Confessions of a Wall Street Analyst (15 page)

Just as for a candidate for county sheriff, face time played a big part in the care and feeding of clients. Every Sunday night, I’d sit down and go through my Rolodex to determine who I should contact that week. I organized my clients by geography. “Boston” meant Fidelity, Putnam, State Street Research, State Street Bank, Wellington, and MFS, among others. It was customary for analysts to go to Boston twice a year, so I ramped it up to three times once I learned from some of that extra survey information that
I.I.
was happy to provide—for a fee—that I was ranked second to Jack Grubman by Boston voters.

In a typical year, I’d hit Boston three times, Chicago twice, and 27 other cities, ranging from Minneapolis to Montgomery to Portland, Oregon, to Philadelphia, once, with a day or half day in each city. I traveled to Europe at least once a year, visiting mutual funds, pension funds, and trust companies in London, Edinburgh, Amsterdam, Rotterdam, Paris, Stockholm, Frankfurt, Milan, and sometimes Dublin and Madrid, often hitting two cities per day.

Each day would begin with a breakfast meeting and go on late into the evening, with clients stacked one after another, usually one per hour. I’d give my shtick on the industry and the reasons for my recommendations, try to
tailor something special for each client, and then answer any questions they might have on the industry, on stocks, on deals, or on anything.

With some folks, the call was almost totally social. We knew and liked each other, and if they wanted to talk about skiing or music or politics or the weather, that was fine by me. It added spice to an otherwise highly repetitive life. With others, it was all business from the moment I walked into their office. All of these buy-side analysts and money managers received our research, but they got everyone else’s research too. So it was this personal touch combined with my investment ideas that I hoped would win me votes.

I also invited clients to special events, meetings with company executives, and anything else that I thought might interest them. I regularly hosted lunches with telecom executives at the St. Regis Hotel for about 20 carefully selected clients who might truly appreciate getting to know the CEO of Verizon, say, or were particularly interested in the viewpoints of the chairman of the Federal Communications Commission.

For five years running, I organized ski trips for buy-side clients to Vail, Telluride, Park City, Snowbird, and Whistler. Everyone had to pay their own way—this wasn’t a freebie from Merrill—but it was a great opportunity not only to have fun but also to debate the key issues facing telecom investors.

I came to really like this part of my job, although it was exhausting. I had to be “on” all the time. Every move I made, every quote in the paper, every bad joke, could end up as a reason to vote for me or against me. It sounds absurd, and it was. Yet ultimately this ranking made a huge difference to both my career and my firm.

So in late 1995, shortly after I had upgraded the Bells and downgraded AT&T, I was traveling when I got the word that it finally happened. I’d snagged the number-one rating in wireline services, achieving the goal I’d set when I came to Merrill. Of course, this also meant I’d unseated Jack. I was proud as hell, thrilled for my team because I thought I would likely be able to get them bigger raises now, and at the same time, scared: having made it meant that all of my competitors, especially Jack, would be gunning harder for me the next time. This was no time to coast.

My making it to number one coincided with Merrill’s becoming the number one research department, with the highest number of ranked analysts of all the Wall Street firms. On December 8 of that year, Merrill held a special lunch, inviting each analyst who was ranked as a runner-up or higher.

The lunch was held in Merrill’s executive dining room, and 12 or so ta
bles were set up, each one pairing a few analysts with a senior executive or two. I was seated with “Danny Boy” Tully, proving, I guess, that the firm actually did hold telecom in high regard. Eventually, Tully and a few other Merrill executives made speeches that thanked and congratulated us. Getting ranked in
I.I.,
they said, was good for everyone. It made it easier for the retail brokers to attract clients, helped the traders and institutional sales people generate more commissions, and, lest we forget, it helped the bankers attract investment banking business from corporate executives.

“Just to Make Things Interesting”

As the Telecom Act headed toward President Clinton’s desk, every analyst meeting or company visit took on added importance. A huge merger wave seemed poised to wash over the telecom industry, and we were ravenous for clues as to who was going to swallow whom. Although LDDS was still certainly a “second tier” long distance company, it had clearly emerged as the most interesting—not to mention the biggest—of that group in the past year.

This was mostly because of its high-flying stock and the fact that LDDS had made two major acquisitions: IDB WorldCom, bought out of near-bankruptcy after the follies of its executives, and WilTel, the national fiber-optic long distance network, which it bought for $2.5 billion in a Salomon-advised deal. It had also picked up its new name, LDDS WorldCom, meant to better evoke the company’s global ambitions.

On January 31, 1996, I attended an analyst meeting hosted by LDDS WorldCom at the New York Hilton. The meeting was uneventful and I learned little, at least not until I was leaving the hotel. As I was walking to the escalators, Jack Grubman came up alongside me and we ended up walking out together.

“Hey,” he grunted, ever the tough guy. “How ya doin’?”

“Fine, Jack, you?” was my minimalist response.

“Good,” Jack answered. “So I guess we’re on opposite sides of this Baby Bell versus long distance argument, huh?” he said.

“Certainly looks like it,” I acknowledged. Damn straight we were. He had just issued a 115-page report arguing virtually the exact opposite of the opinion I had issued six months earlier. Any analyst (read: me) who thought the Baby Bells were going anywhere, he wrote, was “starry eyed,” “bull-headed,” and “nuts.”

“Well, you know, Dan,” Jack blurted suddenly, “if you hadn’t reversed [your opinion], I probably would have—just to make things interesting.”

I looked around to see if anyone else had heard this. Here was a top-ranked telecom analyst, one with a huge following among both institutions and individuals, telling me—his chief rival—that he would have changed his opinion “to make things interesting”? I thought I heard the music from
The Twilight Zone
playing in my ears. He’d had a completely straight face. Was he joking, or did he actually mean that? I didn’t know what to say, so I said nothing. Fortunately, we had reached the Hilton’s exit and we parted ways.

As I jumped into a cab to head downtown to my office, I pondered the role of an analyst. Wasn’t I supposed to recommend stocks that my analysis suggests will go up and not recommend those that it suggests will go down? So what job was Jack doing? Would he change his opinion for the sake of its entertainment value?

“Now I get it,” I said to myself. “Jack’s in the entertainment business and I’m in the stock-picking business.” He didn’t have it all wrong, actually. The way we conveyed our opinions was important, as I’d learned, and we both spent a lot of our time entertaining people and trying to make them like us. But even to joke about this stuff was, in my mind, the antithesis of funny. We were just so different.

That difference in itself was entertaining, it turned out. The clients and companies we worked with were well aware of our evident mutual dislike, and eventually, Mark Landler, a reporter from
The New York Times,
decided it deserved a story.

The result, “The Siskel and Ebert of Telecom Investing,” appeared on the front page of the
Times
’ Sunday business section on February 4, 1996, complete with “Picks and Pans from Jack and Dan” and photos. I refused to pose with Jack, a fact Landler made a point of mentioning in the story. I suppose the piece was good publicity for both of us, although neither of us could resist a few digs at the other.
⁶

I said Jack was “intuitive and gut-oriented.” When pressed on how Jack and I were different, I deadpanned “Before making conclusions, I try to do the work.”

Jack’s response was both funny and true: “I bet you that in college, Dan was prepared for every test, while I was cramming at the last minute,” he said.

The story went on to discuss why Jack favored the long distance companies like AT&T and MCI and why I liked the Bells. Then Jack said some
thing that, in retrospect, sounds pretty prescient, though in an odd way. Alluding to his view—an absurd one in my opinion—that the Bells would never meet my forecasts unless they violated the legal requirements of the Telecom Act, he boldly asserted, “If you believe Dan on the ability of the Bells to collude and conspire, the CEOs of these companies will all be sharing a cell at Leavenworth in five years.” He sure was right about CEOs going to jail, but wrong about which ones.

1996–1997

For some of the people in my world, intimidation was simply part of doing business. It was natural, I suppose, in a world that was entirely transactional: if you do x, I’ll do y. If you don’t, you’re screwed unless you have enough power to resist the arm-twisting. I’d mostly managed to avoid this stuff—until now.

M&A Mania

M
Y RIVALRY
with Jack Grubman had existed since my MCI days, but my reversal on the Baby Bells had taken it to a whole new level. Now, as 1996 dawned, it would ratchet up a few more notches as we came down on the opposite side of almost every new strategic move announced in our industry. We spent this year locked in combat, going head-to-head not only on several major deals but also on what we believed was the appropriate role of an analyst.

In part, that was because there were so many new deals to disagree about. The Telecom Act of 1996 launched one of the biggest merger and initial public offering (IPO) waves in history. President Clinton signed it on February 8, in a midday ceremony at the Library of Congress. Al Gore, claiming credit for his “information superhighway” legislation, was present, as was Reed Hundt, Gore’s high school buddy and chairman of the Federal Communications Commission.

Over the next four years, seven of the nation’s eight largest local phone companies, the Baby Bells, would enter into multibillion-dollar mergers, mostly with each other. The major long distance companies would scramble
to find a way to offer local service, with both WorldCom and AT&T paying huge premiums for startup competitive local carriers such as MFS and Teleport. Even MCI would be gobbled up in dramatic fashion. And with the emergence of the Internet as a transformative communication tool, new long distance companies such as Qwest and Global Crossing emerged, offering “broadband,” or high-speed data transmission services. The numbers were mind-boggling and the pace was staggering.

More deals, of course, meant more multimillion-dollar fees for bankers. Yet this deal frenzy wasn’t just about M&A, nor was it only about the Bells versus the long distance incumbents. It was also the beginning of the IPO boom, in part because the new entrants in the telecom field desperately needed capital to compete against the fat incumbents.

On April 1, I awoke to the news that Southwestern Bell (SBC), based in Texas, was buying Pacific Telesis, another Baby Bell based in San Francisco, in a $16.7 billion deal. It was a smart move for SBC, in my view, but one that came as a huge surprise to most industry observers. I had not expected this particular combination, but I had been predicting Bell mergers, including the $23 billion combination of Bell Atlantic, based in Philadelphia, and New York-based NYNEX, which came three weeks later, on April 22.

I wasn’t brought over the Wall in either case. Merrill’s bankers, led by my colleague Tom Middleton, were advising Bell Atlantic and snagged a huge $30 million fee. I was informed of the Bell Atlantic–NYNEX deal the night before its official announcement, because Merrill’s compliance lawyers wanted to make sure I knew I would be restricted from commenting on the deal and should remain silent in the morning. I viewed both mergers positively, for both the cost savings and the greatly expanded geographic coverage it would give the merged companies. I thought they were doubling their bets on something good. Not surprisingly, Jack’s view was the exact opposite: that the Bells were putting all of their chips on something bad.

Nothing Personal?

But Jack and I didn’t disagree on absolutely everything—or so I thought. We were both bullish on the new startup local phone carriers, companies that were building local phone networks to compete with the formerly monopolistic Baby Bells. The two largest of these startups were the Jim Crowe–founded MFS, which had been the first of the group to have an ini
tial public offering back in 1993, and Teleport Communications. Salomon had handled MFS’s IPO before Jack came to the firm.

Now, in June of 1996, Teleport wanted to go public. Although I firmly believed that the Bells had the advantage over the long distance companies, I believed just as firmly that these startup local carriers were a good investment story. With their fiber-optic cables, they offered the only possible alternative for the long distance companies wanting to bypass the Bells’ local monopoly. Either AT&T, MCI, and the others would be the startups’ natural customers or, desperate to reduce their dependence on the Bells, they’d buy them up—hopefully at big premiums. My colleague Mark Kastan and I had been recommending MFS shares since January, having titled our initial report “MFS: Desperately Sought Assets” on the theory that it was a good acquisition candidate.

Merrill was handling the Teleport IPO largely because, seeking a cheaper telecom option, it had been one of the company’s founders and had been one of its largest customers. So it was Mark Kastan’s and my job to come up with an estimate of the price the public markets would pay for the company. This was much tougher than making such a prediction for an already publicly traded company. Teleport’s history was much shorter, and there were few similar public companies to which it could be compared. Indeed, MFS was the only similar company. If I had been analyzing Bell Atlantic or SBC or GTE, by contrast, I would have had a huge base of information to start with and, of course, a long history of how its price-to-earnings ratio and other valuation measures compared with those of other companies.

Just when the Teleport IPO road show was set to begin, MFS and its banker, Salomon, suddenly announced that MFS would soon be selling an additional $1.17 billion of stock to the public in what is known as a secondary offering. The announcement was unusual because it meant that both Teleport and MFS were coming to the capital markets at the same time and competing for investors’ attention and dollars. Since MFS shares were already publicly traded and the company’s management was better known than Teleport’s, there was a risk that Teleport’s offering would be overshadowed by the MFS road show. It seemed as if MFS and Salomon were trying to undercut Teleport and Merrill by showing everyone who was boss of this new sector.

As Teleport’s IPO approached, Mark and I hosted two conference calls, one to Merrill’s retail brokers and one to several hundred institutional investors. Somehow, Jack managed to hear one of our conference calls, and he went bonkers. Was it personal? Or was it just Jack being his intensely com
petitive self? I didn’t know. Whatever the reason, Jack was so agitated when he heard what we were saying that he apparently decided to violate the rules of both his own bank and the Securities and Exchange Commission. At Salomon—and at all investment banks—all research reports had to be reviewed by an internal compliance department before being sent to clients, to make sure that analysts had a reasonable basis for recommendations and also to keep them from inadvertently publishing confidential information about a banking client.

The SEC’s regulations at the time stated that a research analyst could not write about a company if his firm was in the process of underwriting a stock offering for that company. This was to prevent the underwriting firm from “conditioning” or hyping the market in advance of an offering.

Nevertheless, on June 18, 1996, Jack faxed a two-page report to hundreds of his clients, titled “Merrill Commentary on Teleport/MFS Comparison Flawed.” It was 13 days before the MFS offering and 9 days before the Teleport IPO, a time during which he was supposed to be restricted from writing reports on MFS. Someone faxed it to the CFO of Teleport, who faxed it on to me.

I blanched when I read some of this report. It sure seemed as if it was conditioning the market with its bullish comments on MFS. And the personal venom really got me. The first sentence read: “Merrill Lynch (lead manager of Teleport IPO) held a conference call yesterday where they attempted to justify Teleport vs. MFS by putting forth typically stupid arguments.” The next paragraph was subtitled “Rebutting Merrill’s ridiculous arguments of yesterday.” It read: “It is no wonder that our auto analyst returned from Merrill after a couple days given the lack of intellectual honesty put forth by them vis-à-vis MFS and Teleport.”
¹

Okay, I thought, this guy has really hit the skids. Jack was referring to the fact that a few days earlier, Merrill had hired an analyst from Salomon who decided that he didn’t want to stay, as happens occasionally. Sometimes analysts just didn’t feel comfortable in their new culture and quickly hightailed it back home, often scoring another raise in the process. What did this have to do with the opinion of a telecom analyst on Teleport? Well, maybe you would have had to take a
Being John Malkovich
–type journey into the folds of Jack Grubman’s brain to find a connection.

That was weird, all right. But the real issue was that Jack had apparently sent out a report that could boost MFS’s stock price—in effect, conditioning the market in violation of SEC regulations. I didn’t really mind; I knew our
analysis of Teleport and MFS was not “stupid.” I figured Jack’s emotional outburst could only hurt him with our mutual clients. Jack’s attacks also brought me more attention from the buy-side. But I did send a copy to Andy Melnick, the head of research at Merrill, who apparently passed it on to Herb Allison, who ran Merrill’s investment banking business and would soon become Merrill’s president. About a week later, I was told that Herb had called his counterpart at Salomon, Deryck Maughan, to complain.

I later heard from a few clients that the Salomon compliance department had contacted them as part of an investigation into the report. They were asked when and how they received this fax. Apparently, Jack’s report had not been approved by compliance. It sure looked as if Jack was finally about to get what was coming to him.

But if Jack received a reprimand of some sort, it was never apparent. He simply continued on his merry way, interpreting his job as he saw fit. And it appeared to me that Salomon condoned it or, at the least, ignored it, thereby reinforcing his behavior. Whether or not he was using not-yet-public information prior to Frontier’s acquisition of ALC, or whether he was bypassing a compliance review or simply making unsupported, outlandish accusations, he pushed the line, was rewarded for it, and did it again, each time advancing just a little bit further. Worst of all, I thought, he was establishing a model that many younger analysts would try to follow in the months and years to come.

Despite Jack’s interference, Teleport’s IPO was a big success. The initial price of the stock was $16, and it closed at $17.63 at the end of the first day. Within three months of the offering, Teleport’s stock price had risen 34 percent, to $23.63. MFS, too, succeeded in its offering, raising over $1 billion.

About a month after this incident, I got the news that I had landed the top spot in
I.I.
for the second year in a row, with Jack coming in second again. I was relieved, more than anything. The only thing harder than making number one was staying number one.

Internet Ignorance

As the deals kept coming, one after the other, I felt like a tennis player facing Pete Sampras. The best I could hope for was to return the serve and buy enough time to get in place for the next one. The next month, on August 26, 1996, WorldCom shocked the Street when it announced that it was buying
MFS, Teleport’s competitor and Jack’s favorite startup local carrier, for $14.4 billion or $55 a share, a 23 percent premium over MFS’s trading price. This was good news for Mark and me and better news for Jack. We’d all been recommending MFS shares, so investors who followed our advice made lots of money. But the buyer
and
the seller, WorldCom and MFS, were both Salomon clients, not to mention Jack’s favorite two companies at the time. It appeared to many that Jack, like the Wizard of Oz, had orchestrated this deal. And Jack, with his smug insinuations, played this new part to the hilt.

Jack had an increasingly powerful ally and friend in the form of Bernie Ebbers, the CEO of WorldCom. WorldCom now did almost all of its business with Salomon Brothers, thanks in large part to Bernie’s favorite analyst. As the 1990s went on, Jack and Bernie came to be thought of in the same breath. WorldCom’s mushrooming growth and soaring stock price made Jack look increasingly brilliant, while Jack’s growing influence, combined with his constant touting of WorldCom’s stock, made Bernie look equally astute. The two were becoming close friends as well. Bernie was Jack’s starmaker and Jack was Bernie’s.

Despite our frustration over Jack’s triumph, Mark and I thought the deal made tremendous strategic sense. And it fit in perfectly with our earlier prediction that the long distance companies desperately needed to build or buy local infrastructure. Nevertheless, we thought WorldCom was paying a very steep price, so we repeated our cautious stance and Neutral rating on WorldCom shares.

We estimated the acquisition would reduce WorldCom’s earnings per share by 87 percent, from $1.24 to just 17 cents, because MFS, as a startup, was losing massive amounts of money. Investors seemed to agree: WorldCom’s shares fell 16 percent the day of the acquisition announcement, while MFS shares jumped 28 percent that same day to approach the price WorldCom had offered for the company.

I wanted to know more about the pricing of the deal. So two days later, Mark and I met with Jim Crowe, MFS’s CEO and founder. A former executive at the privately held Omaha construction firm Peter Kiewit & Sons, Crowe had astutely pushed Kiewit into telecom as a logical outgrowth of its construction capabilities. After all, building a startup local carrier was basically one huge construction job: digging up city streets, pulling fiber through sewer conduits, drilling holes through foundation walls, and constructing power rooms to house telecommunications equipment.

Jim Crowe had the appearance and deep, booming voice of a marine drill sergeant. A fit guy in his mid-forties, he stood about six feet two and wore a flattop that made him look like a frowning Herman Munster. He was completely obsessed with his company and an indefatigable evangelist for it. This didn’t mean he was a schmoozer type, however. No, a meeting with Jim Crowe was like a meeting with the school nerd who’d been born again. He’d come at you again, and again, and again, not with words and jokes, but with numbers. He never smiled, never laughed, and he had what seemed like a compulsive need to quantify everything, a trait that he and I shared. One might have thought Jim and I would have gotten along famously. We didn’t.