Felix Salmon

Sell-side snafu of the day, JP Morgan edition

Felix Salmon
Jul 16, 2010 06:21 UTC


This is the stock chart for ATP Oil and Gas over the past five days: it plunged at the open on Tuesday and then soared at the close today. And it’s all because of Joseph Allman, the analyst for ATP at JP Morgan

ATP stock closed at $10.43 on Monday and then dropped to $9.12 on Tuesday morning — a fall of more than 12.5% — when JP Morgan put out a very bearish research note with the title “Trading at a Premium; Financing Needs Likely Greater Than Market Thinks; Downgrading to Underweight.”

The headline was bad enough, including as it did a downgrade on the stock, but the meat of the note was worse: Allman calculated that ATPG would need $500 million of external capital — more than its entire market capitalization.


At the end of the trading day today, Allman put out a second research note, saying that the first note was wrong:

In our July 13 note, we stated that it appeared that ATPG would need $500MM of external capital. This model corrects that error and reduces that need to $50MM.

Yep, JP Morgan was out by an entire order of magnitude in the calculations which prompted the downgrade. And when it admitted its mistake today, the stock went straight back up to $10.12, a rise of 11.1% on the day and of a whopping 14.4% from the day’s low.

When JPM’s mea culpa appeared today, ATP’s stock immediately shot back up — but of course by that point it was too late for anybody who had been stopped out on the way down.

And if you were lucky enough to have any kind of early access to JP Morgan’s research product, you could have made a fortune first selling ATPG on the way down and then buying it back on the way up.

There are three lessons to this story, I think. Firstly, small stocks are volatile. Secondly, paying too much attention to sell-side analysis can be hazardous to your wealth. And thirdly, prices really do move on sell-side research. Even when it’s utterly wrong-headed.


^what TFF just said. Sell-side analysis, perhaps only slightly more useful than a 2006-vintage MBS rated AAA by Moodys / S&P.

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Why sell-side analysts are wrong

Felix Salmon
Jun 21, 2010 15:30 UTC

Aaron Pressman has a good report on the sell-side failure to perceive the risks surrounding BP in the wake of the Deepwater Horizon catastrophe. Why was Wall Street so very bullish on the stock even as it was being pummeled in the markets?

Pressman points to a number of factors, including banks’ desire for a healthy relationship with BP, and analysts’ tendency to cluster together for comfort. Joshua Brown reckons it’s deeper than that, and that sell-side analysts tend to see everything in terms of value and discounted cash flow, which are not particularly useful tools when companies get hit by unexpected tail risks.

And more generally, as Lynn Thomasson shows, sell-side ratings are a pretty good contrary indicator:

Wall Street’s lowest-rated stocks have turned into this year’s best performers…

Huntington Bancshares Inc., the regional lender in Columbus, Ohio, had twice as many “sell” ratings as “buys” in December and jumped 66 percent this year for the fourth-largest advance in the Standard & Poor’s 500 Index. Eastman Kodak Co. and Sunoco Inc. have gained more than 20 percent after more than 30 percent of the analysts covering them at the start of the year recommended getting rid of the shares…

Coca-Cola Co., the world’s largest soda maker, had 14 “buys” and 1 “sell” rating in December and has lost 8.2 percent this year…

Pfizer Inc., the world’s largest pharmaceutical company, is down 16 percent this year even after 81 percent of analysts covering the New York-based firm said investors should buy shares.

The one part of all of this I disagree with is in Pressman’s piece:

Wrong-way Wall Street calls are more than just an academic problem. They cost real people real money.

This was the theory behind Eliot Spitzer’s war on sell-side analysts; it was dubious then, and it’s even more dubious now. Investors — even retail investors — aren’t sheep who simply do what they’re told by sell-side analysts. Institutional investors, in particular, use sell-side analysts as a source of ideas, and even more as a source of access to the company. Big investors are a little bit like bloggers, actually, but instead of linking to articles and then saying what they think, they give out soft-dollar commissions and put on their own trades. Which, like blog entries, can either agree or disagree with the original idea.

But Brown’s point is important as well. Sell-side analysts live in mediocristan, and are prone to being blindsided by the unexpected; they almost never, for instance, recommend negative-carry trades. Investors, if they’re any good, know this. No one ever made money by blindly following sell-side advice, and so we should hardly be surprised that people whose position coincided with the sell-side consensus ended up losing a lot.


In any worst-case scenario that wipes out BP shareholders, it may be foolhardy to think that bondholders would be spared. If things got that bad, the niceties of settled law would fare no better than they did in the GM and Chrysler bankruptcies.

There is considerable political risk here: in effect, there is no such thing as senior debt of BP. New equity in a post-bankruptcy BP would be handed to fishermen and other “stakeholders”, not to “greedy speculators” like yourself.

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Guy Hands and Citi’s Chinese walls

Felix Salmon
Dec 16, 2009 18:43 UTC

Terra Firma has filed a slightly batshit lawsuit against Citigroup, in which the poor sheeplike Guy Hands claims he only bid for EMI because Citi’s David Wormsley told him he ought to.

There’s another part of the lawsuit, though, which hasn’t got quite as much attention: Hands claims that Citi put out a research report in September the publication of which had all manner of nefarious undertones:

While nominally labeled an analyst report regarding the publicly traded stock of Warner, the core of the Citi Report was a broadside attack on Terra Firma, its investment in EMI, and its reputation. Citi launched the attack in order to create marketplace uncertainty about EMI’s ability to operate as a going concern, thereby damaging EMI’s currentand prospective business relationships and profitability, and undermining Terra Firma’s ability tomanage EMI successfully.

In other words, Citi’s objective in publishing the Citi Report was to undermine EMI’s performance, causing the business to fail the quarterly covenant test and thereby allowCiti to wrest control of EMI from Terra Firma.

Wow, a research report can do all that?

Citi was kind enough to send me a copy of the report, although they refuse to let me post it here so that you can see for yourself what it does and doesn’t contain.

It’s true that the report talks a lot about “EMI’s banks” without ever disclosing that in fact there’s only one bank involved — Citi. One would think that given the authorship of the report, that would be a pretty obvious disclosure to make, but at the same time the identity of EMI’s banker was already known to anybody following the EMI saga.

But I see no “broadside attack on Terra Firma” in the report. Instead, it’s all based on the fact — and it is a fact — that Terra Firma is asking Citi to write down the principal amount owed, in return for Terra Firma injecting hundreds of millions of dollars of new money into EMI. Writes analyst Jason Bazinet:

The key question for the banks is do they accept Terra’s offer to lower debt, wait for the industry to turn- around, or do they push EMI into insolvency?

The point here is that any bank can be expected to act in its own best interest. Terra Firma is offering one option: a write-down of principal, along with an increased chance of repayment after new money is invested into the company. But any such option carries an implicit ultimatum: if you don’t write down your loan, Terra Firma is saying, then we won’t inject any more money, and EMI will be forced into bankruptcy.

Bazinet’s report basically just looks at what happens in that latter case. When a company declares bankruptcy, it essentially gets taken over by its creditors. In this case, the creditor is Citi, which — as the Terra Firma lawsuit explains at length — has long been advising both EMI and Warner Brothers with an eye to merging the two companies. But even putting to one side the existence of Citi’s M&A advisory practice, the obvious Plan A for any creditor faced with Terra Firma’s ultimatum is to seize the company and sell it to Warner. If the proceeds of such an action mean that the bank gets its original loan back in full, there’s no reason to go along with Terra Firma’s plan and write down the loan.

Bazinet’s analysis indeed comes to the conclusion that if EMI were to declare bankruptcy, “the banks will likely recoup their initial investment in the firm, increasing the possibility of an EMI insolvency”. If Citi’s lending arm were to come to the same conclusion, then the chances of them taking Terra Firma up on its offer would be slim indeed.

But it’s a very, very long way from that simple argument to this kind of conspiracy theory:

Artists who are considering signing contracts with EMI are less likely to do so as a result of the Citi Report, and more likely to sign instead with either Warner or one of the other major music labels…

The purpose behind Citi’s smear campaign is to force these artists and counterparties to refuse to do business with EMI, thereby undermining EMI’ s ability to generate revenue and, hence, to meet the financial covenants in the Financing Agreements.

Somehow I doubt that a band on the verge of being signed by EMI will (a) find the Citi report; (b) read and understand it; and (c) decide that the risk of EMI merging with Warner brothers means that they’d be better off not signing with EMI at all. The worst-case scenario would be that the band in question might ask for some kind of change-of-control clause, saying that if EMI merges with another label, the band has the right to renegotiate its contract. Call it a Poison PiL. (Any such agreement, of course, would only strengthen Terra Firma’s bargaining position with its bank.)

More generally, Hands is leveling an extremely serious accusation against Citi generally and Bazinet in particular — that Citi’s research arm is happy to do the bidding of its investment bankers, and that Chinese walls at the company are either low or nonexistent. Remember that we’re talking about the former employer of Jack Grubman here: Citi, more than most banks, knows the dangers of using research for ulterior motives.

My feeling is that Bazinet is simply collateral damage in the war between Citi and Terra Firma. Hands threw the accusation against Bazinet into the lawsuit not because he particularly thought it would stand up in court, but rather because he wanted to come out guns-blazing for strategic reasons. If Citi doesn’t accept his ultimatum now, it might still be able to sell EMI to Warner, but it will also have a major lawsuit to contend with, which will cost it significant amounts in management time, legal fees, and general public image. Hands doesn’t want to win this lawsuit: he wants to drop it, in return for an agreement by Citi to write down its loan. It’s a high-risk play, because the suit makes him look a bit stupid. But that’s obviously a price he’s willing to pay.

(Many thanks to Peter Kafka for setting me off on this trail.)


More generally, Hands is leveling an extremely serious accusation against Citi generally and Bazinet in particular — that Citi’s research arm is happy to do the bidding of its investment bankers, and that Chinese walls at the company are either low or nonexistent. Remember that we’re talking about the former employer of Jack Grubman here: Citi, more than most banks, knows the dangers of using research for ulterior motives.

I will not allow myself to believe that you are as naive as you are painting yourself. You are a freaking financial blogger at Reuters! Chinese walls??? Sure, leave a chair out for Eliahu, but do NOT tell people you actually believe he’s sitting there.

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Annals of research transparency, JP Morgan/MBIA edition

Felix Salmon
Aug 11, 2009 15:26 UTC

According to MBIA’s latest quarterly report, the insurer has a book value of $2.8 billion, or about $13 per share. JP Morgan analysts Andrew Wessel and Daniel Kim beg to disagree, quite violently: in a note issued this morning they said that MBIA’s tangible book value is actually negative, to the tune of about -$40 per share. Downgrading MBIA to “Underperform”, in an action which has helped to send MBIA’s stock down 14% today, they write:

Although we believe it will be some time before cash at the HoldCo runs out, it is difficult to envision a scenario where there is much capital remaining for shareholders given expected future losses at the consolidated operating company.

The report comes with three pages of disclosures and fine print, including three “Important Disclosures” about the fact that MBIA (a) is or was a client of JP Morgan; (b) will or might pay investment-banking fees to JP Morgan in the next three months; and (c) has paid non-investment-banking fees to JP Morgan in the past 12 months.

The report also covers the substantial legal risk facing MBIA:

Purchasers of credit protection and insured bond holders are suing MBI due to its good bank/bad bank split, which left structured and international obligations with significantly less capital to cover future claims. The plaintiffs argue they purchased protection based on consolidated capital levels, and the transfer must be reversed, as that would no longer be the case. We believe the outcome of this suit is also highly uncertain, and could have serious negative impacts on MBI if it were to lose.

It’s definitely a little weird, then, as an MBIA spokesman pointed out to me this morning, that nowhere in the report do JP Morgan’s analysts disclose that JP Morgan itself is one of the plaintiffs in that suit.

This is why disclosures — especially in a rules-based system like the one we’ve got — are never going to solve anything. There’s a whole slew of things wrong with them:

  • They’re almost universally ignored by people reading the reports.
  • They’re used by banks as a CYA mechanism, rather than as a way of imparting important information.
  • They’re written in a legalistic and deliberately uninformative way: there’s no way of telling, for instance, whether JP Morgan’s fees from MBIA are significant or not.
  • They leave out the kind of information which any disclosure written in good faith by a human being would put front and center — like JP Morgan’s involvement in the lawsuit against MBIA.

I’m not accusing Wessel and Kim of acting in bad faith here — after all, the lawsuit was filed in May, and their downgrade came only in August; what’s more, the downgrade doesn’t really help JP Morgan’s cause. But there is a certain lack of transparency to their report, which could be (and is, by MBIA) viewed as a conflict of interest. After all, a lot of the arguments they make in their note are substantially identical to the arguments made in the JP Morgan lawsuit. Especially since they specifically cite the lawsuit as a risk factor facing MBIA, would it have killed them to have noted that JP Morgan was one of the plaintiffs?


“Sorry but I think this comment is silly. The author is asking JPM to disclose JPM’s relationship in a JPM research note. This is surely the spirit, if not the letter of the disclosure regulations”

Oh sure. They absolutely should have disclosed it. I’m not arguing with Felix at all. I’m just saying that in terms of evaluating the conflict, there’s no particular reason for JPM to give more biased advice than the other major research houses. So people should be aware of the conflict when they look at other people’s research on MBIA too.

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Annals of no-comment, Meredith Whitney edition

Felix Salmon
Apr 9, 2009 12:14 UTC

David Weidner speaks to Meredith Whitney:

When I asked Ms. Whitney this week if she deserved acclaim for The Call – in particular credit for calling the meltdown – she declined comment…

“The disclosure (at banks) was playing catch-up,” Ms. Whitney said. “You really had to dig deep and pay attention to balance sheets. A lot of people knew the system was overlevered. That’s why finding the inflection point was so meaningful.”

That’s declining comment? It seems like quite a good answer to me. The Call in question was Whitney’s sell rating on Citigroup in October 2007, when Citi was trading at more than $40 a share; it more or less marked the point at which Citigroup’s share price fell off a cliff. (See the graph below.)

Whitney’s point is well taken: it’s one thing to point out that lots of banks had lots of leverage. But it’s another thing to get the timing right and work out exactly when all that overleverage was going to hit them in the share price.

Weidner’s not impressed: he says that “Ms Whitney’s call on Citi wasn’t that great”, and compares her unfavorably to Dick Bove, Mike Mayo, and Charles Peabody; not to mention Nouriel Roubini and Nassim Taleb. But this isn’t some kind of competition with only one winner. And when it comes to research, it’s not just what you say, it’s how you say it. Whitney has the rare ability, among sell-side analysts, to speak in clear and unhedged declarative statements, which has served her very well. Add to that the fact that she was right, and you can see how she became such a star.



Nice Post Felix. Whitney said it spot on. Nobody is a prophet, but Whitney made a great call, and deserves the credit.

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