . . . . . . . 51
Vale . . . . . . . . . . . . . . . . . . . 53
Bank of America Merrill Lynch . . . . . . Cover 4
ITG . . . . . . . . . . . . . . . . . . . . . 27
Zagat . . . . . . . . . . . . . . . . . . 70
Kellogg . . . . . . . . . . . . . . . . 29
FOCUS SERIES
Prudential . . . . . . . . . . . . . . 34
Cubist Pharmaceuticals . .17
RBC . . . . . . . . . . . . . . . . . . . . 9
ICBC . . . . . . . . . . . . . . . . . . 87
Sungard . . . . . . . . . . . . . . . . . 4
URALSIB Capital . . . . . . . 33
Barclays Capital . . . . . . . . 13 BlackRock . . . . . . . . . . . . . 23 Bloomberg . . . . . . . . . . . . . . 3 BNP Paribas . . . . . . . Cover 3 Columbia Management . . 31 Deutsche Bank . . . . . . . . . 11
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VENTIONAL WISDOM THE FUTURIST
THE CHARTIST
CONTENTS INSIDE II TICKER FIVE QU
18% 15%
U.S. MARKET VALUE
18% 12%
15%
S&P ENERGY/ S&P 500
12% 9% 9%
6%
6%
’02
ENERGY GROUPS ABOVE THEIR 30-WEEK MOVING AVERAGES
2004
2006
2008
2010
90%
90%
60% 30%
60% 30%
Oil Slick
Source: BCA Research (www.BCAresearch.com).
BAD PRESS AND BP BLOWOUTS ASIDE, THE
energy business is poised for a performance comeback. The sector’s share of the equity capital market in the U.S. has fallen to 10 percent from 16 percent just two years ago (upper chart). Data from BCA Research reveal the potential for a modest bubbling up, if not gusher, of investor value. The percent-
age of energy groups whose prices are greater than their 30-week moving averages (lower chart) has started to edge higher, a pattern seen before previous performance upswings. More importantly, the sector appears as an attractive buy in a world starved for higher returns. Oil may not be eco-perfect, but it still makes the wheels of — The Editors commerce spin. INSTITUTIONALINVESTOR.COM
NIGEL HOLMES
Energy Stocks: Gusher Ahead?
B…ING BIG DO…SN’T M…AN YOU STOP GROWING.
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