Confessions of a Wall Street Analyst (27 page)

It was now 6:00
PM
and the documents and dinner plans were being finalized. When Sol heard about Joe’s threats, he was not a happy man. But he was in a pickle. His largest shareholders liked the Qwest deal and were far less concerned about his ego than their financial returns. They respected Joe as a terrific telecom manager, even if his brash personality rubbed some of them the wrong way, and many felt that Joe’s style was exactly what was needed to make it in this Wild West telecom industry. More important, with the deal’s terms already fully vetted in public, Sol could not possibly ask his board or his shareholders to walk away from the deal because he was not happy with his own role.

Sol knew Joe had maneuvered him into checkmate. Sol reconvened his board by phone and recommended approval of the new deal with himself as co-chairman and Joe as CEO and co-chairman. Joe would run every aspect of the company and Sol’s role would be largely ceremonial. US West’s board approved the recommendation. And poor old Sol retreated to his hotel room.

I hadn’t been over the Wall for any of this, and I’d been happy about that. From what I could tell from the outside, it was a huge mess. But then Tom Middleton called. He told me that Joe and Sol wanted the research analysts at their bankers’ firms to help them prepare for the announcement by anticipating questions, reviewing the slide presentations, and playing devil’s advocate. With his usual sarcasm, Tom said “Dan, you and Paula aren’t going to golf camp this weekend, are you?” Middleton was referring to the year before, when I’d canceled golf school after Bell Atlantic announced it was buying GTE. The funny thing was that we
were
about to go, and this time I wasn’t missing it for anyone.

“Well, Tom, that’s great,” I said. “Congratulations to you. But, in fact, we
are signed up for golf camp again, and this time we’re going to go. I don’t care if I have to do 10 conference calls from the putting greens, but this time we’re going.”

I wasn’t trying to be ornery, but I’d been through this stuff before, and frankly, it had lost some of its luster. Sure, I knew Al and Sol were already angry with me and that my firm had $30 million riding on the deal. But, realistically, what value was I really going to provide at this point?

Tom and I both knew the analysts would sit around all weekend with their feet up on some DLJer’s desk until around 11:00 on Sunday evening, at which point Sol and Joe, although they hated each other, would stroll into a conference room, oozing self-confidence and pretending to be blood brothers. What was the point of skepticism when the deal was done, definitive agreements were already signed, and
The Wall Street Journal
and
The New York Times
had already been spoon-fed the scoop? Most important, each of our firms was being paid between $10 million and $30 million. Why would any of the bankers want a research analyst to ask any skeptical questions at this late stage in the game? Even I saw the downside of that one.

Tom, realizing I wasn’t going to change my mind, confirmed my cell phone number and said good-bye, mumbling something like “I should have been an analyst.” But despite everyone else helping Joe and Sol get ready, both of them were in for another disappointment after the news crossed the wires on Monday morning. Global Crossing shares fell heavily, from $46.38 the day before the announcement to $26 over the next two months, while the other acquirer, Qwest, dropped 16 percent, US West fell 7 percent, and Frontier slipped 17 percent in the same period.

To Publish or Not?

By mid-July, it had been exactly four months since I had written anything other than factual summaries on Global, Frontier, Qwest, and US West. And although I had made what I thought was the best decision at the time, I was really beginning to suffer for it. I had been essentially mute on four of the major companies in my industry for months while my competitors, whether they worked for the banks involved or not, continued to speak out. The Merrill salesmen and my clients were calling me all the time looking for some guidance on these falling stocks, and I couldn’t say anything during the most important period of the year for me—the time when the
I.I.
votes were cast.

I felt more and more anxious. What the others were doing didn’t seem right, but clearly no one was objecting to it, and I, as the lone holdout, was the only person paying the price. So in a move that now looks blatantly inconsistent, I decided to resume coverage of Qwest and US West. I issued reports on each of them with Accumulate, or “2,” ratings, on July 21.

My earlier conversations with the lawyers didn’t really play into it at all, at least not at first. I liked the way the two deals had ended up. In the Qwest–US West deal, I thought the decision to dramatically cut US West’s dividend was wise, since it freed up money to invest in cell-phone service and high-speed Internet access, among other things. Plus the stocks had fallen so far that they were now good values. Based on my models, I saw Qwest shares rising as much as 33 percent and US West’s 28 percent.

But I wasn’t totally sanguine either. “Our rating is Accumulate instead of Buy,” I wrote. “Despite such attractive upside, we anticipate the usual pressure from short-selling arbs and the approximate one year wait until merger close. We are also concerned about increasing wholesale [long distance] pricing pressure and new initiative startup costs at both companies.”

Megan and I immediately started to work on a similar report on Global Crossing and Frontier. But, within a few days, I began to have second thoughts. Merrill was going to make about $20 million, but most of the fee depended on the deal actually being consummated. Since the shareholder votes hadn’t yet happened, it occurred to me once again that perhaps I shouldn’t be writing about any of these four companies. My opinion, if positive, could be interpreted as trying to influence shareholders to vote yes on a deal that Merrill had millions riding on. I asked the compliance folks about it, and they reminded me that I was cleared to write whatever I wanted thanks to the SEC’s No-Action Letter.

But I quickly realized that regulation or no regulation, I had just violated the principles I had so steadfastly held to back in March when this particular four-way M&A episode got started. I began to fear that my clients might think my report was not an honest one, and that it was somehow tainted by the interests of Merrill’s bankers.

So I made yet another arbitrary decision. Though I couldn’t undo the Qwest and US West reports and their Accumulate ratings, I told Megan to stop working on our resumption of coverage of Global Crossing and Frontier until the shareholder vote was over. As with every move an analyst makes, this decision translated to someone important being unhappy. This time it was Global’s chairman, Gary Winnick, and his CFO, Dan Cohrs. They were
outraged that while many analysts were writing bullish reports, I hadn’t yet published an opinion or forecasts for either Global Crossing or Frontier.

Then there was the fact that I had already written such reports about US West and Qwest. My position was obviously contradictory. After all, Global had hired Merrill to be advisers. Wasn’t it reasonable to expect some support from their friends? Gary scheduled a meeting with Dave Komansky, Merrill’s CEO, and the bankers told me the lack of research “support” would probably come up. Although Dave never said anything to me about Gary or Global Crossing, I felt that I was really pushing it this time.

So here I was, having set the wrong precedent by writing on the first two companies and now trying to defend my decision to
not
reinstate coverage on the other two. I had ignored the shareholder-vote conflict issue in one case and now was invoking it along with my integrity in another. It was pretty inconsistent. Logic suggested that I should publish on the second deal just as I had on the first. On the other hand, two wrongs didn’t make a right. So I decided to stick to my guns and not publish until after the Global Crossing and Frontier shareholder votes were complete, which fortunately was just a few months off.

In September 1999, after the Global Crossing–Frontier deal had been approved by both sets of shareholders, I resumed coverage of Global Crossing with an Accumulate rating. By the end of the year, investors’ negative reactions to the deals had dissipated in the ongoing frenzy for Internet and telecom stocks. Global Crossing shares bounced back to $50 per share, not as high as the $64 they had reached on May 13 but still more than double the $23 they had traded at a year earlier. And Qwest shares had recovered, too, to $43 per share, down from a mid-April high of $48 but still up 72 percent in the last year. Not bad for companies that had gotten into a bidding war, generated enormous shareholder confusion and anger, and had turned themselves inside out from pure Internet startups to schizophrenic hybrids now owning both new-and old-economy assets. I felt a bit schizophrenic myself.

1999

The contract was ready for signing. All I had to do was put pen to paper and I’d have a nifty $1.5 million bonus that I hadn’t even expected, in addition to having doubled my pay. It was truly surreal. The most surreal thing of all was the fact that the bank would never even miss it. A mere $1.5 million? For CSFB, it was a blip, nothing more, nothing less.

“Shame on Them?”

I
N THE FALL OF
1999,
Institutional Investor
magazine published its annual ranking of the All-America Research Team, along with a cover story looking at the trends in the research business and the changing role of the research analyst. For the third year in a row, I was the second-ranked telecom analyst, behind Jack Grubman. I wasn’t surprised at all: he was not only the best-known analyst in telecom but also the best-known analyst on all of Wall Street. Some hated him, some loved him, but everyone listened to what he had to say.

And if you really listened to what he said, it was pretty amazing.
I.I.
interviewed Jack as part of its cover story, and he was proud to speak out, a man at the top of his game. He made no apologies for his aggressive actions in favor of the companies he liked, as well as his role in helping Salomon Smith Barney’s bankers land some of the biggest deals on the planet.

“Though some money managers grouse that they can never get him on the phone because he’s so busy helping out on deals, many more rave about the connections he’s made with top telecom company executives from all that deal making,” the magazine wrote.

Jack’s response was bold, even for him. “‘The role of the sell-side has changed so dramatically. You try to do your best to stay objective, but it’s becoming an increasingly difficult challenge,’ says Grubman, stressing that disclosure of potential conflicts to clients is essential. ‘They know when I have an ax to grind—I tell them. There are known conflicts and potential land mines. But anyone who steps on one, it’s really shame on them.’”
¹

Earlier that year, Jack even announced proudly to a rival banker that “when it comes to Bernie and me, there’s no Chinese Wall.” He also sent a blast voice mail to upward of 1,000 buy-side analysts and money managers mocking a competitor at PaineWebber who had predicted that WorldCom would end up acquiring Nextel, a wireless company, despite the fact that negotiations had recently been broken off. “I was there and I didn’t see [the PaineWebber analyst] there across the table,” he bragged. “Believe me, these companies are not getting back together. This deal is dead!”

Jack was simply rubbing all of our noses in the fact that he was on the inside of these negotiations and the rest of us weren’t—so how could any of us predict the future better than him?
The New York Times
published a short article summarizing the voice mail and, once again, I figured Arthur Levitt’s SEC would now be propelled into action, even if it hadn’t before.
²

This was typical Jack: brash, arrogant, reckless, and—literally—daring. He was daring the authorities to catch him. Jack seemed to feel he could tell the world that he knew what he was doing was dangerous and possibly wrong, but somehow he felt he was so clever that he could fly above the fray. Shame on them?

The $14 Billion Leak

On September 8, 1999, about 200 Wall Street investors and analysts who covered the telecom sector arrived at the Kansas City Hyatt for an all-day meeting with the management of Sprint, the $80 billion telecommunications giant. The meeting had kicked off the evening before in the hotel’s ballroom with a dinner and a keynote speech by Sprint’s longtime CEO, Bill Esrey.

I managed to get a seat next to Bill. Also seated at the table were eight other analysts. Some were from the sell-side like me, and others were buy-siders from money management firms and large pension funds. As we dined on filet mignon and poached salmon and sipped red wine, it was business as
usual for me: find out what was going on at Sprint and then turn that edge into value for my clients.

We had about 30 minutes before Bill Esrey was scheduled to speak to the entire room, so we jumped right into it, each of us eager to sneak in a few questions that might tease out a little information about how the numbers were looking and what strategic moves Bill might be contemplating. Virtually all of Sprint’s competitors had been caught up in the epidemic of M&A activity. So when the conversation turned toward possible mergers or acquisitions on Sprint’s part, we all leaned forward in our chairs. Would it be better, I asked, for Sprint to partner with a Baby Bell such as Verizon or BellSouth, or to merge with a foreign-owned company, such as Deutsche Telekom? Bill gave the expected pluses and minuses of each, seeming to lean away from both moves. As often was the case with Bill, who seemed to hate analyst meetings, he was just vague enough to give us nothing to go on.

Finally, I threw out the question none of us expected a serious response to: might Sprint consider merging with another long-distance company, like AT&T or MCI WorldCom? It was a very unlikely scenario, since it would certainly set off alarm bells in the world of antitrust, and since Bill himself had often slammed WorldCom as a poorly managed company. So I was surprised to hear him suddenly launch into a discussion of the pros and cons of a WorldCom–Sprint merger. He remained firmly in the theoretical, but it seemed—to my ears at least—that the pros outweighed the cons. Bill said the cost-savings would be huge. When probed, he said he didn’t think the government should oppose such a merger on antitrust grounds. Uncharacteristically, he didn’t even criticize Bernie Ebbers and the rest of WorldCom’s management. It was odd to hear the usually reticent Bill Esrey entertaining such an idea at all. He wouldn’t really consider such a move, would he?

We all wanted to press him further on this, but just then our private time was over and it was time for Esrey’s speech to the entire group. He bounded up on stage with the energy of a fit ranch hand, his bald head reflecting the bright lights. With a slight lisp, he delivered an upbeat outlook for the company, projecting that revenues would grow 20 percent per year for the next three years, propelled mostly by Sprint’s wireless PCS unit. He said nothing about any possible deals.

When the speech was over, my tablemates and I went out into the lobby for a break. Suddenly, the cell phone of one of the buy-side analysts rang insistently. It was a banker friend, calling from Germany, he said, who had
heard a very specific rumor of a coming Sprint–WorldCom merger that would give Sprint 0.94 shares of WorldCom, or about $70 for each Sprint share, more than 50 percent above its current price. If true, it would be enormous, the biggest deal ever. My blood began to pump, fueled by a combination of fear, anger, and excitement. How could someone in Germany already know something that had not yet been announced? I strained to hear more.

As we left the ballroom and descended the steps to the hotel lobby, we saw Jack Grubman coming through the front entrance of the hotel with two telecom analysts from two of the world’s largest mutual fund groups. Shoulders hunched in his oversized, double-breasted suit, he projected the cocky confidence of a man who knew billions hung on his every word. Jack and the two buy-siders had gone out to eat, intentionally missing Bill Esrey’s speech and, of course, the chance to pick Esrey’s brain at dinner. How could they afford to skip out on these opportunities, which, after all, were the analyst’s bread and butter? To skip the dinner and the interaction with Esrey and Sprint’s top executives meant they must have felt pretty confident about their own abilities to predict the future. Or perhaps they simply felt that their powers of prognostication would gain far more from two hours with Jack Grubman.

Agitated, adrenaline on overload, my buy-sider friend spotted Grubman and homed in like a heat-seeking missile. “I’m going to ask Jack,” he said. “Since this involves WorldCom, if it’s real, he’ll know for sure.” He assumed that Salomon would be doing the banking and, therefore, that Jack might have gone over the Wall. About 30 minutes later, I ran into the investor at the hotel bar. “Dan, Jack says those numbers are exactly right: 0.94 WorldCom shares for each Sprint share.”

The specificity of the rumor—and Jack’s confirmation of it—staggered me. Nothing had been announced. How could Jack know the exact ratio of the deal? Had a Salomon banker or someone from WorldCom tipped him off? Had he been over the Wall and decided to share what he’d heard?

Suddenly, I had two big problems. First, I had a Neutral rating on Sprint’s stock. If the rumor was true, I would look pretty bad, since Sprint’s shares would trade way up once the deal was announced; $70 was a huge premium to Sprint’s current $46 stock price. Should I upgrade my Sprint rating based on what I had heard? It was only 9:00
PM
and I had all night to write it up, get it approved by Merrill Lynch’s compliance department, and announce it to Merrill’s brokers the next morning. I would look brilliant if the deal was ultimately announced.

But there was a second, much bigger problem with that. If Jack’s confirmation was based on inside information, now I, too, was in possession of it. If I upgraded the shares, I could be using that inside information illegally. On the other hand, people traded on rumors all the time. Maybe Jack and these guys were simply dealing in gossip, which to my knowledge wasn’t illegal. But this seemed like too big a leak in too big a deal. Surely, it was going to be the one that would finally get someone busted. I left my Neutral rating in place and decided to take my lumps if the merger actually happened. Better to be wrong than in stripes.

It took sixteen days for
The Wall Street Journal
to sniff out the rumor. On September 24,
The Journal
printed a story speculating that WorldCom and Sprint executives were discussing a merger, causing Sprint shares to jump almost $4 or 8 percent that day. But the two stocks had already moved and some investors had already profited: in the sixteen days before the
Journal
’s “scoop,” Sprint shares had risen by a total of $5.4 billion, or $6 3/16 per share; and WorldCom shares had dropped by $1.9 billion, or 93 cents per share. And the market value of Sprint PCS, also likely to be acquired in the transaction, rose $6.4 billion, or $6.75 per share during the same 16-day period.

Together, that added up to a total of $13.7 billion of shareholder value that had changed hands, with some investors winning thanks to their inside information and others losing thanks to their lack of it. If you or your mutual fund sold shares of Sprint during that time, the buyer of your shares may have been armed with an unfair edge. Alternatively, you or your fund manager may have bought shares of WorldCom without realizing what the seller may have known—that WorldCom shares would likely fall once the deal was announced. You’d been cheated without knowing it. After the article appeared, another twelve days passed before the deal was officially announced—at, yes, exactly the ratio that the investor had heard and Jack Grubman had confirmed. It was clearly old news for some big players.

It was indeed the biggest deal ever announced in the history of Wall Street, and not only did Jack Grubman know about it beforehand but, it appeared, so did at least one of the world’s largest money management firms. It had happened again. But this time, the leaker had given four weeks’ notice, rather than the three days’ when Global Crossing bought Frontier or the 15-minute heads-up given when Frontier bought ALC.

Of course, it was impossible to know where the original leak had come from. It was equally impossible to know whether Jack had obtained this confidential information while over the Wall—that is, while he and Salomon
Smith Barney were advising WorldCom in the negotiations with Sprint. Perhaps he was merely passing on a rumor that someone else had passed to him. But if he had been over the Wall, it was a suicidal move, I thought, given that there had already been an internal investigation at Salomon over his compliance issues. I had also heard whispers that the SEC had been preparing a big file on him. With
The Wall Street Journal
’s critical pieces about him in 1997 and the one about Level 3 a few months earlier highlighting the conflicts of interest between his research recommendations and his banking maneuvers, I felt certain that his every move was being tracked.

A few months earlier, I’d received a call from a
Forbes
reporter who wanted to write a story on how some analysts might be using advance information to their advantage as well as promising bullish research on a company’s stock in exchange for that company’s investment banking business. I gave him some ideas to pursue and names of people to call, stressing that I wanted to remain off the record. I hadn’t heard back from him by this time, but with all these questions percolating, I figured it was only a matter of time until Jack got what was coming to him. I told Paula, for what felt like the tenth time, “Well, he’s finally tripped the wire. If he’s breaking the law, it’s just a matter of days now.”

The Ambush

In the meantime, my relatively skeptical reports and opinions apparently weren’t playing well in the executive suites of Merrill Lynch. As Salomon continued to win the lion’s share of telecom deals, David Komansky, Merrill’s CEO, couldn’t help but notice. Merrill had, earlier that year, hired Henry Blodget from Oppenheimer & Co. as its Internet analyst after his outrageous call that Amazon.com would go to $400 a share came true and anointed him the hottest name in Internet stocks. Although Merrill still lagged several other banks, the banking that had begun to flow Merrill’s way as a result of his hiring made it all the more obvious that this wasn’t happening in my sector.

As more and more companies went public, there were more and more companies to cover. While our telecom team had expanded to six people to meet the demand, there were certain companies, like Level 3 and other dot-com types, that just weren’t going to be covered by me—partly because I didn’t have the time, partly because I thought they were overinflated blobs
of nothingness and not necessarily telecom companies. This frustrated Merrill’s bankers and executives, of course.