Confessions of a Wall Street Analyst (23 page)

So I listened and nodded my head. Everyone was going through various prices to be paid for AirTouch and looking at the negative impact on earnings. They discussed the possibility that Vodafone, a British wireless telecom company that had partnerships or equity stakes in almost every country in the world except the United States, might also bid. But Chris Gent, Vodafone’s CEO, was out of touch at a cricket tournament in Australia, so no one knew what to expect. The bankers and executives went through a series of scenarios, all of which hurt earnings by over 10 percent, with some as high as 25 percent or even 30 percent. For a slow but stable earnings grower like a Baby Bell, these were some seriously large and negative numbers. Although I thought the deal was a bad idea, it would be a great one for my firm; a $45 billion bid meant a potential fee for Merrill of approximately $25 million.

The meeting ended on an expectant note, with everyone wondering whether Vodafone would make a bid. The next day, they did. We were called back in for a long conference call with GTE, which was still in the process of merging with Bell Atlantic, and its CEO, Chuck Lee. The terms of the Bell Atlantic–GTE merger specified that neither company could undertake a major strategic move without the approval of the other, so Chuck had veto power over this deal. GTE’s bankers were Salomon Brothers, so a bunch of its bankers and Jack Grubman were also on this call.

Jack prattled on for about 20 minutes about how terrific the deal would be, how Bell Atlantic should outbid Vodafone so that it would have a national wireless “footprint,” and how size and scale were going to determine the winners in telecom. Chuck Lee was in favor too. Everyone liked the deal, it seemed. Except for me.

The call ended, and Ivan and his CFO, Fred, indicated that they wanted to speak with me privately in Fred’s office. Ivan asked me whether or not Bell Atlantic should bid again, and if so, how high it could go without its stock falling too far as a result of selling by investors displeased by the hit to earnings that would result.

I took a breath and in the course of ten seconds helped to lose Merrill one of the biggest deals of the year, if not decade.

“You are better off letting Vodafone win,” I said. “Then it will have to come to you to partner. AirTouch will still need to have national coverage and there is no better, in fact no
other,
way to accomplish that than partner
ing with you. This way, your stock will go back up out of relief that you didn’t make such a big acquisition with such a big effect on earnings. And your cellular customers will still get nationwide coverage but at a far lower cost.”

Fred and Ivan just sat there, listening. Ivan, as always, had a poker face on. Finally, the CFO looked over at Ivan. “I think that’s where we’re headed, Ivan,” he said, which was Fred’s way of making a recommendation to his boss. Ivan didn’t say anything at all.

When I came out of Fred’s office, Michael Costa and Tom Middleton, the Merrill bankers, accosted me, wanting to know what had transpired. I told them that I had suggested they not make a counterbid. If the Bell Atlantic executives listened to me, that meant a lot of work and no payday for Merrill and lower bonuses for its bankers, especially these two.

Clearly, they were disappointed, but these bankers weren’t stupid. As much as they wanted the fees and as frustrated as they must have been with me, they also agreed with my reasoning. And hopefully Ivan and Fred would respect Merrill for its sound, non-self-serving advice, and that would translate into some other payday some other time.

On January 15, 1999, AirTouch accepted Vodafone’s counterbid of $66 billion, or $97 per share. Bell Atlantic never made another bid. And by September of that year, Gent had come to Bell Atlantic with a joint-venture proposal. I felt that I had saved Bell Atlantic shareholders a bundle. But I had helped to lose my firm roughly $25 million, the M&A fee for one of the biggest deals in history.

1999

“You know, Dan, our stock is down $4 today,” he said, with the kind of bellowing laugh that can emanate only from a wealthy man, “and I’ve lost almost a billion dollars in just a few hours! Can you believe that? My net worth is actually down a billion dollars today!”

I laughed, as apparently was required. I guess it was somehow truly amusing that the coming or going of $1 billion did not really seem to matter. What a 1999 moment.

My Multibillion-Dollar Mistake: AT&T

P
ERHAPS IT WAS
simply the pressure of dealing with so many companies and deals at the same time. Perhaps I was beginning to feel out of step with a stock market that knew no bounds. Perhaps I was swayed by the charisma of a new, überconfident chief executive. Whatever the reason, I kicked off 1999 with a multibillion-dollar mistake—one of the worst decisions of my professional life.

Way back in October 1997, AT&T’s board had finally made a bold move after a humiliating series of events. First, CEO Bob Allen had bullied the board into choosing the corporate empty suit John Walter as AT&T’s CEO-in-waiting. Then, when it became clear Walter was a disaster, the press had excoriated the board for paying him $26 million in severance for nine months of work. On October 20, it brought in a new CEO, C. Michael Armstrong, a dynamic turnaround specialist from Hughes Electronics Corporation. The market loved this choice, and AT&T stock leaped more than 16 percent, from $43 to nearly $50, in the two weeks between the time the rumors began and the decision became official.

Armstrong, a balding, impressive smooth talker with a disarming smile
who seemed to understand technology, quickly charmed the press and the Street, in part because he had miraculously transformed Hughes Electronics from a defense contractor to a satellite TV business, DirecTV. In many ways, AT&T was like the Hughes Corporation Armstrong inherited in 1991—a dying giant with a need to spend enormous sums to gain a foothold in a new business. The changeover at Hughes had been painful, involving huge employee and cost cuts, significant startup costs to get the satellite TV business underway, and enormous risk. Armstrong openly acknowledged that it was a bet-the-company strategy, and it had paid off.

After his predecessors, dull powercrat Bob Allen and the woefully underqualified John Walter, Mike Armstrong had the aura of a savior. He tackled AT&T’s problems head-on and laid out a clear action plan. He did nothing to discourage the increasingly popular belief that if anyone could fix this broken company, he could. I listened to everything he said and liked what I heard. Still, I remained skeptical: I thought that AT&T had simply delayed the inevitable for far too long and that Armstrong’s challenge might be simply too great and too costly. So I left my rating at Neutral for quite some time, even as my institutional investor clients became enamored of Mike and AT&T shares rocketed to $75.75 at the end of December 1998. Anyone who followed my advice missed a huge run-up.

From the beginning, Armstrong promised to address AT&T’s main problems: getting local access to add to its established long-distance prowess and expanding its international reach. His first big move came in January 1998 when he bought Teleport, the startup local phone company that Mark and I liked so much, for $11.3 billion, thus gaining an instant presence in the market for local phone service for business customers. To address the local phone market for consumers, he bought cable company Tele-Communications International. And finally, in December 1998, just before Bell Atlantic’s run at AirTouch, Armstrong announced he was buying IBM Global Network, an IBM business unit that provided communications services for large multinational corporations around the world. He had filled AT&T’s major strategic holes in less than a year. I started to wonder if this guy really was the knight in shining armor for this antiquated old bureaucracy, and whether I should think about upgrading the stock.

So I did what I always did in these circumstances: I began a debate with myself and with all of the people whose opinions I respected, such as Bill Newbury, TIAA-CREF’s (Teachers Insurance and Annuity Association-College Retirement Equities Fund) telecom and cable analyst and a major
client of mine. Newbury was a major bull on AT&T and taunted me, saying that I was missing the biggest stock in telecom. I absorbed the digs. It was always fun to argue an unpopular position, and since I had actually been quite right for a long time (AT&T did eventually go as low as $30.75 after I downgraded it three and a half years earlier, when it was trading at $55), I wasn’t too concerned. But the conversation did add to my growing sense that some important things were going on at AT&T.

The other point that got my wheels turning was that it had been widely reported that AT&T was considering using a
tracking stock
to separate its cable and wireless divisions from its long distance business. The use of tracking stocks allows a company to create separate stocks for different units. It would separate the big startup losses of AT&T’s fast-growing cable and wireless businesses from the slowing but still-profitable long distance business. This came at a time when the stock market was paying incredible premiums for fast-growing businesses, even those with no earnings, while devaluing old “traditional” assets—in this case, AT&T’s voice long distance business.

With Armstrong’s recent acquisitions, the company now had a chance to radically transform itself. I thought the tracking stock, if it did what it had done for Sprint and others, would give AT&T more financial flexibility and a higher stock valuation. I set up a meeting with Dan Somers, AT&T’s CFO, to discuss AT&T’s future. I asked him whether the tracker was still going to be announced at next month’s annual analyst meeting, and he smiled reassuringly.

So with the tracker as the news hook, in late December of 1998 I decided to upgrade AT&T, outlining my thoughts during that family vacation in Florida before I was interrupted by the Bell Atlantic–AirTouch negotiations. I knew there was an AT&T analyst meeting scheduled for Friday, January 8, 1999, and I thought the upgrade should come out just before then. By the time I got off Bell Atlantic’s jet, I had started typing up the AT&T draft report on the way to Ivan Seidenberg’s office. That Saturday, of course, was taken up by the over-the-Wall meetings at Bell Atlantic, but as soon as I got home I shifted gears, spending two close-to-sleepless nights editing the draft. We went out with the AT&T upgrade on Merrill’s morning call on Tuesday, January 5, raising the stock one notch, from Neutral to Accumulate. AT&T shares traded up about 2 percent that day, a sign, I figured, that my argument resonated with investors.

The next morning, I got a call from the Merrill banker responsible for the AT&T relationship, telling me that I would be brought over the Wall on
Thursday for an AT&T rehearsal in order to help it prepare for its Friday analyst meeting, which would have several hundred analysts, money managers, and journalists in attendance. It was a hectic week for me, with my AT&T upgrade, a trip to Arkansas, and two over-the-Wall sessions for two different companies within four days.

I showed up at AT&T’s bucolic Basking Ridge, New Jersey, headquarters and strolled into the boardroom, expecting a boring day listening to predictable slide presentations. The sell-side analysts had the best seats, and I was seated directly across from Mike Armstrong, with Jessica Reif-Cohen, Merrill’s cable analyst, to my left and Jack Grubman next to her. Frank Governali of Goldman sat to my right, with Denny Leibowitz, the legendary DLJ cable, media, and wireless analyst who had been rated number one in his category on the
I.I.
list for over 15 years, to the right of him. Along with a few other analysts, there were several bankers. I was just about to settle into my seat when the Merrill banker pulled me into a corner.

“Dan,” he whispered, not messing around with pleasantries, “the tracker is canceled.”

It was one of those moments that seemed to last for hours. I could feel the blood draining from my face and my legs beginning to wobble. How could that be possible? I had just upgraded AT&T in large part because of the likelihood of a tracking stock for AT&T’s wireless and cable units. I would look like a complete and total fool without the tracking stock plan. Geez, Connie Weaver, who several years earlier had left MCI and become AT&T’s head of investor relations, had even named her dog Tracker!

Just then, Mike Armstrong walked in, brimming with confidence as usual, and sat directly across from the other analysts and me, flanked by AT&T’s key executives. The bankers in the room were relegated to seats along the periphery. Mike asked everyone to take their seats and took a small piece of paper out of his shirt pocket on which he’d handwritten his own notes. No cue cards or teleprompters for this guy; it was impressive. After thanking everyone for coming on such short notice, Mike began reading from his crumpled piece of paper. He explained that he’d decided not to do the tracker because AT&T shares had done very well lately, and since the point of the tracker was to attract investors, perhaps it wasn’t necessary.

Armstrong emphasized that he could always return to the tracker if he thought the company or its stock price needed it. I tried to look impassive, but I was burning up inside, thinking about how everyone in the room knew how bad I looked, and that many of them were enjoying my misery. Wrap
ping up, he said he’d like some feedback from the analysts in the room before he gave us a preview of the next day’s presentation. “How do you react to what I just said?” Armstrong asked. “How will the market react?”

I could barely think straight. All I could think about was what a fool I was going to look like the next day, and if he really wanted to hear what I thought, it wasn’t going to be pretty. I watched as the analysts, one after another, each told Armstrong he was making the right decision. I waited for the others to finish speaking, partly because I wanted to hear as many perspectives as possible, but also because I desperately needed time to figure out what to say and how to say it without looking as if I was chewing on a bunch of sour grapes. Finally, it was my turn.

“I disagree,” I said, trying my best to sound professional and change Armstrong’s mind. “In this market, if you don’t unlock the value in the high-growth but money-losing cable and wireless units, you are robbing AT&T of future growth opportunities.” I added that I thought that most around the table would agree that Sprint’s two trackers together had achieved a higher stock market value than otherwise would have been achieved, and that this gave Sprint PCS, the wireless portion, the ability to spend more money and to build out its network more rapidly. Everyone was silent for a moment, until Armstrong, sounding a bit perturbed, thanked me. It was clear that his decision was final and he was just practicing his speech.

Finally, at the end of the day, Connie Weaver, AT&T’s investor relations head, told me Armstrong wanted to meet with me in his office. She took me in and closed the door as she left. It was unprecedented for Connie to leave me alone with an AT&T executive—she was infamous for never letting that happen—but I guess Armstrong wanted this to be totally private. I walked in and took a seat on his couch. He sat down in the lounge chair to my right.

I didn’t know what to expect. If it were Joe Nacchio, I would have received a verbal spanking: “Who are you to question a decision that my board, my management committee, and 29 well-trained bankers and analysts in that room today agree with?” But that would have been Joe. Mike Armstrong was a gentleman and a professional. I imagined he’d say something like, “You know, Dan, you have the respect of many people in this industry, but in the future if you don’t agree with an aspect of what I’m doing, please tell me privately.”

But he was a lot subtler than that. In fact, he hardly acknowledged my earlier comments and reiterated his excitement about AT&T’s future. “Dan, you know you can call me anytime you want,” he stated. Was he insinuating
that if I had called him and asked about the tracker, he would have given me nonpublic inside information about the tracking stock being scrapped? I doubted that, but I didn’t know what he really meant. I told him I appreciated that, but it was not my style to run my draft reports by management before I published.

It turned out that AT&T investors didn’t see the decision as a problem. Much to my surprise and relief, AT&T shares did not fall following the analyst meeting the next day. They held steady, a sign that investors still liked AT&T, tracking stocks or not. Ehud Gelblum, the most recent addition to my research team, and I wrote a report summarizing the meeting, titled “AT&T: The Magical Mystery Tour Continues: More Notes from Bullish Analyst Meeting,” reflecting my amazement that investors continued to believe in Armstrong even when he flip-flopped. Indeed, the stock continued to soar, moving up 22 percent to an all-time high of $95 over the next thirty days and bailing me out—for the moment. Thank God for this crazy market, I said to myself.

“You’re Missing the Fucking Boat on Level 3”

The Internet boom was now in full swing, and rather than being a phenomenon that would include telecom, it began to define telecom. No longer were the companies I covered relevant because of the traditional phone calls or voice communication they transmitted. Now it was all about data transmission, which was growing at what appeared to be an exponential rate. Data transmission meant sending e-mails, pictures, huge data files—you name it—over the Internet. Just as the railroads had unleashed the power of America’s manufacturing muscle a century earlier, the telephone, cable, and wireless companies were laying the tracks (fiber-optic, in this case) to connect the virtual economy. Or so went the hype.

I had been fully aware of the Netscape IPO, Al Gore’s information superhighway, and, of course, the stock market hype that was exploding all around me. But the light hadn’t really begun to click on inside my head until that August 1996 meeting with Jim Crowe, who was then the CEO of MFS. I first heard at that meeting about Internet protocol, or IP, the technology that would be built into the telecommunications networks of the future and could truly transform every company I followed.