Confessions of a Wall Street Analyst (19 page)

It was a very tense moment. I had no idea what Megan and Mark had already said, what my competitors were saying, or whether new information had come out overnight that might have changed our point of view. I didn’t even know for sure what we had said in that morning’s report. When Chris finished his comments, I interjected that I had just joined the call from Italy and was available to answer questions.

The first one came from a portfolio manager at a large British pension fund who apparently owned a large slug of BT shares. “Do you guys think BT will proceed with this deal, as many sell-siders and MCI seem to be suggesting, or will the terms be renegotiated to a lower price?” It was a perfectly reasonable question and, boy, was it chock-full of information. His words suggested to me, though I couldn’t be sure, that while I was sleeping, MCI executives had reassured investors the deal was going through as planned, and that, apparently, most of my competitors believed them.

Chris, Mark, and Megan all knew that I should be the one to take that question. I realized I had a split second to make the call on something I hadn’t really thought through. I had not read the MCI-BT merger agreement and thus I didn’t even know what rights BT had to terminate or force a renegotiation.

But sometimes even analytical types have to fly by the seat of their pants. So, sitting on the edge of the hotel bed, I blurted, “Of course this deal is getting renegotiated! MCI just cut its earnings outlook by 40 percent, and we’ve cut our earnings estimates from $2.00 to $1.15 a share, in part because of local entry costs, and also because of a much tougher long distance business, problems we’ve been forecasting for two years [never miss a chance to toot your own horn]. I can’t imagine that BT, or its shareholders, could stomach paying as much for a company with $1.15 of earnings power as one with $2.00 of earnings power.” Chris picked up the logic and backed me up.

I didn’t realize it, but my off-the-cuff prediction had just propelled me into a hailstorm of controversy. I had locked myself into a position that absolutely no one else supported. With our vacation coming to an end, we
drove north to Milan to catch our respective flights. Paula flew home, and I began a week of prescheduled meetings with institutional investors in Milan, Zurich, Amsterdam, Edinburgh, and London. Many of the clients, especially the British, happened to be loaded up on BT shares and were extremely upset about the MCI news and the negative impact it was having on BT’s stock.

As I traveled from meeting to meeting, I received numerous press calls and returned one to Richard Waters, a reporter I knew from
The Financial Times.
Talking to the media was an easy way to broadcast my point of view quickly without having to call scores of clients and salespeople.

Richard quoted me in the next day’s
Financial Times,
one of the most widely read financial newspapers in the world: “A renegotiation is imperative—it’s absolutely going to happen.” Further, he said, I was predicting a 20 percent reduction in the price BT would pay for MCI.
²
I also received a barrage of calls from my traditional buy-side clients, as well as from a new constituency: risk arbitrage funds.

Arbitrageurs, or arbs, for short, make their money on the difference between the stock prices of companies involved in a merger. In this case, arbs had earlier bet that MCI’s price of $25.13 on the day before the deal was announced would slowly rise to BT’s takeout offer of $41.80 as the deal neared completion. As a hedge, they had also bet that BT’s stock would fall in the same period of time, which is what usually happens to the acquirer’s stock in a takeover. But now that MCI’s earnings had tanked, the arbitrage bet had been called into question.

Needless to say, the arbs were completely spooked by the MCI news. If MCI’s bad news led BT to pull out of the deal or to demand a lower price, the arbs would lose lots of money. Not only would their ownership position in MCI shares get killed when MCI shares tanked, but BT shares would rise, doubling their pain. It would be the opposite of what they had bet, and it would squeeze the arb community harder than anything had before.

Nothing matches the intensity of an arb whose bet on a merger is going awry. The arb guys are tough guys—smart, quick, and probing. They often are lawyers or have access to the best and most expensive legal advice in the world. Much of their work depends on understanding the fine contractual details of merger agreements.

Although it seemed totally logical to me that the deal would be renegotiated, I was nervous about my stance. Logic, I’d learned, didn’t always mat
ter when it came to the stock market or corporate decisions. Most of my clients and the arbs thought I was wrong, and they had no problem telling me so, sometimes forcefully. Merrill’s retail brokers and salespeople were razzing me, too, because they were hearing from their clients that most of the “smart guys” on Wall Street (including some well-known arbs and, of course, Jack Grubman, best known for his inside connections in the telecom industry) had opposite opinions from mine.

Even my own team was beginning to get worried. None said it out loud, but I sensed they were definitely wondering if I had jumped the gun with too little information. After all, they knew I hadn’t even read the merger agreement yet.

With my London meetings done, I hustled to Heathrow Airport, checking my voice mail en route using the driver’s cell phone. The first call I returned was to an American reporter at the Dow Jones News Service, at that time the most widely read electronic news source in the investment world. Asked why my opinion was so different from everyone else’s, I said I was puzzled too. “Those who don’t see a change coming must have taken those little pink pills that I refused to take in college,” I chuckled. “That stuff can come back on you years later.” As we hung up, I thought to myself:
She’s not going to use that quote, is she?
Of course she was.

We were stuck in London traffic. So I returned another call, this one from an investor client whom I had known for several years and respected. He was a very thoughtful and clever attorney-turned-investor who had put the arb spread on the BT-MCI deal. He had read the merger agreement several times, it seemed, and he had talked to Jack Grubman too.

This client was usually as gentlemanly as they come. But not this time. He barked into the phone, “Dan, you are wrong. Have you read the agreement? You’ve got to, especially the part about a confidential addendum. It says BT has no right to back out of the deal if MCI’s problems stem from its attempt to enter the local market.”

Uh-oh. Confidential addendum? This was the first I’d heard about any confidential addendum, and it terrified me.

“Okay, I’ll look at the agreement as soon as I get home,” I said, trying to remain calm but quaking inside. This guy knew his stuff, especially with regard to mergers, and he was telling me BT couldn’t renege on this deal.

“But, tell me,” I continued, “how do you know what’s
in
the confidential document?”

“Grubman’s got it. He told me,” was my client’s smug reply.

My frustration boiled over. Once again, Jack was claiming to have information that no one else did and using it to bolster his case.

“Get a copy of the damn document and then let’s talk, okay?” I snapped. He agreed and we hung up. We talked several times over the next few weeks, but if he ever got a copy, I never heard about it.

Could Jack really have a secret document that only BT and MCI insiders had access to? Since I knew how skilled he was at getting information, his assertions made me very, very nervous. If he was right, I had made a grievous error in judgment, the merger would go through as announced, and I would look as if I had no idea what I was talking about. I hadn’t done a lot of digging into the merger agreement, but when I finally got my hands on it and looked at the fine print, there was indeed a reference to some kind of confidential addendum. Yikes!

When I thought about it, however, I couldn’t understand why a renegotiation clause would be kept secret. Wouldn’t that be something shareholders—the company’s owners—had the right to see before approving the merger? More sensible to me was that the addendum included some confidential competitive information, such as MCI’s plans for local entry, which the company didn’t want to get out to competitors. So even though Jack had been right about the existence of the addendum, the idea that it actually locked BT into this deal with no way out still seemed pretty unlikely to me. I also figured MCI’s financial strength was weakening so much that the last thing CEO Bert Roberts wanted was to lose this deal. I thought he might be willing to take a lower price for fear of losing the deal entirely. So I stuck to my guns and told anyone who would listen that the price BT would pay for MCI would be cut by roughly 20 percent.

Once again, Jack and I were on opposite sides of an argument. But as increasingly seemed to be the case, his argument had the most believers by far. I was all alone on this one.

MCI/BT: The “BloodBath”

For the next month or so, the worried calls from investors continued to stream into my office, MCI kept insisting the BT deal would stand with no changes, and I kept insisting that it couldn’t. And then, one early August morning in my New York office, I received an interesting call from two guys
from BT’s strategic analysis group. They told me that the executive team was holed up in a conference room at MCI headquarters in Washington, where they were reviewing MCI’s new financial forecasts and trying to figure out what had gone wrong.

I asked whether they were considering renegotiating, but they wouldn’t tell me. Instead, they had a lot of questions for me. This was unusual, but it wasn’t unheard of. I sometimes received calls from telecom executives, asking for further elaboration on my reports or outlook. In some cases, they hoped to change my mind or glean some tidbit about a competitor. I had often been asked to make presentations to management and, in some cases, to the boards of the companies I covered. There was nothing nefarious about this, at least as long as they didn’t share any nonpublic information with me.

The BT folks asked me about Qwest, and it quickly became clear to me that they knew virtually nothing about the company. This made it all the more amazing that the top executives at BT had been willing to get into bed with MCI without adequately understanding its competitors. Were they asking because they were interested in buying Qwest or because they were finally realizing how tough a market long distance was? I felt the tiniest bit of hope that maybe, just maybe, these guys were questioning their decision.

I had just written a lengthy report initiating coverage on Qwest, with an Accumulate, or “2” out of 5, rating. They asked me to fax it to their hotel. About five days later, on August 5, the BT strategy guys called again. This time, they asked me to meet with BT’s CEO, Sir Peter Bonfield, and its CFO, Robert Brace, in Sir Peter’s suite at the Four Seasons Hotel in Georgetown. So I flew down to D.C. and slipped into the Four Seasons around 11:00
PM
.

At 10:00 the next morning, I took the elevator up to the appointed suite. I hadn’t told a soul about this meeting. Certainly, Merrill’s M&A bankers would have eagerly accompanied me if they had known about it. They had been frozen out of the big fees from the BT-MCI merger and would have loved to pitch some different strategic moves to Sir Peter and Robert Brace. But the BT guys wanted this meeting kept quiet and I saw no reason to ignore their wishes. I wasn’t sure what they wanted from me, so I’d prepared some handwritten notes about various options for partnering in the U.S.

As I sat in the lavishly appointed suite, I realized I had a chance to influence how this deal would end up. I believed that BT should hightail it out of Dodge, because merging with MCI could be the worst decision in its long
history. The existing long distance companies were already suffering early signs of decline, and their market was about to be invaded by the Baby Bells. Sir Peter, an understated British executive with a gray beard and a slight frame, led the questioning. First, he asked what his shareholders were telling me.

“The British fund managers,” I said, “who own far more BT shares than MCI shares, clearly want this deal to go away or, at the least, for you to pay a much lower price. The Americans, on the other hand, tend to hold more MCI shares than BT shares, and thus are praying the deal closes with no change in terms. And then there are the arbs,” I continued, “who own very large blocks of MCI shares and have bet against BT shares, and who desperately need you to bail them out by sticking to the original price.”

Sir Peter moved on. “What about the new telecom companies in the U.S. market? Are they going to amount to anything?”

“If I were going to buy a long distance company,” I said, “I would much rather buy something like Qwest than MCI. Qwest will have a brand-new network, using the latest and most cost-efficient technologies, and thus will be able to offer long distance service at prices far lower than MCI, AT&T, and Sprint.” I was telling them the same things I was saying to investors and anyone else who would listen—that buying MCI would be a bad move. “Further,” I continued, watching Sir Peter’s and Robert’s stony faces, “Qwest can target the best long distance customers, stealing those who generate the highest profit margins.”

No one said anything to me about what they intended to do, and I didn’t ask. Robert chuckled at one point, nervously (or was it just that British way), that they had “alternatives,” which I hoped implied that they weren’t locked in by any confidential addendum. But of course I couldn’t be sure.

Clearly, Sir Peter was in a tough spot. His board could easily turn on him if he went ahead with such an obviously overpriced deal. On the other hand, his board could also nail him if, after three years of partnership with MCI, the merger and BT’s global strategic plan fell apart. If he tried to renegotiate the deal with MCI, MCI might fight back on legal grounds or simply try to prolong the process, further pressuring BT’s share price.