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Is an equity research analyst just a marketer?

ER kicked out of the front office

Happy Sunday. Let’s get started:

This year marks the 20th anniversary of the Eliot Spitzer settlement. Not related to his prostitution-induced departure from public office, this settlement was a $1.4 billion agreement with investment banks over allegations that they misled investors.

Wall Street didn’t like the gift Spitz brought them

The former New York Attorney General (and later Governor) had big beef with equity research conflicts of interest — analysts recommending garbage companies because their firm hauled in millions of dollars in fees for capital markets and advisory work.

Star Salomon Smith Barney telecom analyst Jack Grubman provides a classic anecdote to describe the dynamic:

In 1999, Grubman’s boss, who happened to be an independent board member of AT&T, rang him up and suggested Grubman take a “fresh look” at the business.

That fresh look prompted Grubman to upgrade his AT&T recommendation from Hold to Buy, which, conincidentally, preceded Salomon Smith Barney’s $63 million investment banking fee haul from the IPO of AT&T’s wireless unit.

Our man Grubman got his fair share — his total compensation between 1999 and his departure from the firm in 2002 was nearly $69 million.

Like Grubman, nearly all equity research analysts were intimately involved in securing new investment banking business for their firm. A practice so pervasive that banks often expanded research coverage to hundreds of obscure companies solely to get a chance at a lucrative mandate.

Spitzer wasn’t having it. Either deeply affronted by Wall Street’s sliminess or looking to set himself up for a future presidential run, he came down hard.

Spitzer’s settlement shake-up…

⁃ Largely barred interactions between investment bankers and equity research analysts (the ‘Chinese Wall’)

⁃ Eliminated investment banking division influence on ER compensation

⁃ Outlawed promises of favorable research made to potential clients

⁃ Prohibited research analysts from attending IPO pitches or roadshows alongside investment bankers

While potentially improving the quality and veracity of the research product, Spitzer’s regulations led to the awkward situation in which one half of a firm (the investment banking division) could implicitly sanction a business by underwriting its IPO, while the other half (the equity research analysts) could call the same company an uninvestable pile of refuse.

The bigger issue, though, was the transformation of the entire equity research business model.

These fundamental changes severed equity research’s link to firm revenue. The division no longer had a role in new business wins and became a cost center without directly attributable benefits.

Investment banks’ solution was to bundle payment for equity research with trade execution fees charged to brokerage clients.

This solution has since proved precarious for equity research teams:

1. Fee compression within the sell-side cash equities business has collapsed margins, with trade execution now largely commoditized. Bank market share has also declined as high-frequency trading firms expand their influence.

2. At the same time, the number of investment managers willing to pay for equity research services has fallen off a cliff. Most large hedge funds and asset managers now have their own internal research teams.

3. Research departments also contend with falling information costs. Buy-side clients now have easy access to management teams, expert networks, alternative data, and any number of increasingly sophisticated sources to squeeze out a little bit of alpha, eating away at any edge equity research may have provided.

4. And, as much as a research team would dispute this, they also increasingly compete with publications like the Financial Times or Wall Street Journal, as well as specialized blogs and Substacks (many of which are written by former sell-side analysts or ex-institutional investors).

The irony is that equity research is now more dependent on investment banking than ever. Commissions from cash equity sales cover a fraction of the expense, and the remainder is indirectly subsidized by the capital markets and M&A advisory businesses.

So, next time you see an equity research analyst, just let them know that they’re really just a content marketer for investment bankers.

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🍾 Deals, Deals, Deals | The week's most interesting transactions

1. British online grocery business Ocado had a wild week, with shares jumping nearly 50% on reported takeover interest.

Amazon is leading the pack of bidders, which is rumored to include other large U.S. tech firms. The potential buyers are trying to get their hands on Ocado’s automated warehouse tech, which had been leading the businesses’ transformation from grocer to growth stock.

One group that won’t be pleased: short-sellers. Ocado was one of the most-shorted stocks in the FTSE index and has now turned bearish traders upside down.

2. Jeff Leerink is back on top after SVB Financial agreed to sell its investment banking arm to the group’s management team, backed by Baupost.

Leerink will remain CEO of the group, capping off a wild ride following his sale of namesake firm Leerink Partners to SVB back in 2018 for $280 million.

News also broke this week that Abu Dhabi’s sovereign wealth fund got close to acquiring Lazard last year. The deal ultimately fell apart, but it’s yet another example of Gulf desire to level up their global financial presence. (Read more: FT)

3. Michael Jordan is still putting numbers on the board, posting some big-time returns following his agreement to sell the Charlotte Hornets.

Gabe Plotkin, formerly of Melvin Capital, and Rick Schnall (CD&R) have picked up the franchise for $3 billion. That gives Jordan a more than 10.0x return on his 2010 purchase of the team for $275 million (discounting any potential leverage upside). Plus, he’ll keep a minority stake.

On the flip side, Melvin LPs must be more than a little salty to see Plotkin snagging NBA teams ~24 months after blowing up the fund.

4. Crack open the IPO window — new offerings are finally starting to flow:

 Kodiak Gas Services set terms, owned by EQT ($1.5 billion mid-range market value).

 Fidelis set terms, backed by Crestview, Goldman Sachs, CVC Capital Partners and Pine Brook Partners ($2.1 billion).

 Savers Value Village set terms, owned by Ares ($2.8 billion).

 Apogee Therapeutics filed for a $100 million IPO. Backers include Fairmount, Venrock, Deep Track, Fidelity and RTW.

 Flix, the bus operator that owns Greyhound, has brought on Evercore for an IPO advisory assignment. Current backers include General Atlantic, Permira, Silver Lake, BlackRock, TCV, and Baillie Gifford.

This week’s other big dog deals…

⁃ Blackstone, KKR, and CD&R reportedly each held discussions with Siemens over the possible acquisition of a majority of its 32% stake in its listed energy division. All three backed out from the deal in diligence, which looks like the right move following last week’s profit warning related to delays in its wind turbine turnaround efforts. Shares drilled 37% on Friday.

⁃ Blackstone led a second investment in clean energy developer Invenergy Renewables, putting an additional $1 billion to work after its earlier $3 billion contribution.

⁃ Covestro, a German plastics manufacturer, rejected a $12 billion buyout offer from Abu Dhabi National Oil Co. (Adnoc).

⁃ Apax Partners, BC Partners and Hearst Communications are reportedly in the final round of bidding for Ascential’s consumer trend analytics unit, which could be worth north of $1 billion.

⁃ Silver Lake looks like it might finally get it done with Software AG. Competitive bidder Bain Capital has stood down, leaving Silver Lake’s €32-per-share offer the likely outcome.

⁃ Ball Corp. is looking to offload its aerospace unit, seeking buyers for a business which could be worth more than $5 billion.

⁃ Civitas Resources is picking up a portfolio of Midland and Delaware Basin assets from NGP portfolio companies Hibernia Energy III and Tap Rock Resources for $4.7 billion.

⁃ Abcam, a supplier of biotech and life sciences tools with a $5.3 billion market cap, has retained Morgan Stanley and Lazard to explore strategic options, including a potential sale. The move follows involvement from activist Starboard Value.

⁃ Eni has agreed to buy a majority stake in Neptune Energy, owned by Carlyle, CVC, and CIC, for $4.9 billion.

⁃ Global Infrastructure Partners nearing a deal to sell Italian train operator Italo to MSC Mediterranean Shipping Co. for €4 billion.

⁃ Global New Material (fka Chesir) is in discussions with Merck KGaA on a potential acquisition of its pigments unit for roughly $1.1 billion.

⁃ Textron is looking to sell its auto fuel tank business, which could be worth more than $1 billion.

⁃ Aledade, a primary care network, raised $260 million in Series F funding led by Lightspeed, with participation from Venrock, OMERS, Fidelity, and Avidity.

⁃ Bain Capital Special Situations reached an agreement with Intel to purchase a 20% stake in its IMS nanofabrication business at a $4.3 billion valuation.

⁃ IBM is exploring a possible $5 billion acquisition of automation software business Apptio, owned by Vista Equity.

⁃ Eli Lilly reached an agreement to acquire Dice Therapeutics for $2.4 billion, a 42% premium.

⁃ Saudi Arabia's PIF is reportedly in pole position to acquire Vale’s nickel and copper mining unit for roughly $2.5 billion. Competing bidders include Mitsui & Co. and Qatar Investment Authority.

⁃ Vodafone handed Morgan Stanley the mandate to evaluate a potential sale of its Spanish unit.

💰 Fundraising | The firms stacking it up across buyout, growth, and venture

⁃ Wellington Management raised $2.6 billion for a fourth late-stage venture fund.

⁃ Oaktree raised $2.3 billion for an inaugural private credit fund focused on life sciences companies.

⁃ BV Investment Partners locked up $1.5 billion for an 11th fund and is on course to hit a $1.8 billion hard cap.

⁃ Aldine Capital Partners raised $276 million for a fourth lower middle market hybrid fund.

⁃ Illuminate Financial raised $235 million for a third venture fund focused on financial startups.

⁃ Stone-Goff Partners raised a $175 million fourth buyout fund.

📜 Bullpen Reading Roundup | Get quick with the ALT + Tab

1. What do Cava, Panera, and the lunch spot of choice for Boston finance bros all have in common?

They owe their success, at least in part, to Ron Shaich. After a $7.5 billion exit to JAB Holdings, the Panera founder said ‘no’ to chilling on a beach and instead formed restaurant-focused investment firm Act III.

Axios’ Dan Primack sat down with Shaich at a Tatte cafe to get the background. (Check it out: Axios)

2. It’s safe to say you never want to hear one of your investments described as a ticking time bomb, much less your entire asset class.

Unfortunately for everyone in CRE, that’s the conclusion Businessweek arrived at after taking a look at the impending doom faced in nearly every major city. (Check it out: BBG)

3. Even historically high rates can’t stop the thirst for yield, leading investors to ever more esoteric debt instruments.

This week, KKR announced a $44 billion multi-year exclusive deal to acquire PayPal’s buy-now-pay-later receivables. The firm’s private credit funds will hold the loans, providing PayPal with additional cash to complete share buybacks. (Check it out: BBG)

4. But, a portfolio of BNPL loans is beyond boring compared to what’s going down at niche disaster investors.

One venture firm raised a $35 million fund to go after wildfire-focused seed-stage investments, while another is on the hunt for infrastructure resiliency startups. I guess it makes sense to save the planet and get some returns while you’re at it? (Check it out: Axios)

Thanks for reading, catch you guys next week. Drop a line with any feedback or scoops (just reply here; kept anonymous).

— Sam