A barrage of federal rules on disclosure has Wall Street analysts barred from private meetings with auto CEOs and financial staffs, leaving these high-powered financial gurus in an information black hole. With Wall Street and Main Street having access to the same information, are the financial elite losing their clout in the auto industry? Or did they wield too much power in the first place?
Stephen Girsky is surrounded by reporters following a presentation at an automotive conference in Dearborn.
But before Morgan Stanley’s managing director and top auto analyst can answer their questions, he throws a curveball: He needs everyone’s business cards.
Down the road atMotor Co. headquarters, Chairman Bill Ford Jr. won’t return a stock analyst’s phone call – it’s not worth the legal risk.
And in New York, veteran automotive analysts are quitting the business out of frustration. Those who remain become harder pressed to generate revenue and define their roles.
The knowledge base and clout of Wall Street is being evaluated – and downgraded – to comply with an onslaught of regulations imposed in 2000 by the federal government that limit the amount of “insider” information analysts can gain from auto makers and suppliers – in fact, any publicly traded company.
The end result? The typical stock analyst isn’t entitled to any more information than the average investor who surfs the Internet.
Legal muzzles are having a real effect on how analysts do business and gather information, and that has the potential to further frustrate industry executives who already feel they don’t always get a fair and accurate shake from The Street.
In the past, analysts would visit – or be summoned by – chief executive and financial officers for insider-type presentations on future product programs, financial targets and other key data.
“I would bring a smaller group of six, seven or eight institutional investors out tofor a full day with (former Chairman Robert) , (former Vice Chairman Bob) Lutz and (former design chief Tom) Gale to walk through the styling studio,” recalls Joe Phillippi, a one-time auto analyst with Lehman Bros., who now consults for AutoTrends Consulting in New Jersey.
“It was an ability to show The Street that there was real momentum (at),” he says. “The only way you can do that now is with analyst meetings. But it will be 80, 90 or 100 of them on a bus from all over the world.”
The sea change that has handcuffed the analyst community took place in 2000, when the Securities and Exchange Commission passed regulation FD (Fair Disclosure). It requires all public companies to publicly disseminate any information provided to the financial community that could have an impact on financial results.
This put an end to the cozy one-on-one meetings where information was fed, piecemeal, to select analysts. Picking up a phone and calling key executives isn’t as easy as it used to be, either.
The regulations have made the relationship between auto makers and the analyst community “very different than it has been in the past,” says Bill. “I won’t take calls from analysts. I am very scripted when I talk to them. I don’t particularly want to go to jail. So, it’s just not worth it.”
Analysts are careful about what they say, as well. Girsky won’t talk to the media until he has everyone’s business cards, because he is required to send disclaimers stating he believes everything he says and owns none of the stocks issued by the companies he follows.
But the regulations also have ushered in a new openness that allows average investors to listen in directly on meetings between company management and Wall Street. “I think it’s been better because it generally (makes) more information available and (the information) is much more accessible,” John Casesa, auto analyst with Merrill Lynch, tells Ward’s.
“The auto makers are much more open in sharing their plans, their views, their product programs with us,” Casesa says. “They spend a lot of time explaining what they are up to compared with 10 years ago.”
Says Girsky: “We don’t see the management (at the major auto makers) as much as we used to, but we still see them.”
But with everyone privy to the same information, some question the value of the service analysts provide.
Phil Martens, Ford group vice president-product creation, considered a career in the investment community while attending business school.
“I tried to rationalize what was the economic value-add that they possess, that their work produces,” he says. A colleague defined it as “helping commercial lubricity between the financial markets and corporate America.”
But Martens felt that wasn’t enough. “To this day, I still sit here and I go, ‘Are they any smarter than they were when I was in business school?’” he says. “I don’t know. Are they adding economic value? I still wonder.
“They are only as good as the information they gather,” Martens adds. “And that information sometimes, I find, is not deep enough to really do the analysis they should be doing.”
The new regulations don’t mean Wall Street has entirely lost its influence on auto makers. Many companies still take analyst reports to heart.
“They might have seen something you didn’t see for your own company some time ahead,” says Chrysler Group CEO Dieter Zetsche. “In some cases, we learned or had to admit in hindsight that some observations (by analysts) haven’t been that dumb.”
Ford’s Martens also concedes there are many capable analysts. “Many of them are actually analytically very strong in terms of their ability to dissect and understand trends and analysis,” he says.
“There are some that have been covering our industry for a long time that know our industry well,” agrees Bill Ford. “(But there are) others who wouldn’t know a car if it ran them over. Some live in New York and probably don’t ever drive a vehicle. (And there are) others who are car nuts and want to come to all the (auto) shows and kick the tires.” Of course, the relationship between The Street and the auto industry often was contentious even before Reg FD.
During the Internet boom of the late 1990s, analysts viewed auto makers and suppliers as “old economy” stocks providing too-low and too-slow a return to shareholders. Internet stocks were soaring, and analysts recommended investors buy into these fast-charging “new economy” companies that were destined to leave the auto industry in their dust.
It was a period that also saw many technology company executives discounting the value of old-line companies, such as auto manufacturers.
In his speech at the Convergence automotive electronics conference in 2000, Sun Microsystems CEO Scott McNealy labeled the automobile “nothing more than a Java browser with tires.”
Auto executives bristled at his analysis, saying the automobile is as much about emotion as it is about technology. That message also failed to resonate with Wall Street, and OEMs and suppliers saw their stocks flagging in the face of soaring dot-coms.
Companies such as Yahoo, which produced no tangible product and had few physical assets, saw its market capitalization (the total value of outstanding shares) shoot into the stratosphere.
Yahoo ended 1999 with a market cap of $113 billion, while America Online’s soared to $169.6 billion. GM’s market cap, meanwhile, was $46.5 billion, while Ford was at $60.8 billion and DaimlerChrysler AG totaled $66.8 billion.
It was only after the Internet bubble burst that Wall Street began leading investors back to the traditional manufacturing industries, such as auto makers and suppliers.
Auto-related stocks are now the flavor-of-the-day, thanks to a rebounding U.S. economy and rosy outlook for auto sales in 2004. “These stocks are highly linked to the economic recovery,” says Girksy.
Collectively, stock analysts still wield a lot of power in the business community. After all, Wall Street is where individual and institutional investors, who hold the money to make businesses operate, come to work every day.
“Investors have an enormous variety of stocks they can buy. And, by the way, they don’t have to buy stocks. They can buy bonds or put money in a mattress. And investors have been pretty burned over the last couple of years,” says John Devine, GM chief financial officer. “(To win them over) you have to get the earnings, you have to strengthen the balance sheet.”
So how does an analyst maintain a competitive advantage in a market where everyone has the same information?
Veteran Phillippi says today’s analysts have to reinvent themselves, becoming more like investigative journalists. Because insider information is scant, Wall Street types need to explore areas such as manufacturing productivity and technology to determine whether one auto maker has an advantage over another.
“They have to do in-depth studies on various aspects of the product; talk about going to modular manufacturing. It’s a lot of seemingly esoteric stuff,” he says. “That’s the only way you are going to get inside the company.”
Girsky says the competitive advantage now rests on whether the analyst’s firm has the depth to cover the entire economy. He says if a firm has staff to closely follow suppliers, public auto dealers and other auto-related enterprises, it can pool those resources to gain insight into what the OEMs are doing to improve their businesses.
“There is a lot more to this business than just regurgitating what management tells you,” he says. “Frankly, that’s never been the business.”
The majority follow hard data to devise their predictions for each of the auto companies and suppliers. They use historical dividend payouts, global and regional auto sales trends, as well as economic and earnings data to determine just how much an auto maker or supplier should translate to the bottom line.
Stock-price predictions are based on similar data, although economic trends play a huge part.
That doesn’t mean everyone is going to get it right. A look at stock prices over the past calendar year for GM, Ford and DaimlerChrysler shows some analysts were way off the mark.
Take Ford, for instance.
In March, when shares were trading at $8, Deutsche Securities issued a sell recommendation. UBS Warburg also recommended its clients reduce their holdings in Ford. In December, when the stock was trading at $14 per share, they issued buy ratings. Between February and May, GM stock was downgraded by six of the leading investment firms. Shares in the world’s largest auto maker were trading at around $33 per share in May. In early January 2004, GM shares shot up to $54 per share, and within that time span most of the same firms upgraded their recommendations.
Phillippi says analysts who advise clients to buy high and sell low are going to lose their credibility with the sales staff, “and they’re not going to push your merchandise. It’s suicide.”
False predictions can land an analyst in hot water with the firm, cautions Phillippi. The information is used by the sales forces at their respective brokerage firms as guidance for their clients. Making too many mistakes could put an analyst in the dog house real fast, he says.
Despite the pressure, corporate executives contend Wall Street isn’t influencing how they do business.
“Am I oblivious to what they say? Of course not,” says Bill Ford. “And do we communicate with them? All the time. But I don’t run my business for them, because I don’t think you can. I mean, that’s the surest way to ruin.”
But history suggests otherwise. The track record shows Ford may have paid too much attention to Wall Street back in 2000, when it bowed to demands to “improve shareholder value.”
Several analysts pressured Ford to disperse its huge cash reserves to shareholders. And Ford did, distributing $5.7 billion in cash to its stockholders as part of what it called its Value Enhancement Plan. The program saw Ford investors exchange their old Ford stock for new shares, plus $20 in cash or an additional 0.748 shares of the new stock for each share they already owned. The transaction boosted the number of outstanding Ford shares by 600 million to 1.893 billion.
“It burned all the cash,” notes Phillippi.
Ford then suffered through the Firestone tire debacle, which began in summer 2000. The recall of millions of defective tires on Ford’s Explorer SUV cost the company $2.1 billion in net income, depleting Ford’s net cash reserves by the end of 2001.
Wall Street also was on GM’s case for having too large a pension fund imbalance earlier in 2003. GM executives blamed the shortfall on paper losses due to the declining stock market, but analysts continued to call for a cash infusion to bolster the sagging reserves.
GM executives at the time said Wall Street was overreacting, with CFO Devine dubbing it a “Chicken Little” syndrome and assuring investors and analysts the sky was not falling.
“U.S. equity markets posted negative returns for three years in a row for either the first time ever or like since the 1920s. And so people said, ‘What if that continues?’ Well, unless you assume the U.S. economy is going to destruct, it’s not going to,” GM Chairman Rick Wagoner tells Ward’s. “Eventually, the very forces that give you three years of negative returns are going to give you higher returns in the future. It’s undoubtedly true it (the under-funding of pensions) was overstated.”
Still, Wagoner and his team bowed to the pressure. In June 2003, GM issued a prospectus for the issuance of $5.25 billion in long-term debt, due partially in 2013 and 2023, to help fund its pension plans. The debt was combined with some of the proceeds of the sale of GM’s Hughes Electronics unit to News Corp. (a maneuver also pushed heavily by Wall Street) to help shore up the pension position.
But this begs the question, why did GM take such aggressive action, knowing it would cost an additional $1 billion in interest payments on the debt annually, and just when the U.S. economy was starting to turn the corner? The auto maker now could find its pension reserves in an over-funded status if investments provide returns better than 9% annually – conceivable in a recovering economy.
“It was a financial issue, but it also impacted the perception of– by people on The Street, by people in Washington, by people in the media,” says Devine, in defense. “We wanted to get it off the table as quickly as we could.”
In another example, all of the Big Three were coaxed into jumping on the Internet bandwagon when they formed Covisint in February 2000. The new company was supposed to be the sole online portal for supplier bidding and surplus-equipment auctions for each of the auto makers, not only saving money but making money for its corporate stakeholders.
After trying to make the operation work in a climate of lower costs, Covisint now is being dismantled, with the recent sale of its online auction unit.
Former Ford CEO Jacques Nasser was one executive who listened keenly to what Wall Street had to say. During the Internet heyday, Nasser shifted Ford’s focus from building automobiles to becoming a “consumer-products” company.
He wanted Ford to be able to take control of the customer from cradle-to-grave. He purchased driving schools, salvage yards and even gave computers to all Ford employees, to demonstrate Ford’s transformation, all to the delight of Wall Street.
Ford since has had to sell at a loss many of the assets Nasser acquired and shift its strategy back to the basics: building cars and trucks customers want to buy.
It’s not just U.S. auto makers that give in to investor pressures. In Europe, where analysts still have a cozy relationship with auto executives,AG was forced to divest its Rover unit after analysts hammered the German auto maker when the unit continued to post losses.
Wolfgang Bernhard, Chrysler chief operating officer and former head of Mercedes-Benz’s AMG performance unit, says there are as many pressures placed on European executives from analysts as in the U.S. “It doesn’t make much difference (what part of the world you are in),” he says.
The analytical portion of the business is just one side of what makes investment firms tick. There’s another side of Wall Street that’s more important in terms of profitability: the investment-banking aspect of the business.
Here, the same firms that make stock recommendations deploy their banking staffs to drum up business from some of the same companies they analyze.
In the case of Ford’s VEP program, for instance, J.P. Morgan was paid $2 million to make a recommendation on the validity of the program. The Wall Street firm said it viewed the program as “fair, from a financial point of view.”
The GM bond program was underwritten by a number of Wall Street firms, including Morgan Stanley & Co. Inc.; Merrill Lynch International; Citigroup Global Markets Inc.; Banc of America Securities LLC; Goldman, Sachs & Co.; and J.P. Morgan Securities Inc. All of these firms will be paid a “concession” of between 0.25% and 0.45% on the principal amount from the notes issued. A minimum of $13.1 million will be shared between the firms as a result of the “concessions.”
Several of these same firms have analysts who cover GM, some of whom had been demanding the auto maker shore up its pension funding.
Such potential conflicts of interest suggest there is some merit in the new regulations. Recent actions taken by the SEC to investigate firms that are playing both sides of the investment fence have put the brakes on questionable dealings that could blemish the reputations of the high-stakes financial gurus.
Building a barrier between the investment and banking sides of the financial business is critical, says Chrysler’s Zetsche.
“The only thing which really should be observed is a clear Chinese wall between (merger and acquisition) activities and the investment side of the business,” he says. “And in some cases there might have been a little gray zone and that’s the only area where we really should go after.”
More and more firms are putting in safeguards to assure the investment side of the business has no relation or correlation with investment banking.
Auto makers need to step up as well.
The evolutionary game of the auto business, where global issues are taking precedence over regional concerns, requires thinking far beyond the next quarter or next year, says Jay Alix, founder of corporate turnaround-specialist AlixPartners.
“The (auto) industry is in a 10-year global economic war and you would never tell a country in a 10-year global war that everything will be all right in six months,” he says. “It’s a difficult time for CEOs in the automotive industry. I think the executives have got to have the courage to tell Wall Street what’s really happening.
“I think Wall Street needs to look at the automotive industry as a good long-term investment. Pick the winners and losers, go long on the winners, go short on the losers, and make your investments that way, instead of just pressuring everybody to do better,” Alix says.
Ford’s Martens agrees, adding that analysts should have managerial experience before criticizing or judging an organization’s future from the sidelines.
“I think you have to have experience running a company or running a major division to really appreciate what it takes or what the outputs are going to be,” Martens says.
The big question now is whether there has been an overreaction to the new rules. As with many new regulations, there’s a tendency to go to extremes to prevent potential legal action.
Federal regulators, themselves, are continuing to interpret the rules and communicate with corporations on just how far they can go in giving information to the investment community.
Girsky acknowledges corporations may be overreacting to the regulatory climate, noting they are filing disclosures to comply with the new regulations at an exorbitant rate. While the long-term implications of these new rules have yet to be determined, they are causing all of corporate America to change the way it does business with investors and analysts.
But in the long run, auto makers and suppliers may have to do what they have always done when it comes to criticism from Wall Street: grin and bear it.
“I may be unhappy with how The Street views us, I may not agree with it, but I’ve learned over the years you don’t complain about it. You just do something about it,” sums up GM’s Devine.
– With Alisa Priddle, David E. Zoia and Brian Corbett