In this clip from Industry Focus: Tech, the team continues their discussion of the ins and outs of Wall Street analyst research and the sometimes murky relationship between the underwriters of an IPO and the corresponding research of those same financial institutions.
There is a reason why you will rarely see analysts bash the client companies their banks just recently took public -- Snap (SNAP 2.87%) is just one such example.
A full transcript follows the video.
This video was recorded on March 31, 2017.
Dylan Lewis: By my count, looking at Snap, we have six buy ratings, two hold ratings, and one sell rating from analysts so far. A lot of price targets seem to be in the high $20s and low $30s from some of the underwriting banks from the IPO. It's kind of funny how that works out, huh?
Evan Niu: Yeah. The underwriters have a longer quiet period. The quiet period just went up, so now all the underwriters can start putting out their own ratings. Some of the other ratings we've seen before were from other firms. If you look at the IPO, there were seven underwriters. One is boutique and really doesn't issue ratings, Allen & Company. One hasn't issued a rating yet, as of right now, they haven't issued one, that's Barclays.
So, out of the five remaining underwriters, there are four buys and one hold. So, of course, it looks a little like they're biased, because they underwrote this giant deal. But, to be fair, there are some other more objective ratings that have come out in the past few days also that are buy ratings, like Cowen, Citi, Jefferies, RBC, and a couple or some others last week or so. So, it's not like you have to be an underwriter to like the stock, there are certainly other people who had nothing to do with the deal that are out there being bullish. But, as far as investors are concerned, it looks a little biased, but there is supposed to be this Chinese wall between investment banking and research, but I'm sure the analysts are very well aware that if the other side of the business has this huge deal, it doesn't really look good if you go out and start bashing it, because they're probably not going to win those deals in the future.
Lewis: Yeah. I think before we get too far into this conversation, it's good to be clear, there are regulations in place to prevent the investment banking arm of a firm from reaching into research analyst coverage. Like you said, there's the wall between the business. Usually, folks can't even be in the same room with each other without a chaperone or something like that. But, there are some incentives at play. Really, you can't be surprised by this, because at the end of the day, the underwriting banks just spent months talking about how great Snap is to all of their clients, all of these institutional investors, all these high-net-worth individuals. So, it's really not all that surprising for an analyst from that firm to feel the same way about it, right?
Niu: Yeah. They should be able to, objectively, if they really felt that way. But the optics would be really hard to justify. Like you mentioned, they've been talking this thing up. The underwriters make all sorts of money on these deals, not only in terms of the fees that they collect, but in terms of, once the trading starts and they have their big clients. The whole goal of these IPOs is to put together, engineer a nice pop on the first day. Most people say the IPO went great if you get a big jump. Snap did on the first day, and went up about 40% on the first day of trading relative to the offering price. They have a lot of incentives to make the deal look good. And then, of course, once the quiet period is over, if the analysts come out and start bashing the company, it doesn't really make a lot of sense. That's not to say that it's impossible, I'm sure there are cases that it's happened. I don't have any off the top of my head. But, I think you'd have to be really naive to think that these Chinese walls work exactly as they're intended to all the time.
Lewis: Yeah. And while it is tempting to drop conspiracy theories with this type of stuff, I do think it's worth remembering that, like I said, these banks spent a ton of time telling institutions and high-net-worth individuals what a good company Snap is, and really selling Snap. So, losing that business and tarnishing the relationship with those institutions or those high-net-worth individuals that they spent so much time bringing in with these research notes would be almost a bigger loss for an investment bank or a research firm or an investment management company. So, that's something that plays into this.
As an aside, I think the quiet period and the regulations are set up in a way that reinforces all of this. We talked about how they can't put out any notes on this. That's only for 25 days after the issuance. To go back to this, they just talked about how excited they are about the company on their roadshow. Nothing is going to change, there aren't any new financials out. So, I think one way they could improve these regulations is maybe by forcing analysts to wait until the company has reported a quarter of financials first, because that would actually give them the chance to say something new. And then, if they wanted to put out bearish coverage, they would always have the ability to hide behind the fact that, in the most recent quarter, they saw something they didn't like. It gives them an out.
Niu: Right, it could give them a little bit more justification. But I think the challenge there is, earnings schedules are so tricky, and they can be so specific to each company. So, I think the regulations are meant to -- I guess they felt 25 days is a good enough period of time.
Lewis: Yeah. The takeaway here is, you should never expect to see a research analyst come out and bash a company that his or her firm had underwritten the IPO for, it's just probably not going to happen all that often.