Green Shoots of Research


New York – During this extraordinary upheaval in the research marketplace, the winners are those that find ways to expand their capabilities even as most firms hunker down or contract. The availability of research talent is unprecedented, existing business models are breaking down, investors are becoming more reliant on external research. What more can you ask for?

As we noted in January (Damn the Torpedoes), the environment for research is extremely tough. Commission spending on research is likely to be down 30- 40% in 2009 (worse in the UK). Layoffs are spreading to the buy side, with all types of investors cutting positions. Commentators are predicting that 30% to 50% of hedge funds will close. We predict a 15-20% decline in spending on alternative research in 2009. And it is a perfect time to invest.

We are seeing this up and down the research supply chain. The bulge firms are going through huge changes. Barclays Capital is expanding aggressively, as it builds out its non-US capabilities to complement the acquisition of Lehman’s US operations. Similarly, Nomura is also on a hiring binge to augment the Lehman non-US staff it inherited. Credit Suisse has been also adding research capabilities, even as most bulge firms shrink their research staff.

The regionals and mid-tier firms are among the most aggressive in adding research staff. Wedbush Morgan, Morgan Keegan, Stifel Nicolaus, Baird, BMO Capital Markets have all been adding research staff this year. Similarly, execution-only brokerages are seeing a unique opportunity to expand into research, but this remains a developing trend.

We have commented extensively on the explosion in new research boutiques as research analysts leave larger firms to join alternative research boutiques or start their own. The challenge for all the new boutiques is distribution. Branded analysts like Meredith Whitney or Ivy Zelman don’t suffer as much as lesser-known analysts. Even if highly ranked, analysts who go out on their own quickly find out how much they had benefited from the sales forces of the larger firms–which is why the research distribution platforms should be thriving in this environment.

Some platforms are doing well. Soleil Securities Corporation has been adding analysts, salespeople and traders throughout the crisis. When we wrote about Soleil last November we were rebuked by the new CEO, Terry Gardner, for questioning their business model. Since then, Soleil has added 6 research staff, including Greg Valliere, a founder of Washington Research Group, and ex-Fed governor Lyle Gramley (another refugee from WRG). It has also hired five traders, including four ex-Merrill sales traders and a new head of equity trading. Given the nature of its business, some analysts have also exited from the platform over this period. Even though it has added 3 boutiques, two boutiques have left the platform, bringing the total up one firm to 22 firms. Nevertheless, Soleil’s expansion speaks well of its future prospects.

ResearchEdge, a new research provider founded by an ex-hedge fund portfolio manager, is also expanding, most recently with the addition of the forensic-oriented to its platform.

However, other distribution platforms have not fared as well. We have written extensively of Access 342, which developed an innovative concept of compensating analysts through an auction process. No matter how innovative, getting funding in this environment is a challenge, and Access 342 is still finalizing its capital. Another distribution platform, StreetBrains, is in consolidation mode in the current capital-constrained environment.

However, new entrants continue to emerge. Think 20/20 is a newly formed network of nine analysts, salespeople and editors based in Reston Virginia with ambitions for research distribution and management access. We also hear of other networks being formed, provided they can obtain the capital.

The supply is there, even if the capital is scarce. Overall, equity research has a glut of capacity which has been created by the subsidy formed by buy-side mis-perception of ‘free research’ through bundled commissions. The equity business model is changing, and over time the supply side of the equation has to be rationalized to match the new reality of increasingly unbundled research commissions. In the meantime, opportunities will continue for strong research players to get stronger, and nimble (and capitalized) players to expand. May you live in interesting times!


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