Confessions of a Wall Street Analyst (38 page)
Read Confessions of a Wall Street Analyst Online
Authors: Dan Reingold
By October of 2000, AT&T’s shares were mired in a decline that had begun shortly after the announcement of the AT&T Wireless IPO back in 1999. On October 4, 2000,
The Wall Street Journal
ran a story on the front page of its Money & Investing section about Jack’s ill-timed upgrade of AT&T, hinting that it might hurt Salomon Smith Barney’s banking business, which had hit a phenomenal $350 million in fees in 1999. It read, “everyone seemed to win—everyone, that is, except investors who heeded his call and bought AT&T stock.”
16
Incredibly, two days after the article appeared, Jack reversed himself again, downgrading AT&T shares to a “2,” or Outperform. The downgrade shocked most of the media and Salomon Smith Barney’s brokerage clients, but it was old news for many of the professionals. Back in May, when Jack rated AT&T shares a Buy, or “1,” and just after the AT&T Wireless IPO was completed with a $63 million payoff to Jack’s firm, I received an e-mail from a client who worked for a hedge fund. “Fyi, Jack is pissing all over AT&T,” he wrote, suggesting that Jack’s private comments to some institutional investors were far more bearish than his written reports, which Salomon Smith Barney’s brokers and individual investors relied upon.
Jack’s tactics were finally attracting some negative attention. I was happy about it, and I wasn’t the only one. Just after the
Journal
article came out, I got an e-mail from Frank Quattrone. Ever the competitor, he saw the negative articles about Jack as a major opportunity.
“Hey,” he wrote, “Grubby-man is getting drubbed on the att round trip. Major oppty for you to crush him for good. Planning any major marketing/advertising events?”
Unlike Frank, I wasn’t much of a self-promoter, so I simply responded, “Any ideas?” and the discussion ended there. I was glad I wasn’t the only one noticing Jack’s diminished status.
It was at about this time that AT&T’s Armstrong decided to throw in the towel on his cosmic strategy of integrating voice, video, and wireless into one
bundle of services. Instead, he decided to break up AT&T all over again by dividing the company into three completely separate companies—AT&T Long Distance, AT&T Wireless, and AT&T Broadband (cable TV and modern services). Unbeknownst to me, CSFB and Goldman bankers had been brought in to plan the restructuring. On October 23, I was called over the Wall, along with Goldman’s telecom analyst, Frank Governali, to hear a preview of what Mike and his CFO, Chuck Noski, would say the next day at a hastily arranged analyst meeting.
We met secretly in AT&T’s virtually uninhabited downtown Manhattan offices at the foot of Sixth Avenue. Almost all of AT&T’s executives worked out of the New Jersey headquarters, but the company had kept the building to use for New York meetings. They had draft slides ready to go and wasted no time getting down to business. I had had no advance briefing from Chris Lawrence, CSFB’S AT&T banker, or his team, so this was all brand-new to me.
I was amazed that Mike was giving up on integration. I asked why a few different ways, but he only said that the stock had been pounded and that the market wasn’t giving credit to the company’s long-run strategy. In effect, he was saying that the market’s myopia was forcing him to abandon his grand transformation plan. He seemed exhausted more than frustrated. Yet by the next morning he would be back to his ebullient self, confident smile and John Wayne voice at the ready.
And then AT&T’s CFO, Chuck Noski, told Goldman’s Frank Governali and me what Mike Armstrong was planning to announce about earnings and revenues. It was horrendous. The competitive pressures from WorldCom, Sprint, several new startups, and, of course the Bells, were causing AT&T to lose share and cut prices at a far faster pace than expected. I was suffering along with the company, having recommended AT&T at Merrill almost two years earlier, at a post-split $52 per share. AT&T shares had fallen 48 percent since then and were now trading at $27.
With the exception of IDB back in 1994, upgrading AT&T had been my worst stock call ever, and things had only gotten steadily worse. But now, with me over the Wall and CSFB likely to be advising AT&T for the next year or two, I didn’t think I should be issuing any opinions. CSFB’s compliance officers agreed, so I was instantly restricted from commenting on AT&T and its shares. From October 23, 2000, I couldn’t write or say a word about AT&T. As frustrating as this was, I was also relieved: my call had been a disaster and this, at least, stopped the bleeding.
The analyst meeting didn’t go over well. AT&T shares fell another 13 percent. And the market was beginning to realize that the disease that was afflicting AT&T—brutal competition for long distance services, the move to make long distance free for cellular calls, and the muscle of the Baby Bells—was beginning to give the other long distance companies more than a sniffle as well.
Except, that is, for good old Qwest. Exactly a week after AT&T’s dour earnings announcement, Qwest held an all-day analyst meeting in Manhattan, at the Waldorf-Astoria Hotel. As we sat in the Grand Ballroom awaiting Joe Nacchio’s talk, the mood was defiantly confident. It seemed the polar opposite of the morose tone of the AT&T meeting. Clearly, whatever one thought of Joe, he was doing something right. Qwest continued to thrive, reporting robust and on-target growth in revenues and operating cash flow.
Suddenly, the lights dimmed and the stage lit up. Out marched Joe, dressed in full Australian outback regalia and pith helmet, to the overdramatic sounds of the music from the hit TV show
Survivor.
Arrayed around the stage were a series of burning torches, each one representing one of Qwest’s competitors. There was a torch for AT&T, another for WorldCom, and one torch each for Sprint, Global Crossing, Verizon (the former Bell Atlantic), and several of the other Baby Bells. You can imagine what came next. Nacchio, completely in his element, traipsed merrily across the stage to each one of his rivals’ torches and delivered a short monologue on what was wrong with each one of them. Then, with evident pleasure, he snuffed out each of their flames.
“I don’t know what’s wrong with the other guys in the industry,” he repeated over and over during the course of the meeting, “but Qwest is doing just fine.” Yes, he acknowledged, the economy was soft in a few regions, but US West’s regional economy was resilient and other growth sources, such as data, Internet services, and wireless services, were more than compensating. Then there was the stability of US West’s local business, which was still more or less a monopoly. If there was to be only one Survivor, he assured all of us, it would be Qwest.
While the skit was silly, those of us still recommending Qwest’s shares found the meeting somewhat of a relief. There were still some winners in this sector, and what seemed to be happening was that the day of reckoning for the incumbent long-distance companies that I had warned about five years earlier was upon us. Some companies were getting their lunches
eaten; others were prospering. It wasn’t a slowdown in overall demand as much as a Darwinian shakeout.
But that sense of relief didn’t last long. Just as I was leaving the Qwest meeting, I got word that WorldCom was holding a surprise analyst meeting in New York the next day, November 1. I figured it was going to be bad news, and it was. I intentionally arrived early at the meeting, about 6:45
AM
, to get the press release as soon as it came out at 7:00
AM
. It announced that WorldCom was going to create two, yep, tracking stocks, one for services to businesses and one for services to consumers.
More significant, it also was reducing its growth projections due to “intense pricing pressures, unfavorable foreign exchange rates and the shift of consumer voice to wireless technologies.”
17
Though the new targets were dismal, it sure looked as if Scott Sullivan and his team had done extremely detailed analyses of WorldCom’s various lines of business.
Wow, I thought, these are huge cuts. The water torture of the past three quarters had turned into a downpour. I knew this would be very bad for WorldCom’s share price, and I knew I needed to tell CSFB’s sales force as quickly as possible. But first I wanted to get a better understanding of what was happening. Bernie was not around yet, but I found Scott and asked a few questions about what was driving the bad news. He had some pretty logical answers that were consistent with Armstrong’s answers a week earlier. When I asked about his new forecasts, he said he would not talk about them until Bernie made his opening remarks. Realizing that I wasn’t going to get much more from him and that CSFB’s morning meeting would be ending soon, I pulled out my BlackBerry and started to type up an e-mail to CSFB’s sales force.
With its wireless e-mail capability, the BlackBerry had completely transformed my job: no more racing to beat my competitors to the phone banks, no more having to wait until a meeting was over to get my thoughts back to my team or the sales force. I decided to immediately downgrade WorldCom’s shares for the second time this year, this time from Buy, or “2,” to Hold, or “3.” I also dramatically lowered my earnings estimates for 2001 to $1.10 per share, down 46 percent from my prior estimate of $2.02. A huge $2.7 billion dollars of annual profit had just disappeared.
At the meeting, even Bernie seemed humbled, a shadow of his former swaggering self. “We recognize we have let you down,” he said, promising to do better. “When I was 16 years old, I was a six-foot-three, 130-pound kid
trying out for the high school basketball team. I was one of six Anglo-Saxon kids among a Native American community. Our coach didn’t speak English. I was competing for starting center against a kid the same height but 100 pounds heavier. The coach threw the ball out into the center of the court and said whoever comes up with the ball is the starter. I came up with it. We are going to come up with the ball too. We are going to right this effort as never before.”
Later, he was a lot less sanguine. “People have a legitimate right to ask if I’m the right person to lead the company,” he told reporters after the meeting.
18
WorldCom’s announcement was an unmitigated disaster for virtually everyone in the investment world. Lots of professional fund managers still owned the stock, which had already been suffering and was about to get crushed, and virtually all Wall Street analysts were still recommending it. The only thing that made the pain bearable for us was the fact that this business was all about comparative performance. So if we all got hosed, at least we were all in it together.
A day later, two other investment banks downgraded WorldCom shares: Merrill Lynch, with my former colleague Adam Quinton, and Wachovia Securities, both from “Buy, or “1,” to Neutral, or “3.” Salomon Smith Barney and J.P. Morgan were handling the tracking-stock deal, so I assumed they would not comment.
But I had forgotten once again about the SEC’s No-Action Letter. Jack reiterated his Buy, or “1,” rating, in a lengthy report approved by his compliance department, as did the analyst at JP Morgan. By this point, compliance lawyers could drive an oil tanker through the loopholes in the SEC regulations, with plenty of room left over for an investment bank and its analyst to do whatever they wanted. Thanks to the No-Action Letter, analysts knew they could write about virtually anything they pleased, conflict or no conflict, with no fear of getting in trouble. Arthur Levitt’s sleepy SEC appeared to pay not a whit of attention.
What had at first seemed like a bit of softness for one company had mushroomed into a calamity for all of the long distance incumbents. On November 3, Sprint held an analyst meeting that was a virtual carbon copy of the others, except it didn’t announce a tracking stock, because it already had one. I was of two minds as I tried to digest the news. On one hand, I was devastated to have missed the biggest and most bearish nine-day period ever for the incumbent long-distance companies. Dammit, I thought, if only I had
stuck with that position that I had launched with a bang back in July of 1995 and never upgraded those stocks to Buys. I should have ignored all the data and Internet hoopla and stuck to my narrow argument that the voice long distance business was going to get creamed.
On the other hand, I felt a kind of guilty vindication. My overall theory that the Baby Bells were the best situated to compete in this market had been strengthened, not weakened, by what had just transpired. Now WorldCom, Sprint, and AT&T were too weak and too distracted to attack the local market, giving the Baby Bells still more power.
In our insular Wall Street world, I suddenly looked a lot better than a lot of my competitors. Clients began calling to congratulate me, citing both my relatively early downgrade of WorldCom and the fact that my argument of five years ago was beginning to bear fruit. Jack, they said, was no longer looking as savvy as he had just a few months earlier. An important shift was happening, we all intuitively understood. What we didn’t yet understand was exactly how seismic it would become, and how devastating the results would be.
The victory couldn’t help but feel hollow. When I came home and told Paula the news, she congratulated me, but it didn’t take long for her to ask, “So what’s going to keep you going now?” It was a good question. The twin towers were down, the markets were down, much of the telecom industry was down, the reputation of analysts was down, and even Jack Grubman was on the way down. Every part of my professional world was unraveling, from the companies I followed to the firms I worked for.
M
R. REINGOLD,
” the voice mail message began, “I saw your report today about WorldCom.” I didn’t know who he was, but his voice had an ominous tone.
“Mr. Reingold, you are making the stock go down with lies about the company. I know how you Wall Street firms work. You guys short the stock and then go out there with your negative reports and force the stock down.” By now, he was starting to breathe heavily, growing more and more agitated. “I’m going to take you and your firm to court, Mr. Reingold,” he screamed. “I am not going away. You guys and all the others like you will
pay
! See you in court!” He hung up.
The first time this man called me was in the middle of 2000, after my first downgrade of WorldCom’s stock and after I had begun to regularly reduce my earnings estimates for the company. Every sell-side analyst on the Street got calls from such people on occasion, and as the stock market began to teeter and tumble, there were understandably many more of them. By October 2002, when the market hit its bottom, the Dow Jones industrial av
erage had lost 38 percent from its high, while the NASDAQ composite index had tumbled a horrifying 78 percent. Some estimates put the total value of stock market losses at about $8 trillion.
Yet today, after analysts have been excoriated—and rightfully so—for remaining relentlessly sunny as the clouds on the Street began to build, there’s a part of the story that is rarely understood. That’s the unslakable thirst of investors—whether pros, individuals, or that new breed, day traders—for bullish commentary, as if such commentary could make “the value of these stocks…perpetually rise,” in Jack Grubman’s words of 1999. My irate caller’s rant came from the misplaced belief that analysts had the magic wand to reverse a stock’s decline, simply by saying it wasn’t so. He saw us as all-powerful, when we turned out to be anything but. In a panic-driven market, no one person or group could halt an avalanche. The true believers couldn’t, and wouldn’t, accept this reality.
A few months later, in late 2000, the same man called again and left even more threatening messages, full of venom. I was unnerved, so I forwarded the message to CSFB’s legal and security departments. The folks in security actually hired a private detective to find out more, and after a little bit of digging, they discovered that he was an attorney in a Boston suburb with a history of class-action lawsuits against Wall Street. That made me relax a little bit. At least, he seemed to use legal means to fight his battles and wasn’t, I figured, some wacko who was going to blow me away one morning as I walked into the office.
But what was most disturbing—and eye-opening—was that he seemed utterly convinced that we at CSFB were artificially forcing down WorldCom’s shares. The great irony, of course, is that WorldCom’s problems were only beginning. While he was apoplectic that WorldCom’s stock had fallen from a high of $64 to $15, the company was essentially bankrupt already. I’m sure he now wishes I’d been more negative on the stock at the time, not less. I certainly wish I had.
There had been countless press stories romanticizing the stock market and the brilliant minds behind it, and now, as the indices began to sink into an unforgiving quicksand, the pendulum swung to the other extreme. First came the dot-com debacle. Pets.com was one of the first newly public American companies to go under, in November of 2000, with hundreds of others soon to follow. A bitterly funny Web site, Fuckedcompany.com, sprang up to spread the latest gossip about each failed dot-com and the number of layoffs
associated with it. In a split second, the market psychology on these new companies switched from “anything is possible” to “nothing is real.” There were still jokes, but the tone changed from giddy silliness to gallows humor.
I watched all this through the eyes of a bystander, or so I thought. As the dot-com meteorites quickly disappeared into a black hole, it still seemed relatively easy to believe that what was going on
there
was a South Sea Trading Company–style bubble bursting, while what was happening in telecom was simply a classic shakeout. People were not going to stop talking on the phone, obviously. And businesses were not going to stop sending information and data from one place to another via the Internet either, though the traffic wasn’t as much as prophesized.
Sure, the Telecom Act of 1996 was doing significant harm to the incumbent long-distance companies, and sure, the bull market had funneled too much cheap money to the startups, but the Baby Bells still seemed to be on solid ground and Qwest had the advantage of owning a real phone company in US West. Even Global Crossing’s business came mostly from overseas, where competition wasn’t as intense.
What an incredible piece of self-delusion. No one had realized it, but our sector was headed for a collapse that would make the dot-com crash look like a fender bender.
As 2001 dawned, some disturbing events began to hit much closer to home. The first telecom group to lose favor was the startup local telephone companies that had sprung up to meet the new telecom needs of the dot-coms. Companies such as ICG, Winstar, Metromedia Fiber Network, McLeodUSA, and XO Communications, which provided local phone and data service in competition with the Baby Bells, began to buckle under the weight of their enormous debt, which they had easily raised from investors who believed they would fill a massive unmet need for communications services.
Mark Kastan and I both thought that the winners among them would be the ones that built real networks and were not dependent upon the Baby Bells to connect to customers. But it turned out that building local infrastructure—that last mile to the home—is extremely expensive and takes a very, very long time. And although the startup local carriers were more than flush with cash thanks to the generous stock and bond markets, the money came so easily that they wasted a lot of it on fancy headquarters and massive advertising programs and neglected their buildouts.
Ultimately, the dot-com collapse had a domino effect on the local carri
ers: when the dot-coms’ capital dried up, they cut back their expansion plans and canceled orders for communications lines. The Bells, with their healthier finances and well-diversified customer base, weren’t affected nearly as much.
The local-carrier collapse hit Jack the hardest, because he continued to strongly recommend almost every one that did its banking with Salomon—which was most of them—even as the stocks began to tumble. The first to file for bankruptcy was ICG, in November 2000, followed, five months later, by Winstar Communications, a company that had been a top pick of Jack’s and of Mark Kastan’s. Although Mark was more selective in his recommendations than Jack, all of us were slow to see what poor competitors a lot of these companies were and how quickly the funding would dry up. But as the year went on, it was Jack’s reputation that took more and more of a hit. He’d always claimed to be in the co-pilot’s seat with these companies. So why didn’t he know they were about to crash, his critics asked?
Yet as strange as it may sound given the speed with which the market fell apart, the whole thing was pretty anticlimactic. The year 2001, for me, was a lot like being stuck in a ship taking on water. There was no single event that told everyone that it was over. Instead, we experienced a slow-motion decline that at first seemed strange and later seemed somehow normal. The Dow had peaked in early 2000, but fallen and risen several times since then, creating a sense that this might still be a short-term correction rather than a major bear market. And the true believers of the Internet kept on talking. Although fewer people were listening, those believers provided a final lifeline for the investors who hadn’t yet realized that a major chunk of their life savings might have disappeared.
With no real idea how long all of this would last, most of the Street analysts just dug in and stuck to their investment theses. For me, that meant I continued to talk up the Bells and Qwest and to talk down WorldCom, the company most exposed to the downward trends in long distance. I remained restricted on AT&T and couldn’t talk or write about it. I think that my jubilation over the first part of my longtime arguments having come true—the incumbent long-distance companies were in big trouble—may have kept me from fully understanding just how all-encompassing the global glut of telecommunications services would be. I still believed that there would be survivors in this industry, and that one of them would be Global Crossing, which I was recommending with a Buy, or “2,” rating.
For Jack, sticking to the program meant continuing to pound the table
for his favorites—WorldCom, Global, Qwest, and virtually every local startup—and to steer investors away from the Baby Bells even though he now had Buy, or “1,” ratings on SBC and Verizon, two of the three Baby Bells. The remarkable thing about Jack was that the worse things got, the louder he talked, as if he could make it so simply because he said so. It wasn’t actually an unreasonable point of view, given that until now most people seemed to think he really did make the world turn.
The 2001 CSFB Global Telecom CEO Conference took place in March, as always, but the tone was decidedly less exultant than it had been the prior year. Many months earlier, we had decided to move from the Plaza to the Grand Hyatt to better accommodate the crowds, but they were long gone. The NASDAQ had dropped a shocking 59 percent in the past year alone, taking along with it most of the telecom startups. We had 25 percent fewer people than the year before, but it was still a good turnout considering the huge snowstorm that hit New York on the first day. There was a lot of talking going on, but not a whole lot of deal making. The telecom world was coming to terms with the fact that not everyone was going to be a winner—and that, in fact, many were going to be big, big losers.
In the meantime, we had a show to put on. We didn’t exactly party like it was 1999, but we didn’t go into mourning either. In fact, our budget for the conference had been bumped up by almost 40 percent, to $2.3 million. Our attendees still expected a good show, and we obliged. We considered a lot of big names for our special entertainment, people like Sting and Seinfeld.
The going rate for these guys was as inflated as the stock of the executives they were performing for. Sting, for example, charged between $600,000 and $1.1 million, plus six first-class and nine coach round-trip plane tickets, 14 hotel rooms, ground transportation, and production. Seinfeld required a $550,000 fee, along with private aircraft or two first-class round-trip airfares, one hotel suite, and one single room. Not only would these guys bust my budget, they just seemed too ostentatious given what was happening in the markets.
We ultimately chose Harry Connick, Jr., at a “bargain” cost of $375,000 plus two first-class and 18 coach-class round-trip airfares, two suites, and 18
rooms, along with ground transportation and production costs. I thought he summed up the mood I was striving for—serious and classy. Instead of MP3 players, we gave out Motorola walkie-talkies. It was still absurd—just not quite as absurd as it had been the year before.
We had to walk an odd tightrope in this image-is-everything environment. To come off as cheap would imply that CSFB was suffering, and my bosses didn’t want to project that. On the other hand, too much bling would mean we were oblivious to what was going on in the world and in the market, and that, too, would come off poorly. Our marquee speakers were Ivan Seidenberg of Verizon, Qwest’s Joe Nacchio, and Duane Ackerman, CEO of BellSouth. AT&T, WorldCom, and Sprint executives were nowhere to be found. The idea of being pelted with questions from 1,000 angry investors probably wasn’t that appealing to them.
In contrast, Global’s president, David Walsh, substituting for CEO Tom Casey, and Joe Nacchio were just as ebullient as could be. Joe exulted over the strong demand Qwest had seen in January, while Walsh confirmed the first quarter’s positive outlook.
Perhaps because I was no longer recommending his stock, or perhaps because his stock was in free fall (having plummeted from $41 to $16 over the last year), Bernie Ebbers didn’t speak at this year’s event. Yet WorldCom was unquestionably the main topic of discussion in the hallways, as it had been everywhere I’d gone for the past few months. On January 22, 2001,
Fortune
published a piece, “Can Bernie Bounce Back?” that described him as down but not out and suggested that the company might make a good takeover candidate.
1
I didn’t know if anyone was truly thinking about buying WorldCom, but I thought it would be an incredibly stupid move to do so. My January report had reiterated my Hold rating, with the stock at $22.75, and said: “We remain on the sidelines on WCOM.”
By the time of the conference, however, takeover rumors involving WorldCom were rife, particularly one that suggested that SBC might buy WorldCom. A reporter from Bloomberg News later that day asked me if I thought Bernie would sell the company for $35 a share, even though he supposedly had been looking for $50.
“In a New York minute,” I said offhandedly.
“Who could afford WorldCom?” he asked.
“That’s the problem,” I responded, explaining that a buyer faced a
slumping long-distance business, demoralized employees, and a long regulatory review.
2
If that was Bernie’s way out of the fix he was in, he was in big trouble.
It should be obvious by now just how unevenly information travels on Wall Street. Of course, the individual investor gets the least information and gets it last. But even within my world, the playing field is not level for institutional investors that aren’t as big or as powerful or don’t have as many votes in the
I.I.
survey as others, or for those who simply are not able to attend a particular small-group meeting. There are the official rules and then there is the way things really are.
