Blodget on Vonage

Vonage has had a torrid few weeks since it went public in May at $17 per share: the stock closed today at just $6.84. And who better to weigh in on this state of affairs than our old friend Henry Blodget? I've just found a posting of his from July 6, when the stock had fallen to $8.25, and two of the IPO's underwriters had just put out negative research on the company.

Blodget, of course, knows what it's like to be a tech-stock analyst: he was one. And he knows what it's like to be pressured into writing positive reports on companies that your bank does business with: because he did that, he had to pay a whopping great fine, and is now barred from the securities industry. So one would think that Blodget would welcome this brave new world where analysts can turn around a month after the IPO and say without fear of being fired that they think the stock stinks.

But, of course, one would be wrong. Blodget doesn't think that at all. Instead, he thinks that the firms did their clients a disservice by not publishing the research earlier:

Let's look at this from the perspective of an IPO buyer. Wouldn't you have liked to have known that these analysts thought the stock wasn't worth $8.25 before you paid $17 for it? Or, if that was impossible, wouldn't you have liked to have been confident that the analyst had signed off on the deal before it was sold to you? Don't you feel a bit shafted that you were sold a stock at $17 that the only real expert at the firm thinks is not even worth $8.25?

With this kind of logical ability, it's no wonder Blodget could persuade himself that Amazon was worth $400 a share at the height of dotcom fever. Let's run through some of the assumptions here:

First, it seems that if you want an investment bank to value a company, "the only real expert at the firm" is going to be... wait for it... a stock analyst. Not a banker, who's actually charged with selling the company, but rather an analyst who's only interested in what direction the stock is going in. It turns out that in the World of Blodget, all the gazillionaire bankers working in equity capital markets or mergers and acquisitions are chumps, really, compared to their much poorer brethren poring over SEC filings and writing widely-ignored research reports.

It seems that Blodget still doesn't get it. Someone who's very good at valuing companies will not be wasted in equity research, and will become a banker quite quickly. Someone who's very good at arbitraging the difference between what a company is actually worth and what the market thinks it's worth will also not be wasted in equity research and will instead most likely join a hedge fund. The main skill of people in equity research is not to pinpoint the value of a company, but rather to come up with ideas or insights which the investment bank's clients can then use to come to their own decision as to whether a stock is worth buying or selling. The headline buy/sell recommendation is actually pretty irrelevant for the majority of the people who receive the research.

(I know, I described this view of equity analysts as "hopelessly out of date" four years ago, but I did say that things were swinging back in that direction, and in this particular case I think it's true.)

Second, what on earth makes Blodget think that these analysts did actually think the stock wasn't worth $8.25 before the IPO? Blodget, more than anybody, knows that buy/sell recommendations are based on where the analyst thinks the stock is going: before the IPO, there wasn't a month's worth of data showing the share price going steadily south. Blodget seems to be living in some kind of parallel universe where a stock analyst takes a company's books, works out a valuation, and only then compares his own valuation to that of the market. If his valuation is higher then he puts a "buy" rating on the stock, and if it's lower then he slaps on a "sell". But of course no stock analyst actually works like this: one thing that is still true from four years ago is that the reasons why one might want to buy a falling stock are often very different from the reasons why one might want to buy a rising stock.

Clearly, the market has looked at the valuation that Vonage's bankers put on the company when it went public, and decided that it doesn't make sense. Indeed, it's entirely possible that any non-zero valuation for Vonage doesn't make sense, given that the company might well never make a profit. In any case, the direction that the stock is headed in is unambiguous, and I daresay that there are precious few companies which lost half their market capitalization in the first month of trading, and then proceeded to turn around and bounce healthily back. In other words, even if you thought that Vonage was worth, say, $25 per share, you'd think twice before putting on a "buy" recommendation after the stock had sunk from $17 to $8.25 in the course of its first month trading.

Which is to say that having a stock analyst "sign off on the deal" before it's priced is extremely silly. What would that entail, anyway? Giving the stock analyst veto power over whether the company can be brought to market at any given price? Surely the market should be the main arbiter of the price, not one analyst. I really can't imagine what Blodget has in mind here. Presumably he means some kind of statement from the analyst that the IPO price is not unreasonable – but asking an analyst to provide such a statement puts him in an impossible situation. How could he say no?

Posted by Felix at 19:24 EST

Comments

A few large independant research firm issued a sell report on Vonage as soon the IPO price was known.
Check Greg Lundberg from Soleil Securities.
Those who know the telecom industry know that VG was deseparatly looking to be bought out. As no one was stupid enough the choose the IPO road.
Vonage as a very weak competitive position and should go under in the near term.

Posted by: catalyst at 21:32 EST, July 21, 2006