SpaceX and the myth of independent Wall St research

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is a former global head of equity capital markets at Bank of America and is now a managing director at Seda Experts

The banks that underwrote SpaceX’s blockbuster flotation last month have finally published their research on Elon Musk’s company after the expiry of the regulatory “quiet period” on advisers to the deal.

Every one recommends buying the stock. Goldman Sachs, which took the prime lead-left slot on the list of advisers in documents for the initial public offering, put a $205 price target on the shares. Morgan Stanley went to $300. Raymond James was even more hopeful, putting out an $800 price target, implying a valuation of more than $10tn.

Each bank justifies the numbers differently, but the conclusion is invariably bullish. Deutsche Bank, for example, hailed SpaceX as “the apex of civilizational ambition, oftentimes expressed in steel and fire, bending the arc of history”. The current share price of about $125 — down 44 per cent from the post-IPO peak and 6 per cent below the offer price — suggests investors are more tempered.

You might expect wildly divergent views on a company as speculative as SpaceX. Here the underwriters disagreed only over the scale of the upside. Sceptical voices came from outside the syndicate. Morningstar, for example, valued the shares at $63.

Twenty-three years after then-New York attorney-general Eliot Spitzer forced Wall Street to separate equity research from investment banking, the episode raises an awkward question. Did Spitzer, dubbed at the time the “Sheriff of Wall Street”, change the legal mechanics without really altering the underlying incentives?

When the dotcom bubble burst, regulators uncovered emails showing that Wall Street analysts were privately disparaging stocks they were publicly touting. A 2003 global settlement between banks and regulators on analyst research imposed sweeping restrictions. It barred investment bankers from influencing analyst compensation, tightly controlled communications between research and banking, and banned analysts from IPO pitches and roadshows. Spitzer’s premise was that shielding analysts from bankers would deliver truly independent — and better — research.

On one level, the reforms succeeded. Banks have constructed a robust compliance apparatus to wall off research from investment banking. “Chaperones” now police interactions between analysts and corporate finance to prevent even the appearance of pressure.

Having worked under this regime for two decades, I can attest that chaperones take their role seriously. They quickly intervene at any hint of undue influence, while bankers generally respect both the letter and spirit of the rules. Nobody wants to face disciplinary action.

The Spitzer global settlement formally ended last December in favour of more flexible rules overseen by an industry association. But investment bankers know better than to browbeat analysts, and compliance departments enforce boundaries with vigilance.

Still, analysts do not operate in a vacuum. They want to participate in marquee deals, they value management access for their institutional investor clientele, and they are likely to know, say, if their chief executive has been lobbying for a lead role for their bank. Nobody has to spell it out.

Those who participated in private fundraising rounds as well as the IPO have little appetite for research that questions the valuation while lock-ups on selling remain.

So who exactly is the intended readership for broker research? No fund manager I know relies on sell-side recommendations to allocate capital. Investors build their own models and assume that Wall Street research is incapable of objectivity on a banner transaction such as SpaceX’s listing. What they prize instead is the clean layout of company-furnished data and access to management.

It is possible some retail investors may follow the research ratings, but in my experience the audience that matters most is the company itself. Management teams appreciate reports seeing their narrative endorsed in a report carrying the logo of a major bank. Flattery takes you a long way in finance, as it does in life.

This is not to suggest analysts are saying things they do not believe. Rather, they are like the young fish in David Foster Wallace’s famous This Is Water parable, unaware of the water around them precisely because it is everywhere. Analysts do not need to be instructed what to write if the ecosystem has already established what counts as a reasonable view.

Spitzer may have eliminated the overt conflicts of the dotcom era. But his reforms could not erase the incentives. On SpaceX, bankers did not have to tell analysts what conclusions to reach to get the research they wanted.