Confessions of a Wall Street Analyst (31 page)

That’s because CSFB had no retail brokers, other than some salespeople who served very high net worth individuals who were generally quite sophisticated businesspeople and corporate executives. CSFB’s institutional sales force, about 150 strong throughout the world at the time, comprised MBAs and others with substantial experience in the markets. The only challenge was that I had to convert my recommendations to CSFB’s unique rating scheme. While Merrill’s scheme of intermediate versus long-term ratings and various risk and dividend ratings was confusing in its endless categories and criteria, CSFB’s had terminology that didn’t match up well with that used by the rest of the Street.

Though it was a multilevel system like Merrill’s and each level (1, 2, 3, etc.) represented the same percentage upside or downside, CSFB’s top rating, Strong Buy, was what Merrill called a Buy. Its second rating was Buy, which is what Merrill called Accumulate and Salomon Smith Barney called Outperform. Despite the confusing semantic differences, these rating systems were virtually identical. A “1” suggested the analyst felt very strongly that this stock was going to do very well, outperform the market by a substantial amount, and had upside over the next year of 20 percent or more. Similarly, regardless of whether it was called Accumulate, Outperform, or Buy, a “2” meant the analyst thought the stock would outperform the market by a small amount and had upside in the 10–20 percent range. But those
who weren’t clients often confused our Buy, or “2,” rating with other firms’ Buy, which for them was their top rating.

CSFB also had only four choices for ratings, where the others had five. In the case of a “4”-or “5”-rated stock, CSFB used Sell, but the rest of the Street had a quirky nomenclature, clearly intended to soften the blow to investment banking clients and, in some cases, to buy-siders who got angry when a big stock holding of theirs was slammed by an analyst. So, if an analyst thought there was 10–20 percent downside in a given stock over the next 12 months, the appropriate rating was Reduce at Merrill, Underperform at SSB, and Sell at CSFB. And if the analyst thought there was more than 20 percent downside over that same time period, the stock would be rated “5” and labeled Avoid at Merrill, Sell at SSB, and, again, Sell at CSFB.

“I’ve Never Had a Conversation Like This.”

Toward the end of December, we made our formal pitch to AT&T in front of its treasurer and its new CFO, Chuck Noski. Chuck, another Hughes Electronics transplant, had just signed on that month. He was truly a wild card: he hadn’t been in the telecom industry. He didn’t know many of the telecom bankers nor did he know any of the twenty or so Wall Street analysts who followed AT&T. He certainly didn’t know much about Jack’s “special” approach to the analyst’s role, though I supposed he knew Jack could move stocks far more powerfully than the rest of us.

It was a bit of a problem for CSFB, since its bankers had had the closest relationship with Chuck Noski’s predecessor, Dan Somers, whom AT&T’s CEO, Mike Armstrong, had just sent out to Denver to run its cable business. We met with Chuck and his team two days before Christmas to display our wares, much as a traveling salesman would sell pots and pans. Only what we were essentially selling was the ability to sell.

Most of the pitch meetings I’ve ever been in have been the same, and this one was no different. The bankers proffered their services, and CSFB wireless analyst Cindy Motz and I talked about our research. AT&T executives asked us questions, such as how could they best reach retail investors if they went with CSFB, which didn’t have retail brokers or customers, what was the right price for the shares, and what aspects of the company should be emphasized during the road show. I thought the CSFB team handled the meeting well, and we waited expectantly for the news.

Sometime around the end of January, I got word from Chuck Ward, the head of CSFB’s investment bank, that made me realize—yet again—how naïve I still was. He called me up to his office, where he told me he had talked with Chuck Noski and that it looked as if AT&T had decided to go with three bankers. He said that one of them was going to be Salomon, which meant that not one of them was going to be us, since Goldman and Merrill were shoo-ins. We were screwed—and Jack had been rewarded for what seemed the most sinister move I’d seen in my 11 years as a research analyst. In addition to my own personal anger and frustration, I was embarrassed for AT&T, since everyone, and I mean everyone, saw right through this one.

Furious, I told Chuck that I was going to call Chuck Noski and tell him how outrageous I thought this was. He smirked and said, “Good luck. I guess we’ve got nothing to lose.” I don’t know whether I thought I could actually make a difference, but there was nothing that could stop me at that point. All I could think was that Jack’s model was now the only working model for an analyst. There had to be something I could do about it.

I had met Chuck Noski for the first time during the pitch meetings. Short in stature and quiet in demeanor, he seemed very smart and very analytical. I figured he could use an education in Grubman’s World, a world a lot like
Wayne’s World:
you had to live in it in order to believe it. I hoped I could show him how bad it would look for AT&T to pick Salomon. And if I could change his mind, I would also be showing Chuck Ward that I could make a difference for CSFB.

So I put in a call to Chuck Noski. He called back a day later, just as I was boarding a plane from Portland, Oregon, to Whistler, the Canadian resort where I was going to spend a few days skiing with clients after four grueling days of meetings up and down the West Coast. I had 10 minutes before the plane took off, so I didn’t waste any time once Chuck confirmed to me what I feared was true—that AT&T was getting ready to announce it had hired Goldman, Merrill, and Salomon as lead underwriters.

“Chuck, I want to apologize at the outset of this conversation,” I started. “My plane is taking off in less than 10 minutes and I need to quickly convey some things to you about my competitor at Salomon. I may not come across as politely or professionally as I normally would like to.”

“Go ahead, Dan, I’m a good listener,” Chuck replied.

“Grubman’s research is a sham,” I blurted, every bit of self-control I had evaporating. “He sells his Buy ratings for investment banking business. In
effect, he’s a whore and everyone knows it. If you guys hire Salomon, you will be perceived as naïve dupes, and shareholders will lose respect for AT&T management.”

I tried to tell Chuck that by rewarding this behavior, he was simply encouraging more and more research analysts to emulate Jack’s approach, and that that wouldn’t benefit anyone. I was more emotional, and more personal, than I’d ever been with a company executive. He heard me out, but he was clearly taken aback, particularly by the fact that I would dare to call my competitor a whore and him a dupe.

“I’ve never had a conversation like this, Dan,” he said.

“This is really a different industry,” I said. “Grubman’s behavior is really outrageous.”

Finally, Chuck told me that he’d discuss our conversation with Michael Armstrong.

“I have taken notes and I’ve heard you,” he said politely but firmly.

Well, I guess he had heard me, but he certainly didn’t listen to me. CSFB would end up being a co-manager with about six other firms, the booby prize after losing out on the world’s biggest IPO ever. CSFB’s take was $15 million instead of the $63 million that Salomon, Goldman, and Merrill each took home. Jack had delivered a $48 million bonus to his firm with a few strokes of the keyboard.

As I walked across the tarmac toward the waiting twin prop, I was truly disgusted—with Wall Street, with the analyst community for imitating people like Jack, with the press for celebrating him, and with corporate America in general for its willingness to deal with the devil.

The fact that Sandy Weill, the co-CEO of Citigroup, which owned SSB, sat on AT&T’s board, while Armstrong sat on Citigroup’s board, troubled me a lot too. Critics of these “interlocking directorships” considered them to be a corporate governance no-no because of the temptation for mutual backscratching, and suddenly I could see why. There was one other explanation for the move, although it was the most pathetic one: perhaps Mike Armstrong simply thought Jack’s November upgrade was a great piece of honest research extolling the virtues of his cable telephony strategy. If so, Armstrong was the only one on earth who believed that Jack’s upgrade was authentic.

That evening, I returned a call to Rebecca Blumenstein of
The Wall Street Journal,
who was preparing a story about the intense battle between SSB and CSFB for the third and last lead underwriting spot. She wanted to
know what was going on and whether I knew if a final decision had been made. I played somewhat dumb—not so dumb as to make her think I wasn’t a player but enough so that I could deny that I knew the final decision. In any case, she wrote a fairly accurate article that said CSFB had fought hard but lost, and that given my recent arrival at CSFB and the firm’s historical excellent investment banking relationship with AT&T, this was somewhat embarrassing for me.
⁷

It
was
embarrassing for me, but it was even more embarrassing for my profession and for Mike Armstrong and Chuck Noski. I was also, I suppose, a bit embarrassed about my outburst. Chuck Ward later told me that he had called Dan Somers, AT&T’s former CFO, to follow up, and that Dan had told him I had “made enemies of friends.” Nice way to start off on the right foot with a new job, I thought ruefully. Chuck Ward never asked for my help again. I guess I had devised one very effective way to get bankers off an analyst’s back.

A few years later, in November 2002, Chuck Noski announced his resignation from AT&T. We had maintained a decent professional relationship despite its awkward beginnings, so I called to congratulate him. After a bit of pleasant chitchat, his tone turned serious. He told me that he regretted not listening to me about the IPO. I’m sure he did; the whole thing unleashed a storm of controversy that would later envelop Jack, Sandy Weill, and Mike Armstrong, among others. But at the time, all we knew was that Jack’s way was the winning way.

2000

Without realizing it at the time, I presided over what was probably the last hurrah for the fearless leaders of telecom. My conference coincided perfectly with the absolute zenith of the bull market. There was a giddy hysteria to it that at the time was thrilling and contagious; looking back, it seems pathetic. Everyone there was making money hand over fist, from the executives whose stock options were soaring to the bankers who were awash in deal fees to the institutional investors who, armed with that extra edge, were getting to IPOs and M&A announcements just a little bit sooner than the rest of the world.

Playing with the Devil

T
HE NEW MILLENNIUM DAWNED
with the kind of frenzied excess that had come to seem normal. In retrospect, it was really the dancing-on-graves-with-fingers-crossed kind of mania that happens when everyone knows in their heart that it just can’t last. The first big telecom event of the year was Salomon Smith Barney’s annual Palm Springs telecom and media conference in January, hosted by Jack Grubman. I wasn’t invited, of course, but I paid a lot of attention to the wires, since some news was likely to break during the event.

Like my conference, it was a star-studded gathering, a who’s who of telecom attended by many of the industry’s top executives. Our two events, held just two months apart, were the two best-attended conferences for telecom investors, and we each tried to put on the most dynamic show possible. Jack’s event, because it took place at a golf resort, was more casual in style, while ours, in New York, was a bit more formal and urbane. As always, we were competing—this time, to attract the most influential speakers and attendees, who would, hopefully, bring to light some important new information.

In Palm Springs, Bernie Ebbers and Scott Sullivan of WorldCom were
the most popular speakers, and rightfully so, since the company’s stock continued to soar, having nearly quintupled in the previous four years and become the NASDAQ’s most successful stock of the decade. The gym teacher cowboy from Canada and the numbers whiz from upstate New York were the dream team of telecom who had transformed the industry like no others. Way back in 1995, the company had hired Michael Jordan as a spokesperson. And now, it seemed, WorldCom had become the Michael Jordan of its own sector, outhustling, outthinking, and out–wheeling and dealing its plodding competitors. (In 2005, Michael Jordan would sue the company, claiming that the company owed him $8 million.
¹
)

But what Bernie and Scott were saying on this day, though diffused in a fluffy cloud of optimism, got some tongues wagging. Clients called to tell me that one of their slides showed a revenue growth range of 13.5–15.5 percent for the year 2000. It was a terrific range to have, but it wasn’t quite the 14.5–15.5 percent range that had been cited in their conference call a few months earlier, in October.

A full percentage point may not seem like a lot, but it can have a major effect on investor perceptions and, if the downward trend continues, on a company’s stock price. Conference attendees buzzed. Were Bernie and Scott saying that the real number was only 13.5 percent now and the Wall Street consensus of 14.5–15.5 percent was too high? Were they just hedging in case the economy slowed? Or did they know something we didn’t? Some of the biggest WorldCom bulls actually wondered whether the presentation simply had a typo. People asked Scott what it all meant, but he simply said that that was the range, and not to read any more into the top end of the range than the low end. That day, WorldCom shares fell 11 percent, from $49.94 to $44.44. It sure looked as if the attendees at Salomon’s conference were reading more into the low end.

The stock settled down after a few days, but toward the end of January it began to slide again, falling about 25 cents a day or so. I watched with concern, as I still had a Strong Buy, or “1,” rating on it, the top rating in CSFB’s system, and finally called some of my clients to see if they knew anything. One of them told me that he’d spoken to Jack, who had said he’d talked to Scott and that 13–15 percent, not 13.5–15.5 percent, was actually more accurate, with the lower end more likely than the higher end.

We all knew better than to believe everything Jack said by now, but when it came to WorldCom, it was foolish to ignore him: he was better connected with this company than anyone, and he’d certainly come up with
critical information before. If this information was true, however, it was a terrifying number for anyone who owned WorldCom, since if the revenue numbers came out that low, the stock would surely plummet.

This was particularly true for a growth company like WorldCom with a suddenly slowing growth rate. Wall Street is a game of expectations: when expectations are not met, the market usually reacts swiftly and brutally. I was worried, but I didn’t want to change anything until I had more than hearsay backing me up.

At the end of January 2000, I hosted a luncheon for Ivan Seidenberg, CEO of Bell Atlantic, and invited some money managers from the country’s biggest financial institutions. This was one of those perks for the most favored—or most powerful—clients; an intimate group of 20 people lunching with a top executive. I held about eight of these each year, and almost always scheduled them in the elegant Library Room on the second floor of the St. Regis Hotel. The St. Regis, located in midtown Manhattan, was one of New York’s swankiest hotels, a place where the ornate Louis XIV–decorated rooms went for around $575 a night.

As my handpicked group of powerful investors chatted before sitting down, I heard more about Jack’s claim that he’d talked to Scott Sullivan. The irony was that Jack was now so powerful that these rumors took on a life of their own. He had succeeded in making everyone believe that his relationship with WorldCom was so tight that even if what he said wasn’t true, few would doubt him. Anything he said was now as important, if not more important, than what Bernie or Scott said about WorldCom. I had no idea what was correct; all I knew was that the stock was dropping.

After lunch I asked Ehud Gelblum and Ido Cohen, an extremely bright young analyst I had hired shortly after my move to CSFB, to call Blair Bingham, one of WorldCom’s investor relations guys, and press him for some more information. I showed Ivan out and returned to the St. Regis’s Library Room to hear Blair, on speakerphone, reiterating that the range remained 13.5–15.5 percent.

I jumped in. “Hi, Blair, this is Dan,” I said. “Here’s our dilemma. We’re recommending your stock with a Strong Buy rating. We’re getting a lot of questions lately, because apparently Jack is saying that the revenue forecast should be closer to the lower end of that range, based on a recent conversation he had with Scott.”

Blair dismissed my question right away. “I don’t know anything about such a conversation, Dan,” he said, “and I don’t know what Jack is saying,
but it doesn’t matter anyway. Bernie told everyone in Palm Springs that the range was 13.5–15.5 percent and one shouldn’t read anything more into the lower end than the higher end.”

“I hear you,” I interrupted, “but you’ve got a problem. I don’t know who said what to whom, but I do know you guys have given Jack a very disproportionate voice on your stock. If he says revenues will grow 13 percent and you deny it, the vast majority of investors are going to either believe the 13 percent or live in fear of it. No one is going to believe you.”

I asked him to get Scott Sullivan, the CFO, on the phone. “Otherwise,” I threatened, “I’m going to have to cut our revenue forecast this afternoon.” I was playing hardball, but I needed some answers here.

“Well, uh, I’ll try,” Blair said doubtfully, “but I don’t know if I can find him…”

“We’ll just wait here on the line, Blair,” I said. “Thanks.”

Amazingly, Scott came on the line within five minutes.

“Hey, Dan, what’s up?” Scott began nonchalantly. No matter what was going on, Scott was exactly the same. He spoke in a monotone, dressed and acted conservatively, and never appeared to get excited when the stock was soaring or distressed when it wasn’t. He was as steady as Qwest’s Joe Nacchio was volatile.

“Just trying to get a read on your outlook for revenues and struggling with Jack’s banter that it’s going to be lower than you’ve indicated,” I said.

“What do you mean?” asked Scott.

“Come on, Scott,” I said. “You know how this works. You, or perhaps Bernie, told the Salomon conference that you were anticipating revenues to grow 13.5–15.5 percent this year. But then I’m hearing from some buy-siders that Jack cited a private conversation with you in which you endorsed the lower end of a 13–15 percent range.”

Scott denied it. “I haven’t talked to him since his conference,” he said.

“If you haven’t talked to him,” I said, “then you need to say that publicly. Right now, your largest holders are believing him, as he has quite a record of having far better information than the rest of us,” I continued, and then added for effect, “Even those of us who have been bullish on your stock.”

“I’m telling you now,” Scott said, exasperated. “Why don’t you pass this on to your clients?”

“It won’t do much good, Scott. You have created your own monster here,” I said, referring to Jack.

Scott denied it again.