Seriously though, I was reading this piece in the SJ Mercury News about Frank Quattrone's return to technology finance, and something that Frank was reported to have said caught my attention. Here's the paragraph from the article:
But the result has been that a large number of analysts have left investment banks to join hedge funds and private equity firms, Quattrone said. The remaining analysts have focused on covering bigger corporations, rather than small start-ups, because there's no money and little recognition in covering the smaller companies, he said.
At first blush, you may agree with Frank. However, that analysis is counter intuitive to me. While what Frank said here may be true (I don't know), it appears to me to offer an opportunity for someone to profit. See, if there is less analyst coverage of smaller tech firms (especially those with real businesses, revenues and profits), then a studious operator can use the lack of coverage to their advantage.
Every trader, portfolio manager, or even small investor, is looking for an edge. The analyst rules implemented in the wake of the Blodget and Grubman scandals create a vacuum of public information around small companies, according to Frank. So the operator who is peering into the cracks, doing the due diligence, and sniffing out the promising companies that have minimal or no analyst coverage, has a better chance of finding a "hit" before the market does. Its a perfect arbitrage play. Of course it takes courage to do, but isn't that the point? The successful operators feel fear like everyone else, but they don't let that fear stop them from making good, well reasoned investments (or trades). So the operator that steps into this information void, spends the time learning about the company, and generates an investment thesis for it is taking a huge risk. However, that risk is mitigated somewhat by the fact that s/he's got a larger margin of safety to work with while the stock is undiscovered.
None of this means that our hypothetical operator can't be wrong. The investment thesis could be bogus. The timing could be sub-optimal. Any number of things can go wrong; that is the risk of the market. However, finding an unloved gem is the kind of investment everyone wants to make. So analysts' failures to cover these small companies creates an opening for the intelligent and courageous operator to profit handsomely. Shouldn't we be glad that these information arbitrage opportunities are being created? If we are the competent and capable operator, we should be giving thanks and showing gratitude for such situations, so I would think.
I don't feel bad for the sell-side analysts. If their work is any good, they'll get known for it. Meredith Whitney and Dick Bove come to mind. The good analysts will have options. Hell, even the less-than-best analysts will probably land on their feet too, usually within a hedge fund or private equity firm, as Quattrone acknowledges, or some other buy-side entity. The analysts creating forgettable research will fade into obscurity within their firms, and the typical retail investor will probably place (misguided) value in/on their work. I don't see how life is so bad for our sell-side analyst. Will it be as easy as it was during the go-go 90s? No. Will it orders of magnitude harder for them to make a living? I doubt.
Its too easy to tag along on the words of the great Frank Quattrone, given his reputation and past success. I think Frank misses the mark on this one, though. However, Frank wasn't a trader. He was a banker. As such, he probably never had to consider this issue too closely. In Frank's world, the sell-side coverage was probably proof that he was doing his job (and well). It probably justified the expense that the IPOing startup went through to work with Quattrone and his gang at CSFB. All of this would serve to burnish Frank's reputation as the go-to banker, which made him more prized and valued by whichever firm employed him.
I don't know if he's just looking at this void through the eyes of a banker, or if he has really evaluated the pros and cons of the reduction in sell-side coverage for smaller stocks (across industries, but especially in technology). I hope he has, and that he saw something I missed. In that case, I would LOVE to know what I overlooked. However, I don't get the feeling, from reading this (very) short article, that he did that evaluation.
Until next time, good people...