Confessions of a Wall Street Analyst (41 page)

If Jack had indeed had this conversation, it was dangerous, since he risked getting his source in big trouble for leaking confidential board deliberations, and it was stupid. But he simply couldn’t help himself, I guessed. His seemingly pathological need to impress got in the way of his instinct for self-preservation. I turned to see what Armstrong was doing, but he had turned his face away and sat silent as a stone. In the end, Comcast did up its bid and AT&T took it.

Qwest and Global: The Swapstakes

In the beginning of August, Gary Winnick broke his promise: Global Crossing missed its second-quarter 2001 numbers. With the stock now at $7 per share, I immediately downgraded the stock from Buy to Hold, or from “2” to “3,” certain, finally, that this company was in big trouble.

It was apparent that Gary had no clue how bad things were, even very late in the quarter. That was almost as troubling as the disappointing numbers, because it meant he was either incompetent or completely out of the loop. Neither explanation was very comforting.

Even more disturbing was the fact that the company was using what it called “reciprocal purchase agreements” to generate more than one-fifth of its revenues. These agreements, also referred to commonly as “swaps,” were the ultimate addiction of many of the companies that flamed out so spectacularly in 2001 and 2002. Basically, a swap was an agreement by two companies to purchase goods or services from each other at the same time, inflating both companies’ revenues without any true economic purpose being fulfilled. In the case of Global Crossing or Qwest, the company would sell another phone company the right to use its fiber, as these companies did with the IRUs, and at the same time purchase the rights to use some of the other phone company’s capacity. If done for legitimate business reasons and at market rates, there was nothing wrong with a swap. But if done to create
the illusion of business that didn’t really exist or if priced at above-market levels, swaps were inappropriate at best and illegal at worst. Either way, if not disclosed to investors, they were very misleading because they suggested that revenues were higher and growing faster than they really were.

For example, Qwest might purchase an IRU from Global Crossing giving it the right to use the latter’s New York to Houston fiber-optic line, while Global purchased rights to use Qwest’s Los Angeles to Seattle line. The two companies might agree to pay each other $100 million. It was reasonable to think each company was filling in geographic holes, but you couldn’t really be sure. Each would then book the $100 million received as revenues in “year one,” while spreading out the $100 million paid over the 20 or so years it expected to use that fiber-optic line.

The net effect: each company had juiced its revenues by $100 million and its operating cash flow by some large fraction of that. Both companies could therefore proclaim a lot of new business and meet their revenue goals even though it wasn’t clear if this was a real transaction or just a mutual backscratching exercise. Most companies didn’t report the results in enough detail to know for sure. Some, including Qwest, didn’t even tell us they were doing swaps at all.

Global Crossing, to its credit, had first mentioned its swaps in May of 2001 when it reported its first-quarter results. But the mention was buried in one vague sentence in a long press release full of self-congratulatory quotes from Global Crossing executives. As far as I know, no one—including me—took any note of it, which isn’t surprising considering the company had exceeded most analysts’ expectations for revenues and cash flow. And the market didn’t notice either: Global’s stock rose 30 cents to $14.10 the day after the swaps were reported.

By the second quarter, however, it became clear that swaps were making up a good deal of Global’s revenue growth. It wasn’t certain there was anything wrong with the accounting—Andersen, Global’s accountant, had apparently okayed the approach—but it seemed odd to me and many of my clients that so much of its new revenue was coming from these seeming quid pro quos. Swaps became the topic de jour; we all began to ask every company we covered how much of its revenues, if any, came from swaps and how it was accounting for them. It wasn’t until near the end of the year that Qwest publicly disclosed its swap revenues.

On August 6, a few days after Global missed its numbers, Gary Winnick called me again. I called back and was patched through to him at his new
home in Beverly Hills, where I could hear the sounds of hammers and power saws. Gary’s new home was not just any old new home: this palace, formerly owned by Conrad Hilton, had at least a dozen bedrooms and a dozen bathrooms. Gary had paid some $60 million for the Bel Air estate, making it, at the time, the largest sum ever paid for a private home.

Global Crossing, although it had never made a dime in profit, had just two years before boasted a market capitalization greater than that of General Motors. And Gary Winnick, unlike some of his competitors, had sold a portion of his shares while the stock was still high, netting an astonishing take of over $700 million. Now the stock was trading at $6.28 per share. Either he was a damn smart investor, understanding that his new company’s shares were propelled by an unsustainable bull market, or he knew something the rest of the world didn’t about Global’s problems.

To be polite, I asked him how the renovations were going. “Good,” he said. “It’s a big project [and indeed it was, costing something like another $30 million], but it’s coming along nicely.” Pleasantries over, Gary got down to business. He acknowledged that he’d been wrong when he assured me second-quarter revenues would come in on target.

“Dan, I know we didn’t make the numbers,” he said. “You know, I have been leaving Tom [Casey] alone and thought he could handle it. But I’m gonna get back involved now, as I want to make sure we get back on track.”

“Oh, okay,” I said, not sure what else to say.

“Gotta go,” Gary said, over the din of pounding hammers and static from the cordless phone. “Someone’s at the door.”

Get back involved?
From my perspective, he’d always been part of day-to-day management, or if he hadn’t been, why hadn’t he? Yes, he was the nonexecutive chairman of the company, but he was also its founder and had billions still riding on it. I thanked Gary for the call. At least he was man enough to acknowledge how wrong—or misleading—he’d been. I didn’t know which it was, but neither was good. No top executive had ever given me assurances that were missed so widely. And no top executive had ever admitted to me he was not sufficiently involved in his business.

Vindicated—But So What?

On September 10, 2001, Qwest reduced its earnings guidance for the first time. Joe Nacchio was finally admitting that Qwest wasn’t necessarily going
to be the ultimate Survivor and was not immune to the problems affecting everyone in our industry. He refused, however, to admit that there was anything funny going on with the numbers.

“There is no accounting issue,” Joe said in a conference call that day. “Let me say this one hundred percent clear.” Referring to Morgan Stanley, he continued, “There is one house on Wall Street that doesn’t understand…. We follow the rules.”

Qwest’s guide-down was big, and bad, news. But just as I was trying to decide whether this signified the end of this company’s run as a growth stock, the terror attacks of September 11 made this huge shift in the telecom business seem irrelevant and unimportant.

On that Tuesday, Paula and I were in Italy, partway through a bicycling trip in Parma. I had been trying to call in to my voice mail as we pedaled along (this time I’d brought a cell phone), but AT&T’s international circuits were constantly busy. We walked into the lobby of our hotel, sore from biking 30 miles, and saw a group of people huddled around the television. We assumed it was a soccer match from the emotional intensity of the crowd. But it wasn’t.

We glimpsed the screen with the pictures of the falling towers and stopped in shock, unable to move or speak. It was the most terrifying image I have ever seen in my life. We held each other, horrified, thinking of all the people we knew—and didn’t—that might not have made it out alive. We frantically tried to call home to check on friends and family, but we couldn’t get a circuit to the States. Fortunately, the hotel concierge let us use her computer, and using e-mail, we learned that our kids, our kids’ friends’ parents, and our niece and her boyfriend, who lived just a little bit north of Ground Zero, were okay. CSFB’s offices, located in lower Midtown, were not at Ground Zero but were not too far from the carnage.

I finally managed to get through to my office and spoke to everyone on my team, urging them all to just go home to be with their families. But many thousands of people, some of whom were family members of people I worked with, were not okay. After years of nonstop work, I realized in a split second—as, I’m sure, most people did—that our obsessions with work and careers were meaningless in the face of such tragedy. All of these years of analyzing, picking stocks, competing: did any of it really matter?

On Wall Street, the attacks simply froze every assumption and every thought process in its tracks. They may also have halted many of the investigations into these companies or individuals in their tracks, partly because
the SEC’s Wall Street investigation office—with all of its documentation and casework, including that Grubman file that had ostensibly been started years earlier—was located in one of the World Trade Center buildings. Its findings simply dissolved into dust like everything else.

Yet Wall Street, animal that it is, never grinds to a halt for too long. So even though it wasn’t known when the markets would reopen, we were told to be ready to make a call on our sector and stocks. Would they be helped or hurt by what had just happened?

On Monday, September 18, when the markets finally reopened, Paula and I were still in Europe, since we couldn’t get a flight home. We were driving from Milan to Paris, since Paris had far more U.S.-bound flights. I used my cell phone to call in some comments about how phone companies, particularly Baby Bells, do well in uncertain times and tend to be countercyclical, but I was deflated and depressed, as was everyone. It all seemed so pointless. Whether or not WorldCom or any other company made its numbers seemed so irrelevant.

In reality, the tragedy of September 11 provided convenient cover for many of the struggling telcos—as well as many other companies. The uncertainty it brought on froze the purchase and expansion plans of many of them. If M&A had been drying up before, it was now as parched as a desert. Any earnings disappointments or misfires that came up could now be laid at the feet of the global disruption rather than any flaw in a company’s business model or execution.

Right in this midst of the chaos, the news I’d been waiting to hear for so long finally arrived. After four long years, I had finally regained the number one position in the
Institutional Investor
ranking of research analysts in the wireline telecom category, because my picks, the Baby Bells, had held up relatively well compared to WorldCom and some of Jack’s other favorites. Jack was second, though still tops in the startup local carrier sector, not that there were many companies left in it.

In May 2001, when clients had voted, what they knew was that the incumbent long-distance companies, especially WorldCom, Jack’s favorite, had crashed, while the Baby Bells were looking like the survivors, to use Joe Nacchio’s word. Jack had done such a great job of being identified with WorldCom’s success that he was now twinned with its failure. He began to look like the Wizard of Oz—a lonely, powerless man behind a flimsy curtain—rather than the all-powerful, all-knowing, larger-than-life magician so many believed he had been.

In a normal year, I would have been thrilled, proud, victorious. Now, in the context of a terrifying new world and a dying industry, it didn’t feel like much of a victory. I had achieved the professional goal I’d worked toward for many years. Sure, the number one ranking on the
Institutional Investor
magazine poll made my team and me feel happy, relieved, even vindicated, but there wasn’t any partying or cheering.

Our team was evolving, too; Ehud—who I had hoped would soon take over the bulk of my coverage of stocks—left to work at a hedge fund. And Ido, Julia, and Connie understood that one of my primary motivations for keeping going for so long—to beat my chief rival—was no longer there. I’m sure they wondered whether I would quit soon.

For me, the victory couldn’t help but feel hollow. When I arrived home and told Paula the news, she congratulated me, but it didn’t take long for her to ask, “So what’s going to keep you going now?” It was a good question. The twin towers were down, the markets were down, much of the telecom industry was down, the reputation of analysts was down, and even Jack Grubman was on the way down. Every part of my professional world was unraveling, from the companies I followed to the firms I worked for. I still felt good about the way I’d done my job, but I didn’t feel good about doing it in an environment like this one. As we talked, it was clear that I’d lost my passion for the business.

There was one moment of personal satisfaction, however, and it happened in late September, when
Institutional Investor
scheduled a photo shoot for all the top-ranked analysts at a studio on the far west side of Manhattan. I walked in to see about 50 analysts, most of whom I didn’t know. Someone called my name and I looked up to see an old colleague from Merrill.

Standing next to him was Jack, who was still ranked first in the local startup category, although I had recaptured what was called the telecom or “wireline” slot. When he saw me, his jaw dropped and his face went gray. Even with the dramatic fall of WorldCom’s stock, his reversals on AT&T, and the virtual demise of most of his favorite startup local phone companies, it seemed it had never crossed his mind that he wasn’t still the king of the telecom hill. Until that moment, he clearly had no idea that he had lost in the wireline category. Doing what I thought was the right thing, I stuck out my hand to “congratulate” him. He muttered something incomprehensible and turned away, clearly mortified that not only had he been unseated, he’d had to learn about it in front of all his peers.