Confessions of a Wall Street Analyst (39 page)

A perfect example took place on June 14, 2001, when I sponsored a private meeting with Global Crossing executives for a small group of seventeen carefully selected clients. As it turned out, a lot of hedge fund guys came to this particular meeting, from such big names as SAC, Pequot, Galleon, and Chilton. Some of them were short Global stock and were loaded for bear, hoping to hear some bad news that would drive the stock down. They wouldn’t be disappointed.

The meeting took place at 88 Pine Street, Global Crossing’s New York headquarters. It was a very modern space, with lots of black and silver and a sleek new-economy feel to it. The schedule called for an executive from every major sales category of the company to make an informal presentation and take questions from us. But as we got ready for the 2:00
PM
meeting to start, I was surprised to see Global Crossing’s fourth CEO in three years, Tom Casey, a former banker at Merrill and lawyer to telecom companies, stride into the room with Global’s president, David Walsh, by his side. Tom hadn’t been on the agenda.

The turnover at the top of Global had been worrisome—the stock traded down every time one of the CEOs left—but at the same time, understandable: each of them was paid such an outrageous amount of money in salary and stock options (Bob Annunziata left with $16 million for 11 months of work) that no one was surprised when they headed off to the beach after a year or so.

Yet later it was learned that Tom Casey’s predecessor, the previous CEO, Leo Hindery, convinced that Global Crossing’s business was not as
strong as everyone believed, had written a devastating memo to Chairman Gary Winnick at the time of his departure nine months earlier, although this wouldn’t be discovered by investigators until the following year. Leo predicted the company would fail unless it made major strategic changes. “Like the resplendently colored salmon going up river to spawn, at the end of our journey our niche too is going to die rather than live and prosper,” he wrote. “…The stock market can be fooled, but not forever, and it is fundamentally insightful and always unforgiving of being mislead [
sic
]….Without looking like we’re shaking our bootie all over the world, [we should] sell ourselves quickly to whichever of the six possible acquirers offers our shareholders the highest value.”
³

But the booty shaking apparently hadn’t attracted anyone, so here was Casey, standing all alone, his booty still. He wanted to chat with the group before the sales presentations began, so I introduced him quickly and he got right down to business. Casey asked what he said was a “hypothetical” question: “What would you guys think,” he said, “if we stopped selling IRUs and instead sold capacity only via shorter-term leases?”

IRUs, otherwise known as indefeasible rights of use, were long-term rights to use Global’s fiber-optic network—its main asset.
*

Tom Casey’s “hypothetical question” immediately raised eyebrows in the room. Most of my seventeen clients had their BlackBerries and, boy, did a lot of thumbs suddenly get a workout. Just about everyone in the room understood in a split second what I did—that Global must really be having problems selling IRUs—and this meant big trouble for the stock. Tom Casey hadn’t said the company was definitely changing its policy, nor had he warned that its forecasts were in jeopardy, but his hypothetical question caused everyone to ask their own question, which was some variant of the
following: why would he even consider voluntarily halting the IRU gravy train unless customers were jumping off it?

I immediately asked for more. How would they make this transition, and why would they consider it? Others asked Tom if he was seeing tougher price competition or slower demand, and whether, if Global made this move, it would be a temporary or permanent decision. His answers didn’t satisfy anybody. Everyone who worked for a hedge fund, and therefore was able to sell stock short, instantly sent a note back to their trading desks: “SHORT GX!” In the course of one hour, from 2:00 to 3:00
PM
, Global Crossing’s stock dropped 17 percent, from $10.50 to $8.66, on heavy volume, proving once again the insider’s advantage the big guys had over the little guys. Other than those of us in Global Crossing’s conference room, no one knew why the stock was falling—not individual investors, not institutional investors, not even those watching CNBC and other financial news shows.

At 5:00
PM
, Tom Casey and Global’s IR director, Ken Simril, moved uptown to another private buy-sider meeting, this one a dinner hosted by Jack Grubman. I rushed back to the office and prepared a report with my team that would cut our forecasts for Global Crossing. It seemed obvious that the buying power was shifting to the customer and thus future revenues would be lower. I left at about 10:00
PM
and Ido and Ehud stayed at the office to make changes to the final draft. By the time I got home an hour later, the report was ready to go. Ehud asked if he could run the report by Ken Simril, the IR guy, figuring we’d get more detailed feedback if Ken had to react to something concrete and in writing. I said fine. At around midnight, Ehud and Ido called back to say that Ken had awakened Global’s CFO, Dan Cohrs, at the St. Regis Hotel and that he would soon be calling us to talk about it.

As tired as I was, I was happy about this. Cohrs knew the forecasts cold and thus we’d at least get a sense of whether our numbers were lower or higher than theirs. Either way, we’d be smarter after the call. At about 1:00
AM
, my home phone rang again. On the line were Ehud and Ido, a very sleepy and annoyed Dan Cohrs, and an equally sleepy but not-yet-annoyed me. The CFO didn’t waste any time.

“Dan, do you have to publish this?” he asked in a raspy voice. “I don’t see why you have to or why you would want to. It was a private meeting, Tom’s comments weren’t official, in fact they were hypothetical, and we are not changing our guidance at all. We said similar things at Jack’s dinner and Jack had no problem. He will be reiterating his numbers tomorrow morning.”

Well, hooray for him, I thought. Had Jack not realized what Tom Casey was saying, or Casey toned down his comments for the dinner, realizing how much they had scared the earlier audience? I had no idea, but I did know that I didn’t appreciate Cohrs’s attempt to goad me into backing off. Anyone who thought I was going to follow Grubman’s lead was smoking some very strong stuff.

“I understand your points and I appreciate them,” I said, as I had now learned to at least pretend to be listening before I delivered the news people didn’t want to hear. “However, I already had some concerns about my forecasts that were amplified by the discussions today.”

Cohrs cut me off. “But, Dan, this creates a big FD [Regulation Fair Disclosure] problem for me. It forces me to make a filing with the SEC tomorrow saying that we have changed our guidance.” I didn’t know if he meant this or not, but, if he did, he was admitting that the company had given material information to one group that it hadn’t shared with everyone—exactly what Reg FD prohibited.

“Hold it right there,” I said. “I don’t know if you have changed guidance or not. But I do know that I’m more concerned about your revenue outlook, and I need to lower my forecasts as a result. These are my forecasts, my points of view, and my concerns. I’m not saying you lowered guidance. We are simply lowering
our
forecasts. I apologize if this puts you in a corner, but I just have to do it.”

Cohrs, quite pissed, signed off. It was now 1:30
AM
and we were all exhausted. The next morning, Ehud spoke on my behalf at CSFB’s morning meeting, informing the salespeople that we were lowering our forecast for Global’s 2001 revenues by 8 percent. Our report was published a few minutes later. Cohrs opted not to make a filing with the SEC.

Also that morning, a report from Jack, titled “Global Crossing:
True Feedback
[emphasis added] from Management Meeting” appeared. “Contrary to comments by a competitor,” he wrote, referring to me, “GX management did not alter prev. published financial guidance…. GX did not say it was changing [its] business model to a leased vs IRU business. Pressure on stock overdone. Reiterate buy.”

We were onto something, but I still didn’t downgrade the stock from its Buy, or “2,” rating, because Global was now at $8.66 a share—significantly below my new and lower target price of $14. I concluded it was simply too cheap to bail out now.

A few weeks later, I received a message from Gary Winnick, Global
Crossing’s chairman. I called back and his secretary hooked me into his cell phone, as he was en route to investment banker Herb Allen’s exclusive annual powwow of business movers and shakers held every year in Sun Valley, a fact he wasted no time announcing. Although Gary’s tone was polite, his words were biting.

“I heard you are predicting a revenue miss in the second quarter,” he said. “I just want you to know that you will be proven wrong.”

I suppose those were intended to be fighting words, a threat in the sense that I would be embarrassed for lowering my forecasts. But, with a positive rating still on the stock, I was actually hoping he would be proven right. And, given that the quarter was already over, I figured he—if anyone—should know. Better to be wrong on the forecast but right on the stock, I figured.

Nacchio’s Wrath

Just around the time of Gary Winnick’s phone call,
The Wall Street Journal
ran a story, “Overbuilt Web: How the Fiber Barons Plunged the Nation into a Telecom Glut.”
⁴
It argued that the race to build out capacity had more to do with the dueling egos of Level 3’s Jim Crowe and Qwest’s Joe Nacchio than the need for more fiber. Still, Qwest came out as the winner in the piece, mainly because it was well-diversified with its ownership of US West. It was clear that the biggest losers were incumbent long-distance companies such as WorldCom and AT&T, which were in full meltdown. Despite the fiber glut, companies like Global and Qwest were still signing up corporate and government customers for high-speed data and Internet services and hitting their numbers.

Not everyone, however, believed that. Simon Flannery, Morgan Stanley’s fairly new telecom analyst, had also been recommending Qwest with an Outperform or “2” rating, Morgan Stanley’s equivalent of CSFB’s Buy. A serious Irishman with a decent reputation, I didn’t know him too well, but had seen some of his reports and they were excellent. On June 20, 2001, he published a report, co-written with two other Morgan Stanley analysts, lowering his rating on Qwest to Hold based on a bunch of arcane accounting concerns.

I studied the report carefully and reviewed each of its arguments. While I believed there were some interesting technical points about the accounting, I also thought these items would not affect future revenues or cash flow,
the two elements that most affected my Strong Buy rating. The report also questioned whether Qwest’s current rate of revenue growth was sustainable, without showing any real evidence to the contrary. I concluded it was just Flannery’s hunch. My analysis of Qwest’s recent financial reports showed the opposite.

At a time when most analysts were still bullish on Qwest, Simon’s report hit the Street with a bang. And good old Joe Nacchio, as you might imagine, was apoplectic—and determined to make this guy pay. Later that same day, Joe held a conference call to respond to Simon’s report. I couldn’t remember any other company ever holding a conference call specifically to refute an analyst’s report. I thought it would be an interesting call, and I was right.

“I’d like people to make sure they’re listening clearly,” Joe said. “There are no accounting issues or improprieties in Qwest’s financial reports. Let me repeat that. There are no accounting issues or improprieties in our reports. Innuendoes [
sic
] on our integrity are not going to be tolerated,” Joe raged, “irregardless [
sic
] of who makes them, including what I used to think was a reputable, branded firm like Morgan Stanley. This report is laced with innuendoes that are unsupported and are a direct attack on our intelligence and our integrity. I’m extraordinarily disappointed with what I consider unprofessional and irresponsible behavior from a major investment bank.”
⁵

Joe didn’t stop there. To an audience of over 1,000 fund managers and analysts, he said he had called Phil Purcell, Morgan Stanley’s CEO, and reamed him out. Then he declared that Morgan Stanley would no longer be considered for Qwest’s investment banking assignments and cast aspersions on the firm’s motivations.

“For a firm like Morgan Stanley to be taking this approach with us, while at the same time they have Strong Buys on companies that have large financings in front of them, would make me look twice,” he shouted. Thereafter, Simon was banned from visiting the company or talking to its executives. He also was blocked from asking questions on Qwest’s investor calls.
⁶

I was hardly surprised to hear this, given what I’d experienced with Nacchio. But I couldn’t believe how far he had gone. Intimidation in private was the norm for Joe, but to go public with it not only was outrageously unprofessional but also managed to unify the entire investment community against him. Though many of us disagreed with Simon’s conclusions, we all supported his right to his opinion. One friend of mine on the buy-side, who owned lots of Qwest shares, even circulated a letter, to be sent to Nacchio, imploring him to let Wall Street analysts do their jobs. I gladly signed it.

I was torn about what this meant for the stock. On one hand, I had never been a fan of Joe’s, and this act certainly seemed like that of a CEO who had lost control. On the other hand, I disagreed with Simon’s conclusions. Qwest, now trading at $30, was so cheap that it would be silly for investors to sell out now. I felt that the stock had fallen too far on the news, and that investors would be wise to take advantage of this temporary dip to load up on the shares. It reminded me of the irrational arb spread between Qwest and US West share prices when I was skiing in Vail.