Confessions of a Wall Street Analyst (4 page)

I had met Jack recently when MCI CFO Bill Conway, Jim, and I had done the rounds on Wall Street, visiting with each of the major investment banks’ telecom analysts. Like me, Jack was a bit of a wonk, having studied math as an undergraduate at Boston University (though he claimed his degree was from MIT) and then earning a master’s degree in probability theory from Columbia University. AT&T recruited him into its management training program. After the breakup of AT&T into eight separately traded stocks in 1984, PaineWebber recruited him to be its analyst for the new telecom services sector.

Jack came to Wall Street with a deep understanding of the regulatory changes underway in the industry, as well as a great background in telecom engineering. He went out of his way to flaunt that engineering knowledge in the reports he wrote. A middle-class guy from Philly, Jack made much of his supposed rough beginnings and loved to remind people that his father had been a boxer and that he, too, liked to box for fun. Although his nose hadn’t been flattened yet, there was an in-your-face quality about Grubman that made you pay attention.

My first noteworthy interaction with Jack came in March of 1988. We in investor relations got word that he had written a negative report on MCI. I had to scramble to get a faxed copy from a buy-sider who owned lots of MCI shares and was panicked about the report’s allegations. Using a heap of technical jargon that no one in the investment world could make head or tail of, Jack argued that Sprint’s network was far superior to MCI’s and that MCI had chosen the wrong technical path, with potentially disastrous implications. “We think Sprint will do to MCI what DEC did to Data General, surpass a supposedly better competitor by having superior technology,” he wrote.
¹
Dense with detail and layered with so much techno-speak as to make it unintelligible yet impressive-sounding, the report had the effect of
dissing MCI without anyone understanding exactly why. It was a technique Jack would use again and again on the Street: overwhelm everyone with technical stuff and therefore make everyone else’s research appear shallow—and uninformed—by comparison.

The president of MCI, Bert Roberts, read the report and went ballistic. “This jerk is not just saying he doesn’t recommend our stock,” he fumed, “he’s basically telling the world that we don’t know what the hell we’re doing!” Bert, an engineer by training, said there were tons of errors in the report. He told Jim and me to counter Jack’s “crap” with the facts and to make sure the buy-side and other sell-side analysts did not believe his conclusions. Longer term, we obviously needed to turn this guy around to our line of thinking. So while we would certainly try to discredit what was inaccurate, we’d also play a little bit of good cop–bad cop, wining and dining him and trying to change his attitude. That was the plan, anyway.

Jim assigned me the task of dissecting the report and countering it point by point. My first move was to meet with MCI’s own engineers and come up with a list of inaccuracies. I found lots of them. Armed with my talking points, I called Jack.

“Look,” I said, trying to keep my voice cordial, “I’ve talked with our engineers, and I’d like to run through a bunch of things with you.” I went through about six or seven points, explaining how his report stated that we were doing the opposite of Sprint when in fact we were actually using the identical technical approach. Jack listened carefully, or at least that was my impression. To my surprise, he didn’t even really try to debate me. “I’m really sorry,” he said, although he didn’t sound very apologetic.

“How did you get this information in the first place?” I asked. “Why didn’t you at least run it by us to see whether it was true before publishing the report?”

“I ran it by an engineer friend at AT&T,” he said, without a trace of shame. “He said it was a great report.”

Now, I’m a pretty calm guy, but I almost lost it when I heard that. He had relied on someone who worked for AT&T, a competitor that would do almost anything to discredit our long distance service. Was this how Wall Street research was done, by relying on biased sources and unchecked assumptions?

I was angry, but for a different reason than one might think. Of course, Grubman’s report would hurt MCI and make our jobs tougher. Even if he wrote a clarification, it would be difficult to erase the impression that he had
created in the minds of the brokers at PaineWebber, who had already been fed summaries of Jack’s conclusions, as they were with all research reports. They had already taken those summaries, chewed them up into even tinier bits, and, like a herd of cows with their cuds, redigested them for PaineWebber’s masses of investor clients, down to one basic message: MCI is in deep trouble; dump its shares.

As irritating as that was, what offended me the most was the notion that Jack Grubman was more interested in making a splash than in really understanding what he was writing about. I couldn’t believe that he was willing to sign his name to research so shoddy. I would have been mortified if someone corrected me like that, mortified that people would think that my analysis and research were shallow and misleading. But maybe this was my own insecurity coming to the fore. I had always been the one who outresearched or outstudied everyone else rather than wowing people with quick answers or brainpower. I’d never been the genius—not in high school, college, or at work. Rather, out of necessity I suppose, I simply tried to work harder and dig deeper than anyone else.

So I couldn’t really help myself as I listened to Jack’s grating voice and heard that feigned apology. “This is embarrassing for
me,”
I said, turning red. “I’m a Chartered Financial Analyst (CFA) and I’m embarrassed to be part of a profession that has people like you doing research that is so misleading and irresponsible.” Jack responded with a series of condescending mumbles to the effect that I didn’t have a clue about how Wall Street worked, that he was simply doing what he was paid to do and, given the huge amount PaineWebber was paying him, he must be damn good at it. We hung up. He didn’t change his report, though, fortunately, it had less impact than we’d feared. I had had my first clash with Jack Grubman.

Street Smarts

Despite my troubling experience with Jack, I came to really enjoy the investor relations job and my interactions with the wild, fast-paced world of Wall Street. I quickly learned that investor relations was more of an art than a science—especially when it came to managing the analysts’ earnings expectations. Knowing how companies did this was a skill that would serve me very well later, when I moved to the Street.

Bert Roberts, MCI’s president, believed that it was critical that MCI’s
shares trade higher on the day of quarterly-earnings releases. This was because the next day’s press coverage would be enthusiastic if we met or beat expectations, and full of fawning quotes from the analysts that followed us. But if we missed the Street’s earnings expectations
and
our stock price fell that day, the articles would be negative and critical. This, Bert believed with good reason, would influence customers’ perceptions of MCI as a stable supplier of telecom services. The more positive the press coverage, the easier it would be for a corporate telecom manager to buy more services from upstart MCI rather than old, reliable AT&T. So that meant that those of us in investor relations had to try to make sure that the stock reacted positively on earnings day.

In practice, that meant two things. If it had been a bad quarter, we needed to leak that information slowly and quietly, so that the stock would drop during the week or two before the earnings announcement, but without generating any media attention. That was a lot better than the stock plummeting on earnings day, when the world was focused on it. Positive news would also be leaked but downplayed a bit, so that the stock would still see a decent bounce when the better-than-expected news hit. It was a common practice, so common that I didn’t even take note of it at the time. (The SEC’s Regulation FD, for Fair Disclosure—which required that all financial information be released to everyone at the same time—wasn’t passed until 13 years later.) Yet it meant that some people benefited, while others, primarily small investors, never knew what was going on. It was simply, I learned, part of the game.

Sometimes getting that news out meant making just a few calls to the analyst community. If we felt the Street’s earnings projections and thus MCI’s stock price were too low relative to what we were likely to deliver, we often would call two or three top sell-side Wall Street analysts. The conversation would go something like this: “Hey, Robert [Morris, Goldman Sachs’s top-rated telecom analyst]. What’s going on? We haven’t talked in a while.” Knowing exactly what was up, Morris would say, “You know, I’ve got my model here in front of me and I wondered if my revenue growth projection of 25.3 percent this year was within range.” We would then launch into a little game of “warmer,” “colder,” until Morris “divined” that his quarterly projection for MCI’s earnings per share was a penny or two too low. He’d thank us, hang up, and call his sales force to announce that he had just spoken to management (i.e., me) and that he felt good about how the quarter was shaping up, so he had decided to increase his MCI forecast. Brilliant.

We’d usually call two or three analysts at about the same time, but Morris was consistently the first to call back and the first to get his updated forecast out. Like magic, when the NASDAQ opened at 9:30
AM
, MCI shares traded up. By the time the other analysts called back, Goldman’s sales force had informed virtually every buy-side analyst and portfolio manager in the Western world of the new forecast. And then the other sell-side analysts—the ones we hadn’t called—would start getting calls from buy-side clients asking what they thought of Goldman’s earnings increase and what, if anything, they had heard from MCI.

They’d flood our phone lines, and we’d simply say that Morris had been going over his model and increased it. “That seemed okay to us,” we’d say. They then revised their estimates, and the boost to our stock price caused by Morris’s earlier update held firm. If you were among the largest institutional money managers, you had it made. If you were an individual investor, you were inevitably too late to the party; the stock had already risen and you’d missed its move.

On the other hand, if the news was bad, we might also call a few of the most influential analysts, but, more often, we would pack up and, with minimal notice, fly to Boston for a day of meetings. Boston was where the largest and most powerful mutual funds were located, companies such as Fidelity, Putnam, and many others. We always booked Fidelity first, at 8:00
AM
, and then usually Putnam at 9:30
AM
, followed by Wellington, MFS, State Street Research, and other large institutional investors.

The meetings were almost always the same: with a group of 15 or so Fidelity portfolio managers, including the famous Peter Lynch, watching, Fidelity’s telecom analyst would run us through a grueling series of questions regarding every line on MCI’s income statement. Fidelity’s portfolio managers paid attention to every word we spoke, every number that left our lips, even our tones of voice and facial expressions. Eventually, it would dawn on someone that we were guiding down our earnings estimates, at which point the Fidelity portfolio managers would suddenly bolt out of the room, hustle down to Fidelity’s trading floor, and tell their in-house traders to sell MCI shares when the market opened at 9:30
AM
. Brilliant again.

These various Fidelity portfolio managers, armed with an inside edge that no one else had, would now be racing to unload their MCI shares ahead of their competitors at other money management firms. FIDO, as the Street called it, wouldn’t exactly
make
money on a morning like this. Rather, it wouldn’t
lose
money when the stock fell on our bad news. Many others did
lose money, however. They were the ones buying the shares that Fidelity was unloading at 9:31
AM
.

It was a fate that other institutional investors couldn’t avoid. And the little guy, the individual investor, the retiree? If they owned a Fidelity mutual fund, it worked to their advantage—this time. No wonder Fidelity was the country’s investment darling. But if they didn’t, they were out of luck. It was my first lesson that life on the Street, with its uneven information flows, often rewarded the powerful and connected over the merely smart. It distorted the entire market in the process.

Ed Comes Knocking

By mid-1988, my new career was working out well. I didn’t feel like I was changing the world, exactly, or bringing peace to it, but I
was
working for a company that was doing some good by making phone calls cheaper and improving the quality of phone service. Plus, I was now making $70,000 a year. By my standard of seeking work that I found intellectually interesting, it was working out well. And by my more practical standard of earning a decent living for my family, I was content too.

Over time, I had developed a good working relationship with some of the other analysts, particularly Ed Greenberg, the telecom analyst from Morgan Stanley. Physically, there was nothing impressive about him—he was a shortish and baldish guy—but his brain was something worth celebrating. He was one of the smartest people I’d ever met, with an incredible analytical ability but also a variety of other intellectual interests ranging from theater to music to baseball. Even in his forties, he still joked that his dream was to play center field for the Yankees.

According to
Institutional Investor,
a magazine that ran what I thought at the time was an obscure survey of buy-siders, Ed was the number-two-rated Wall Street telecom analyst, behind Goldman’s Robert Morris. I was vaguely aware that the ranking meant a lot for analysts in terms of their compensation, and that we in MCI’s investor relations department needed to provide special care and feeding for the top vote-getters, since they were, as that famous line from George Orwell’s
Animal Farm
goes, more equal than others. But I liked Ed, not because of his ranking, but because of the way he thought. He figured out trends in telecom two or three years ahead of anyone, often even ahead of the chief executives and chief strategists at the
companies he covered. In fact, he was so prescient that he often recommended investments far too early.