Confessions of a Wall Street Analyst (35 page)

If one looked at it from Qwest CEO Joe Nacchio’s perspective, this made tremendous sense: Joe would receive over $700 million in stock if Qwest were bought out by another company like Deutsche Telekom. All of his shares and options would vest immediately. Buy-siders later told me that Joe was fueling the fire by critizing US West’s management at the same time that he was supposedly in negotiations with Deutsche Telekom.

Just as had happened two years earlier with the BT-MCI deal, I didn’t
know whether Qwest could, under the terms of its merger contract with US West, actually back out of the deal. As good as Vail’s sunlight and visibility were from a skier’s perspective, they didn’t help me as an analyst. I simply couldn’t be sure from the top of a mountain. In the meantime, US West shares were down big time, falling 11 percent that morning as the story spread, while Qwest shares had surged 26.5 percent on the takeover speculation.

This meant that US West was now trading about 40 percent below what Qwest had committed to pay in the deal, reflecting the market’s fear that the US West–Qwest merger was dead in the water. People who owned US West were bailing out as rapidly as they could, while investors were piling into Qwest, thinking a rich price was coming soon from Deutsche Telekom. Much of this was fueled by arbitrageurs. Arbitrageurs, or “arbs,” are the traders who make a living by betting on whether a given deal will happen or not and trying to take advantage of the difference between the original price offered for a company at the time a deal is announced and where it’s currently trading, also called the “arb spread.”

Usually, arb spreads run between 5 percent and 15 percent on mergers with six months or less to go until the deal closes. This time, the spread was huge, partly because of the uncertainty of the situation, but also because three years earlier, the arb community had lost so much money in the BT-MCI debacle that it had turned gun-shy on large telecom mergers. As a result, arbs were desperately unloading their US West shares, panicked that they would get burned as badly as they had been by MCI.

With all of this information swirling around the Street, I had to make a call quickly. My new sales force at CSFB, which had not yet seen me handle a crisis, and my clients were clamoring for instant advice, which meant I didn’t have time to read the merger agreement or to call Joe Nacchio and Sol Trujillo or a few M&A lawyers to get some perspective, as I normally would. I asked Julia to call me back in 15 minutes, which would be 2:00
PM
New York time and noon in Vail, and to arrange for me to speak into CSFB’s “squawk box,” which would broadcast my comments to CSFB’s salespeople around the world. This was the quickest way to get my views out to my clients, not to mention the best way to get my phone to stop ringing so I could get back to skiing. The last thing I wanted was to have another vacation ruined by a merger falling apart, especially on this beautiful mountain on this beautiful March day.

I hung up and got off the lift, almost dropping my phone in the snow. I
quickly told Jeff and Howard what was going on. I asked them if they wanted to go on without me, but Jeff—always the stock junkie—said he wanted to hear what I had to say. Thinking frantically, I decided that if Deutsche Telekom did buy Qwest, it would be foolish to buy it without US West, both to avoid years of litigation and to get US West’s local telephone assets—its “last mile” connections to customers—which I considered so valuable. I didn’t have any facts or experts to back up what was essentially a gut feeling, and I wasn’t going to acquire any in the next 15 minutes.

So just as I had done that night in Tuscany, I made a snap judgment, a potentially reckless one, this time from a Colorado mountain. We skied down until I spotted a small ridge in the sunlight. I looked at my phone to check the cell signal and it was strong enough. I sat down in the snow and called Julia, who connected me to CSFB’s squawk box.

I explained my belief that the Qwest–US West merger would be very tough to undo, and discussed the widening arb spread. “My call is to buy US West and short Qwest shares, and it’s based on my belief that US West is
not
going to be left at the altar. If the deal goes through in the next three or four months, as I continue to predict, you will make the arb spread, a return of approximately 40 percent.”

When I said “short” Qwest shares, I was referring to the practice, used especially by arbitrageurs and hedge funds, of borrowing someone else’s stock and selling it with the commitment to buy it back later. The shortseller’s bet is that the stock’s price will fall and he can then buy back the shares at a lower price, pocketing the difference. I thought that either the merger of US West and Qwest would go through as planned or Deutsche Telekom would buy both US West and Qwest. In either case, US West would be bought out and the huge spread between US West’s deflated current price and the price Qwest was committed to paying would disappear, creating a huge profit for these investors.

It was not an easy situation to predict, especially given Nacchio’s tendency to shoot his mouth off, which is why I used the word “if.” But it seemed obvious that the market was acting irrationally and panicking. It was one of those rare moments of opportunity you hope for as an analyst.

Who Wants to Be a Millionaire?

The gossip and innuendo related to Deutsche Telekom, Qwest, and US West continued to build over the next few days, providing the perfect dramatic backdrop to my conference, which we renamed the CSFB Global Telecom CEO Conference. It was to be held in New York City at the Plaza between March 7 and 10, 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.

Our budget for the conference was an astounding $1.7 million, not as much as my investment banking colleague Frank Quattrone’s, but still a huge 70 percent more than what Merrill had allocated. And although I was still embarrassed by ostentation, I made sure the conference had all the trappings that executives and investors expected. I worked with a conference planner to choose entertainment, considering a lot of big-name performers, but ultimately chose the less showy comedian Darrell Hammond, the
Saturday Night Live
comedian most famous for his Bill Clinton impersonations.

Unfortunately, Hammond bombed. He made a lot of jokes about undeserving rich people that didn’t go over too well in this crowd. We also set up something called a “Telecom Café,” which had tons of Bloomberg machines for instant quotes and research, and flat-screen TVs so people could watch financial news shows. CNBC set up its own studio on the premises where its correspondents could interview our speakers. In the obligatory goody bag given to attendees, we provided everyone with a free MP3 player called the Rio. At the time, long before the iPod, this was one very cool gift.

From the moment the conference began that Tuesday, the town cars were lined up three deep outside the hotel, with over 1,500 institutional and corporate attendees jostling for a position in the Plaza’s Grand Ballroom to hear some of the 81 CEOs we had on the agenda. The venue was so crowded that it was physically difficult to get from one presentation to another, since the narrow hallways were clogged with frantic networking, card
exchanges, and salesmanship. The CEOs were schmoozing the big money managers and either shopping for acquisition targets or trying to sell their own companies. CSFB bankers were trying to grease the wheels and earn some fees. And the investors were trying to find the next WorldCom, or at least hear what the old one had to say. Indeed, it was WorldCom’s Bernie Ebbers who would kick off the conference with a dinner speech. He had also agreed to do a small private meeting that afternoon at 4:30
PM
with some of the largest institutional investors.

At about 3:00
PM
, I took a final walk through the ballroom and the smaller meeting rooms to make sure everything was in order. The rooms looked great, and I wanted to relax for a few minutes before showtime, so I headed down the hall toward the elevator to go to my room and just happened to catch a glimpse of Bernie down at the end of a very long corridor. He was sitting at a table, but it looked as if he was just staring into space. He was completely alone—no handlers, no investor relations guys, no buy-siders, no bodyguards (he was worth nearly a billion dollars at this point). It was bizarre. I couldn’t remember ever seeing a CEO of a major corporation sitting by himself in a public place without someone to prep him or feed him or protect him or do whatever else might be necessary.

I said hi, then thanked him for coming to the conference and asked if there was anything he needed, such as a private room with a phone. We had arranged for a block of rooms for just these kinds of situations. “No,” he said, seeming deflated or even a bit depressed. “I’m fine right here, Dan.” Perhaps he was tired of doing all of these show-and-tells. Perhaps he had more weighty matters on his mind. I’ll never know what he was thinking, since he snapped to it and did a fabulous job at the meeting, but I remember it as a bizarre—and somewhat sad—moment.

Bernie’s dinner keynote address was a huge hit. Too many investors showed up, so we had to wheel TV sets out into the hallway to accommodate the overflow crowd. In his speech, he didn’t let slip any unusual estimates or display any slides showing changes in the revenue projections. No, he simply made fun of my height, as usual, and then went on to his favorite topic—the value of WorldCom shares.

“They put these podiums low enough for Dan to see over,” cracked Bernie, who stood six feet three. “I can’t see my papers.”
³

I don’t think Bernie ever spoke into a microphone in my presence without playing the height card. He loved mocking people, and with me it was always the short-guy thing.

Bernie went on to ask the audience if it wanted to play “Do You Want to Be a Millionaire?” in a nod to the then-hot game show
Who Wants to Be a Millionaire.
“If you do,” he said, “go out and buy 42,000 shares of WorldCom stock and, by the end of this year, you will be a millionaire.”

The stock was then trading at $45 a share, so, although I didn’t figure it out immediately, it turned out he’d made a mistake. In trying to explain how owning WorldCom stock would make you rich, he’d said you should buy nearly $2 million worth of WorldCom stock in order to end up with $1 million. Ironically, by the end of that year, WorldCom’s stock would fall by about 50 percent, proving Bernie right. Maybe he really wasn’t very good with numbers, as his defense attorneys would later claim at his trial. Or maybe he knew what difficulties lay ahead and was giving everyone at my conference a between-the-lines heads-up. We’ll never know.

Bernie went on to discuss how business was booming for his company. “Over the past year, we have had a very, very specific focus,” he said. “We’ve added $4.7 billion in incremental revenue…we’ve increased net income by $2.6 billion, and we have invested about $8 billion…to further improve our network…. We’ve also integrated in the last year MCI, and have exceeded the synergy targets in every quarter….We’ve agreed to merge with Sprint and Sprint PCS and we’ve invested in wireless data…. With[WorldCom shares] trading at or below market multiples, why wouldn’t you invest and become a millionaire?”
⁴

The audience ate it up. But anyone who chose that day to become a contestant on Bernie’s game show would certainly end up wishing that just like on the real
Who Wants to Be a Millionaire,
they could call a friend for advice or use one of their lifelines to escape.

Two Minutes to Midnight

The next morning, as I walked up to the podium in the ballroom to introduce the day’s first speaker, I felt a bit high. So much was happening in this one spot at this one moment in time. It really did feel like the epicenter of the telecom universe and the dawning of a new century, and I was, for a few days anyhow, Dick Clark. Actually, the analogy to
New Year’s Rockin’ Eve
was a lot closer than I realized, because it really was two minutes to midnight.

Midnight, for Wall Street, actually did come on March 10, 2000, the last day of my conference. That day, the NASDAQ hit its all-time high of
5,049 and thereafter began its death swoon. But for those few days, we all, even skeptical me, still believed that there was more good stuff to come.

In part, that was because virtually every one of our scores of speakers said so. Among the most prominent of our scheduled speakers, in addition to Bernie, were Steve Case, CEO of America Online; Vinod Khosla, the red-hot Internet venture capitalist; AT&T’s Michael Armstrong; and Qwest’s Joe Nacchio. Enron’s Jeff Skilling had signed on to come, but canceled at the last minute, citing a scheduling conflict. Almost all of them talked about the wave of insatiable demand for bandwidth, for high-speed Internet access over DSL lines, for anything that would make communications traffic grow faster.

Even the regulators were spouting the hype. Bill Kennard, chairman of the Federal Communications Commission, sounded as if he were running a startup as he quoted that old standby statistic from 1997: “We know from the wireline world,” he said, “that Internet traffic doubles about every 100 days, and that’s a wonderful thing.”
⁵

Kathleen Earley, head of AT&T’s Internet division, filled in for Armstrong at the last minute. She talked about “the end of business as usual.” “AT&T,” she said, “is the only company with all the pieces in place to be able to win in this space…we’re focused on exponentially increasing the number of eyeballs, eardrums, and end points to our network.”
⁶
Even the superlatives had superlatives.