BUSINESSWEEK ONLINE : JULY 10, 2000 ISSUE
COVER STORY

Debt vs. Equity Analysts: Whose Call Counts?


The day before Ravi Suria issued his now-famous report blasting Amazon.com Inc.'s creditworthiness, the Lehman Brothers Inc. debt analyst phoned his equities counterpart, analyst Holly Becker, to discuss his findings. Becker, who has a ''buy'' recommendation on Amazon, wasn't exactly thrilled with Suria's report. She suggested that she be present while Suria presented it to Lehman's sales force the next day. ''I wanted to assure them that his view wasn't my view,'' she says, explaining that Amazon is in good stead as long as it expands beyond book sales and cuts costs.

Call it ''he said, she said,'' but the two vastly different opinions are indicative of the chasm and tension that often exist on Wall Street between debt and equity analysts. The former are known to take a fine-toothed comb to company financials, poring over balance sheets and profit-loss statements. And since they are paid to warn clients whether a company has adequate cash to make its debt payments, they are often ahead of the pack in predicting trouble.

Equity analysts, on the other hand, are more focused on a company's growth outlook. What are the catalysts that will help earnings? Does the company boast product-line changes that will translate into revenue increases? Most important, will the market reward those trends by bidding up the stock's price? ''In a vast oversimplification, equities analysts tend to look at the upside, whereas debt analysts tend to look at the downside,'' says Edward I. Altman, a professor at New York University's Leonard N. Stern School of Business.

DIFFERENT STROKES. Which group should investors heed? Experts say each can provide value. Together, they can give a much fuller picture of a company, with several caveats. Equity analysts' research may have a more bullish cast because the company they're covering is an investment banking client--or they want it to be. Indeed, fewer than 1% of ratings by stock analysts are ''sells,'' according to earnings research firm First Call Corp. ''On the credit side, it's much more difficult to make a wildly bullish case when the issues are plainer: Here's the revenue estimate, here's the cash-flow estimate, here's what they owe in debt,'' says Seth Tobias, a New York hedge-fund manager.

Debt analysts have their biases, too. They tend to look at numbers only on a trailing, or backward-looking, basis and not at projected estimates or the potential of a company's business plan.

However, because they're on the lookout for signs of weakening, debt analysts are often the first to ferret out potentially failing businesses. For example, Lehman's Suria asserts that unless changes are made, Amazon.com won't generate enough cash to sustain and grow its business or become cash-flow positive. Likewise, such analysts are able to point out problems in an entire sector because of weakened creditworthiness. That's why short-sellers of stocks, in particular, tend to pay more attention to debt analysts as well as debt rating services. ''Debt deterioration is often a leading indicator of equity problems,'' says Tobias.

Indeed, after bond-rating services upgrade or downgrade a company's debt, equity analysts often follow with changes to their earnings forecasts, according to a 1998 study by Jeremy C. Goh, a Drexel University professor, and Louis H. Ederington, a University of Oklahoma professor. ''Equity analysts think debt experts have access to information or analysis that they don't have,'' says Ederington.

QUASI-DEBT. In the world of research analytics, a new trend may be brewing as more debt analysts scrutinize e-commerce companies. That's because more established e-commerce companies such DoubleClick Inc. and EarthLink Inc. are now issuing a kind of quasi-debt: convertible securities. These allow investors to convert their bonds into common shares if the stock hits an agreed-on price. Problem is, most of the underlying stock of these instruments has fallen so much that the equity portion is almost worthless and the debt portion is junk. Amazon may have been the first Net company to get a wake-up call from the debt side, but it's unlikely to be the last.

By Marcia Vickers in New York

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