Confessions of a Wall Street Analyst (43 page)

Joe, who was still unaware that I’d downgraded the stock, smiled. “Yes,” he quipped, “but he’s our asshole.”

Not anymore, I wasn’t.

2002–april 2003

I watched the decline of my industry and the collapse of the reputations of some of my competitors and colleagues with a jumble of bewilderment, frustration, mortification, schadenfreude, and, perhaps most significant, relief that I wasn’t going to be dragged into this mess. At least, that’s what I was hoping. But on September 30, 2002, when I got a call from a CSFB attorney named Jennifer Huffman, I couldn’t help but feel my heart sink.

The Worm Turns

I
T WAS A NEW YEAR,
all right, but champagne toasts were few and far between in my world. All of 2001’s problems seemed to be snowballing into even bigger ones, with no end in sight to the carnage in our industry—or to the investigations, which kept revealing yet more incriminating information.

On January 22, 2002, CSFB announced that it was settling the SEC’s and the NASD’s charges of doling out IPO shares to funds willing to pay inflated commissions. The fine was $100 million, the fifth-largest regulatory settlement in the history of Wall Street.

“The profit-sharing activity was pervasive at CSFB,” the SEC proclaimed, blaming “senior executives” without naming names. This particular scandal had nothing to do with research, fortunately, but it was yet another stain on the reputation of my firm and Wall Street at large. I had a feeling that this wasn’t the last of the checks Wall Street was going to write, but still, as huge a number as it was, it was little more than a swat on the hand by the regulators. After all, $100 million was what one CSFB banker—Frank Quattrone—had made in one year.

Less than a week later, on January 28, 2002, Global Crossing declared bankruptcy, wiping out a market value of $54 billion at its peak just two years earlier. It wasn’t a complete surprise to me or to anyone by this point—the stock had been trading for pennies and its enormous $10 billion debt load was clearly not going to be serviced—but it was sad nonetheless.

Sad for investors, of course, since any of them who got in after 2000 lost their shirts, while Gary Winnick and his rotating band of CEOs sold stock worth in the hundreds of millions. Gary alone cashed in over $700 million over the course of four years, second only to Phil Anschutz—who pocketed $1.9 billion on Qwest—as the industry’s champion roulette player.
¹
But the bankruptcy filing was particularly tragic in that the promise of this new world had been exposed as nothing more than hype. And even those of us who had questioned the hype had not questioned it enough. It was this century’s equivalent of the railroad industry boom and bust in the late 1880s. Customers might use all of those undersea cables one day. But not anytime soon.

Global’s collapse came in the shadow of Enron’s sudden meltdown the previous December, which had taken the entire financial world by surprise—the auditors, the regulators, and the Street. Now everyone was scrambling to figure out who had left the barn door open and how. Suddenly, swaps, which had been used by many of the companies in trouble, became public enemy number one. Both the FBI and the SEC opened probes into Global’s numbers. It wasn’t going to help recoup that $54 billion, though. I was pretty sure of that.

It was pathetic—both to watch and to be a part of. At the beginning of March 2002, I held CSFB’s annual telecom conference, this time in Orlando at the Portofino Bay Hotel. Rather than meeting at the heart of the financial world, we instead opted for distraction, taking everyone to Universal’s Islands of Adventure. One night, we reserved the Marvel Super Hero Island for the exclusive use of conference attendees. Maybe, we hoped, one of those superheroes would save us from the wreckage of our industry.

As I strapped myself into the Incredible Hulk Roller Coaster, I couldn’t help thinking that I preferred the real thing to the
virtual
roller coaster we’d all been riding for the past few years. In a real roller coaster, there was gravity; what went up came back down, and we ended the ride where we’d started. On the telecom roller coaster, we’d kept climbing further than anyone believed possible—and then we’d plummeted headlong into a chasm.

Still, as tame as the Universal ride seemed in comparison, it was treacherous in its own way. Megan Kulick, my former associate, who had left Merrill to work for a hedge fund and was now a client of mine, was there. She rode the coaster so many times that she ended up puking her guts out. If that wasn’t a sign of the times, I didn’t know what was.

Although the $1.1 million budget was less than half the prior year’s, we didn’t skimp on the goodies. In fact, considering what was going on in the sector, it’s amazing how luxe the event was. We were a Wall Street investment bank, after all. We hired Kevin Zraly, the internationally acclaimed wine writer and founder of the Windows on the World Wine School, to host a special wine tasting one evening.

The mood was shell-shocked, resigned, and frustrated. That is, except for the value investors, who, like vultures, picked through the skimpy meat left on the bones of some of these companies and debated whether there was anything worth keeping.

The next week, on March 11, WorldCom announced that the SEC had opened an investigation into its accounting practices. This was not exactly a shock, given that every poster child for the go-go 1990s had crashed, many were under suspicion for aggressive accounting, and WorldCom’s stock was now trading at $9 a share, an astounding drop from its high of $64.50. My rating remained Hold, as it had been for the past year and a half.

In a highly unusual move, WorldCom not only publicized the investigation; it also published it in full on its Web site, listing all 24 of the SEC’s queries. The SEC request sought information regarding virtually every element of the way WorldCom recognized revenue and detailed information about how it accounted for its merger reserves. It also asked for material explaining how information was provided to Wall Street analysts and how analyst forecasts were tracked. To me, this last one suggested the inquiry was leading straight to that cozy relationship between the company and Jack Grubman. Could this finally be it?

The investigators also asked a lot of questions about an enormous loan of nearly $400 million that the company had made to Bernie Ebbers. By this point, we all believed that Bernie hadn’t sold any shares of WorldCom stock, instead opting to use it as collateral to buy other assets ranging from a timber company to one of the largest ranches in Canada. As WorldCom’s stock declined in 2000 and 2001, Bernie had faced margin calls from Bank of America, which had loaned him money against his then-valuable stock and now, as the stock declined even further, required more collateral.

Basically, Bernie was a very rich man—but only on paper. He’d bet every last chip on WorldCom, unlike Gary Winnick, Phil Anschutz, Joe Nacchio, and many other telecom executives, who sold when times were good. I was shocked, however, to learn that the board had apparently approved lending him such vast sums of money and that, in addition to the other banks, Citigroup, the parent company of Salomon Smith Barney, had facilitated this obscene leveraging of his assets much earlier, beginning back in 1999.
²

At that time, WorldCom’s board had faced two very unpalatable choices: one, let Bernie sell massive amounts of stock into the open market, which most definitely would push the stock down further and convince the doubters that even Bernie had lost faith; or two, bail him out. So the board did exactly that. It paid off his Bank of America loan and replaced it with a nearly $400 million loan from the company.

Such corporate “generosity” was highly unprecedented. I had heard about some of the smaller loans in early 2001, but by the beginning of 2002, when the news broke that he was actually $400 million in the hole, I realized how deathly serious the situation was. The guy had been averaging over $12 million a year in salary and bonus and owned, at WorldCom’s peak, stock worth over $1.4 billion. Wasn’t it just two years ago that he’d exhorted everyone at my conference to play
Who Wants to Be a Millionaire
by buying his stock?

I also was taken aback by Bernie’s apparent stupidity. Rather than selling some shares and diversifying his holdings, he had doubled up, and more, on his WorldCom bet. This poor schmo had quite literally bet the ranch on WorldCom shares continuing to climb and had also locked himself into illiquid assets, so he had no downside protection if the market, or WorldCom, crashed.

Yet another flurry of negative press stories followed, from broad pieces decrying the collapse of the telecom industry to a
New York Times
piece on executives in trouble, featuring the indignity of poor Bernie having had to sell his 118-foot yacht,
Aquasition.
³
Bernie lost a yacht. Tens of thousands of his employees were going to lose everything. And, if Bernie defaulted, WorldCom shareholders would pay the price for his and his board’s bad decisions. All he’d have to do would be to declare bankruptcy. Then he could start over—not as a mogul, of course, but probably not delivering milk either.

The day after the SEC inquiry was announced, Salomon Smith Barney’s chief strategist, Tobias Levkovich, removed WorldCom from SSB’s “Focus
List” of stocks to buy. Yes, it had been on that list throughout all of the earnings misses and warnings. And why not? Its top analyst, Jack Grubman, still had it as a “1” or Buy. But now even Levkovich, no telecom expert, thought it was time to bail, citing the uncertain outcome of the SEC inquiry.

Sensing more and more vulnerability on the part of the investment banks, New York State attorney general Eliot Spitzer turned up the heat on his probes of the conflicts of interest between research and banking. He made public some of the e-mails written by Merrill Internet stock analyst Henry Blodget, referring to a stock Blodget had recommended with a Buy rating as a “dog,” and others he referred to as “POS,” for “pieces of shit.” He also announced that he was expanding his probe to other banks. Spitzer didn’t name names, but we all knew he probably meant CSFB, Morgan Stanley, and Salomon Smith Barney. And indeed, on April 29,
Business Week
reported that Jack Grubman had become a target of Spitzer’s ongoing investigation of analysts, along with SSB.
⁴

To try to steal some of the regulators’ thunder, banks such as Merrill and CSFB hustled to announce their own reforms, including prohibiting analysts’ compensation from being tied to specific investment banking deals, though they did not offer to stop funding research departments with money from their investment banking departments. It was amazing to see these firms scramble after denying for so long that there was anything questionable about the way they did business.

On April 19, 2002, WorldCom again warned of an earnings shortfall, forecasting financial targets that were much worse than expected. With the Bernie loan debacle and the SEC investigation, it was enough to make me decide that the company’s survival was in real question. So three days later, quite belatedly I admit, I sounded the death knell, lowering my rating from Hold to Sell—the second Sell of my career and the first in many years. I cut my target price dramatically, from $9 to $2. I wrote: “…[The] only exit is takeout by [a Baby Bell] but we believe [the Bells] are highly unlikely to take on $30B of debt, negative revenue growth and inevitable loss of share and pricing power.”

I wasn’t the only person to lower the boom on WorldCom shares, although I was one of the few to go to a Sell. Goldman and JP Morgan also downgraded the stock. And, finally, so did Jack Grubman, who was already having a pretty scary week with the announcement of Spitzer’s probe. He dropped his rating two notches from a Buy, or “1,” to a Neutral, or “3,” citing the SEC investigation and the debt problems.

His report, titled “WCOM: Dramatic Change in EBITDA Guid. [
sic
] Too Much to Ignore,” was telling even in its title. God knows he’d ignored all the other bad news coming out of the company for the previous few years—but I guess this was really too much, even for him.
⁵
Surprisingly, Jack still had followers: WorldCom’s stock fell by a third on the news, from $5.98 to $4.01 per share.

On April 25, WorldCom reported terrible earnings per share and revenue growth. And then, on April 30, the once-unthinkable news broke that Bernie Ebbers—Jack’s starmaker—was out, having resigned under pressure from the board. Not only was he getting the boot for WorldCom’s horrendous performance, but his financial difficulties had compounded with each downward tick of the stock to the point that he was virtually insolvent. I guess the board finally concluded that it’s hard to carry out your fiduciary duties to the shareholders when you owe them $400 million yourself. Maybe the board should have thought about that before they loaned him the money. John Sidgmore, the former CEO of MFS subsidiary UUNet, who had joined WorldCom’s board after it snapped up his company, became the acting CEO.

Jack, meanwhile, had replaced the younger and blonder Henry Blodget as the public face of the bear market. The April issue of
Money
magazine, a publication that had glorified the stock market, put him on its cover. Its title: “Is Jack Grubman the Worst Analyst Ever?” Street people didn’t read
Money
for the most part—it was aimed at the individual investor—but this copy was dog-eared by the time it had made the rounds of our offices. It essentially blamed Jack for the entire telecom bubble. “People hung on his every utterance,” it said. “When he spoke, stocks moved.”

Jack wasn’t the only telecom hero to suffer an abrupt reversal. A month earlier, in March, Qwest had also come into the crosshairs of the SEC, which was investigating its accounting, focusing particularly on its use of swaps to bolster revenues. The stock was now trading at around $9, down from a high of $66 just two years earlier, with its employees’ pension funds virtually wiped out. Joe Nacchio, however, had cashed in stock options worth $74.6 million in 2001 alone and, just five months earlier, had even had his contract renewed until 2005.

But suddenly, Qwest’s long-supportive board had a change of heart. Nacchio, too, had to go. Phil Anschutz, Qwest’s chairman, did the dirty work. On June 14, he got on his private jet and flew to a private airport in New Jersey to break the news in person to Joe, who met him there.
⁶
Ever the
salesman, Joe tried to convince Phil otherwise, but his charm had worn thin. And though the board could have made the case that he was being fired for cause due to the accounting investigations, in which case he wouldn’t be eligible for any severance, it let him leave with a $12 million payout plus a $3 million consulting contract for two years. Joe left rich in dollars but not reputation, his grand strategy disgraced and discredited. He had done what I thought no man ever could: he had come close to destroying a Baby Bell, a cash cow if ever there was one.