But don’t be surprised to see more optimistic ratings 25 days after the IPO date, which is when analysts from larger banks are expected to release ratings of their own.
Conflicts and the blackout period
Major Wall Street banks often do business with the very companies their analysts are covering, creating a potential conflict of interest that could result in these higher ratings. Furthermore, the potential conflicts are exacerbated because these analysts need access to the companies they’re covering and they might get shut out if they issue a “sell rating.”
When it comes to initial public offerings, analysts who weigh in with ratings fall into two buckets: those from independent research firms or smaller banks like Morningstar and Susquehanna, and those from larger institutions like Morgan Stanley (MS) and Goldman Sachs (GS). Because independent firms and smaller banks are usually unaffiliated with the companies their analysts weigh in on (in this case, Snap), they’re more free of conflicts and they can issue reports whenever they please, which is why we’ve already seen at least seven ratings trickle out.
With larger institutions, however, the situation becomes trickier because of the potential conflicts of interest. In this case, Goldman Sachs, Morgan Stanley, JPMorgan Chase (JPM) and Deutsche Bank (DB) have a vested interest in Snap, having been involved in Snap’s IPO.
These banks made millions from Snap’s Wall Street debut but also plan on having their analysts issue “buy,” “sell” or “hold” ratings on the stock 25 days or so after the the IPO date. The big banks haven’t been legally required to adhere to this “quiet period” for emerging-growth companies since the JOBS Act passed in 2012, but they often wait for 25 days to avoid potential lawsuits from other investors or outside parties alleging conflicts of interest.
CEO to analyst: “I’m not going to answer you”
However, these conflicts may still exist. The banks would argue they do not, due to firewalls established between the research departments and banking divisions of Wall Street firms, intended to prevent this very sort of thing from happening. But reality can play out differently.
“When affiliated analysts are allowed unfettered access to a company, they’re more likely to have more optimistic ratings,” explained Matthew Gustafson, assistant professor of finance at Pennsylvania State University.
Under the JOBS Act, signed into law in 2012, emerging growth companies such as Snap are allowed more interactions with the investor and analyst at an institution, versus larger companies that IPO. The JOBS Act even allows the analyst, investor and company to be all in the same room together ahead of the IPO, although there are some restrictions regarding what each party is allowed to say in those situations.
“Such interactions between analysts and bankers would not have been allowed at all before the JOBS Act,” Gustafson explained. “They would have had to meet with other IPO participants separately.”
As a result, analysts permitted to increase pre-IPO communications with investors, bankers, and company management through the JOBS Act issue reports with stock ratings that are more biased and less accurate, according to a report Gustafson co-authored in June 2016.
“In sum, pre-IPO communications appear to result in analyst behavior that benefits preferred clients and the investment bank at the expense of other investors,” the report concluded.
Analysts may also have incentive to issue “buy” ratings so they can get preferential treatment vis-à-vis company access. Issue a negative rating on a company, for example, and an analyst can quickly find themselves left out in the cold. The issue came to a head in 2014 when Cliffs Natural CEO Lourenco Goncalves publicly shut down Wells Fargo analyst Sam Dubinsky on an earnings call that year because Dubinsky had marked the company’s stock with an “underperform” rating.
“You have a $4 price target and you think we can’t sell assets, so I’m going to take the next question, I’m not going to answer you,” Goncalves said on the earnings call.
So don’t be surprised if analysts in the coming weeks play it safe with “Buy” ratings of their own. Just remember, however, that a bullish analyst’s opinion may be biased, unconscious or otherwise.
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