Ask William Walker, CEO of Howard Weil, whether he's interested in becoming an official provider of independent research to some big Wall Street brokerage. "I have only one answer," he scoffs. "No. Never. Not ever. We'll close first."
Walker is not about to shut down his Houston-based brokerage specializing in energy stocks anytime soon. Nor is his 40-person firm likely to be approached by one of the ten Wall Street firms that signed on to a $1.4 billion settlement with state and federal regulators and agreed to dispense independent research to their clients.
Why? Howard Weil's research is prized by investors who rate its insights into the oil and gas patch highly. And his firm isn't caught up in investment banking conflicts, since it doesn't employ a single investment banker.
The catch is that Howard Weil's ten analysts track only about 100 stocks in five energy sectors. The major firms' landmark deal calls for them to provide their customers with outside analysis from at least three vendors on hundreds of common stocks and American depositary receipts in dozens of industries. Thus the firms are likely to be handing out their independent-research mandates -- big brokerages are expected to dole out $433 million worth over the next five years -- to research operations that boast broad coverage lists, such as Morningstar, Standard & Poor's and Value Line.
Too bad a wider audience of clients won't be introduced to the work of analysts at Howard Weil and other boutiques and regional firms. Some labor at firms whose narrow focus makes them unlikely candidates to participate in the research settlement, while others are employed at brokerages with investment banking arms, like Keefe, Bruyette & Woods, that make them ineligible. What they share is the high esteem in which they are held by many of the biggest institutional investors in this country and around the world.
Apart from Howard Weil, among the best of these firms, according to portfolio managers and buy-side analysts polled by Institutional Investor , are Boston-based health care experts Leerink Swann & Co. and New Yorkbased financial services stock specialists KBW. Leerink Swann takes the laurels in Biotechnology, Health Care Facilities, Managed Care, Medical Supplies & Devices, Pharmaceuticals/Major and Pharmaceuticals/Specialty. Investors rate KBW tops in Banks/Large-Cap, Banks/Midcap, Brokers & Asset Managers, Mortgage Finance and Specialty Finance and give KBW honorable mention in Insurance/Life and Insurance/Nonlife. Howard Weil takes top honors in the Integrated Oil and Natural Gas categories along with honorable mention in Oil & Gas Exploration & Production and Oil Services & Equipment. Another favorite: Cleveland's FTN Midwest Research Securities Corp., which is deemed best in Food, Machinery, Retailing/Department Stores & Broadlines, Retailing/Food & Drug Chains and Retailing/Hardlines. FTN Midwest Research also receives honorable mention in Banks/Midcap. To determine the best research teams among these smaller firms for II 's 2003 Best of the Boutiques and Regionals rankings, II polled 3,700 portfolio managers and analysts from 640 buy-side firms.
Other firms that excel in our tabulations are Baltimore-based Legg Mason and Simmons & Co. International, Howard Weil's crosstown energy research rival. Legg Mason wins the Beverages, Telecom Services/Wireless and Telecom Services/Wireline categories and an honorable mention in Retailing/Hardlines. Simmons finishes No. 1 in Oil & Gas Exploration & Production and Oil Services & Equipment and garners an honorable mention in Electric Utilities and Natural Gas.
What most distinguishes these firms from large brokerages and broad-based research enterprises is their intense focus. "We live, eat, drink and sleep the specialty," says Weil's Walker. An investor says he values smaller firms "because of their lack of conflicts and depth of focus." He notes that an analyst at a big firm doesn't have the same "opportunity for cross-fertilization of ideas" in his field as a researcher at a specialty boutique has. At firms like KBW, Leerink Swann and Howard Weil, several analysts ferret out information on supply and demand across the interrelated components of a given sector, such as energy or banking. Says Walker, "We understand how to triangulate the business among majors, exploration, the service companies and power."
Investors add that analysts at specialized firms -- whose compensation may be half that of their Wall Street counterparts -- tend to be more committed to equity research as a career. "Boutique firms attract people who are interested in just doing analysis," says a buy-sider, who contends that researchers at big firms often have to cope with too many extraneous duties, like marketing trips, or harbor ambitions other than doing superb analysis. Small firms' concentration and dedication can extend to the salespeople, many of whom develop their own research expertise over time. The average tenure for a Howard Weil salesperson is 20 years.
Talented small-firm analysts sometimes stand out at activities that traditionally have been the province of big firms, such as gaining access to top management. "We value access and insight," says a client of both full-service firms and specialists. "The big guys tend to be long on access but short on insight. The smaller shops, though it's very sector- and analyst-specific, tend to have unique relationships with companies and better insight into what's going on."
Another investor points to a subtle difference between the majors and the smaller firms that he has observed in management meetings over the years. Companies will always defer to a big brokerage and its analyst, but they display more personal respect for a talented researcher at a smaller firm. "Managements don't have to have a relationship with the smaller guys, but those who are smart and thoughtful have value to managements, and operators view them as 'thought peers'," he explains.
Not having to worry about covering every single stock can be another advantage for the little guys. Regionals and boutiques can "pick their spots," says Ira Malis, who heads research at Legg Mason. His firm has "the freedom to go deeper into some areas" where it sees opportunities, and it doesn't have to worry about covering everything.
For example, Legg Mason employs four researchers in IT services, 11 in real estate investment trusts and 14 in telecoms. Unlike the big Wall Street firms, Legg Mason covers just 30 percent of the S&P 500 index companies.
Flexibility allows smaller firms to conduct unusual research projects that big firms might shun. One example: Last December, KBW produced an in-depth study of Ford Motor Credit Co., which is a primary driver of Ford Motor Co.'s earnings but whose financial performance was deteriorating. The result, says John Howard, KBW's director of research, was to draw together the interests of institutional investors' own auto and consumer finance researchers, who don't normally have to speak to each other very often. "This project forced that communication," says Howard. Although KBW didn't make a specific sell recommendation, the study highlighted some of Ford Motor Credit's problems just before a roughly 35 percent tumble in Ford's share price. (The stock has more than recovered the loss since then.)
Clients of small firms can be demanding, says Daniel Pickering, research chief at energy specialist Simmons. Boutiques' salespeople and researchers work so closely with customers that they may end up offering what amount to customized services. For example, boutiques may recommend an inexpensive oil stock to a value investor or a little-known exploration company to a small-cap manager.
"What's a buy for one client may not be a buy for another," says Pickering. "Nuance is more important than ever." Hedge funds, whose rapid growth and voracious appetite for trading ideas is influencing research everywhere, particularly appreciate this personalized service, says Pickering.
For all their apparent strengths, smaller brokerage firms have to hustle to stay ahead of the majors. Walker is proud that Howard Weil, which relies on brokerage commissions and fees from secondary market sales, increased its profits and revenues by 10 percent per year through the worst bear market in recent memory. The firm succeeded by "doing the most we can with the fewest number of people," he says.
William Conroy heads research at Sanders Morris Harris, a brokerage house whose analysts win the Entertainment sector. "We continue to see clients cull their broker coverage," he says. "So it remains a challenge to not become a casualty of that trend." Providing first-rate research, of course, is one way to stay clear of the circular file.
|BEST BOUTIQUES A N D R E GIONAL FIRMS|
In polling f o r o ur 2003 All-America Research Team, we asked investors to name the best bouti q ue or regional f i rm by s ect o r. He re a re t h e o utstan d i n g f i r ms in t h e i r re s pective categories.