“Tap-tap-tap, is this thing on?”
I’d like to thank the Academy, Mr. HIStalk, and Inga for allowing me the chance to post on a regular basis. Starting today, I’ll be writing a column sharing the Wall Street/investor perspective on HCIT, so I first thought I’d briefly share my background to give an idea of why Mr.HIStalk thought I’d be a good regular contributor.
I began my Street career on a crisp autumn day as a sell-side stock analyst (well, I was an associate analyst first) covering healthcare IT companies, most of which seem to have been acquired by HBO & Co. (now, of course, known as McKesson). Spending about a decade as a research analyst, I covered the stocks of around 25 companies such as Cerner, HBO, Sunquest, Eclipsys, etc. As the dotcom/e-health era arose, I covered those stocks as well, helping to take companies like Allscripts, Healthstream and others public.
After ten years, it was time for a change, so I went to what many called “the dark side” and became an investment banker. I spent six years doing both M&A and public offerings, primarily in the healthcare IT sector that we all know and love.
Wall Street has a few things to recommend it as a career, but the ability to speak truth isn’t always one of them. So, in March, I left the Street to become an independent strategic advisor to healthcare IT and other companies. So far, so good …
Yes, but just what does an analyst do and what’s the sell-side and how is it different from banking? For my first few posts, Mr. HIStalk and I thought a brief tutorial on the industry might be interesting to you, gentle readers. Let’s start with equity research.
There are two sides of Wall Street, the “buy-side” and the “sell-side”. Buy-side means the entities that actually purchase stocks (mutual funds, hedge funds, pensions, etc.). These institutional investors are what typically drive stock prices and through their commission dollars, sell-side behavior.
Sell-side analysts work for brokerage firms, aka investment banks. The other key difference is where buy-side analysts might cover hundreds of stocks or even the entire healthcare sector (from Merck to Mediumune and from McKesson to Medtronic), sell-side analysts typically focus on much smaller swaths of the economy such as biotech, big pharma, or healthcare IT and distribution, covering 15-25 stocks.
It’s the sell-side analysts’ job to know how the companies in their sector perform, what’s driving their growth, and to predict what their income statements will look like each quarter for the next few years. Why? Because it is viewed as axiomatic that earnings drive stock prices and so an analyst will model what they expect the company to earn and then try to determine if its stock price is appropriate. If it’s not, the analyst puts a coveted “buy” rating on it and proceeds to pitch the idea to the buy-side. If a buy-side client likes your idea, there’s the usually unspoken assumption that their fund will try to buy the stock through your firm and you get some credit for the commission dollar.
Earnings might drive stock prices, but I think John Maynard Keynes had a better assessment. He said, in effect, that picking stocks is like judging a beauty contest, but you are trying to figure out who the other judges would find the most attractive. This is why companies that care about their stock prices (and given that CEOs tend to own a lot of stock, most seem to care about this), care about the care and feeding of their sell-side analysts, trying always to paint the rosiest picture possible without (hopefully) crossing the line into fabrication or outright dishonesty.
I say “hopefully” because in my research days, I had countless CEOs telling me how their company was kicking competitive butt, taking market share, etc. All too often (especially early in my tenure), I’d then stand in front of my sales force and call clients to say, “we’re feeling very confident in HIStalkCo’s upcoming quarter”. Usually other analysts were saying the same thing (conformity is typically rewarded) and a “whisper number” began to circulate, meaning analysts are in print saying earnings will be $0.12 this quarter, but they’re all really expecting $0.15. This is why stocks would sometimes drop after hitting analysts’ consensus. This rosy feeling would often last until the company in question reported its quarter and, instead of the $0.12 – 0.15 expected, they reported $0.05 and the stock (of both the company and the analysts) fell.
I should note that it wasn’t always outright dishonesty. CEOs, by their nature, tend to be optimists and salespeople at heart, and the best salespeople, in my experience, believe their own stories.
A few questions might arise.
What does share price mean to me, the customer? In my view, often more than it should. Assuming your vendor has a decent amount of cash on their balance sheet and has a market capitalization high enough to remain somewhat relevant to investors (say, over a few hundred million), let investors and vendors obsess over share price and you can obsess over implementation and support issues.
Why the focus on quarterly results? When I was on the banking side, I had a client who was private and had just missed their internal quarterly budget numbers. The CFO, however, felt “great” about the year. Wanting to go public in the worst way, he asked me why they couldn’t just give annual guidance (like some companies were starting to). The answer is analysts are required by both their firms and their clients to develop quarterly estimates, which are then published. That means an expectation has been set, regardless of whether the company has endorsed it.
The company then achieves, exceeds, or disappoints on those expectations and, in my experience, its stock price reacts accordingly. Discussing what it would be like if this weren’t so is like discussing how pro baseball would be like if they switched to softballs. It might make an interesting conversation over a glass of cabernet or two, but it’s not terribly relevant to the real world. The fact is that quarterly results matter to stock prices here in America, at least in the short term. (incidentally, the company than proceeded to go public in the worst way, missing their forecasts within a few weeks of its IPO. The stock never again saw the IPO price and the management team didn’t get half the kicking around they deserved).
Should I chose a vendor that’s public or private? I’ve never selected a vendor, but IMO, you should choose the one that offers the best product for the best price (sorry to state the obvious). Recognize that there are certain incentives that drive public companies and this quarterly earnings game can impact the amount they spend on R&D, customer service, or other areas you care about. Recognize also, however, that this access to capital and currency allows them to invest in ways private companies often can’t and also is often a recruitment and retention tool (assuming the stock price goes up).
What else matters when dealing with public companies? There was an interesting Readers Write posting a few months ago where a customer complained that they were being ignored by a vendor for reasons having to do with their need to make quarterly numbers. Now as I mentioned, companies really care about their stock price and what investors are saying about them, perhaps more than they should.
Further, analysts (at least good ones) love to have any kind of proprietary morsel about the companies they cover. It’s always great to go to the buy-side and share special information — a key form of currency on Wall Street, and customer insights are always some of the best. It shows the analysts are doing some research away from the companies they follow.
Were I the ill-used client in question, I’d draft a lengthy e-mail detailing all these issues and send it to the vendor’s CFO saying, I’ll be forwarding this and similar views to one or two analysts that follow the company. I’ve not tried it, but it might improve your care and feeding as no company should want to have anything but a good reputation for customer service. Recall how the stock of Cerner fell after CEO Neal Patterson wrote his scathing “parking lot” e-mail and it surfaced on Yahoo! a few days later.
Thanks for your attention, I very much appreciate it. If interest warrants, we’re hoping to make this a regular column. Please let me know what topics you’d like to see discussed or just e-mail or leave a comment. Other areas Mr. HIStalk and I thought might be well received are:
A similar view of investment banking
How does an IPO work?
What exactly is private equity and what is it doing in healthcare IT?
An M&A watch – who’s buying whom, why, and does it make even a modicum of sense?
Ben Rooks is the founder of ST Advisors, a strategic consultancy offering long-term and project-relationships to companies and financial sponsors. He earned an MBA in healthcare management from The Wharton School of the University of Pennsylvania, has done healthcare IT equity research, and has worked as an investment banker in over 25 successfully closed healthcare and medical technology transactions valued from $40 to $365 million.