Blodget on Vonage

Vonage has had a torrid few weeks since it went public in May at $17 per share:

the stock closed today at just

$6.84. And who better to weigh in on this state of affairs than our old friend

Henry Blodget? I’ve just found a posting of his from July 6, when the stock

had fallen to $8.25, and two of the IPO’s underwriters had just put out negative

research on the company.

Blodget, of course, knows what it’s like to be a tech-stock analyst: he was

one. And he knows what it’s like to be pressured into writing positive reports

on companies that your bank does business with: because he did that, he had

to pay a whopping great fine, and is now barred from the securities industry.

So one would think that Blodget would welcome this brave new world where analysts

can turn around a month after the IPO and say without fear of being fired that

they think the stock stinks.

But, of course, one would be wrong. Blodget doesn’t

think that at all. Instead, he thinks that the firms did their clients a

disservice by not publishing the research earlier:

Let’s look at this from the perspective of an IPO buyer. Wouldn’t you have

liked to have known that these analysts thought the stock wasn’t worth $8.25

before you paid $17 for it? Or, if that was impossible, wouldn’t

you have liked to have been confident that the analyst had signed off on the

deal before it was sold to you? Don’t you feel a bit shafted that you were

sold a stock at $17 that the only real expert at the firm thinks is not even

worth $8.25?

With this kind of logical ability, it’s no wonder Blodget could persuade himself

that Amazon was worth $400 a share at the height of dotcom fever. Let’s run

through some of the assumptions here:

First, it seems that if you want an investment bank to value a company, "the

only real expert at the firm" is going to be… wait for it… a stock

analyst. Not a banker, who’s actually charged with selling the company,

but rather an analyst who’s only interested in what direction the stock is going

in. It turns out that in the World of Blodget, all the gazillionaire bankers

working in equity capital markets or mergers and acquisitions are chumps, really,

compared to their much poorer brethren poring over SEC filings and writing widely-ignored

research reports.

It seems that Blodget still doesn’t get it. Someone who’s very good at valuing

companies will not be wasted in equity research, and will become a banker quite

quickly. Someone who’s very good at arbitraging the difference between what

a company is actually worth and what the market thinks it’s worth will also

not be wasted in equity research and will instead most likely join a hedge fund.

The main skill of people in equity research is not to pinpoint the value of

a company, but rather to come up with ideas or insights which the investment

bank’s clients can then use to come to their own decision as to whether a stock

is worth buying or selling. The headline buy/sell recommendation is actually

pretty irrelevant for the majority of the people who receive the research.

(I know, I described this

view of equity analysts as "hopelessly out of date" four years ago,

but I did say that things were swinging back in that direction, and in this

particular case I think it’s true.)

Second, what on earth makes Blodget think that these analysts did

actually think the stock wasn’t worth $8.25 before the IPO? Blodget, more than

anybody, knows that buy/sell recommendations are based on where the analyst

thinks the stock is going: before the IPO, there wasn’t a month’s worth of data

showing the share price going steadily south. Blodget seems to be living in

some kind of parallel universe where a stock analyst takes a company’s books,

works out a valuation, and only then compares his own valuation to that of the

market. If his valuation is higher then he puts a "buy" rating on

the stock, and if it’s lower then he slaps on a "sell". But of course

no stock analyst actually works like this: one thing that is still true from

four years ago is that the reasons why one might want to buy a falling stock

are often very different from the reasons why one might want to buy a rising

stock.

Clearly, the market has looked at the valuation that Vonage’s bankers put on

the company when it went public, and decided that it doesn’t make sense. Indeed,

it’s entirely possible that any non-zero valuation for Vonage doesn’t

make sense, given that the company might well never make a profit. In any case,

the direction that the stock is headed in is unambiguous, and I daresay that

there are precious few companies which lost half their market capitalization

in the first month of trading, and then proceeded to turn around and bounce

healthily back. In other words, even if you thought that Vonage was worth, say,

$25 per share, you’d think twice before putting on a "buy" recommendation

after the stock had sunk from $17 to $8.25 in the course of its first month

trading.

Which is to say that having a stock analyst "sign off on the deal"

before it’s priced is extremely silly. What would that entail, anyway? Giving

the stock analyst veto power over whether the company can be brought to market

at any given price? Surely the market should be the main arbiter of

the price, not one analyst. I really can’t imagine what Blodget has in mind

here. Presumably he means some kind of statement from the analyst that the IPO

price is not unreasonable – but asking an analyst to provide such a statement

puts him in an impossible situation. How could he say no?