Confessions of a Wall Street Analyst (21 page)

But MCI didn’t respond to either GTE’s or WorldCom’s offer, and Bernie lost his patience. On November 10, 1997, nearly a month after GTE’s bid, WorldCom upped its offer, announcing in a conference call that it would pay $51 per MCI share in stock, up dramatically from the earlier $41.50. Bernie, ever the cowboy, called Bert Roberts, MCI’s CEO, his “new boss” during the conference call, although of course the opposite would be true.

WorldCom’s CFO, Scott Sullivan, Bernie’s straight man, reiterated his estimates of the cost savings and additions to earnings per share that would result from the merger over the next five years. Indeed, Scott’s intimate knowledge of every cost item was impressive. He sure seemed to have a handle on the details.

In the end, GTE folded, BT bowed out, and MCI enthusiastically, or so it appeared, accepted WorldCom’s offer. WorldCom had won control of MCI in a deal worth $37 billion. Although I felt a little uneasy about the
snake devouring the elephant, it would have been suicidal to bet against WorldCom at this point. WorldCom’s bold takeover of MCI, a company four times its size, was the event that signified the arrival of telecom to the center of the world stage.

Our once-sleepy industry was suddenly looking like
Barbarians at the Gate
all over again, with breathtaking hostile takeover offers fueled by a stock market that was making anything possible. In four short years, a tiny upstart company run by a former gym teacher had catapulted itself into the same league as old Ma Bell. WorldCom symbolized how the telecommunications industry had transformed itself from a snooze-inducing swampland to the glamour girl of the Street.

And we, the analysts, were at the nexus of it all. On one hand, we were trying to deliver thoughtful analysis on what the deals really meant; on the other, we were influencing the deals themselves by advising the companies involved and pushing our vision of the industry out to the world with our research. It was a high-stakes balancing act, for sure.

This was also the event that catapulted the team of Jack Grubman and Bernie Ebbers to the top of the telecom universe. The two reinforced each others’ power, daring anyone to match their audacity. Within hours of MCI’s accepting WorldCom’s bid, Jack Grubman, his disastrous secret-document claim now a relic of the past, told anyone who would listen that he was the guy who convinced Bernie and Scott to make the offer for MCI. He may or may not have been, but it didn’t matter: Jack’s behind-the-scenes role in WorldCom’s acquisition of MCI made him into a magnet for the buy-side. Money managers and buy-side telecom analysts began to realize that Jack might know about market-moving events before they were announced. He brandished his image as the telecom industry’s consummate insider, one who orchestrated mergers and acquisitions, brought in big fees for Salomon’s bankers, and according to some buy-siders, provided advance notice of upcoming deals. All I could do was sit back and watch.

Jack Plays Loose: I Play Banker

A few months after WorldCom won MCI, the next round of Bell mergers got rolling. SBC, formerly Southwestern Bell, pounced on Ameritech, the Chicago-based Baby Bell. SBC would now have a geographic reach that covered one-third of the United States, stretching from California to Texas to
Ohio. The $62 billion deal was announced on Monday morning, May 11, 1998, and made perfect sense to me. The two companies had lots of duplicate costs that could be eliminated. Plus, an enlarged service area was particularly important for improving service to traveling (“roaming”) cell phone customers and for SBC’s plans to begin offering long distance services.

That wasn’t the spin the chairmen, Ed Whitacre of SBC and Dick Notebaert of Ameritech, used, however. They promised the deal would help the American consumer because the money the merged company saved would be used to build its own startup local carriers in areas outside its own traditional service regions. That, they argued, would bring competition and lower prices to customers served by Baby Bells Bell Atlantic, BellSouth, and US West. To pitch the deal as pro-consumer was absolutely critical because the Federal Communications Commission and the Antitrust Division of the U.S. Department of Justice were beginning to take a hard look at whether the telecom merger wave had gone too far.

Although I was a supporter of the Baby Bells, I thought Ed Whitacre and Dick Notebaert’s pro-consumer story was total bull and was presented for one reason only—to get government approval. It was too late and far too expensive, in my opinion, for SBC, or any of the Bells, to begin the long process of building local telecom carriers in other areas, and they were probably too slow and bureaucratic to get it done anyhow. And, most important, the Bells had lots of great opportunities to grow
inside
their own regions by offering long distance, wireless, and high-speed Internet access services. So what was the point of major spending outside their home areas?

But that wasn’t what Jack Grubman was saying. Suddenly, the guy who had ridiculed everything the Bells had done for the past several years did a complete about-face. Jack wrote, “The reason we have always liked Ed Whitacre is in a sense he reminds us of Bernie Ebbers.”
⁵
Given Jack’s endless worship of Bernie, it seemed that he was anointing SBC boss Ed Whitacre a king.

In my mind, Ed Whitacre was indeed very smart and savvy, and I liked his personality. He was a circumspect and serious Texan who avoided the Internet and dot-com hype that so many others in the telecom industry were embracing. Jack’s firm, Salomon Smith Barney (SSB), was SBC’s adviser on the deal. Even though Jack had argued that SBC’s purchase of PacTel and Bell Atlantic’s acquisition of NYNEX were both bad moves, he now lauded this similar deal as brilliant and good for both consumers and shareholders.

Many savvy buy-siders looked cynically on what Jack was doing. One
e-mailed me later that morning, attaching Jack’s report on the merger with a cover message: “Here’s the JG scoop—and to me it reads as if he is getting paid by SBC for this note. In other words, for SSB to get the big money on this it has to go through, and for that to happen the DOJ must be satisfied that this will probably add to competition. If you like this deal—which you seem to—I’d pipe down and let JG do his magic!” I doubt that SSB’s retail investors understood it quite this way.

I don’t know for sure whether or not Jack was brought over the Wall on this deal and therefore knew about it beforehand. But on May 6, 1998, just five days
before
the merger was announced, Jack had come out with a report called “CLECs [Local Startups] Surpass Bells in Net Business Line Additions for the First Time.” Never mind that his math was wrong. What mattered was what he wrote toward the end: “If [a Baby Bell] acquires assets for capabilities that take them away from being a regional carrier on defense into a more offensive, fully-integrated national or even global provider, then we would gladly rethink our investment position on that particular [Baby Bell].”
⁶

What he seemed to be signaling was that if a Baby Bell began to compete out of its home territory, exactly what SBC and Ameritech were now announcing, he would consider upgrading it. There was nothing illegal in a statement like this, but it sure seemed to me that he already knew something was coming and that he was laying the groundwork for the news to come and for his radical reversal of opinion.

On the morning of the merger announcement, May 11, Jack published a long and detailed report on First Call, the wire service for research reports, at 10:09, just 20 minutes after the Whitacre and Notebaert investor conference call about the merger had ended. I had barely finished listening to the call and had just begun to write up my initial comments when his report crossed the wire. He didn’t give any recommendations about SBC or Ameritech shares, because, with SSB advising SBC, his compliance department would likely have limited his commentary to the publicly announced facts of the merger. Since Salomon would be collecting a fat fee for advising SBC, it would face a conflict of interest between its corporate client, SBC, and its investor clients. Nevertheless, he did brashly add a few sentences that 99 out of 100 compliance officers would have—and should have—deleted.

“From an SBC perspective,
assuming this line is kept in by our lawyers,”
he wrote, “we think the strategic moves they are making will clearly be addi
tive to long-term shareholder value.”
⁷
In effect, he had issued a buy recommendation on SBC, and even Jack thought he was going too far, hinting that that line would be deleted. But it wasn’t.

In conversations with my buy-side clients, I also learned that Jack had been telling people that morning that SBC had been planning to announce a deal to purchase an unnamed startup local carrier at the same time as it announced its Ameritech acquisition. The implication was that such a deal might still happen. Had he been told this in over-the-Wall meetings? I figured this, along with the comment in the research report, might set off alarm bells over at the Securities and Exchange Commission. Maybe, finally, someone would start an investigation.

The next day, I wrote a client the following e-mail: “…Interesting to essentially upgrade a stock for which he is restricted. He may have finally tripped the wires at the SEC…. Word is he is whispering that the original SBC plan was to announce [an acquisition of a startup local carrier] today in addition to the Ameritech bit.”

The client wrote me right back. “As for JG, it was no whisper. His salespeople left me a message saying he thought SBC would announce a [local carrier] deal with the Ameritech deal but it will come soon.” With information like that, money managers might load up on a group of startup local carrier shares that day and hope for a big takeout price on one of them. But the deal never came: Jack’s information, wherever it came from, might have been juicy, but it wasn’t always right. Just like the BT-MCI secret addendum.

What was most fascinating about this deal was that Salomon got the banking business even though Jack had been negative on SBC before the deal was announced, rating it only a “3,” or Neutral. Was this because SBC, to its credit, didn’t pay attention to the research position of the analyst and simply hired the bankers it liked best? Or was it more strategic than that? Did SBC hope to turn Jack around with this deal, bringing the top-ranked telecom analyst to its side? We’ll probably never know. But when I visited Ameritech’s CEO, Dick Notebaert, in Chicago later that month, he told me that the folks at SBC had assured him an upgrade from Jack was in the offing.

My banker colleagues were distraught. Neither company had hired Merrill as a merger adviser, and they were particularly distressed to be excluded because it would cause Merrill to suffer in the M&A “league tables,” a ranking compiled by Securities Data Corporation (SDC). SDC measured the value of each M&A deal and tracked which investment banks had been
hired as advisers. Its results were published every quarter in
The Wall Street Journal
and
The New York Times.

These league table rankings were to investment bankers what the
I.I.
magazine analyst poll was to sell-side research analysts—a very silly measure that often inspired absurd behavior. Just as analysts traveled to Birmingham, Alabama, for a one-hour meeting with one voter, bankers offered services for cut-rate fees. Merrill was building a very successful M&A practice and, at this moment, it was ranked number one, leading Goldman Sachs by about $40 billion. But this deal was worth $62 billion, so missing out on this merger would push Merrill down in the rankings and boost the firms hired by SBC and Ameritech—Salomon and Goldman Sachs.

I was really perturbed. I felt strongly that SBC was hiring Salomon to buy an upgrade from Jack and get the benefit of his influence in Washington. The first, I thought, was wrong, and the latter would backfire. The staffers at the FCC had to know Jack’s games. So, motivated by a sense of outrage and hoping to help my firm as well, I did something I’d never done before: I decided to don the banker hat and try to convince Ameritech to hire Merrill as its second adviser (in addition to Goldman Sachs). I met with Ameritech’s conservative CFO, Oren Schaffer, in New York and basically pulled out all the stops. I explained that 30 of the past 38 mergers had had two investment banks representing each side, and that Merrill would work for as little as $1 million. It simply wanted its name attached and league table credit. I also told Oren that they and SBC looked silly cuddling up to Jack. “Everyone knows that his positive comments are driven by banking fees,” I said. “The regulators will see through him too.”

This was an aggressive role for an analyst to play, one that could certainly be perceived as a conflict of interest. But I had not been forced into it by anyone on the banking side, nor would my compensation be impacted by the outcome. Banking interests had never affected my investment opinions, and I had been positive on SBC and Ameritech and on Baby Bell mergers for three years already, anyhow. I simply wanted to help my banking colleagues, and I’d had it with Jack’s questionable methods.

Oren punted, suggesting that I meet with his boss, Dick Notebaert. So, a few days later, I flew to Chicago and met Dick for breakfast at the Four Seasons Hotel on Chicago’s Near North Side. I knew Dick well, as he had been a top Ameritech executive when I started at Morgan Stanley. He was short like me, sarcastic, and into corny practical jokes. Back in 1994, when I was cautious on the Baby Bells, I had written that they were stuck in a “div
idend straightjacket”—meaning their investors were demanding continuation of the annual cash dividend when I believed that the Bells should invest their cash in new growth businesses. Dick sent me a real straightjacket after reading that report. I suppose it was funny.

Still, I thought Dick was a logical and reasonable guy. So I laid out the same argument again. He listened carefully, and said he appreciated the issues. He also explained his choice of Goldman Sachs. Goldman, he suggested, would likely be very helpful in getting the merger approved by federal regulators, since Bob Rubin, former co-chairman of Goldman Sachs, was now U.S. treasury secretary in the Clinton administration. Dick said that he’d get back to me.