The Flight of the Sell-Side Analyst

Small-cap and mid-cap companies -- and some large companies, too -- are suffering through a drought of sell-side analyst coverage. The dearth is moving some executives to think about bypassing analysts altogether.

Sell-side analysts are fleeing smaller issuers, leaving executives at those abandoned companies to fend for themselves in dealing with large investors. Indeed, analysts who work for the sell-side research units of large brokers and investment banks are heading en masse for the economic shelter of large-cap companies.

The reason for the exodus? Large-caps boast heavily-traded stocks — and their whopping fees — as well as the potential for profitable investment-banking business.

The movement to big-company stocks has, however, been spawning a large share of losers. According to Reuters Research, there’s been a 13 percent increase in the number of companies that lost sell-side coverage completely since 2002. The researchers calculate that 666 companies of the 4,075 in its database had been “orphaned” by sell-side analysts as of January 2004. Two years ago, only 85 companies were left without analyst coverage.

Most of the new orphans are small: 97 percent of the companies left without analyst coverage this year have a market cap under $1 billion. The bulk of the remainder consists of big-caps that lack heavy trading volume. All but eight of the 19 large-cap companies that lack coverage came in under 1 million shares of total volume over the last 10-day period ending July 1. By way of contrast, heavily covered giants like Microsoft Corp., General Electric Co., and Ford Motor Co. traded between 90 million and 500 million shares during that same period.

The effects of the analyst migration extend beyond the orphans to those companies that are hanging on by a thread. Reuters reports that 380 are down to a pair of analysts tracking their stock, while 473 companies have just one. At such companies, executives will surely be under increasing pressure to keep from losing their existing coverage or to replace lost analysts in some way.

That’s because decreasing coverage means a dwindling exposure to investors — a situation that makes raising capital difficult. “If you don’t have analyst coverage, investors don’t really know about you,” warns Ashwani Kaul, a senior market analyst at Reuters Research. At the same time, Kaul reckons, the analyst rush to big-caps creates “a void for investors who are interested in small- and mid-cap companies.”

Sell-Side Economics

Even if analysts had the will to fill the void, however, the bodies just aren’t there. 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.


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