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Paulo Santos, Think Finance (371 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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Back during the 2000 tech bubble, it was common for brokers to curry favor with issuers through their research opinions, so as to attract investment banking. This practice was widespread, and while initially it led to such oddities as only 2.9% of stocks being rated as sells vs. 69.2% being rated as buys, soon the practice turned even more outrageous. There was the famous case of analysts being caught calling their buy picks "POS" (piles of manure, let's say) in private emails.

The huge losses that investors suffered as a result of such biases, as well as the unethical behavior they unearthed, led to a significant backlash. There were bans from the industry and more usage of grading along a normalized curve, where more sells were required.

Still, the inherent incentive never went away. An investment banking organization has two kinds of customers to appease: issuers, who always like a favorable opinion, and holders of investments that the investment bank formerly sold them. Both want to see upgrades and raised price targets. Both generate commissions. The public at large is hardly a consideration.

Fast-Forward to 2013

All this is to say that sometimes the decency of it all is forgotten. The push to perform is so great that people lose sight of how it looks. And we've gotten yet another example of how investment banking commissions are sometimes the one factor doing the talking in these research opinions. Two days ago, Morgan Stanley came out with an upgrade on Amazon.com (AMZN), after having downgraded it back in February 2012 at much lower levels on much higher earnings. Today, Goldman Sachs and Merrill Lynch also upgraded their price targets for Amazon.com.

This might lead one to wonder if there's some news on Amazon.com that prompted all these revisions. There isn't. What news there is talks of an unexpected slowdown in online retail during December. The sparse numbers from Amazon, highlighting the 40%-plus year-on-year 3P growth, say the same: slowdown. So if there is no news that would prompt a massive, simultaneous revision of Amazon.com's value, why the coincidence of Morgan Stanley, Goldman Sachs, and Merrill Lynch upgrading it in the space of just three days?

I will put forward an explanation in the form of a table from the November 8-K, where Amazon.com announced its $3 billion juicy debt issuance:

Click to enlarge image.

Conclusion

The reason why these houses decided to increase their price targets on Amazon.com was not a renewed trust in Amazon.com's business model. It was not some game-changing news showing better prospects. It was not an earnings surprise to the upside. Nor was it the cheapness of Amazon.com's valuation.

The reason why these houses upgraded Amazon, what ties them together, was the fact that they underwrote -- and earned commissions on -- Amazon.com's recent $3 billion debt issuance.

Amazon.com continues to be a clear short, and it's likely that it will continue to show decreased revenue growth rates. It's also likely that it will have yet another profit warning for Q1 2013, since there is no reason to believe there has been any recent improvement in margins. In fact, there are reasons to believe in continued deterioration, such as collection of sales taxes, continued physical to digital migration, increased competition (including price matching by physical retailers), etc.

Source: Amazon: Conflict Of Interest Rears Its Ugly Head