Confessions of a Wall Street Analyst (20 page)

Sir Peter thanked me and abruptly ended the meeting. It had lasted only 30 minutes. I didn’t know what to think. Had he cut the meeting short because he thought my perspectives were ridiculous or because he agreed? I had no idea.

As it turned out, I wasn’t the only analyst having secret meetings. Ac
cording to several buy-siders, in the middle of August the Lehman Brothers telecom analyst, Blake Bath, claimed he’d had a private conversation with MCI’s CFO, Doug Maine. On the morning of Wednesday, August 20, Blake went on Lehman’s squawk box announcing that he had it on good faith from sources within MCI that the deal would definitely not be renegotiated. This was good enough for many members of the arb community, who assumed that Blake’s source was Maine and that his former boss wouldn’t lie to him. They piled back into the stock, believing that MCI’s shares had fallen too much in all the confusion and controversy. If Blake was right and the deal closed as planned, they’d make a ton of dough as MCI shares rose sharply and BT shares fell.

Poor old Blake Bath. He must have forgotten the analyst’s golden rule: just because management tells you something doesn’t make it true. That very evening, the news broke that the deal was, indeed, being renegotiated. Shareholders in MCI would now get the equivalent of $33.80 for every MCI share, down $8, or 22 percent, from the original $41.80 deal and making the Lehman analyst look like a clueless rube. The next day, MCI shares cratered, falling $6.13, or 17 percent, while BT shares rose 7 percent. This was how he earned the moniker “BloodBath” among some investors. MCI’s CFO, Doug Maine, by the way, denied ever telling Blake the deal would or would not be renegotiated.

I couldn’t have asked for a more perfect outcome, since I had been predicting a 20 percent drop in what BT would pay for MCI shares. Whatever secret document Jack allegedly saw didn’t do much to change the fact that the deal simply no longer made sense at the original price, given MCI’s poor performance.

By several accounts, Salomon’s arbs lost around $100 million on the deal, since they apparently listened to Jack and his pitch about the confidential document. That was huge bucks even for the bizarre world I inhabited, and rumor had it that this big loss was one of the major reasons why Salomon Brothers sold itself, on September 24, 1997, to Smith Barney, a subsidiary of Travelers Corporation, the acquisitive financial supermarket led by Sandy Weill.
³

I received a little public vindication as well when CNBC’s David Faber called me one of the “winners” in the deal. “Back on July 31, Dan Reingold at Merrill Lynch said ‘I think this deal’s going to be renegotiated,’” Faber said. “Everybody was saying: ‘Dan, you’re out of your mind.’ But apparently Mr. Reingold knew something that a lot of other people on Wall Street did
not.” The report went on to name Jack Grubman and good old Blake Bath among the losers. I didn’t mind a bit.
⁴

I had been completely out on a limb on this deal, but it had worked out for the best. Ironically, the insider edge that Jack was making his signature hurt him this time, while my status as a true outsider—physically removed from the information I needed at a critical time—somehow worked to my advantage.

I felt pretty confident that I’d keep my number one spot. In July, when I’d got the call from the
I.I.
folks, I assumed, or hoped, anyhow, that I was still number one. There wasn’t a request for a picture, but I knew they already had one from the previous two years, so I didn’t sweat it. But then, sometime in September, a client told me that Jack had told him that he had retaken the top position. A sinking feeling told me he was telling the truth. When the magazine came out the next month, I found out Jack was, indeed, the top dog again, and that I had come in second.

I was very disappointed, as much for my team as for me, as we had busted our butts. But timing is everything, and to correctly predict in August that the MCI and BT deal would be renegotiated in dramatic fashion wasn’t nearly as important, in my world, as being right in the spring during
I.I.
voting season. I had been right at the wrong time. At the time of the vote, what buy-side voters remembered was the incredible stock performance of WorldCom, Jack’s favorite, which had rocketed from $19 to $26 in the nine months between its acquisition of MFS the previous August and May 1997, when the
I.I.
ballots were mailed. Back then, no one knew that MCI’s deal with BT was about to go sour and MCI shares would go into a tailspin.

But actually the truth was simpler than that: Jack was the most energetic, bullish, and visible cheerleader for our entire industry, a once-sleepy group that was suddenly red-hot—and making a lot of people a lot of money. I told my team that number two was something to be proud of. I think they felt a little better, but not much. And I just resolved to work that much harder. Jack had the market’s momentum and the inside edge behind him, but I, as always, believed I could grind it out.

Jack and Bernie: Inextricably Linked

Hospitals are like Wall Street in one major respect: the only way to get good information is to get there at the crack of dawn. If you need to talk to a doc
tor, the best bet is to catch him or her on the early rounds, before the new challenges of the day bubble over and the other streams of anxious families arrive.

This was why my older brother, his wife, and I were pulling into the parking lot of Buffalo General Hospital at 6:30
AM
on a chilly Wednesday morning, October 1, 1997. It was just over a month after the BT-MCI deal had been renegotiated. It had been a stressful few days; my mom had had what we hoped was a benign tumor removed from her brain, but we had no idea what her prognosis was. She was recovering very slowly. We had lots of questions for the surgeon about her status, but he’d been impossible to track down, so we decided to ambush him when he came out of the ICU at the end of his morning rounds.

But I was still in the car when my pager beeped with a message from my colleague Mark Kastan. I looked down and read a sentence that I was sure had gotten garbled somehow. It said: “Wcom buying MCI, call my cell now, need to make joint call.”

“Holy shit,” I yelled. “He must have it backwards.” How could tiny WorldCom buy massive MCI? It would be like a minnow swallowing a whale. My brother and sister-in-law turned around from the front seat. I could see the irritation and stress on their faces. Surely I had more important things to think about that morning than some stupid deal. “What company is blowing up now?” my brother said sarcastically, recalling my fiasco with IDB back in 1994, on the day of Jennifer’s eye surgery.

“Oh, no, it’s just the opposite,” I said, still incredulous. “Kastan says WorldCom is bidding for MCI, but he must have mixed it up. This is big. I’ve got to stay in the car and figure it out. I’ll meet you in the waiting room, okay?”

Of course I wanted more than anything to go inside and figure out what was happening with my mom. But even if the opposite were true, that MCI was buying WorldCom, this was, at the time, the biggest deal ever in our sector, one that would completely realign the telecom planets, and one that I absolutely had to be out in front on. Yes, my priorities were out of order, but that was what Wall Street was all about, wasn’t it?

My brother suggested that I stake my claim to the bank of pay phones inside, but I told him I had no time. I had to reach Mark Kastan immediately, figure out what was happening, and decide what our reaction would be. I plugged my cell phone into the car lighter and dialed Mark’s cell as he was en route to Manhattan on the ferry from Hoboken, and he said the words I
had never imagined hearing: yes, it was WorldCom making an unsolicited, hostile bid for MCI, in an audacious move to try to steal it from BT and to become, in one fell swoop, the second largest telecommunications company in the world.

This was huge news, and not particularly good news, for me. But it was absolutely wonderful news for Jack. WorldCom, this company that Jack had touted incessantly and that I had always regarded as something of a joke ever since that fateful meeting in Mississippi with Bernie Ebbers, was suddenly very much for real. According to the announcement, Mark told me, the deal would increase WorldCom’s earnings per share by 22 percent in the first year. I checked the math against our models, factoring in an estimate of savings from eliminating duplicate costs. The numbers jibed with WorldCom’s claims. I didn’t much like either company, but the combination of the two would change the industry for the better.

“Dan, I know you don’t like them,” Mark said, “but this deal will add more than 20 percent to earnings per share. That’s huge, and it’s good for the industry to have one fewer competitor. Let’s upgrade WorldCom.”

Mark had worked as an analyst at a money management firm for nearly 10 years before joining me at Merrill, and he still thought like a buy-sider. In this case, this meant ignoring the long term and instead focusing on what this meant for earnings in the next few years. If I thought about the deal that way, I had to admit he was right. This was a blockbuster story: the numbers worked like a charm (on paper, at least); and it was the perfect opportunity for us to move over to the bullish side on WorldCom. I’d predicted trouble from the hugely expensive MFS acquisition a year earlier, and I’d been wrong: the stock had almost doubled in the time frame, and I’d missed every bit of it. By this point in time, the bull market was beginning to take on a life of its own, and the companies that showed the best growth prospects were fast becoming investor darlings. This was the case with WorldCom.

This was a major dilemma. I still didn’t feel confident that WorldCom could transform successfully into a telecom giant. Nor did I support the thesis that the long distance carriers like AT&T, MCI, and Sprint had the edge. That was Jack’s story. My story was that the Baby Bells had the advantage.

But on the other hand, my job was to help my clients make money, and it was clear to both of us that WorldCom together with MCI had quite a bullish earnings outlook. A marriage of MCI and WorldCom made a lot more sense than MCI with BT, for three reasons: it would reduce the number of long distance competitors; it would combine WorldCom’s and MCI’s
huge long distance networks and sales forces, saving gobs of money by eliminating redundant equipment and employees; and it would help MCI build local networks far less expensively than if it did it on its own.

So I took a deep breath and told Mark he was right. We’d upgrade WorldCom to Accumulate from Neutral, leaving MCI at a “no rating,” or “6-6,” in accordance with Merrill’s rule that we couldn’t rate stocks in the process of being acquired.

Knowing I needed some time to focus on my mother, Mark offered to get everything ready for the 7:30 Merrill morning call and page me when it was time to call in. My brother had tracked down the surgeon, and the news was worrisome: the surgery had gone fine, but my mom was coming out of the anesthesia very slowly, which concerned him a little bit and us a lot. We didn’t know what to think.

At 7:10, my pager sounded again. “Cleared for call,” it read. “7:30 a.m. for 4 mins, pls call ofc now.” Twenty minutes later, we would speak to about 150 of Merrill’s institutional salespeople and to Merrill’s 12,000 retail brokers, who needed a concise summary of our upgrade so that they could call their clients—individual investors—and convince them to buy WorldCom shares as soon as the market opened at 9:30.

I called Mark, who walked me through the latest info on the newswires. It was a hostile bid, with no guarantee that MCI would accept it. WorldCom was offering the equivalent of $41.50 per MCI share in WorldCom stock, a whopping 41 percent above MCI’s current trading price of $29.43 and 23 percent above BT’s revised offer of $33.80. From MCI’s perspective, there was no way CEO Bert Roberts and the board could turn this down, especially after all of the humiliation they had endured with BT. WorldCom could pay this price because of its high-flying stock and powerful price-to-earnings ratio. When put side by side, WorldCom’s offer was virtually the same as BT’s original offer. If this deal went through, all of those arbs that had been squeezed so badly would be bailed out if they still held MCI shares.

We spoke on the squawk box together, Mark from Merrill’s morning call room and me from a pay phone inside Buffalo General Hospital, where I controlled two lines, to the dismay of hospital visitors who were trying to call their families. I talked on one and checked my voice mail on the other. We explained that we thought one less competitor would be good for the long distance market and that the 20 percent boost to earnings was very positive.

I spent a few more hours at the phone bank, talking with clients and
salespeople about the deal and our upgrade. Periodically, I’d take a break and check in at the ICU, where my sister and dad had since arrived, to see how Mom was doing. For lack of anything better to do, they were all watching the coverage of the deal on CNBC, bemused that the faraway stock market was having as much of an impact on my life as what was happening in the ICU a few feet away. We still had little news on Mom’s condition.

Although the day was one adrenaline rush followed by another, I must admit that the high point wasn’t the call, but rather our quick field trip to the Anchor Bar for lunch. The Anchor Bar was an institution in Buffalo, world famous as the place that had invented Buffalo wings. Every good Buffalonian knows how a real Buffalo wing should look and taste: an oily mix of Tabasco, butter, and cayenne pepper, the requisite plastic tub of blue cheese with some slightly soggy celery nearby. I was starving and stressed, so it was a welcome respite. In the days that followed, my mom’s condition started to improve, although she had to stay in the hospital for several more weeks. Her tumor did turn out to be benign.

In mid-October, in a scene reminiscent of the 1980s, local phone company GTE stepped in, countering with an all-cash bid for MCI that most of us on the Street thought was absurd because there was little overlap between the two companies and therefore little in the way of cost savings. BT remained silent, apparently seeing this as an opportunity to escape the company that, just three months ago, had shocked all of us with a 40 percent cut in its earnings outlook.