Sell Side Research in a post-9/11 World

The 5 year anniversary of 9/11 has made me think back to all that has transpired since that tragic and painful day. When my thoughts over this time frame turn towards the profound changes in Wall Street and the markets, one of the biggest shifts that comes to mind is in the realm of equity research. It was not too long ago that research analysts were rock stars, literally, being bid away by other firms and hedge funds for mind-boggling dollars. I remember some of the CEO Internet Roundables during my years at Deutsche Bank when our analysts were the hosts and starred along with the CEOs of the day such as Tim Koogle of Yahoo!, Tom Jermoluk of @Home and George Bell of Excite. Man, those were the days - and we partied like it was 1999 (because it was).

And man, are those days ever gone. The plunge in equity capital markets revenues precipitated by the drying up of the IPO market shined a bright light on that giant research nut, that massive cost center that was only a topic of discussion around bonus time when equities and banking sparred over "You pick up 2/3 and I'll pick up 1/3. No, go screw yourself. It's 50/50."  Without question, sell-side research has seen some bad, bad days since the bubble burst five years ago. It was easy to gloss over bloated cost structures and internecine battles when everyone was minting money, but once that merry-go-round stopped... Not to mention the pissed off investors and the email trails discovered during the Fall of Blodget, the taming of Meeker and the Humiliation of Grubman. Anyway, this is old news.

But what of sell-side research today? A report by the consulting firm Booz Allen titled Saving Sell Side Research highlights a number of the key threats to those who lack the vision and adaptability to change with the market - massively declining research spend due to competitive forces, more robust performance measurement metrics, and a squeezing of the middle (being neither a high-quality, focused boutique nor a global behemoth with the resources to deliver a superior global product). This report outlines three specific prescriptives to the sell side, assuming a rational business case can be made for keeping research at all:

1. Delivery Model Streamlining (more efficient resource allocation, "rationalize" compensation, increase outsourcing)
2. Offering Redesign (expand coverage of small/mid caps, add expert networks, quality models, performance metrics, add a degree of client exclusivity)
3. Differentiated Service Levels and Pricing (calibrating levels for small, mid-size and large firms, hedge funds, etc.)

Wow, doesn't it seem that sell-side research is actually being pushed to be run like a business? I love the way the prescriptives read in consultant-speak: aren't they really saying, in English, "Cut costs and run the business efficiently," "Deliver a product that your customers value" and "Have prices reflect the value of the product you're providing"? Clearly, these things make sense. They make sense for every other industry so why not research?

I'd like to thank reader Yaser Anwar for providing me with the Booz Allen research piece - it got me to put in words things that had been rattling around in my head for some time.

It is interesting to consider where some of those commission dollars previously used to pay for sell-side research have gone? Providers of expert networks, perhaps? Even Bear Stearns has entered the fray. Maybe alternative information providers the extract unique and hard-to-access data from the Internet and other sources? Possibly augmenting in-house research capabilities? I'd argue that it is a mix of these three and more. The buy side knows what research is worth and is done paying for product that doesn't deliver. With Lehman and Deutsche unbundling commissions for Fidelity, it is now possible to truly pay for what you use (as long as you are a sufficiently large client and breaking the soft-dollar chain makes sense for you).

I am convinced that we are entering "the a la carte world," where kind of like SaaS you can pay for only what you need. This will lead, as properly referred to in the Booz report, in a barbelling of the research industry (just like the phenomenon going on in the hedge fund industry). Further, you will see greater use of alternative research methods (expert networks, alternative information providers, financial intelligence tools) as a vehicle for supporting the idea generation that is already taking place on the buy side, continuing to marginalize the value of idea-driven sell side research. It is a train that just cannot be stopped. Just like free markets, efficiency will eventually find its way into the nooks and crannies of the business. "Eventually" just happens to be today.

The change is already happening. Either get on the bus or else....

Comments

[Alex Sharp]

So as a college student interested in getting into equity research, would you suggest I look more closely at the buy side?

[Robert Passarella]

Roger, you've really hit home on this one.

I've been around sell-side research for a long time and the end result is that a majority of the product is old news. EPS estimates are a commodity, price targets are for retail and most of the big houses outsource model creation to India, part of the cost cutting thing. So if you can outsource it, it must be a commodity.

The only thing of value today is the connections an analyst has to the company, however reg FD limits a majority of the stuff they learn and can disseminate. The only thing remaining are industry overview reports; they are really the last piece of value left for identifying firm and market forces; so that a professional can determine what he should be looking for and generally what catalysts will make an equity move. They need to change and understand that the majority of what they deliver has little monetary value. Analysts use to have insight today they only deal in hindsight. I've talked to a lot of these folks and most of them have never had to build a for-pay product and therein lies the problem.

You need new ideas for non-traditional products that interest the customer and are above all timely -- big sell-side firms don't innovate like that anymore.