BOSTON, (Reuters) – As early word of BP’s Deepwater Horizon blowout began spreading, investors panicked. After closing above $60 before the April 20 disaster, the energy giant’s shares plunged almost 20 percent in New York, to below $50, in just two weeks.
It is not hard to understand why. Even then, the out-of-control oil spill in the midst of rich fishing grounds and nearby resort beaches raised the specter of horrific damages and untold potential liabilities.
Yet, nearly to a person, the dozens of securities analysts who followed the British oil giant were unfazed. As BP shares continued to drop, most were screaming the same message: buy, baby, buy.
Credit Suisse, which had a “buy” rating on the stock at the time, did not even mention the accident in an April 28 report. The firm upgraded earnings estimates after BP reported strong quarterly results the day before.
A day later, with BP’s shares then down 11 percent, Citigroup’s Mark Fletcher weighed in. He argued that the decline was “disproportionate to the likely costs to the company, even assuming damages can be claimed.” In the same report, he estimated BP’s total share of the cleanup at just $450 million — today, conservative guesses put the figure at $10 billion to $20 billion.
Around that time, Morgan Stanley was among the chorus citing the strong rebound of Exxon shares after the 1989 Valdez tanker spill in Prince William Sound, Alaska, as a reason to be bullish. “We think the sell-off presents an attractive buying opportunity for investors with medium-term investment horizons,” the firm wrote.
All told, 27 of 34 analysts tracked by Thomson Reuters rated the stock “buy” or “outperform” as recently as May 11. The other seven rated the shares “hold.” There was not a single rating of “sell” or “underperform” among those tracked.
And then there was the exuberant television host Jim Cramer, who insisted that Bear Stearns was fine just days before the company’s stock crashed. On May 10, he told viewers of his “Mad Money” show on CNBC that he was purchasing shares of BP for his charitable trust at just under $50. “If you get any good news at all, you’re at the bottom,” he said. “I’d like to buy it.
If he did, he didn’t make out so well. As estimates of the spill grew — and grew and grew — and efforts to cap it failed, BP’s stock sunk ever lower. It didn’t hit bottom for another month, the New York-traded ADRs touching $29 in midday trading on June 9, down 52 percent from just before the Deepwater Horizon disaster. That’s approaching $100 billion in shareholder wealth that has been destroyed.
How could so many analysts have gotten the call so wrong? Of course, to err is human. And Wall Street is also prone to herd-like tendencies. But some experts say the unanimity of error around the BP blow-up also has exposed — yet again — the conflicts and weaknesses that still bedevil the sell-side analyst community, despite a decade of much-heralded reform.
Like its fellow major oil producers, BP is a huge securities issuer and one of Wall Street’s larger underwriting customers. The company sold $38 billion of debt over the past five years, generating hundreds of millions of dollars in fees on 64 deals, according to Thomson Reuters data. The top underwriters were UBS and Credit Suisse, both of which rated BP shares a “buy” in May after the disaster.
No one has alleged an organized conspiracy, and among those who were most bullish on BP were Evolution Securities, Charles Stanley and ING, who do no underwriting business with BP.
But despite all the new rules and practices enacted over the past decade to eliminate conflicts of interest, analysts can still be influenced by the unspoken threat that their firm will be left out, Bentley University professor of finance Leonard Rosenthal said.
“Underwriting is a big factor,” Rosenthal said. “There’s always going to be pressure on sell-side analysts to be more optimistic.”
Group think
That’s not to say the reforms have had no impact at all. Analysts are more likely to issue “sell” recommendations on stocks they cover than before the regulatory changes which largely took effect in 2002. Ten years ago, fewer than 1 percent of all ratings were “sell,” but since then “sell” ratings have climbed as high as 11 percent in 2003 and stand at 6 percent so far in 2010, according to Thomson Reuters data.
The botched BP calls point to a reluctance on the part of analysts to challenge companies. Among other things, they may worry about jeopardizing their access to top executives. “It’s one of the classic drivers of the analyst business — access to management,” said Boston College professor Amy Hutton, who has studied conflicts in the industry.
Such entry can come in handy. On June 10, for example, Credit Suisse revealed to clients in a research note that BP estimated the cost of capping the well and cleaning up the damages at just $3 billion to $6 billion, a figure that had not been released to the public. The note was based on information directly provided to the bank at a breakfast meeting with BP’s chief of staff, Steve Westwall.
Others say the failure of even one analyst at a major firm to grasp the potential risks and advise clients to dump the stock reflects the profession’s overall group-think tendencies. “For sell-side analysts, the incentive is to remain toward the center of the pack. If they are going to be wrong, they have got to be in good company,” said Michael MacPhee, at investment manager Baillie Gifford.
Of course, wrong-way Wall Street calls are more than just an academic problem. They cost real people real money. David Dugdale, European equities specialist with investment manager MFC Global, said his firm was among those who took analysts’ advice and bought BP stock shortly after the initial share price drop, only to sell down the stake later after further falls. “I didn’t see any note saying sell BP, so looking at it objectively, the sell side got it wrong,” he said.
Analysts protest that such 20/20 hindsight can often be unflattering. The Deepwater Horizon situation, they say, was unprecedented and almost impossible to predict. “From the outset of this tragic accident and environmental catastrophe, regaining control of the leaking oil well has proved more difficult than initially thought and estimates relating to the amount of oil leaking have been increased several times,” said Tony Shepard at Charles Stanley.
Eventually, the risks became more apparent even to Wall Street. Shepard’s cutting his BP rating to “hold” from “buy” was the first of a rash of downgrades in June, after the stock had already fallen 34 percent. As the shares headed toward almost half their pre-disaster level, most analysts issued more cautious notes, with Goldman, Natixis, S&P equity research and Charles Stanley, cutting their ratings to neutral or hold from buy.
By June 16, BP was rated a buy by 16 analysts, outperform by eight, a hold by another 8 with only one sell, according to data on Reuters Knowledge. That was the date, of course, when BP agreed to fund a $20 billion escrow account and suspend its dividends for the year.
With the price around half what it was before the spill, analysts might have a stronger argument that BP was a buy in mid-June, though that will be of little comfort to anybody who followed the advice to buy a month ago.
Lonely voices
Only a tiny minority of analysts accurately evaluated the risks to BP’s stock price from the outset. Douglas Christopher at Los Angeles-based broker and money manager Crowell, Weedon & Co., who is not among the 34 tracked by Thomson Reuters, may have been the only analyst to slap an outright “sell” on the stock early on. In a report dated May 3, Christopher cited BP’s lack of insurance, the many unknowns in the situation and the growing political outrage. He urged his clients to swap into safer energy producers like Valero or Hugoton.
“The involvement of the Obama administration, Homeland Security, Energy Czar, State Governments, the Military and the Coast Guard etc. ensures that the Gulf of Mexico cleanup will cost billions,” Christopher wrote. “Given the real and potential risks, we would avoid BP shares.”
Philip Weiss at Argus Research Co., a mid-tier New York firm that does no investment banking, moved even sooner, if less definitively. He downgraded BP from “buy” to “hold” on April 30. “While we think the damages associated with the incident will be meaningfully less than the reduction we have already seen to the company’s market cap, we are also aware that the incident increases the uncertainty associated with BP shares,” he wrote.
Hutton of Boston College says given Wall Street’s track record, investors would do well to consider a downgrade to “hold” as a call to sell.
Weiss also was one of the only analysts to predict the political fallout from the spill. Known as the most environmentally friendly major oil company, the BP brand was worth $17 billion before the spill, according to research cited by Weiss. “The company now runs the risk of being associated with one of the most significant environmental issues in the U.S.,” he wrote.
One person who is not surprised by the analyst community’s big failure on BP is John Olson. An acclaimed natural gas analyst himself, Olson was fired by Merrill Lynch in 1998 after Enron left the firm out of a lucrative underwriting deal. Enron specifically cited Olson’s lack of enthusiasm for its stock as the reason for the snub. He was soon let go, a lesson that was hardly lost on his peers.
“I perceive no great change in the nexus between investment banking and research,” Olson said. “It still operates as an indirect route to banking business.”
Today Olson is co-manager of a successful Houston-based energy hedge fund. No one knows for sure whether BP is a buy or a sell today. But for the record, Olson says he isn’t getting anywhere near the stock, even at what might seem to be depressed levels.
“It’s radioactive,” he said.
