City: Queens Moat shocks sleeping City

THE analysts at Paribas Capital Markets could hardly have been more wrong last August: 'The share price has reacted as if the company was in financial difficulties,' they said about Queens Moat Houses. 'We do not believe this to be so.'

Although it will be a little time before Grant Thornton - the accountants sent in by the banks - sort out what has happened at Queens Moat, there can be no doubt that things are serious. A freeze on repayments on most of the pounds 1bn bank debt is a sign of a company in dire straits. And with the joint managing director, Martin Marcus, and the finance director, David Hersey, suspended, you have to fear the worst. (The Stock Exchange will no doubt have some sharp questions for Mr Marcus, who sold half his shareholding the day before the closed period for directors' dealings began last February.)

To be fair to the analysts at Paribas, they were not alone - not by a long way. Most of the City agreed with them. Almost all the big broking houses had put out bullish notes about the company in recent months. Coming so soon after the fall from grace of Spring Ram - one of the City's favourite stocks - the failure over Queens Moat should perhaps be a signal for the brokers to rethink their research process and share recommendations.

The trouble with being a stockbroker is that you have to sell shares to stay in a job. When confronted with a sector as shot to pieces as hotels, however, this becomes difficult. You cannot keep telling your clients to steer clear of hotel stocks year after year because you won't get any business. You have to tell them something else instead - you have to be optimistic. Perhaps this is why so many brokers chose to accept what the hotel companies told them, when they should have been more sceptical.

The brokers will certainly claim that they were not, at the very least, given the full facts by Queens Moat. But this is only half a defence.

It is naive to place too much faith in company directors, even at the best of times. Unfortunately, it is quite normal for brokers to do so.

It is standard practice for analysts to discuss the company with its management, make some estimates, run them in front of the finance director and, by the movement of his eyebrows, judge how close to the truth they are. This makes no allowance at all for the danger of being given inaccurate information by a director, or not being told crucial facts.

In the case of Queens Moat, brokers were confident of their forecasts because their discussions with the company's top directors had been more than usually thorough - or so they thought. Whatever it is that has gone wrong at the company clearly did not surface in those discussions. This left the analysts toeing the company line that things were not bad, that Queens Moat shares looked cheap, and that the company's profitability would recover with the UK economy.

In any case, Queens Moat was the kind of company the City always warms to. It could be relied upon to go on expanding even when the hotel market looked bad. Only six months ago, it was saying that its policy of expansion was unchanged. Common sense might have suggested that here was a management becoming detatched from reality, but the City did not see it that way. What the City apparently saw was nice corporate finance and underwriting fees from a company that made seven rights issues in 10 years to fund its growth.

What too many analysts failed to do was examine the company's figures with a cool and critical eye. When, for example, common sense suggested that if a hotel company's profits are collapsing, the value of its hotels must be falling too, the brokers ignored it. In companies like Queens Moat, asset values have remained surprisingly constant - and most of the City accepted this almost without question.

Some brokers confessed themselves unable to explain why a somewhat worrying shrinkage in profit margins on Queens Moat's important German business had taken place last year. For some reason, they do not seem to have been aware that Germany was heading steeply into recession at that point and that recession hits hotel profits hard.

While the dramatic nature of last week's events at Queens Moat was a surprise, the discovery that it has problems should not have been a bolt from the blue. Even more embarrassing for most brokers is that a small band of analysts had done their homework. Mark Finnie at NatWest Securities, for instance, was warning about cash flow and banking covenants last summer. The stock market also smelt a rat. Ignoring the blandishments of the brokers, the market chopped the Queens Moat share price from 90p to less than 30p at one point last year, before pushing them back up towards 50p. Clearly, some of the truth of Queens Moat could be glimpsed by those who looked for it hard enough.

In the meantime, the Grant Thornton team is crawling over the books. Who knew what, and when, at Queens Moat may emerge next week. By the time the full story comes out, let's hope the broking houses will have learnt a few simple lessons about research.