Capital Markets

The Drought of Sell-Side Coverage

For many small-cap and mid-cap companies -- and some large companies, too -- there just aren't enough analysts to go around.
Marie LeoneJuly 8, 2004

Layoffs and voluntary exits from the sell-side-research business have gone hand-in-hand with a sputtering stock market, explains John McInerney, a senior director at Citigate Financial Intelligence, a communications firm. As a result, the number of sell-side analysts has decreased over the last few years by 15 percent to 20 percent, estimates McInerney, whose firm recently conducted 90 interviews with corporate issuers as well as sell-side and buy-side analysts.

For many sell-side analysts, choosing which companies to cover seems thus to have become a matter of triage. With the analyst force shrinking, individual researchers have been scrambling to cover their existing lists plus those of the departing analysts, according to issuers surveyed by Citigate. They’ve also had to hustle to cope with accelerated regulatory filing requirements that force the researchers to squeeze more financial-statement reviews into the same work week.

The situation of fewer analyst bodies doing more work can also lead to “analyst churn.” The increased switching of analysts from company to company is the most significant change in investor relations over the past few years, notes Bruce Nolop, CFO of Pitney Bowes Inc. The turnover, he explains, forces the Pitney Bowes investor-relations team to constantly reeducate analysts about the not-so-easily-defined company. A venerable postage-meter manufacturer with a $10 billion market cap, the company has made a recent foray into mailroom services and outsourcing.

In December 2002, 10 sell-side analysts covered Pitney Bowes, Nolop recounts. But by April 2004, that number had dropped to five — three of whom are still new to the company story, having come on board since 2002. That’s left Pitney Bowes with only two veterans, Carol Sabbagah of Lehman Brothers and Shannon Cross, formerly of Merrill Lynch, now with the eponymous Cross Research.

Besides the diminished analyst workforce, Wall Street economics are also spurring shifts in coverage. In effect, the research subsidiaries that employ sell-side analysts aren’t self-sufficient. Investment banks and brokerage houses derive operating profits from investment-banking fees and share-trading commissions, not analyst reports. In the end, sell-side research tends to be a loss leader, bundled for clients along with lucrative services.

Thus, it’s the fees and commissions that “drive analyst coverage,” maintains Ashwani Kaul of Reuters Research, “because that is where the money is.” He contends that many small-cap and mid-cap companies that have great investment potential don’t garner coverage because they don’t represent a substantial source of profit for the firms.

Others agree with Kaul’s assessment. San Francisco-based investor-relations consultant Peter Ausnit, a former sell-side analyst, predicts that over the next decade, sell-side research sponsored by big financial-services firms will increasingly focus on large companies that support Wall Street’s revenue model. Further, analysts tied to big Wall Street firms will soon focus on “only a handful of big-cap stocks that provide sufficient profit margins,” predicts Richard Wayman, president of (For more, see “The Flight of the Sell-Side Analyst.”)