Confessions of a Wall Street Analyst (12 page)

A few months later, I was able to make good use of something I’d learned when I worked in MCI’s investor relations department, though it didn’t help my relationship with the company. One day in November 1994, when I had MCI rated as a Buy, Merrill’s highest rating, I’d gotten to work, as I always did, at 7:15
AM
, and spent the hours before the market opened returning phone calls and talking to salespeople and traders.

As 9:30 approached, the trading desks always became frenetic, with traders yelling orders and market rumors being tossed back and forth across Merrill’s football field of a trading floor. For me, in the quiet of my office 16 floors higher, it was also a tense time of the day. Had any telecom companies issued press releases? Were any of my stocks making unexpected moves? Had I missed any news? Was anyone else announcing an opinion change? Ideally, I wouldn’t find myself on the wrong end of the information flow, but it did happen.

And that was the position I found myself in that chilly morning of November 28 when, just 15 minutes after the market opened, a Merrill trader called, barking that he was seeing some large sell orders on MCI shares. Already, the shares were down 5 percent to $19 from $20. The sellers were offering MCI shares for sale in larger-than-normal blocks. The trader might have known who the seller was, but he was sworn to protect the confidentiality of his client’s trading intentions.

Five percent down was a big move, yet there was no news out, so I went straight to the source, Connie Weaver, MCI’s director of investor relations, to see if I had missed anything. I got her assistant, whom I knew from my days in the MCI IR department. Lucky me. “Hi, Dan,” she said warmly. “Connie and Doug are in Boston today, visiting investors.”

The lightbulb clicked on. Had this trip been planned in advance, some of my Boston clients would have mentioned that MCI was coming to town. Knowing this, I would have called the analysts I worked with at Fidelity at 9:00
AM
, right after the meeting, to see what had gone down. But no one had said a word. So a last-minute trip to Boston could mean only one thing: MCI was playing its patented hot/cold game from the old days! The company was probably seeing softness in its results and wanted to lower expectations before the holiday and postquarter “quiet period” set in, when the company
would no longer be allowed to discuss numbers until its earnings were released.

I spent the rest of the day trying, without success, to confirm this, but I knew in my gut that the company was doing its thing and that no one else understood it—no one else, that is, other than a few “well-informed” money managers in Boston. This was all before SEC chairman Arthur Levitt’s Regulation FD (Fair Disclosure), which outlawed the release of information to any investor group without making it available to all when it went into effect in 2000.

Connie Weaver didn’t call me back until 2:00
PM
. I was not happy, because I needed to understand what had changed in MCI’s business before I could rework my forecast and target price for the stock. She told me MCI was seeing some weakness in sales to midsized corporations, likely due to price-cutting by AT&T, and she didn’t fight back when I suggested I would need to lower my forecast. After talking to her, I knew my suspicions were right: the company was trying for a gentle landing with its bad news by telling the institutional investors in Boston before any others.

It appeared the long-distance price wars were more intense than I had been predicting and it was time to reduce my rating. The next morning, I downgraded MCI shares two notches, from Buy to Neutral—meaning I now thought MCI’s shares would hover within 10 percent of their current price over the next year. I also cut my rating on Sprint from Accumulate to Neutral, assuming that the problems MCI was facing were industry-wide. As it turned out, my concerns were justified: two weeks later, Sprint announced fourth-quarter price pressures, and early in 1995, both Sprint and MCI announced disappointing fourth-quarter revenues and earnings.

The day after I issued my MCI downgrade, Matt Bowman, the Merrill banker, called to tell me that good old Doug Maine was not happy with my decision. “Dan has a right to his own opinion,” Doug apparently said. “I respect that. But I am not happy with the
tone
of his report. And he should have given us
notice
in advance.”

“Tone” and “notice.” I had to laugh. I immediately understood what was going on: his complaint about my “tone” was simply another way of saying he disagreed with my decision to downgrade (believe me, I never got the tone complaint on an upgrade). And “notice” was just another way of asking for time to get a rebuttal ready. If I had informed Doug the day before that I was going to downgrade, two things might have happened. First, he might have
called Matt Bowman, and perhaps MCI’s CEO, Bert Roberts, would have called Merrill CEO Dan Tully, urging them to get me to reconsider.

Second, with “notice,” Connie Weaver and MCI’s investor relations department could launch a preemptive strike by calling important stockholders and countering my argument. What nonsense, I thought. They want to control what we analysts say, and they want the complaint registered via Merrill’s bankers, hoping the message comes through: if you want our banking business, make sure your analyst is good to us.

I can’t tell you how many times I would later hear the “tone and notice” complaint from corporate executives who didn’t like what I had to say, but it was something of a novelty at the time. Anyway, I didn’t pick a fight with Matt and he didn’t with me. I just told him to please tell Doug I was sorry, but I didn’t think I should notify anyone of my downgrade before it had been officially announced at Merrill’s daily meeting for the 150 institutional salespeople and thousands of retail stockbrokers who listened in via a loudspeaker system known as a “squawk box.”

In March 1995, I hosted my annual telecom conference, as I had done the prior year and would do for the next seven years. Virtually every major telecom CEO would make an appearance, and over the years it became an event where one could expect some big deal to be announced or important news revealed. It was a great place for executives to interact with major investors, other executives who might be interested in a deal of some sort, and Merrill’s analysts and bankers. Although MCI CEO Bert Roberts had raced back from a board meeting in London to speak at my conference the prior year, this year he was suddenly unavailable. MCI CFO Doug Maine was sent along as his replacement. The thing was, it was a CEO conference. We all suspected what was going on: this was retribution for my downgrade.

Jack’s Knack

Back on the international front, the pace of privatizations continued to pick up, and with it, the intensity of the competition to underwrite them. By 1995, a few firms were emerging as the clear leaders. Goldman Sachs got the biggest piece of the pie, in part because it had Robert Morris, who for the nine years through mid-1994 had been the number-one-rated telecom analyst. Although Merrill was late to the party, its global brand and sheer size
made it number two, winning the lead in such privatizations as France Telecom, Portugal Telecom, Indosat, and Telefonica del Peru.

Others, like Salomon Brothers and Morgan Stanley, found themselves fighting like hungry dogs over the smallest pieces of business. We know what was going on at Morgan—their U.S. telecom analyst was inexperienced and not highly ranked—but what about Solly? Salomon was the setting for
Liar’s Poker,
Michael Lewis’s book on Wall Street, and it was known as an aggressive trading firm with a weak banking franchise (this was before Salomon was acquired by Travelers’ Smith Barney unit and then Citigroup). Salomon did, however, have Jack Grubman as its new telecom analyst. A year earlier he had moved from PaineWebber with great fanfare.

By this point, a bank’s research analyst was beginning to be one of the most important factors determining which investment banks companies and countries chose to handle their deals. Our research still mattered, but our reputation—ostensibly coming from that research—mattered a lot more. And Jack Grubman, because he had been out front on some of the new, growing companies and because of his aggressive self-promotion, now mattered the most of all. Jack’s contract to move from PaineWebber to Salomon was probably near $2 million per year for three years, easily making him the highest paid analyst on the Street at the time. It made sense, if such pay packages could ever make sense, because the telecom industry was fast becoming the deal center of the world and Jack was the most prominent analyst to move at that time.

By October 1994, Jack would displace Robert Morris to become the top-ranked U.S. telecommunications analyst in the
I.I.
poll. This should have given him a huge edge with foreign government officials choosing underwriters, but it didn’t, mainly because of his personality. Jack came across as pompous, constantly telling management what to do and how to run their companies. He was loud, self-centered, and every sentence he started seemed to begin with “I.” But foreign civil servants didn’t really go for the use of the first person. They were bureaucrats, and they preferred the calm, steady, and more respectful (okay, a little bit staid) voices of Robert Morris and me.

Although Jack and I had the same job, just about everything about the way we did our jobs was different. Mark Landler, a reporter for
The New York Times,
would later write a story calling us the “Siskel and Ebert of Telecom Investing,” and his description was spot-on. “Mr. Grubman, 43,” he wrote, “is the swashbuckler, who boasts about his close ties to the chief executives
of the big telephone companies and whose research reports sometimes read more like polemics than dispassionate studies. Mr. Reingold, 42, is the Wall Street wonk, who cultivates a network of contacts in Washington to gauge the direction of legislation, and who showers his clients with a stream of briefings and updates.”
⁴

When it came to privatization, wonk seemed to be working out better than swashbuckler. Yet Jack’s failure to win foreign deals was not for lack of trying. Like me, he practically lived on a plane for years. I ran into him all over the globe, crossing paths in Australia, Germany, and Peru. In fact, in Peru, I saw Jack on the steps of the Finance Ministry, where our respective pitch teams of bankers and analysts were being chased by paparazzi, eager for a shot of those helping to put together Telefonica del Peru’s upcoming IPO. I guess the arrival of modern capitalism in the form of a bunch of American Wall Streeters was bigger news in Peru than the latest Shining Path terror attack.

Making matters worse for Jack was the fact that when he was recruited, he had promised his Salomon bosses that he’d help them snare big investment-banking deals. Soon after Jack arrived at Salomon, a former Salomon analyst later told me, Jack had boasted at an internal departmental analyst meeting that he would help bring in $40–$50 million in banking fees in the next year, a huge score at that time. So far, it wasn’t happening, although he was being paid, in part, for that claim.

To its credit, Salomon was quick to realize that Jack didn’t play well overseas and that they needed to find a better use for their costly new hire. Jack knew it too. The solution was closer to home, in a new emerging category of telecom companies: the local startups such as MFS and Teleport, which offered local phone service in competition with the Baby Bells, and later, long-distance broadband companies, such as Qwest and Global Crossing, which would compete with AT&T, MCI, Sprint, and WorldCom. The startup local carriers offered lower prices than the Baby Bells because their technology was newer and more efficient, and because their workforces were nonunion.

Jack was one of the very first analysts to see the potential in these emerging telecom startups, and here his brash personality was a perfect fit. Start-ups are run by risk-taking entrepreneurs, people who don’t take no for an answer and people who like to move fast. Before Jack arrived, Salomon had already sponsored the IPO for MFS, one of the two first local telephone startups in the U.S. Jack quickly adopted MFS and its CEO, Jim Crowe. Jack became the patron saint of the local startups, drooling over every one he
could get in to see, and recommending almost every one that hired Salomon to underwrite its stock or bonds. His became the loudest voice heralding a new, hungry, and aggressive type of telecom company. And the louder he talked, the quicker his bosses at Salomon forgot about the failures overseas. This group of startup local phone companies would later become a new category in the
I.I.
rankings, and Jack owned it: from 1999 through 2001, he was rated number one.

I, too, believed that many local startups would do well.
*
But my colleagues in Merrill’s investment banking department were at a major disadvantage: by the time the local carriers began going public and raising money a few months later, I had already decided to upgrade their biggest competitors, the Baby Bells. Most local startup executives hated the Baby Bells and distrusted anyone who felt positively about them. Plus, Jack was far more vocal in his bullishness on the local startups, seeing virtually unlimited upside, and he was conveniently bearish on the Baby Bells, which, incidentally, were cash rich and thus didn’t need to raise money like the startups did. That endeared him even more to the local startup managements.

But that wasn’t Merrill’s and my only disadvantage. One day in April 1995, Frontier, a midsized phone company based in Rochester, New York, announced that it was buying ALC, a long distance reseller based in Birmingham, Michigan. The announcement came just after the market closed at 4:00
PM
, and clients began calling right away to see what I thought of the deal. I didn’t cover either stock at the time, but I was paying attention to the growing consolidation in the industry and thought the price was a fair one. I put in a few calls to larger clients, to give them my views and see what they thought.

At about 4:45 that afternoon, a buy-side fund manager called me, ostensibly to see what I thought of the deal. I detected a strange note in her voice, and wondered if she’d had a rough day or made some poor picks. I had launched into my spiel about how I believed that it would be better for the industry to reduce the number of players when she suddenly cut me off.