How analysts missed signs of PSINet's ruin

April 22, 2001|By Andrew Ratner and Bill Atkinson | Andrew Ratner and Bill Atkinson,SUN STAFF

David Takata kicks himself now for missing the sign.

The investment analyst traveled from Los Angeles to Laurel a year ago to visit the former chief financial officer of PSINet Inc. to learn, among other things, why he'd left. Takata was satisfied with the executive's explanation that he wanted to move on to build an Internet start-up.

But he should have seen it as the beginning of the end for the company that paid millions to have its name on the Baltimore Ravens football stadium but is now on the brink of Chapter 11 bankruptcy, he said.

"Just call me guilty," said Takata, 38, who recommended the stock to investors from 1995 through January, even months after the company began a death spiral. "One of the signs I missed was the CFO leaving. Only recently did I drop coverage on it, so I'm kind of in the same position a lot of folks are. I'm as bad as anybody."

He wasn't the only one to make a bad call. Many analysts pushed PSINet stock, and they were burned.

PSINet isn't the only company to fool analysts. Household names such as Lucent Technologies Inc. and Xerox Corp. also caught the analysts by surprise as their stock prices collapsed.

How could analysts be so wrong?

Investors in PSINet, one of those that fell the hardest, lost more than $11 billion on paper during the past 13 months, as the stock sank from a high of $59.81 per share split adjusted on March 8 last year, to 18.8 cents on April 2, when it stopped trading. The company's market capitalization plunged to $35 million.

To many analysts and investors, PSINet's business - hooking corporations in 28 nations to the Internet - looked like a world-beater. The Ashburn, Va.-based company amassed 100,000 business customers communicating over a million miles of fiber-optic line, enough to circle the Earth 40 times.

Its stock price rocketed even faster than the high-flying Nasdaq composite index., a stock information Web site, listed it among its 25 top performers in 1998.

Jumping on the bandwagon wasn't the problem.

Deciding when to jump off was.

In a lengthy note Nov. 6, titled "Fear Feeding Fear - Lemmings in Full Stampede," analyst Vik Grover of Kaufman Bros. downgraded PSINet shares. But his change was only to "buy" from "strong buy," after a week in which the stock lost two-thirds of its value, to $2.63 a share.

Grover wrote that the price drop was due to "reckless selling by investors that are failing to see the strategic value" of the company. He encouraged long-term investors to buy more PSINet stock, or, as he put it, "double-down."

Grover declined last week to discuss his support of the stock.

"We no longer cover PSINet," a Kaufman Bros. spokesman in New York said. "We dropped coverage on the stock a couple of months ago, so we have no comment."

Analysts are paid by investment firms to research companies. They plow through complex corporate data and meet company executives and competitors to better understand the industries they cover.

Their conclusions are passed on to brokers and large investors to help them decide which stocks to buy - and which to avoid. Like a theater critic on Broadway, their reviews can make or break companies.

But they aren't always well-suited to be the guardians that individual investors and large pension and mutual funds rely on.

"Often they are not very good watchdogs, and they are more promotional artists than watchdogs," said John C. Coffee Jr., a securities law professor at Columbia University in New York.

Coffee argues that analysts are conflicted, partly because their employers - brokerage and investment banking firms - use them to win lucrative underwriting business.

Companies that go public often hire a firm to handle the offering with the expectation that the underwriter's analysts will support the stock with positive comments and ratings.

"If you have an analyst whose compensation is based on his ability to lure business ... it is not a surprise that you get a very compromised analyst," Coffee said.

Analysts are often reluctant to criticize a company, especially a client, for fear of being shut out of the information loop. One of the more celebrated cases involved former Credit Suisse First Boston star analyst Michael Mayo, who was fired in 1999 months after advising investors to sell bank stocks. Months after he warned them that they were about to drop, that is just what happened.

"We are the color commentators," said Greg Gieber, a technology analyst at St. Louis-based A.G. Edwards & Sons Inc. who tracked PSINet. "We are supposed to yell at the time the king doesn't have any clothes on."

Gieber began covering PSINet in September and immediately gave it a "speculative" rating because he thought Internet stocks were valued too high.

"There are some very bright people who got fooled by all of this," he said. "This was a very difficult situation for the analysts, and not as difficult in the end as it was for the investor who lost a lot of money in PSINet."

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.