An investor complaint in 2002 against a Merrill Lynch Internet analyst shined a spotlight on the lucrative relationships between analysts at Wall Street banks and their executive counterparts in investment banking.
The complaint highlighted how analysts, who typically sounded like independent voices dispensing wisdom on the prospects of high risk internet start-up companies, were actually in cahoots with investment bankers. Analysts gave favorable opinions of companies that investment bankers wanted to do business with; the bankers in turn generated millions of dollars in fees. That complaint was the spark that eventually led to a $1.4 billion global Wall Street research settlement.
The decline of Valeant Pharmaceuticals Intl Inc (NYSE:VRX) illustrates that the cozy relationship between Wall Street analysts, bankers and the high-flying companies they underwrite is alive and well.
After the so-called Global Settlement, Wall Street’s research practices were supposedly overhauled to eliminate biased research and conflicts of interest between the research analysts and the investment bankers on the other side of the house.
Unfortunately, the analyst coverage on Valeant shows that despite the global settlement and promises for a Chinese Wall, Wall Street is at it again.
A darling of Wall Street for years, Valeant’s stock price has collapsed, falling from a high of $263.81 last summer to $31.91 on Tuesday. For the last 12 months, Valeant shares are down 84.4%; billions of dollars of investor equity has been lost. The reason? Valeant’s strategy of buying other pharmaceutical companies, slashing costs and sharply raising prices on undervalued drugs has faced sharp criticism.
Berkshire Hathaway Vice Chairman Charlie Munger said Valeant’s businesses practices were “deeply immoral” and “similar to the worst abuses in for-profit education.”
Bill Gross of Janus Capital tweeted that Valeant, “was based on leverage and financial engineering”.
The situation at Valeant is so dire that on Monday, it said its CEO would step down. The company also said it would restate some of its earnings and ask a board member, who was also a former chief financial officer, to resign, accusing him of “improper conduct.”
Despite the months of chaos at Valeant, Wall Street remained in love with the company. Twenty-one of twenty-three Wall Street analysts who cover Valeant had buy or hold ratings on the stock before a massive sell-off earlier this month saw shares fall to $33 from $69 a day earlier this month, according to a recent Financial Times article titled “Investment bank analysts stayed bullish as Valeant struggled.”
Caused by the specter of a default on its $30 billion in debt and the bungling of its earnings forecast, the massive sell-off fueled “new doubts over whether the research produced by investment banks is too bullish about the companies they cover,” according to the FT. “Since last summer, the company has lurched from crisis to crisis.”
Valeant has been attacked by politicians who claim it is fleecing consumers with high prices and securities regulators have the company under investigation. Not to mention we are still waiting for audited 2015 financial results.
In the face of the chaos at Valeant, only two of the 23 analysts who cover the company recently had a sell rating on the company, according to the FT, citing data by Bloomberg.
For example, UBS had a “buy” recommendation and a 12-month $213 price target on Valeant as it cratered on March 15 to $33 per share. Barclays had a more modest but equally dubious price target of $135.
“Wall Street’s unflinching enthusiasm for Valeant deals a fresh blow to the credibility of ‘sell side’ research, which also came in for heavy criticism after the 2000 dotcom crash,” according to the FT.
Could the millions of dollars in investment banking fees paid by Valeant in the last two years have influenced these “buy” recommendations?
“There is an overall pressure on analysts … to wear smiley faces when they look at companies,” a source told the FT. “The analysts who are positive get better access to management.”
That research settlement of yesteryear, obviously, isn’t worth much.
Will Wall Street ‘Sell Side’ research teams ever learn that such conflicts of interest alienate retail investors who view the stock market as rigged against them and favoring the big players?
With Valeant as the most recent example, it would seem that Wall Street’s banks have yet to understand that lesson.
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