Confessions of a Wall Street Analyst (14 page)

Thank you, Joe Perella and Morgan Stanley.

With the Merrill contract set, I had to decide what to do about the Morgan offer. Mayree was calling at home every other evening, asking me where I stood. Paula, as always, was my sounding board. And as always, she gave me the best advice of all. She reminded me that the momentum seemed to be going in the right direction at Merrill. Why mess with a winning formula? And why go back to where you started? They’d always remember you as that wet-behind-the-ears MCI guy who came to the Street not sure what a P/E ratio was.

That settled it. I turned Morgan Stanley down. It was amazing, ridicu
lous, actually: thanks to a few meals out of the office, I had the same job and the same responsibility—but at substantially higher pay and with a lot more job security.

My Major Opinion Change: Upgrading the Bells, Downgrading AT&T

By this time, I’d been at Merrill for two years. I’d been fairly consistent in my stock opinions since the day I’d arrived. I was negative on the Baby Bells, such as BellSouth, SBC, and Bell Atlantic, because I thought the regulators were doing things that constrained their earnings, and that deals like AT&T buying McCaw were aimed at bypassing what was called the local loop—the last bit of wire to the household—which was controlled by the Bells.

Everyone, from my coworkers to my clients, expected this to remain my position. And everyone liked it when an analyst had a clear and consistent position. “Oh, you know Dan. He hates the Baby Bells and loves the long distance companies.” But around the middle of 1995, a series of events led me to change my views and begin recommending that my clients buy the Baby Bells instead.

It all started in mid-June with the passing of a bill by the Senate, the Telecommunications and Deregulation Act of 1995, that I believed would make it much easier for the Bells to get into the business of providing long distance services. Republicans were in charge of both houses of Congress for the first time in many years, and they were a lot more receptive to the Bell companies than the Democrats had been.

It suddenly seemed obvious to me that congressional sentiment was changing in favor of giving the Baby Bells more freedom. A motley but powerful alliance of many Republicans and a few Democrats came together to support this legislation, including Democrat John Dingell, one of the House’s most powerful members and a longtime supporter of the Baby Bells.

I did some investigating of the political environment, talking to congressional staffers, lobbyists, and attorneys I knew on the Hill from my D.C. days, and they backed me up: it seemed as if Congress was going to finally pass legislation that allowed the local phone companies to provide long distance services and encouraged the long distance companies to provide local service. It was called “cross-entry.”

This was a big deal. Similar bills had been debated in every single con
gressional session on the topic since the breakup of AT&T in 1983, but those bills had died in committee as the industry’s powerful interests collided and neutralized each other. Even though the Republicans were behind the legislation, it had come to be identified with Al Gore, who was at the time discussing something he called the “information superhighway,” that is, the Internet. So although the Democrats didn’t really support the bill, it was known as Al Gore’s initiative, making it virtually impossible for President Clinton to veto it.

In early June, I asked Megan Kulick and Mark Kastan, who had been hired to replace Rick Klugman when he left for Grubman’s former spot as PaineWebber’s senior telecom analyst, to run a complex series of financial models assuming the Baby Bells started to offer long distance services under various time frames. Mark had been a client of mine as a buy-side analyst at the Bank of New York and J&W Seligman, a mutual fund manager, for almost 10 years and I was thrilled to have talked him into coming to work with me. He was a smart, somewhat sarcastic, ambitious guy who had the seasoned perspectives of a professional investor and added a new perspective to our team. We worked on the models for six solid weeks. I made up my mind in early July 1995, after I had visited buy-side clients in six European countries and was taking a quick vacation with Paula in Scotland. I left a voice mail for Mark and Megan telling them to swing into action. Then I contemplated the consequences of my opinion shift.

None of my competitors at other firms seemed to be focused on what was happening in Congress. So if I went ahead with a position change, upgrading the Baby Bells and downgrading the long distance companies, I’d be the first one out there to plant a flag. I’d surely get a lot of attention, and hopefully, I’d make my clients some good money. There was only one problem: if I was wrong and this legislation didn’t pass, I was going to look like a complete idiot. For my entire career, I had been cautious on the seven Bells. If I changed my mind, it was going to make waves. It would be the biggest call I’d ever made.

Further, my report would certainly upset AT&T, because I was now backing its biggest threats, the Baby Bells. Merrill did a decent amount of banking business with AT&T, but I didn’t care; I now had a guaranteed contract. I had already downgraded MCI and Sprint to Neutral in late 1994 because of my concerns about long-distance price wars. The Baby Bells, of course, would be thrilled. Doubtless they’d think they’d finally managed to convince me of the folly of my earlier ways. Certainly my clients would be
perplexed, and those who owned AT&T shares would not be happy at all. It would be their decision, of course, whether to listen to me or blow me off.

The argument itself was pretty simple—the legislative tide was shifting in favor of the Bells and away from AT&T and other long distance companies. This simplicity would make it very appealing to both Merrill brokers and sophisticated money managers. Yes, there were a variety of factors, such as the growth of new services like Caller ID, voice mail, and cellular phones, and of course, some loosening of the regulatory rules. But in essence, I was betting it all—perhaps even my career—on those Senate and House bills actually becoming law, and on key sentences in those bills not being lobbied into oblivion at the last minute by the long distance companies.

On July 18, 1995, I was the first speaker on Merrill’s morning call. “For the first time in my career, I am turning bullish on the Bell companies,” I announced. Unlike my first time on the call back in 1989 when I launched coverage of the telecom sector, this time I felt energized and confident. I might be making a huge mistake, but at least my point of view was well thought out and well reasoned. And no one in the banking department made a peep.

Immediately after the call, I dashed back to the office and hopped on the phone. I tried to call as many clients as I possibly could, starting with the largest and most important, like Fidelity. If they didn’t answer, I’d leave a message. “Look,” I said, “I wanted to make you aware that I’ve reversed my position. I’m downgrading AT&T to Neutral and upgrading all the Bells.” My clients reacted in very different ways; some were intrigued, others listened quietly, and a few disagreed vehemently. Quite a few seemed surprised that I’d made the change at all.

And suddenly, I found myself in the spotlight. In September,
Barron’s,
the required Saturday morning reading of every portfolio manager, ran a six-page interview with me, including several large photos taken at my home.
Wall $treet Week with Louis Rukeyser
called, too, asking me to be a guest on their December 15, 1995, show. At the time, the show, despite being among the most boring half hours ever to run on television, boasted the largest audience of any financial show on TV. Appearing on it was considered the financial world’s equivalent of doing guest commentary on
Monday Night Football.
The show was targeted more toward the individual investor than my institutional clients. But I knew I had to do it, partly because Merrill had spent a lot of time lobbying the Rukeyser folks to invite its analysts on the show, and partly because I knew my mom and dad in Florida would get a huge thrill out of seeing me on TV.

It was a long seven months of nervous waiting, but my call was right. The legislation finally became law the following February, when President Bill Clinton signed the Telecom Act of 1996. Bob Allen, AT&T’s CEO, ordered busloads of AT&T employees to protest in Washington as a last-ditch attempt to kill or change the bill, but it passed unchanged. And fortunately, the market seemed to agree with me: the Bells rose on average 32 percent from my July upgrade until the end of the year, beating the pants off the S&P 500 Index’s 10.3 percent rise.

Once again, Jack attacked with a viewpoint that was squarely in opposition to mine. For him, long distance was a complex business that the Baby Bells couldn’t learn quickly (I said it was simple); he said long distance companies like AT&T would take more from the local market than the Bells would in the long distance market (I said the reverse). And in a perfect parallel with his own approach to Wall Street, he argued that marketing skills mattered the most, far more than the physical connections to customers that I thought were key. Again, we were the yin and the yang of our industry.

The Power of the Poll

Even before my opinion change, my status on the Street had been changing. I was about to displace Jack as the top-ranked telecommunications analyst, according to the survey in
Institutional Investor
magazine that ruled our professional lives. To understand the
I.I.
rankings is to understand what really made a Wall Street analyst in the 1990s. Here’s how this whole insane—or was it inane?—process worked.

It all started with a twenty-eight-year-old named Gil Kaplan, a former American Stock Exchange economist trader who founded
Institutional Investor
in 1967, targeting big money managers. In the summer of 1972, Kaplan walked into the office of his editor, Peter Landau, and said, “We’ve got to do a story about the best analysts on Wall Street.” The inspiration for just how to do that came that evening, when Landau and a colleague, Wayne Welch, were having drinks and watching baseball’s All-Star Game. Since the story was slated for the October issue, the pair decided to give it a football theme, call it the “All-America Research Team,” and put Wall Street analysts in football uniforms. “We laughed and laughed,” Landau said. “Little did we know it would become this huge thing on Wall Street.” The
I.I.
rankings were born.
⁵

For people like Martha Stewart, springtime is planting season. For analysts, it was
I.I.
voting season. Every spring,
Institutional Investor
would send out thousands of surveys to portfolio managers, directors of research, and chief investment officers of the world’s largest pension funds, hedge funds, and mutual funds, asking them to rank the analysts in each industry sector based on any criteria they saw fit.
I.I.
then weighted the number of votes for each analyst according to the size of the institution, which was based on the amount of money under management.

Starting in 1972, the October issue of the magazine featured profiles, complete with pictures, of 20 or more stone-faced middle-aged guys, and eventually a few women, in suits (fortunately, there weren’t centerfolds). No muscle-bound, in-their-prime 21-year-old quarterbacks to be found here; instead we learned about the top analysts in the pharmaceuticals sector or the steel industry.

Here, finally, was a way to measure the performance of individual analysts. The banks loved it. The All-America Research Team became a huge hit for
Institutional Investor.
Gil Kaplan had a moneymaking franchise on his hands.

By the time I got to Wall Street, the rankings had become the most accepted way to value an analyst’s contribution. How accurate our stock picks were didn’t matter so much. What did matter was whom the buy-side analysts and portfolio managers voted for in the poll. And so our jobs became as much about responding to the needs of every potential voter as they were about actually doing research and accurately picking stocks.

It had taken me a while to get the hang of this
I.I.
thing. After all, I had once believed that if I could sit in my attic and pound out good analysis, I would be doing the best job I could. But by the time I was at Merrill, I was covering all of my bases. There were approximately 400 institutional money-management firms that voted, and each had at least one or two analysts focusing on telecom stocks. Each of these buy-side analysts, plus many portfolio managers at these firms, was a potential voter. It was my job, like a local pol doling out attention and sometimes favors, to make them like my work, like me, and, most of all, to like me enough to scribble my name onto that
I.I.
survey sheet.

This meant making sure I was always responsive to any question a client had about the industry, even if it meant returning phone calls from Indonesia at 4:00
AM
. I’d do my best to take the initiative by calling clients when
ever there was news or any new developments that could have an impact on their telecom portfolios.

Each client had a different set of priorities, which meant that if you wanted to do well, you had to figure out what made each one tick. Some voted for the name they knew best, meaning it was helpful to be quoted regularly in
The Wall Street Journal.
Others voted for the most influential analyst, the nicest guy, or the most responsive one; some clients actually kept a record of how many times each analyst called in a given quarter. And a few even voted for those whose stock picks had worked out best. It was a complicated psychological study, and it required every bit of emotional intelligence and organizational skill I possessed to remember that Bill at Janus loved to talk about skiing or that Patty at Capital Group had gotten burned buying AT&T a few years ago and was looking for a way to feel better about it.

There was really no end to the amount of work you could put into this aspect of the job, especially if you were a paranoid sort like me. I could always make just one more call, and that’s what I tried to do to stay ahead. I was the hard worker after all, not the intuitive genius.