Wall Street Analysts Dig Deep to Cover Eyecare Stocks
Full-disclosure rules make for tight-lipped companies.
BY JERRY HELZNER, SENIOR EDITOR

But that has all changed during the past few years. Today, an investor in eyecare stocks can now also choose among such industry stalwarts as Alcon and Advanced Medical Optics (AMO), niche companies such as Eyetech Pharmaceuticals, IntraLase and QLT, Inc., and laser vision correction providers, including LCA-Vision and TLC Vision. Even major pharmaceutical firms, Novartis, Pfizer and Genentech, have recognized the extent of the potential opportunity in developing effective treatments for the wet form of macular degeneration and now participate in that area of eye care.

Helping investors to sort through the increasing variety of choices in eyecare investments is a group of more than a dozen securities analysts working for firms ranging from mammoth Merrill Lynch to small "boutiques" catering to high net-worth investors. These analysts are called "sell side" because their research is "sold" to institutional investors, usually in return for the commissions generated by institutional trading. Institutions that purchase large amounts of stock for mutual funds, pension funds and exchange-traded equity funds may also employ their own analysts. These analysts are called "buy side" and tend to have much lower profiles than the analysts who work for the major brokerage firms.

In researching this article, Ophthalmology Management asked several sell-side analysts to discuss the methods and criteria they use to evaluate eyecare stocks. In addition, investor relations officers of three major eyecare companies were asked to describe how they deal with securities analysts in the new era of full and public disclosure of all material company information that is now required by law.

Creating the "Mosaic"

When a security analyst recommends a stock, the stakes are high. Not only are large sums of clients' money at stake, but the analyst is putting his or her professional reputation on the line. That is why analysts must carefully study, and then take into account, a large number of often complex factors before putting their seal of approval on a company's shares.

For example, when evaluating an eyecare company, an analyst must assess such key factors as the outlook for the overall marketplace that the company serves, the track record of the management team, the company's relationships with its customers, the company's reputation for innovation, the potential of the product pipeline and the company's financial health. To obtain this information, analysts talk to a variety of sources, including company management, physicians who use the company's products, industry consultants and competitors.

"Most analysts follow what's called the 'mosaic theory' in analyzing specific industries and companies," says Anthony Vendetti, a senior vice president of Maxim Group and an analyst who covers eyecare companies. "We gather information from various sources and put it all together into an investment thesis. First, I look at the macro-trends that affect the industry, things such as demographics. Then, I try to identify the companies that are going to be the winners within that industry. It's a top-down approach."

Some of the ways Vendetti obtains information about a specific eyecare company are by speaking with management, reading all the public filings that the company makes, going to as many industry conferences as possible, and talking to practicing ophthalmologists to get their opinions on new products the company has launched and their general feedback about how they view the company.

Vendetti says he judges each eyecare company he covers against its competitors.

"Before I can recommend a company, I must believe that management has the forward-thinking capability to achieve rapid growth," he notes.

Theodore Huber, an equity analyst who follows eyecare stocks for Wachovia Securities, also considers a company's capacity for growth a critical factor in his analysis.

"In addition to evaluating the product pipeline and the quality of management, I have to be satisfied that the company can grow the top line and expand its profit margins," he says.

	Steve Hamill, Healthcare Analyst, Piper Jaffray and Co. PHOTO COURTESY OF PIPER JAFFRAY AND CO.

Steve Hamill, C.F.A., vice president, senior analyst, Healthcare, for Piper Jaffray & Co., says he may put less emphasis on the product pipeline than some other analysts.

"The developmental pipeline is always important in the short-term, but it's less of a long-term indicator given the ability of a large company to acquire technology — particularly for companies that are more device-oriented than pharma-oriented."

Analysts also look for "red flags," early signs that a company may not be a worthwhile investment.

"A management team that has a poor track record with not much history of success is a bad sign," says Vendetti. "New products that are launched but not adopted by physicians is another. And sometimes there are clues in the company's financial statements that something is potentially amiss."

Hamill says an overly promotional management team raises doubts with him.

"Many executives feel that they must manage Wall Street," says Hamill. "They tend to 'spin' investors by glossing over the warts and overemphasizing the positives."

"Fieldwork" Provides Answers

Every analyst interviewed for this article placed a high priority on attending the major ophthalmology meetings, such as the annual meetings of the American Academy of Ophthalmology (AAO) and the American Society of Cataract and Refractive Surgery (ASCRS).

"These meetings are an opportunity to visit with multiple management teams in a short period of time, learn the latest clinical data, and talk to many physicians in one place," says Joanne Wuensch, who covers eyecare for Harris Nesbitt Gerard.

"AAO and ASCRS provide great value to analysts," adds Hamill. "There is no better way to see how a company is positioning itself to its customers than to see what they are doing at the booth," he says. "We also try to see if any new scientific data is presented that may make or break a product . . . particularly if it's a new product. Finally, there's no better opportunity to speak with numerous thought-leaders in a short period of time."

"The meetings are invaluable as a way to judge the competitive landscape and get physician feedback on products and companies," notes Vendetti.

The analysts interviewed say they have always spent a great deal of time in doing what they call "fieldwork" — talking to physicians about specific products and companies, observing procedures and even talking to raw-materials suppliers to determine if they have productive relationships with the eyecare companies that are their customers.

Fieldwork has become even more important since 2000, when a new regulation (Reg FD) mandated companies to provide full and public disclosure of all information that could materially affect the company. The spur for Regulation FD was the disclosure of chummy relationships between some high-profile analysts and the companies they covered.

"The regulatory changes have, in my opinion, forced a lot of poor research analysts out of the business," asserts Hamill. "No longer is it sufficient to work at a big-name firm, call up company management and find out how the quarter looks. This has made predicting the short-term even tougher than it was. Today, we are forced, to a much greater degree, to develop independent sources of information and think months, if not years, ahead."

"Analysts are doing more fieldwork because of Reg FD," says Vendetti. "Today, analysts must be skilled in the finance and accounting aspects of businesses, and also must be almost like investigative reporters in doing their fieldwork."

The Information "Gatekeepers"

The investor relations (IR) specialists at several major eyecare companies, including Alcon, AMO and Bausch & Lomb, told Ophthalmology Management that Reg FD has created a more level playing field for investors in terms of allowing all shareholders to obtain the same information at the same time.

"We will allow analysts to talk one-on-one with senior management, but only with an investor relations person in attendance," says Doug MacHatton, vice president of investor relations and strategic communications at Alcon. "These talks are never for the purpose of giving out new information. They are held so that an analyst can gain a better understanding of information that's already been publicly announced."

Clearly, one area of concern is data being compiled from ongoing clinical trials.

"All of our clinical investigators are governed by confidentiality agreements, which they are obligated to abide by when dealing with the public," says MacHatton.

Proof that Alcon's controls on information are working became apparent late last year when important study results from a trial of Retaane, the company's investigational therapy for wet AMD, were released. The data were disappointing, and Alcon shares immediately dropped more than $10 when trading opened.

"The fact that the stock dropped only after the public announcement showed that the information hadn't leaked out," says MacHatton. "The limited number of people who had the information took their pledge of confidentiality very seriously."

	Daniel L. Ritz, director of Investor Relations, Bausch & Lomb  PHOTO COURTESY OF BAUSCH & LOMB

At AMO, Sheree Aronson, vice president of corporate communications and investor relations, says the company's goal is to "ensure full access to everyone at the same time and to the same degree."

The company ensures equal access by issuing news releases, holding conference calls and making presentations at major meetings that are also Web cast. Like other major eyecare companies, AMO allows analysts to speak one-on-one with managers, but only with an IR specialist sitting in, and all of the company's clinical investigators are bound by confidentiality agreements.

"When we announced that we were purchasing VISX, it completely surprised the investment community," says Aronson. "That's a good thing, because it shows that the information was tightly held and didn't leak out."

Though Alcon and AMO were not publicly owned companies before the advent of Reg FD, Bausch & Lomb has a long history of dealing with the analyst community.

"Before Reg FD, analysts could ask the company to review their models and comment on them, and we did," says Daniel Ritz, director of investor relations at B&L. "If someone was off base with their numbers, we would walk through their assumptions to help them get to numbers that were more consistent with our guidance. Subsequent to Reg FD, it's our practice not to review or comment on analyst models."

Ritz says he looks at the IR group at B&L as "gatekeepers" who control the information that flows from the company.

"We'll allow analysts one-on-one contact with top management, but if there's an inadvertent slip and something material comes out of the conversation, we'll immediately disseminate that information through a press release."

Are Analysts Misunderstood?

Though their relationships with analysts are largely governed by the restrictions imposed by Reg FD, company IR specialists say today's analysts are intelligent, hard-working and ethical. Most of them have backgrounds in accounting and finance, and many, like Vendetti and Huber, have years of experience inside the healthcare industry. The perception among many novice investors that Wall Street runs on so-called "inside information" could not be more wrong, say analysts and company officials alike.

"People think that analysts are trying to get an edge with inside information," says MacHatton. "Their real objective is simply to understand the industry and our business better so that they can make an accurate evaluation."

"As we call on physicians in the industry to tap their knowledge and vision, I hope they will recognize that stock analysts do provide a valuable service in return," Hamill concludes. "Hopefully, through our work we can help direct investor funds to companies that provide the best service to physicians, and/or products that meet large, unmet needs in patient care. Such companies typically provide the greatest financial rewards in the long run."