Tuesday, February 28, 2017

Paying for research

This morning I was reading that CLSA -- since 2013 proudly owned by CITIC -- was shutting down its American equity research department -- 90 people will be affected!

Now the value of a lot of research is limited, that is not to say that all research is bad. In fact, I remember that GS's Asia Aerospace research was considered the bible for the sector.  Granted, there was little you could do with the research since the "buy" was for Chinese airlines...that were state owned.  Still it was a vey valuable tool in understanding the local dynamics.  It seems that the US has introduced new legislation that forces brokers to "sell" their research services!  Figures of $10,000 an hour have been mentioned...

Now, research can be sold many times; if GS has 5000/6000 clients they may sell the same research 300x or 400x (I exaggerate) but this is the key -- Those who buy the research are, I presume, prohibited from giving it away or selling it, at the same time the same research can be sold a number of times therefore its value falls as more and more people are aware of the "special" information.

So pricing research is difficult because its value falls based on three principal factors:
  1. Is it any good 
  2. Timeliness of the information
  3. How widely it is distributed
  4. Value is only there if the market finds out about the information
The first will be the hardest, since from now-on research will be behind a paywall - it will be very hard to figure out what is good (there is also the problem of confirmation bias) and what is truly worthless.  Timing:  when did you get the information and was it insider information (by receiving the info you may be breaking the law).  The third is, if 500 people saw the information it is a lot harder to make money of this "privileged" information.  Finally, and this is the big one, very often it is the information that triggers a price change.

As en example, a Japanese company is today sitting on US$ 500 million in cash, yet the market cap of this company is less than US$ 500 million (its actually a real company that is trading around $220 million).  Now if this information is "secret" how will the market know to buy this company's stock to unlock the potential value in the cash at hand?

These were always the problem for paying cash for research -- the value of research changes over time, and a piece of information can be very valuable to a buyer but not to another, adding to the problem.  

CLSA's response is probably the most logical -- give up the ghost and become a pure execution shop. For the others (especially American firms) the solution is seeking payment and shutting down operations (research).  Some research is so bad, that it may simply cease to exist.  More importantly, it will become increasingly difficult for good analysts to emerge -- how do you know an analyst is any good if his research is behind a paywall?  

Finally there is also the law of unintended consequences:  Companies covered by analysts are "giving away" the information to the brokers -- in fact it has a cost to the company (management time, booking a room, hookers etc etc).  If I was the CEO of a major fortune 500 company I would tell the brokers that they have to pay to get the access to the company that the information on the conference call will only be available to the analyst that asked (and paid) for the information.  After all, if the information is valuable brokers should be willing to pay for it?

The logic of companies giving away information to then having it sold...it seems to break the agreement between brokers and companies.


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