By JEFF D. OPDYKE, Staff
Reporter of THE WALL
STREET JOURNAL,
Oct. 23, 2000
Matthew Berler, an analyst at Morgan Stanley Dean Witter & Co., is poring over spreadsheets covering 887 financial factors affecting his earning expectations for Georgia-Pacific Corp.
In the past, he would call executives at the Atlanta forest-products company to quiz them about the more pertinent variables factored into his model. Such one-on-one guidance, he says, was part of a "continuous check on my modeling."
That was then.
Now, something known on Wall Street as Reg FD has entered the picture, and it means Mr. Berler no longer will have access to all the information he uses in his spreadsheets. The result: He is less certain his earnings estimates will match the profit that Georgia-Pacific reports.
"There's a greater risk of error" in all earnings estimates now, Mr. Berler says. Roughly "25% of the accuracy [in earnings models] has always come from the companies, and now that's gone."
Monday begins a new error -- er, era -- for Wall Street analysts as Regulation FD, a new Securities and Exchange Commission rule aimed at ensuring that all investors have equal access to material financial information, goes into effect. But its impact already is being felt, and rarely has a new securities regulation so fundamentally altered the way Wall Street professionals go about their jobs.
Reg FD (for Fair Disclosure) "is already having a chilling effect" on analysts and their contacts with corporate managers, says Stuart Kaswell, general counsel for the Securities Industry Association, an industry trade group that has begun to hear accounts of companies canceling one-on-one meetings with analysts, a staple of the business. While most investors don't know about the new regulation, according to a recent PaineWebber Inc. survey, more than one-third think analysts could become less important.
Corporate trepidation may ease once companies become more familiar with the rule and realize that, in some cases, they have adopted a too-zealous approach. But for now, "companies are in a period of adjustment, and that's changed the relationship" with analysts, says David Brukardt, vice president of corporate and investor relations at Avista Corp., a Spokane, Wash., public utility that last week told analysts that it couldn't meet with them to discuss company-specific issues.
The main thrust of the SEC's mandate: Companies must publicize all potentially market-moving data simultaneously, and they cannot selectively disclose data to certain analysts or big investors before releasing it to the public. In practice, that means the job of Wall Street analysts -- to cobble together a mosaic of data bits mined from companies, competitors, suppliers, customers and internal employees -- "has gotten more difficult," says Richard Schneider, a PaineWebber analyst and 13-year veteran of research on forest-product companies.
Though he says he isn't necessarily concerned about his ultimate success or paycheck, privately he has grumbled to his wife about how corporate caution in the face of Reg FD has made it impossible to collect all the pieces that go into his analysis, particularly items such as company product mixes and operational efficiencies, information that in the past came directly from corporate executives.
In recent days, for example, he was on the phone with executives of a forestry company he follows, but which he won't name, asking about pricing trends in a particular grade of paper. Instead of answering, the executives referred him to publications that track industry trends. The problem with that: "You cannot accurately extrapolate industry trends to individual companies," he says.
Now, he is concerned his estimates might not be as accurate as they once were, back in the days when the executives provided "some fine tuning." With "few places I can go" to gather data on internal operations, his says his analysis now reflects "more judgment calls," and he is waiting to see the consequences of that in his accuracy.
Analysts such as Mr. Schneider traditionally have served as an important link between the flood of financial data from public companies and investors. Delivering accurate earnings forecasts -- the analyst's bread-and-butter product -- typically required an often-cozy, often-symbiotic relationship with corporate management. In pre-Reg FD days, hand-holding wasn't practiced by every company, and many analysts rarely depended solely on "company-speak" to ensure that their earnings estimates were in line with what the company ultimately reported. Still, analysts often spent a lot of time on the phone with chief financial officers, treasurers and investor-relations officials seeking facts.
Corporate chieftains recognize that analysts are a huge cog in the markets and that their "buy" and "sell" recommendations can help keep a company's stock price buoyant, particularly those of small, young companies, "and keeping them happy at all costs has been the modus operandi," says Fiona Ross, a senior managing director at Hill & Knowlton Inc., a New York investor-relations firm and a unit of London's WPP Group.
The chumminess has been particularly visible in the forest-products industry. This cyclical sector is notoriously unpredictable. Because most forestry companies operate in a variety of separate wood, paper and pulp segments, profits ultimately are driven by a wide range of variables, including erratic commodity prices, fluctuating volume, varying product mix, variable costs, and scheduled and unscheduled plant downtime.
Because of the low predictability of earnings, companies such as Georgia-Pacific historically have tried "to help analysts understand the inputs they use in their models" to formulate a more accurate picture of earnings, says Richard Good, Georgia-Pacific's investor-relations director. That often meant working with analysts, one-on-one, on pricing trends and, Mr. Good says, "providing them with up-to-date information on our productive capacities" -- information that ultimately impacts an analyst's earnings model, but which Mr. Good says the company no longer will discuss.
Consider a recent phone call Mr. Good received from Frances Loo, a longtime forestry analyst for securities firm UBS Warburg. She had heard rumors the company was planning downtime at a plant and she wanted to know about the impact on pulp volume for the company and the industry. Mr. Good confirmed the downtime, a routine matter, but then clammed up, in contrast to days past when he talked more freely. "We've had to become more conservative in our communications," he says, adding that the firm's relationship with analysts overall "is different now."
Mr. Good used to field similar calls from Mr. Berler, the Morgan Stanley Dean Witter analyst. Like his peers, Mr. Berler compiles outside research, and often would phone Mr. Good and executives at other companies he follows seeking insight on factors incorporated into his spreadsheets, including commodity prices, volume and costs for each business segment, as well as general corporate expenses, tax rates and other such items. He would methodically walk through the critical suppositions, gauging the executives' comfort with his numbers. At the end of the exercise, "you've narrowed in on a tight [earnings] range," he says. He would check in frequently "for little updates to find out how things are going, where any changes are taking place, so we have a continuous picture of what to expect."
All this had the effect of allowing him to gradually adjust earnings estimates down or up. Companies played along because it helped them manage investor expectations and keep their stock prices from swinging violently. While companies typically didn't spell out exact numbers, "they would tell where you're too aggressive or too shy on market conditions," says Anna Torma, a forest-products analyst at Merrill Lynch Global Securities.
Now, many such conversations are verboten. That prospect has prompted Ms. Torma, for example, to build new contacts within the industry. "Now I'm relying more on customers and global market players," she says.
Mr. Schneider, the PaineWebber analyst, is expanding his contacts among company employees beneath executive ranks. Reg FD doesn't apply to those workers, though that doesn't mean corporate officials can surreptitiously funnel information to analysts through underlings. Even so, Mr. Schneider questions just how effective lower-level staff can be. No analyst "has contact with all [of a company's] sales staff, and the sales people only have an idea about what they are doing. So you still don't get" a complete picture, he says.
The early effects of the regulation, first announced in August, already are apparent in recent stock action. Building Materials Holding Corp., San Francisco, recently announced its quarterly profit will be as much as 17 cents a share, or 25%, lower than expectations. Forestry firm Rayonier Inc., Jacksonville, Fla., said its earnings would miss the mark by as much as seven cents a share, or 14%. Neither company communicated to analysts ahead of time of the pending shortfall. "Because of Reg FD, our counsel guided us to say nothing," says Lesa Thomas, assistant corporate secretary at Building Materials. "In the past, we would have guided analysts."
Questions:
By obtaining information directly from the company, analysts were achieving high predictability, but only vis-a-vis the accounting numbers, because the accounting income can be manipulated, at least in the short run, by the company. As a result, analysts did not perform independent analysis, and there was a looser relationship between their forecasts and the underlying fundamentals. Now that analysts do not have special access to firms, their predictions will be more on the ball.