Mike Mayo is getting a little testy.
"When someone puts a buy rating on the stock, do people misunderstand it?" the
banking analyst yells into his cell phone over the din of a bustling street. "Many people start slamming what I wrote -- saying I'm assuming a big recession or a massive falloff in capital markets. That's the exaggerating element. That's their way to poison the research. That's a prime example of how it's harder to put a sell rating on a stock."
The sell rating in question came Monday morning, when Mayo cast doubt on
J.P. Morgan Chase
. Shortly after the call, he turned on
to see pundits ripping it, the start of a chorus of disapproval. He defended himself on
later Monday, but still sounded miffed on the telephone Tuesday.
The tempest in a teacup stirred up by Mayo's call has already abated, but the risky gambit behind Mayo's call still looms large over his firm's future course. PruSec, which last year maintained a minuscule portion of the investment-banking market, says it is making itself over as a research-focused shop -- one not afraid to utter the s-word. Sell words, at last count, make up about 1% of the ratings given out to companies.
In some ways, the timing is propitious. The Internet bust has left investors feeling a bit duped by Wall Street's rosy reports --
May 14 cover features
Mary Meeker next to the headline, "Can We Ever Trust Wall Street Again?" Meantime, underwriting firms are facing heavy scrutiny -- and lawsuits -- over allegations of excessive trading commissions in the hot initial public offerings of 1999 and 2000. Touting itself as the firm that eschews conflict of interest and makes bearish calls when necessary has been called a shrewd marketing ploy by a host of Street pundits and money managers.
But PruSec faces substantial risks in getting the bearish religion right now, ones that could backfire just as severely as the hopelessly optimistic research put out during the boom has boomeranged. It's giving up the ghost on the lucrative underwriting business. It's invoking the ire and bemusement of Wall Street by defying the accepted vernacular of analystspeak. And third, it's rolling out a slew of bearish calls, such as Mayo's ratings on financials, in the face of widespread talk of a market rebound and an aggressive rate-cut push by the
that helps stocks in general and financials in particular.
If it's marketing, it has gone beyond posturing. In December, 160 employees in the banking department were let go. Since then, the firm has tagged
and others with sell ratings.
"There are two reasons that it's difficult to put a sell call on stocks," says Michael Shea, president of Prudential Securities' equity group. "One, you increase the odds that the company will withhold more information, and that makes your job more difficult as an analyst. And the second reason is that they're pursuing investment banking business, and the odds of pursuing after a mandate to sell is essentially zero."
Unwilling to serve both masters, he says the firm made a transition into a retail-focused shop able to make bearish calls. This new reputation was cemented in February when it hired Mayo, best known for his tenure at
Credit Suisse First Boston
, where he was let go not long after making bearish calls on banking stocks. "We know Mike had the reputation of being a straightforward and plainspoken banking analyst, and when we knew he was available we thought it was a tremendous fit," Shea said. Mayo has become emblematic of the new Prudential research directive -- issue buys on stocks to buy, sells on stocks to sell.
Prudential's investment-banking arm had been growing, but it wasn't a force in the sector. According to information provided by
Thomson Financial/First Call
, Prudential booked $84.7 million in fees for 2000, a 21% gain from 1999's take and good enough to keep it in 14th place a second year. Those numbers add up to a mere 0.3% of the market share. Five companies control 80% of the underwriting on Wall Street. Trying to compete with
, Credit Suisse and Morgan Stanley is pretty fierce.
Another wrinkle in this setup is
Regulation FD, the
Securities and Exchange Commission
rule put in place last year that requires fair disclosure of material information to all investors, is helping research shops such as PruSec,
. These outfits, which don't have investment-banking arms, can make headway against rivals that have relationships with corporations and inside access to information. Corporations now must publicly disseminate information at the same time they tell analysts. "Regulation FD is going to cause Wall Street analysts to do a lot of work," said Dave Brady from asset manager
Stein Roe & Farnham
. "Most of the old relationships are out the door under FD. They'll have to do the real work now."
As a result, many analysts lose their most-favored status and receive the same data as everyone else. Mayo says he hated Reg FD when it first came out, thinking that it would keep him away from information. Now he calls himself a convert. "Not only does it put the retail investor on equal terms, it puts the analyst who's negative on the investment on an equal footing," he said. "They will not shut me out. I get to listen in to corporate calls."
The J.P. Morgan Call
This isn't the first Pru sell call to raise a little flap among Wall Street. In February, for instance, analyst Mark Rowen slapped a sell rating on
. But the online retailer, whose stock has fallen 77% from its all-time high, had received the bearish ratings from other firms as its earnings prospects and balance sheet came under fire. (For what it's worth, the stock is up a modest 0.8% since the Feb. 15 call.)
The J.P. Morgan call is different. Mayo says he knows his view on J.P. Morgan flies in the face of Wall Street's glowing opinion of the company, which is rated buy or better by 19 analysts, according to Morningstar. It also contradicts conventional wisdom because financial stocks historically outperform when the Federal Reserve cuts rates.
"It was at the highest price it was when I made the call. We're negative on the banking industry," he says. "No, we are not assuming a recession. We are not planning on a free-falling capital market. We're not planning on Latin America or Japan falling out of bed." Mayo says that bad loans, exacerbated by American economic sluggishness and slowing capital markets, will catch up to J.P. Morgan before the Fed cuts do.
Not everyone likes his calls. In a
column on Monday,
, who has been bullish on financials since it became clear that the Federal Reserve would start cutting rates, wrote, "You simply don't downgrade banks at this point in the cycle."
Ask sell-side analysts about Mayo and they'll laugh, crack a joke and then tell you what's wrong with him, off the record. He misses the upside. He uses the sell call to get on television. He's dead wrong about J.P. Morgan. Ask the buy-side analysts and they'll cheer him for making gutsy calls and breaking the taboo surrounding the sell rating.
Mayo, who stands by his call, thinks PruSec has to teach the Street how its analyst language works. "We need to educate companies we cover that sell does not mean bankruptcy," he says. "Sell does not mean the company is terrible. Sell means sell. Sell means that the stock will underperform."
That's going to be one tough sell.