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To
OTC Journal Members:
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Is Merrill Lynch
Bullish on Investors? |
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Who could forget the slogan "Merrill
Lynch is Bullish on America". The largest brokerage firm in the
world used the slogan in an advertising campaign during the late 80's and
early 90's, branding it into the psyche of American investors.
As the new baby bull market emerges
and some of the pain associated with the trillions lost by investors betting
on technology stocks fades into oblivion, a look back at the actions of
the old line and venerable Merrill Lynch is warranted. After reading
about the Greatest Cheerleader of All Time, you might begin to wonder if
Merrill
Lynch, the old line brokerage firm is actually "Bullsh#t on Investors".
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January
of 1999 |
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In January of 1999 the Internet/Technology
stock market craze was gaining momentum. Merrill Lynch's internet
analyst Jonathan Cohen was one of the few voices of reason in a
high profile position on Wall Street.
Because of Cohen's common
sense approach, Merrill Lynch, the most powerful brokerage firm
on the planet, wasn't invited to the party. Merrill's internet analyst
Jonathan
Cohen
didn't buy the hype. In retrospect we learned Cohen actually
had it right all along.
In early 1999 Cohen's rating
on on Amazon.com (NASDAQ: AMZN) was a short term reduce and
a long term neutral. These ratings were the most negative
on Wall Street at the time.
Cohen's stance was probably
costing Merrill Lynch millions in underwriting fees and commissions.
Clients were calling their Merrill Lynch brokers to buy Amazon.
The brokers were telling clients their analyst wasn't bullish on the stock.
Two months later the stock would be up 25 points, making Merrill Lynch,
the broker, and the analyst look like idiots.
In a report dated September 1,
1998 titled "The World's Leading Internet Commerce Company
Is Too Expensive" Cohen dishes the dirt on Amazon.com. With the luxury
of 20/20 hindsight, these passages were powerfully prophetic.:
| Independent of its valuation,
we are generally optimistic about Amazon.com's longer term opportunity.
We can not, however, reconcile the value of that opportunity with the company's
recent market capitalization.
..While our opinion is principally
based upon valuation ( as well as our premise that the company lacks the
ability to justify that valuation on an operating basis), it also takes
into account our concerns relating to the long-term margin structure that
we believe will be associated with Amazon.com's underlying model.
The bottom line is that book selling is an inherently competitive and low-margin
business.
..Amazon.com's equity market valuation
has taken on the characteristics of public spectacle, and we are both enthralled
and deeply concerned.
..We have noted with concern that
the most recent Wall Street research valuation analysis we have read seems
to rely on tautological argument: "the valuation is currently X-times revenues,
therefore as revenues increase, the share price would rise proportionately
(assuming the valuation multiple stays the same)". Not only is the
above analysis logically corrupt, it has actually begun to gain some credibility
through its constant misuse.
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In January of 1999 Jonathan Cohen
mysteriously departed from Merrill Lynch. It was never disclosed
whether he was fired or chose to resign, but he was definitely gone, viewed
as a dinosaur that didn't understand the "New Economy" market valuations.
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Enter
The Greatest Cheerleader of All Time- Henry Blodget |
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The "target price heard around the
world" was found in a research report issued on December 16, 1998
from little known analyst Henry Blodget at CIBC World Markets.
The internet revolution was beginning to gather a full head of steam. Doubters
figured this all to be some giant Ponzi scheme. Tech stocks were flying
through the roof and the media was enamored with the riches and the fame
that this technology phenomenon had produced. Venture capitalists, investment
bankers, and entrepreneurs began to grace magazine covers and appear on
mainstream television shows like they were rock stars.
One of the most high profile Internet
darlings was online bookseller Amazon.com. At the time of Blodget's
famous (or should we say infamous target price) the stock had recently
surpassed his previous price target of $150 per share hitting a
high of around $240. This meant that Amazon.com had a market capitalization
north of $12 billion dollars. Henry Blodget, a former lowly
production assistant at CNN, became an overnight media darling.
The following are a few excerpts
from the original research report:
| Amazon.com recently surpassed
our price target of $150. We are maintaining our Buy rating for strong-stomached,
long-term investors and raising our one year price target to $400.
We continue to believe that Amazon.com is in the early stages of building
a global electronic-retailing franchise that could generate $10 billion
in revenue and EPS of $10 in five years.
..we continue to believe that
the company's opportunity is large enough to support a market capitalization
much higher than the current valuation. We also do not believe that
valuation alone will bring the stock down. We expect AMZN to continue
to be extremely volatile, and we regard any significant weakness as a buying
opportunity. |
At the time Amazon.com had 50 million
shares outstanding. Blodget felt compelled to tell the world that
his target price for Amazon.com was $400 per share making for a market
capitalization of over $20 billion for this online bookseller. Blodget
isn't completely irresponsible, and does point out some negatives in a
company he thinks should be worth $20 billion.
| As we noted in our initiation
of coverage report, in the short history of the internet sector, the biggest
money has been made by investors who had the foresight to invest in the
stocks of the leading companies before their business models were proven.
We firmly believe that Amazon.com will one day make a lot of money, and
we find it hard to believe that if our aggressive growth scenario stays
on track over the next 12 months, the stock's upward trend will reverse
itself.
...Amazon.com is a long way from
proving that it will ever make money, and an investment in the shares clearly
requires a strong stomach and a great deal of faith. |
In January of 1999 Henry Blodget,
infamous cheerleader for the Internet Sector at CIBC, would depart for
greener pastures at Merrill Lynch. Newly minted First Vice President
Henry Blodget received quite a financial windfall. Merrill reportedly
had to dish out close to $4 million to lure internet icon Blodget
from CIBC, but the investment paid off. The announcement of his hiring
was heralded by the news media as Merrill's blessing that the "new economy"
was for real. Blodget got right to work and on March 9, 1999 Merrill
Lynch reinstated coverage on Amazon.com with a short term ACCUMULATE
and
long term BUY rating. This was just after a 3:1 split, so the adjusted
target price was $450.
| We are reinstating coverage on
Amazon.com with an Accumulate/Buy rating and a 12-month price objective
of $150.
...Amazon.com's valuation is aggressive,
but we believe a small investment can be justified in light of the company's
leadership position and long-term opportunity. We believe the stock
will continue to be extremely volatile, but trend higher long term.
...In our opinion, Amazon.com
is investing money, not losing money (an important distinction).
Management is committed to building long-term shareholder value at the
expense of near-term bottom line- an unsettling but, in our opinion, smart
strategy.
...Based on our analysis, we believe:
1) the business-to-consumer (B2C)
electronic commerce opportunity is massive-more than large enough to support
a few major players-and electronic retailing is more difficult than it
looks (having a real strong real-world franchise clearly does not guarantee
success);
2) the leading B2C companies (namely,
Amazon.com) could make a great deal of money (note that AMZN's operating
loss as a percentage of revenue is declining- similar to AOL in the days
when people said it couldn't make any money); we believe the electronic
model has enormous advantages over store-based retailing in terms of profitability,
return on invested capital, and customer satisfaction.
3) AMZN's valuation is justifiable,
though expensive. |
Amazon.com was a $20 billion dollar
company at the time. This shift in Merrill's direction on the internet
helped fuel the bubble that was to become one of the greatest boom and
bust cycles of wealth in the history of mankind. For a while Wall Street
became a giant casino where buying an internet stock was no different than
taking a few pulls on the slot machine in Vegas. You may win a few here
or there but ultimately you leave empty handed. There is however a jackpot,
but unfortunately there is only one winner. That designation goes to the
greatest cheerleader of all time, Henry Blodget.
Things seem to be coming to a close
for this opportunistic young analyst. A story in the Wall Street Journal
announced that Merrill Lynch had offered voluntary severance packages to
their employees in an effort to reduce their work force. Thousands
accepted the offer and it was reported that Blodget was one of the
takers.
Blodget has given up the limelight
hoping to make a quiet exit from the business. He is rumored to be leaving
with a $5 million dollar severance package not to mention a handsome salary
reported to be $4 million last year. This perfect ending may not go as
smoothly as Blodget hoped for. The Wall Street Journal is reporting
that the New York state attorney general's office is investigating conflicts
of interest that analysts may have had while making stock recommendations.
Scott
Brown, spokesman for the attorney the general states, "We've had
ongoing investigation into whether there are inherent conflicts in the
work that analysts do for investment houses that are also seeking underwriting
business. Our concern is that the public receives accurate information
when making its investment decisions."
Blodget's hiring by Merrill did
provide the result the firm wanted: more underwritings, investment banking
fees, and commissions. This didn't mean higher quality deals. A report
by
Business
Week in April of 2001 lists Merrill Lynch as having the worst
track record in internet IPOs. Merrill's underwritings in this arena
seem to have been just plain garbage. It's hard to understand why they
did so poorly since they had the largest sales force on the planet andthe
most high profile Internet analyst.
What does this all mean to you as
an investor? Simple- Ignore Wall Street analysts and use you own common
sense. Looking back at the hundreds of past IPOs there is rarely one that
did not receive a buy rating once the 30 day "quiet period" elapsed. The
stocks would then run up on the announcements of buy ratings when those
in the know sold into the flux of retail buying. This retail buying helped
create exit strategies for the big money players that decide to sell their
$19 IPO stock to you for $55 per share. This is why Merrill and
any investment bank will open its checkbook to an analyst that has name
recognition regardless of the real quality of research.
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Conclusion |
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The OTC Journal is published
in plain, understandable English because we know investors are tired of
reading the research that Wall Street dishes out. Reports are often encrypted
in some form of jargon that no one seems to understand. Ratings are also
confusing. When a brokerage firm issues a "HOLD" recommendation
everyone on the Street knows it really means "SELL". Analysts need
access to management, and brokerage firms need massive investment banking
fees. Neither will be forthcoming from a company bearing the stigma of
a "SELL" recommendation.
We make no secret of the fact that
every stock we cover is risky. Investors should be prepared to lose 100%
of the capital they invest in any small or microcap situation. If you can't
afford the risk, please stay out of this end of the market. Our mission
is to find investment ideas in young and growing companies where the upside
potential is worth the downside risk.
We got caught up in the Internet
craze just like Merrill Lynch did, and we covered several flash-in-the-pan
companies that eventually failed. However, unlike Merrill Lynch's Henry
Blodget, we aren't walking away with a $5 million severance package for
being completely wrong and costing the investing public hundreds of millions
of dollars.
On the bright side Jonathan Cohen
is not gone from the scene. Here is an analyst with vision and discipline
worth listening to. Look for Jonathan Cohen related ideas coming from the
OTC
Journal in future editions.
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