Jonathan Cohen: The Analyst

Jonathan Cohen was branded a killjoy when, in late 1998, he issued an analyst report suggesting that Amazon.com was overvalued by several billion dollars. Since Amazon's fall from grace, he has gained a little vindication but much insight into why most analysts don't deliver bad news when they should.

In August 2001, two weeks after Enron chief executive Jeffrey Skilling suddenly quit, Daniel Scotto, a utilities analyst at BNP Paribas SA, issued a report lowering his rating on the energy company from "buy" to "neutral" — Wall Street parlance for "ditch this turkey."

In his report, titled "Enron: All Stressed up and No Place to Go," Scotto wrote, "For investors looking for 'performance' bonds, Enron may not be the ideal choice."

Scott's superiors at the firm were not amused. Three days later, at a meeting with Paribas's executives, which Scotto described as "heated," Scotto was put on a 12-week family leave and told to "cool down." On the day his family leave expired, Scotto was fired.

Scotto told NBC's Matt Lauer that he was terminated because his negative rating of Enron made it difficult for Paribas to go after the energy company's investment-banking business. In a statement, officials at BNP Paribas insist that Scott's leaving was unrelated to his Enron report: "Mr. Scotto's departure from BNP Paribas was related to issues with his performance and effectiveness as a Co-Head of the research group and his reaction to the change in his managerial responsibilities. Any inference that his departure from BNP Paribas was related to his August 2001 Enron research report is false."

But if Scotto sensed something rotten at Enron, Congress wants to know why analysts at other Wall Street firms continued to pump the stock even as the company unraveled. Was it that the firms' investment-banking divisions would have lost deals with Enron had their analysts downgraded the stock?

The Case of the Controversial Report

The Scotto incident was not the first time an analyst has been gutsy enough to deliver the bad news on a popular company. But the practice is so rare — and the ramifications often so dire — that few on Wall Street are willing to risk their jobs or reputations to say that the emperor isn't wearing any clothes.

Back in 1998, Jonathan Cohen did, and while he wasn't canned like Scotto, he was pummeled in the press for his apparent cluelessness about the new rules of the new economy.

In early September of that year, Cohen, a tech-sector securities analyst at Merrill Lynch, issued a report on Amazon.com suggesting that the Internet industry's darling was overvalued by several billion dollars. Cohen's rating was so unprecedented that it perplexed the clerical staff in the firm's publishing department.

"The report was supposed to have a salmon-colored cover" — the Merrill Lynch designation for "get out while the getting's good" — Cohen says, recalling the moment from the offices of JHC Capital Management LLC, the private hedge fund he now runs, around the corner from a Ferrari dealership in Greenwich, Connecticut.

"A woman in the publishing department called me to find out if there had been a mistake. In 10 years, she had never seen a 'sell' cover before."

Cohen assured her the cover was correct; he had, indeed, intended to break ranks with his fellow analysts and say that Amazon, the Internet firmament's hottest stock, faced a risky future.

"Amazon's basic premise was very simple," he says. "It was a commodity vendor in a commodity business with low margins. It's a business that had some economic value, but to suggest that it had, at the time, billions of dollars of economic value was patently absurd."

The Rise of Dotcom Mania

As it turns out, Cohen was right. Trouble was, valuing stocks by rational formulas was an unfashionable, even radically uncool position to take circa 1998. It took nearly a year for the market to come around to Cohen's way of thinking.

By December 15, 1998, Amazon had rocketed to $242.75, up 1000%. Then came the analyst report that would live in infamy. Henry Blodget of CIBC Oppenheimer, Cohen's friend and CNBC debating partner, said that $400 was a reasonable price target for the stock. Cohen followed up the next day, suggesting $50 as a more accurate estimate.

The media response was incredulous. Dale Wettlaufer, a columnist on the Motley Fool, a financial-education Web site, excoriated Cohen in his "Holiday Rants" column on December 24, 1998, writing, "Psst. Just because you can't figure out Amazon.com doesn't mean everyone else is incorrect. $50 a price target? Right. That's about as good a call as your calls on America Online when you were at Smith Barney."

Like Scotto, Cohen also found himself at odds with other members of his firm. Cohen concedes that his truculently bearish stance on Amazon surprised his superiors at Merrill, but he insists that they never pressured him to be more positive. "It got a lot of attention inside the firm, but the response was fairly measured," he says. "It was a fairly easy position to defend. Suggesting that Amazon might be worth less than $300 a share wasn't too difficult, even circa 1998."

That valuation may have made sense to Cohen, but market hysteria was high and going higher, and Amazon was buoyed by the frenzy. By January 1999, the stock hit a split-adjusted price of $417, instantly turning Blodget into the media's favorite soothsayer, and making Cohen's call look like the stubborn edict of an old-economy Luddite, even though he had been bullish on other Internet stocks. In the same month, Yahoo hit a high of $445, and CBS Marketwatch.com had a first-day run-up of 474% when it went public.

In early 1999, Cohen, who has been named one of the 25 best U.S. analysts by both Bloomberg Personal Finance and Financial World magazines, left Merrill for a job at Wit Capital and was replaced by none other than his pal Blodget. Four years later, Cohen confides that his departure was spurred by a sweet offer from Wit. But at the time, the media portrayed the move as Merrill's replacing the benighted Cohen with somebody who understood the new-economy game.

Cohen, a small, balding man with wire-rimmed glasses, says he was unfazed by such criticism. But he concedes that his replacement by an Internet booster was a decision likely to help Merrill's bottom line. "It would have helped the investment-banking business to have somebody who was more bullish," he agrees.

The Cozy Culture on Wall Street

In the wake of the Internet collapse — and now, the Enron debacle — questions are being raised about conflicts of interest between ostensibly objective research analysts and the underwriting divisions of the banks that employ them. Congress has got into the act with hearings, finger-pointing, and enough political grandstanding to fuel a hot-air balloon.

Cohen is not surprised. The problem, he says, has very little to do with any individual firm and everything to do with the structure of Wall Street. "Is there generally a predisposition to have or encourage sell-side analysts to be positive on the stocks they cover? Yes. Absolutely. It is a more profitable way to conduct business," he says.

That never troubled Cohen, he says, because of the ethic he learned at Lehman Brothers at the knee of Jack Rivkin, whom Cohen considers the greatest research director in Wall Street history. "Rivkin instilled a very strong sense of duty to the reader or buyer of the research you were producing," Cohen says. To have a research offering that consists solely of buy ratings is prima facie evidence of bad research.

Still, Cohen says, he understands the pressure on his peers: "I felt comfortable downgrading stocks, but I can infer by the relative rarity of sell recommendations that it's a difficult thing. Everybody was always impressed when I would do it."

Last summer, the market-research firm First Call said that less than 2% of the stocks it tracked had the equivalent of a sell rating.

Those Who Do Not Learn From History

Cohen is quick to point out that while there are parallels between the hype that accompanied the Enron run-up and that which fueled the dotcom bubble, there are also some significant differences. Most important, Cohen says, there may have been a lot of foolishness during the Internet era, but there was no criminal misconduct. "The interesting thing about the technology boom of the mid to late 1990s was that nobody had to commit fraud. You didn't need to. You could actually tell investors the truth, and they would buy anyway."

Indeed, even Cohen admits that he misjudged the fervor for Amazon. In retrospect, he says, he wishes he had done a better job discerning the psychological forces in the market that were acting on the price of the stock and had made a call on the price of shares in the short term.

"The market is efficient, but it's efficient over long periods of time," he says. "It's not necessarily efficient on a trading basis over short periods of time. I don't view the Amazon call as a success. The reasoning in the report was sound, but from a stock-trading perspective, it was a flawed call."

Viewed in a historical context, the Internet frenzy was simply the latest manifestation of the market's tendency, often in the face of new technology, to become divorced from underlying values. It happened, Cohen says, during the railroad boom and to the auto industry, as well as to television manufacturers in the 1950s, to biotech in the '70s, and to software in the '80s. "Each of those cases were technology-based trends that had a legitimate impact on the economies in which they operated. They weren't purely speculation like tulip bulbs."

And, Cohen says, Enron could have benefited from the same type of speculative fervor had executives not pushed the envelope of legality as far as they did. "Enron's mistake," he says, "was that it had a huge investor group that was willing to pay outrageous prices for its equity and for its debt — even had the truth been known. But it got a bit ahead of itself."

Still — should analysts have smelled something fishy with Enron? "To answer yes is so politically correct, it seems ridiculous," he says. "But yes, they should have."

Analysts Are People Too

But, Cohen says, analysts, like most people, are not immune to being blinded by a charismatic business titan with a forcefully held opinion. "When people of substance who are vastly successful and command enormous prominence and authority tell analysts things, analysts are inclined to believe and not question them. It's a lot easier than having to start with the presumption that management may or may not be telling you the truth."

The alternative, Cohen says, is a lot of work, but it can be done. "As an analyst, you should never just talk to the CEO. You should talk to the CFO, the COO, the president, and the guy who takes the garbage out at night. You should be talking to partners, distributors, and disgruntled employees — every person you can possibly get your hands on."

Cohen's advice to investors is similar. Find analysts who have a long-term track record, who say and write things that are fundamentally logical, who have a history of not liking all of the stocks that they cover all the time, and watch their reports. "It's almost like finding a movie reviewer whose opinion you trust," he says.

Yet, in the wake of both the Enron scandal and the dotcom implosion, it can still be hard to find an unkind word about a company on Wall Street. Even Cohen has been surprised that analysts are so reluctant to downgrade a stock. "I would have figured more analysts would now step up, just so as not to be seen as a fool. There have been more sell recommendations, but not as many as I would have thought."

Since Cohen's controversial call, Amazon has fallen off its perch at the pinnacle of the Internet heap, suffering the defection of its president, various rounds of layoffs, and the shuttering of some of its operations centers. In June 2000, Ravi Suria, a bond analyst at Lehman Brothers, issued a scathing report on the company that started a meltdown in Amazon's share price, quickly wiping nearly $1 billion off the company's value. In July 2001, a New York doctor, Debasis Kanjilal, collected $400,000 from Merrill Lynch to settle a suit claiming that he had lost his life savings by following Blodget's advice. Amazon stock is now trading at about $15. Finally, after six years in business, the company announced its first quarterly profit of $5 million in January 2002.

Looking over the past three years, Cohen feels no pleasure in finally seeing his analysis pan out. "I've got other things to think about," he says. "My position now is an investor, and Amazon is one of the stocks that I watch closely. I don't derive any joy from seeing the stock go down. Right now, it's just a vehicle to buy or to short. We don't own any."

Linda Tischler (ltischler@fastcompany.com) is a Fast Company senior writer.

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