Glenn Reynolds can’t make the meeting with Euromoney. The chief executive of independent credit research firm CreditSights has been asked to give testimony before one of the congressional committees investigating the Enron saga. He has less than two days to prepare for it.
That is some accolade for a firm that has been in business for less than 18 months. And it is a bit of a surprise. “We haven’t really marketed ourselves so widely that we’d expect a call from Congress,” says Paul Ciasullo, the firm’s president and head of business development.
But US lawmakers are seeking to understand the causes of the spectacular collapse of Enron – aside from the energy trader’s huge sponsorship of politicians and massive use of lobbyists, of course – and are focusing on the role played by investment banks. The independence or otherwise of research is an obvious issue to consider and questioning the head of an independent firm staffed by former brokerage analysts is a logical step.
Objectivity is the firm’s chief selling point. “At investment banks, who pays you dictates what you do,” says Ciasullo, who has worked at Lehman Brothers, CSFB, Prudential Securities and, most recently, IBJ/Aubrey Lanston. “We have no investment-banking relationships to concern ourselves with.”
As his colleague David Hendler points out: “We can be more hard-edged than at sell-side firms”. Hendler, CreditSights’ financial services analyst, has worked on both the debt and equity sides of sell-side research and is used to controversy. His last sell-side job was at CSFB, on the bank equity research team run by Mike Mayo. The team was bearish on US banks in 1999 and issued sell ratings on nearly all the stocks it covered. The bankers were not pleased, even though the analysts were proved right on most of their calls. The team was sacked after the merger with DLJ in autumn 2000.
One of the problems that sell-side analysts – debt or equity – constantly face is that executives at companies they follow might cut off contact if they issue a negative report. Thus far, it’s not an issue that has affected CreditSights’ analysts. Hendler, for example, has been bearish on JPMorgan Chase, written some harsh reports, and has a sell on both its stocks and bonds. Yet executives are still willing to meet with him. “We have regular contact with firms we analyze,” says Hendler. “They ring us up asking to see us.”
Ciasullo attributes this to the number of subscribers CreditSights has. “We have nearly 500 subscribers now, including some very recognizable investment managers and even some investment banks. If we only had 50 subscribers, issuers wouldn’t care about us, but they can’t ignore 500.”
At $12,000 a year for a subscription, that’s an income of nearly $6 million just in the first year (the firm only started charging in April 2001) and is enough, says Ciasullo, to make CreditSights profitable already.
Being based in a near no-man’s-land in Manhattan must help with the rent. CreditSights’ office is on Park Avenue and 31st in a nondescript building on a nondescript stretch of road, just south of where the mid-town financial district starts and just north of the Union Square area, a favourite location for those few tech companies still in business.
The advent of the internet as a business tool is what made the firm possible, though. Timely printing and mailing, or faxing, of 3,000 analysts’ reports to 500 clients would have been crippling for a small firm, which is why there are so few well-known independent research firms.
Even so, what has really driven CreditSights’ growth is the market environment of the past two years. Companies, investors and sell-side analysts have all been tested by market crashes, the bursting of the tech and internet bubbles, inverted yield curves, recession, defaults, lay-offs and restructurings. Then there was the demise of former darlings such as Enron and Global Crossing, the growth in use of ever more complicated financial instruments and the accounting scandal.
Few have distinguished themselves, least of all analysts, who have often found themselves entangled in conflicts of interest springing from investment-banking relationships or internal structures. Or both.
CreditSights suffers from neither. “We focus on a body of industries and cover what we think is interesting, and what investors want us to cover,” says Ciasullo.
One of the main requests the firm receives, it seems, is for research less compartmentalized by product. “Large investors don’t regard the split between debt and equity research as the most effective any more,” says Ciasullo. It can lead to crucial pieces of information being ignored. “So often equity investors tell us that they never hear about a company’s bank lines or covenant agreements from the sell-side equity analysts,” says Peter Petas, head of global sector strategy and formerly head of emerging-market debt strategy for Deutsche Bank.
It’s not just orthodox investors pushing the changes: hedge funds are an increasingly powerful body of investors that are more willing to switch between products. They have become the major investors in US convertible offerings in the past two years, for example. They are also becoming increasingly interested in credit derivatives.
The rapid rise in convertibles issuance is an apt example of the changes, as they affect both debt and equity for an issuer. Last year there was over $100 billion in new issuance in the US, 60% more than 2000 and many were high-grade issuers, in a market they used to shun. Increasingly, converts are used to restructure balance sheets under stress: Ford, General Motors and Gap are three recent issuers, with Lucent, Xerox and Calpine tapping the market in size last year. The whole range of investors is buying them, for many different reasons. They need research that reflects their interest.
Brokerage houses know that the rapid changes in the market are an issue for their research franchises but do little to address it. Al Jackson, global head of equity research at CSFB, simply says: “Enron was a wake-up call for all of us. It’s key that we get our debt and equity analysts working together.”
CreditSights seized on this. “We look all across the capital structure when analyzing companies,” says Ciasullo. “As a result we have as subscribers a broad mix of convertible investors and equity arbitrage and derivatives players, as well as high-grade and high-yield investors.”
It’s a strategy that combines well with their experience and contacts, not to mention their control of costs. And they have developed their own quantitative analytical system, BondScore. But the timing of the launch was everything. “I’m not sure we could have succeeded at this four years ago,” confesses Ciasullo. “There was more liquidity in the system and more counterparties. And all the focus was on making money in equities.”
