The law of unintended consequences and another “anal”-yst fine mess!

For a highly educated group of people, analysts have an unerring ability for “putting their foot in it” and that’s a theme we have commented on many times on this blog and in this magazine. Indeed, what with Evil Knievil, “system sellers” and crooked public company management, you may be wondering who we respect! 

In the latest example of our friends the “analysts” making a monumental mess of things again, a young scribbler in the USA caused uproar when, in just a series of tweets and emails that he sent, they went viral and drove down the price of a major Midstream Oil Company (pipelines and processing) by several billion dollars. What’s more, the emails and tweets were effectively just a trailer for a formal research note that was scheduled to be published on Tuesday this week (10/9/13) though whether that note will now see the light of day remains to be seen… 

The life of a specialist analyst is usually seen as being one of dull restraint with the odd company visit and a tweak of their capital pricing or discounted cash flow models as the highlights of their world. In a world of over researched companies and online information, it is rare indeed for an analyst to offer any dramatic insight into a particular business or sector. Instead many analysts huddle together in a crowd with largely the same recommendations, price targets and estimates that could almost be clones of each other. This way they reason it is hard for them to lose their job. so much for “value adding”… This publication actually puts it’s neck on the block (and without pay!) in making a call on a sector, stock currency – and as regular readers will know, we have rarely put a step wrong. 

True, a few individuals will always standout from the crowd and these “Gurus” often attract a following amongst money managers and the mainstream financial media. Some have even achieved celebrity status. They may not household names in the strictest sense but their names will often be synonomous with a particular sector, company or call – think of Henry Blodget, Mary Meeker etc from the dotcom boom days. 

Of course, that cult of celebrity can be a double edged sword as we found out when the internet bubble burst and the gory inards of the investment banking business were laid bare for all to see including the probing arms of US regulatory and legal authorities who were very interested in the crossing of Chinese walls and the disconnects between analysts personal views on a stock and the corporate line they were being asked to pedal. 

Elliot Spitzer

Elliott Spitzer and his then colleagues in the New York Attorney General’s office mounted a rigorous investigation which unearthed evidence of internal coercion at some banks/brokers and what appeared to be blatant lying to clients in the worst cases. unsurprisingly there were prosecutions and fines and reputations were left in tatters. 

It is perhaps because of the excesses of the internet bubble and it’s aftermath that we have the current system of “benchmarking” where analysts would, it seems, prefer to resemble the chap next door rather than make a name for themselves. You can never throw that accusation at us! 

Back to the chap who has been making a name for himself, though perhaps not in the way that he had intended . Kevin Kaiser is only 26 and works as an oil analyst for the US based independent research provider Hedge Eye. As relayed earlier, Mr Kaiser came to the attention of the investing public and the world’s media last week as series of emails to clients and tweets to the wider world gathered a momentum of their own. Here’s an example of his missive – 

 “This AM we added SHORT $KMI $KMP $KMR $EPB as new Best Idea. Full report out to clients on Tues 9/10.“ 

What happened next has already become part of market folklore. Mr Kaisers comments went viral and Kinder Morgan Energy Partners  (ticker KMP ) a $30 billion plus company fell almost 2% on the day (03/09/13) and continued to slide the next day by almost 3% before finding support. It was a similar story at the associated Kinder Morgan Inc. (ticker KMI)  

What lessons can we draw form this episode which might be considered little more than a game of electronic Chinese whispers but which clearly has implications for investors? Firstly Hedge Eye is not what you describe as a wall flower; the company has a prominent presence in the US financial media in both its traditional and social formats and actively courts publicity and promotion via these channels. 

Whilst it’s unlikely that this is exactly what they had in mind, they are probably not to unhappy with the results overall, after all we are discussing them right now. Secondly it shows the power of social media in the modern market place and how it can influence and reinforce crowd or herd like behaviour and how ready people are to make investment decisions without being in possession of all the facts. Additionally, once put in motion, these events can take on a life of their with outcomes that may be very different from that that was intended. 

A final observation on this saga is that there is no smoke without fire and if there is that degree of nervousness around these stocks then perhaps Mr Kaiser’s concerns may have some merit. Having read what material is available on the subject it would seem Mr Kaiser wanted to draw investor attention to the differences between servicing shale gas / oil wells versus those that operate under more traditional methods. The thinking being that shale wells can have a relatively short life span at viable output rates. This can be as little as one or two years after which the production company picks up its equipment and moves on to another site. But for pipeline business such as Kinder Morgan the cost of connection to the well is the same as to one that might have ten year life span. Capex costs will likely rise as they (midstream service providers) have to connect more wells more frequently rather than under traditional extraction methods. 

As part of my research into this story I found one rather telling graphic (see below (chart courtesy of the motley fool insider monkey). Kinder Morgan and its associated companies are what are known as MLP’s or Master Limited Partnerships –  these are not present in the UK however they can be considered similar to a REIT and which pays most of its  profits away in the form of dividends and distributions and whose shareholders receive certain tax benefits through ownership. These MLP structures have performed well over recent years as they have been able to borrow money cheaply in a low interest rate environment and at a relatively fixed premium or spread to rates incurred by the US Government via the bond market. Insider monkey draws our attention to the divergence seen earlier this year in Kinder Morgan’s funding spread over US government paper whilst that of the peer group remained in line. Which leads one to wonder, what the bond market can sense about the businesses?  One to watch going forward for curiosity’s sake if nothing else .