Here's an excellent article on why doing the hardcore analysis and being contrarian pays off: "One Analyst's Conseco Call Was a 'Devine' Inspiration
By DEBORAH M. LOHSE
Staff Reporter of THE WALL STREET JOURNAL
At a lunch in February 1999 at New York's swank Four Seasons Hotel,
Conseco Chairman Stephen Hilbert confronted Salomon Smith Barney
analyst Colin Devine, who recently had downgraded Conseco's stock. He
icily reminded the analyst that he was "a good client" of Salomon, and
demanded an explanation for the downgrade.
He doesn't need one anymore.
Since Mr. Devine's call, Conseco's
shares have plunged 77%, more than
twice the 36% drop in an index of
life insurance company shares. A big
chunk of that decline came after the
company's March 31 announcement
that it was selling its subprime
lending unit and taking a large
charge. During the stock's decline,
Mr. Devine also took flak from his
fellow analysts, many of whom had
been far more bullish on Conseco,
many right up until the company's
surprise announcement. So please
excuse him for feeling a bit
vindicated these days.
Mr. Devine's predicament is yet another reminder of the challenges facing
Wall Street's stock analysts nowadays who have the nerve to be negative.
There aren't many of them: Of the 28,000 stock recommendations
currently being tracked by First Call/Thomson Financial, 67% are "buys"
or "strong buys" and 32% are "neutral." Just 0.9% are "sell" or "strong
sell."
All this isn't surprising because more companies are lashing out at analysts
who write negative research reports. Chief executives have become bolder
in publicly belittling the naysayers. Mr. Hilbert last year complained about
Mr. Devine's work to several of Mr. Devine's superiors at Salomon Smith
Barney and its parent Citigroup, alleging factual errors. He also groused in
an interview last year with The Wall Street Journal that Mr. Devine
"doesn't know how to read an income statement."
For Wall Street firms, negative analysts make
it more difficult to court corporate clients
looking for underwriting or merger advice.
And many analysts are paid partly on the
investment-banking business their firms
generate. With the boom in mergers and initial
public stock offerings, many analysts get
annual paychecks topping $1 million. Mr.
Devine's 1999 pay package totaled a tad less
than $500,000.
For much of the past year, Mr. Devine's
"neutral" Conseco rating -- in Wall Street
lingo, that's telling investors to head for the
exits -- flew in the face of more than a dozen of his peers at large Wall
Street firms, who had "strong buy" or other positive ratings on the stock.
Previously, Mr. Devine, a 40-year-old Canadian who got into stock
analysis after stints at Standard & Poor's Ratings Service and a Canadian
insurance company, had been as bullish as his peers, rating Conseco "buy"
even after it made its controversial decision in mid-1998 to buy the
subprime lender, Green Tree Financial, for stock with an initial value of
$7.6 billion.
But in the months after the Green Tree deal closed, he began to fear that
Conseco wouldn't be able to pull off its ambitious plans to expand Green
Tree's lending operations without cash-flow problems or adding to its debt
problems. (Conseco later renamed Green Tree as Conseco Finance.)
Also, relying on research from fellow Salomon stock analyst William Ryan,
a finance-company specialist, he worried that Conseco was overestimating
the profitability of parts of the loans it kept on its books.
Rollin M. Dick, Conseco's chief financial officer, says in a statement that
the "time for rehashing the Conseco Finance acquisition is over" and that
"the future value of our enterprise will be driven not by what we say today,
but by what we do in the coming months to unlock hidden value on our
balance sheet, refocus our operations, and regain the confidence of
investors."
Investors seemed to side with Mr. Devine, with the
stock taking a steady beating from the day the deal
was announced. "It's nice to have your work
validated," Mr. Devine says. Still, he says he
wishes he'd gone negative just before the
much-criticized Green Tree deal was announced,
when Conseco shares peaked at around $55. "I
missed the first 20 bucks of this decline," he
laments.
Investors who followed Mr. Devine's call would
have avoided the subsequent 77% plunge in
Conseco stock. Others, who only sold upon the
surprise Green Tree sale announcement March 31, would have lost 60%
after his downgrade. Conseco shares were unchanged at $7.875 Thursday
in 4 p.m. New York Stock Exchange composite trading, near their all-time
low of $7.0625.
As the stock traded lower over the past 15 months, some of Mr. Devine's
research peers belittled him to their clients. Paul Newsome, formerly of
CIBC Oppenheimer, mentioned Mr. Devine by name in a January 1999
e-mail to some clients in which he called Mr. Devine's analysis "noble, but
flawed." Mr. Newsome, who now covers property-casualty stocks for
Lehman Brothers, says he stands by the work he did, and still considers at
least some of Mr. Devine's points flawed.
Many Conseco bulls based their ratings on optimistic views of the growth
in Green Tree. Just after the sale announcement two weeks ago, many
analysts downgraded Conseco, when the company also said it would take
a $350 million earnings hit for having misvalued some loan-related
securities, wiping out more than half of its earnings related to that unit.
Caitlin Long, a Credit Suisse First Boston analyst who had long had a
"strong buy" on Conseco, said in a note to clients March 31 that she was
downgrading her "rather stale strong buy" rating on Conseco to "hold" after
Conseco's announcement, noting concerns that "there really was a problem
at Green Tree that precipitated all of this." Currently, of 11 analysts'
recommendations tracked by First Call/Thomson Financial, one is a
"strong buy," three are "buy" or "outperform," and seven are "neutral."
Some analysts now privately congratulate Mr. Devine for his prescient call,
though they still quibble that he may ultimately be proved wrong on certain
cash-flow and credit-quality issues. "I'm not sure that anybody knows for
sure" the exact problems at Conseco, one analyst suggests.
Conseco executives, who recently declined to comment beyond a written
statement referring to two recent news releases, have said they opted to
sell Green Tree because they were "unable to generate the level of
shareholder value that we believed was warranted" and that faulty
modeling had caused the misvaluation.
Mr. Devine credits Salomon's head of global stock research, John
Hoffman, and Salomon's research directors for standing by his conclusions.
But he concedes that the attacks caused him to "go back" and re-evaluate
his work more than he would have otherwise, both for himself and at the
request of his superiors.
Luckily, he says, the stock's continuous decline helped buffer the
onslaught. "The ultimate test of whether it was right or wrong was in the
performance of the stock," said Mr. Devine.
Recently, a Salomon Smith Barney vice president in the research
department, Timothy Tucker, issued an internal memo congratulating Mr.
Devine and his colleague, Mr. Ryan. The memo to the research staff called
Mr. Devine's January downgrade "well-timed," and noted that a lesson to
be learned is that "swallowing management pronouncements whole can get
analysts and investors into trouble." A person close to Conseco said
management believes it has been sufficiently forthcoming with Wall Street.
As for Conseco's prospects, analysts and investors are anxiously awaiting
Conseco's delayed filing of its audited 1999 annual report, which it
promised by today. Some, including Mr. Devine, fear Conseco won't be
able to fully recoup its $4.7 billion in book value plus loans to Green Tree,
leading to concerns about possible additional earnings charges.
Even now, some bullish analysts remain undaunted. Eric Berg, the current
Lehman life-insurance analyst who worked with Mr. Newsome at
Oppenheimer, won't comment on Mr. Devine. But he remains a supporter
of Conseco, giving it an "outperform" rating, though that's lower than the
"buy" he gave it at Oppenheimer.
Mr. Berg's reasoning? Quickly getting rid of Green Tree in all likelihood
will be good for the company, he says, given that Conseco's low debt
ratings made it hard to make Green Tree's borrowing rates competitive
and that Conseco was at the whims of the bond market.
Yet some on Wall Street suggest there could be an additional factor behind
Mr. Berg's optimism: Conseco hired Lehman as the investment banker for
its planned divestiture.
Mr. Berg denies that Lehman's role has any influence on him. While he can
"understand investors might raise an eyebrow," Mr. Berg says, his rating is
"based on a dispassionate examination of the facts." |
