Read Confessions of a Wall Street Analyst Online
Authors: Dan Reingold
But I looked pretty pathetic when at 8:49, just 33 minutes after WorldCom’s press release came out, Jack’s clients began to receive his 10-page report full of lengthy analyses, tables, and charts. It was amazing in its detail, which was far more voluminous and precise than anything in the company’s press release, and even more detailed than anything that would be mentioned in the conference call, which wouldn’t take place for another hour. Some clients forwarded the e-mail to me almost immediately. Scott’s earlier assurance to me that “that stuff is not going on anymore” with Jack sure looked like a lie.
“I can’t believe what is going on here,” I raged to my team. “In order to understand the WorldCom quarter in its full details and to know what my clients already know, I have to read a competitor’s report! Am I that bad an analyst,” I asked sarcastically, “or is there something shady going on here?”
To be fair, it was not illegal for Jack to publish whatever information he had, provided he did not receive it while over the Wall and working with Salomon Smith Barney’s bankers. Assuming he made the information available to everyone simultaneously and thus didn’t favor one client over others, he would have been following the rules of the Institute for Chartered Financial Analysts, an organization that certifies securities analysts. The wrongdoing, if it existed, was on the part of WorldCom if someone there indeed passed
the results to Jack before announcing them to the public, which is what I believed was happening. There was no way he could have absorbed, analyzed, written, and gotten compliance approval in those 33 minutes.
I’ve never understood what WorldCom gained by giving Jack advance notice and information. First, there was the legal risk; second, this treatment bolstered his credibility to the point that people believed him more than WorldCom’s own executives, as we saw with the revenue-growth story at his conference earlier in 2000. It worked to the detriment of Jack’s competitors, including me, but wouldn’t a company want as many voices on the Street as possible? What if Jack changed his tune on the company? Or did they have a reason to believe that Jack simply wouldn’t ever change his tune, and thus this was the best possible way to ensure that there would always be at least one loyal cheerleader, even if the home team was getting routed?
What I kept butting my head against was the reality that Jack’s style of doing business was now
the
style of doing business, wrong, right, or what have you. Back in May,
Business Week
had published a huge feature on Jack titled “The Power Broker,” written by Peter Elstrom. With an opening spread featuring Jack, hands on hips, looking off to the side as if he were gazing into a crystal ball, it somehow managed to burnish his image at the same time that it exposed a lot of the lines he was crossing, many of which he readily volunteered. “You don’t know Jack?” it read. “You should. In the past four years, as the deregulated telecom marketplace has exploded with possibilities, so too has the influence of Jack Benjamin Grubman.”
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The article discussed his influence on the banking side, asserting he’d played a major role in bringing in $5.7 billion in telecom IPOs to Salomon Smith Barney since 1997, and wondered aloud about the conflicts of interest he seemed to invite. It also mentioned that he’d embellished his résumé, saying he’d graduated from MIT when it had been Boston University and that he’d grown up in tough South Philadelphia, home of Rocky Balboa, when in reality it had been a not-so colorful middle-class neighborhood in Northeast Philly. “At some point, I probably felt insecure,” he said by way of excuse.
The story continued: “‘What used to be a conflict is now a synergy,’ he says. ‘Someone like me who is banking-intensive would have been looked at disdainfully by the buy side 15 years ago. Now they know that I’m in the flow of what’s going on. That helps me help them think about the industry.’”
When asked about such close ties affecting objectivity, he scoffed. “‘Objective? The other word for it is uninformed,’ he said.”
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I read the piece
and said to myself—and to anyone who would listen—this guy was a reckless fool and might end up in jail, pulling others down with him.
Our “uninformed” team spent a very long day and grueling night preparing an in-depth review of WorldCom’s results. The report was published the next morning at 7:30
AM
, almost 23 hours after Jack’s tome had hit the buy-side’s e-mail boxes. And we still didn’t have all the information he had. The only thing I knew for sure was that if anything else started to go sour at WorldCom, I wasn’t going to be the first to know.
I couldn’t have been more right. About a month and a half later, on September 6, Ehud and I were in a taxi, on our way from the Kansas City Airport to Sprint’s headquarters for a day of meetings. My pager went off with a message from Ido that WorldCom was buying Intermedia, a startup local carrier and Web-hosting company, and that a conference call had just started. Fortunately, we had a long drive from the airport, so we each called in on our cell phones. We’d missed Bernie’s introduction, but Scott Sullivan had just come on to describe how the purchase would impact earnings. He said it would reduce 2001 earnings per share by 10 to 12 cents, which translated, he said, “into $2.13 to $2.15 a share.” Everything at WorldCom, Scott said, remained on track.
Ehud and I looked at each other, mystified. “On track?” I mouthed silently. Our estimate had been $2.42 a share, which we knew was just a tad above the $2.40 the company had been comfortable with on July 27, when it had reported its second-quarter results. So with this deal, Scott’s numbers should be down to around $2.28 to $2.30, not the much lower range Scott had just predicted.
My first reaction was to be furious with Ehud, because I jumped to the conclusion that WorldCom had guided earnings downward, perhaps while I was on vacation in August, and that somehow he had missed it. I put my hand over the phone and snapped “What’s going on? Are our estimates way out of the range or what?” Yet I also suspected that Scott had a way of always assuring everyone that everything was fine, even as it was being altered for the worse.
Ehud, though relatively new to the business, was razor sharp and rarely made a mistake. “I’m almost positive they haven’t altered their guidance
since the call at the end of July, and it was $2.40 then. That I know for sure.” I asked what the First Call consensus estimate was—an average of all the analyst estimates—but he didn’t know offhand and suggested having Ido or Julia check it back at the office.
“We don’t have time,” I said. “If he did something sleazy, I’ve got to expose it on this call when we get to Q&A.” So, risking the embarrassment of having missed something that everyone else knew, I asked the following question on the call with some 1,000 investors listening in:
“Scott, could you please repeat your EPS guidance for 2001? I’m not sure I heard it right. Did you say the new range is $2.13 to $2.15, down 10 to 12 cents?”
“Well, Dan, not exactly,” Scott said. “I said down 10 to 12 cents from the expectations of the major people who follow the stock.”
“That’s weird,” I said. “My estimate is $2.42, so I’ve lost 15 cents or more somehow.”
“Dan, I don’t know why your number is so high,” Scott said, essentially confirming his lower numbers. “Others are at $2.25.”
As we pulled up to Sprint’s headquarters, I shot another look at Ehud. Did he mess up royally, or were we exposing the CFO of one of the largest and best-loved companies in the world as a liar? We had to go to our meetings, so we’d have to wait until later to find out who was right. In the meantime WorldCom’s shares were dropping like a lead balloon. Perhaps people were going back and looking at their models and realizing that Scott had just sneaked in a 15 cent, or 6.3 percent, cut in his earnings estimates for the year, a shocking half-billion dollar reduction in WorldCom’s earnings outlook. WorldCom shares fell 17 percent from $36.93 to $30.56 and Intermedia shares soared 34 percent from $22.87 to $30.69 over the next three days.
When we were able to call Ido and get the First Call numbers, we found that Ehud was right, as usual. The average or consensus earnings forecast remained at $2.40—although it turned out that three analysts—Jack, Frank Governali of Goldman, and Eric Strumingher of PaineWebber—had lowered their estimates to $2.25 in the previous month. Jack had been first, of course, on August 4, while Strumingher had come down just a week ago, on the 28th. The other 16 of us were either on vacation during much of August and out of touch with the company or were not privy to the real story. Scott may have guided Jack down first, and the other two, being smart and attentive, may have seen his change and contacted the company to try to figure out what had made him do it.
Clearly, if there was bad news, WorldCom preferred it to come out of the mouth of its biggest supporter. It’s also possible that he did some good analytic work on his own, finding some issues that jeopardized WorldCom’s ability to meet its $2.40 estimate and writing it up for all to see. In that case, the rest of us had simply been asleep at the switch. Still, at this point, I saw an inside job in just about everything that happened with WorldCom or Jack. Amazingly, we tried to listen to the tape of this call about a day later, and found, to our surprise, that my questions and Scott’s answers to them had been mysteriously deleted. The rest of the Q&A session remained unaltered. But at least 1,000 people had heard our exchange and Ido had made his own recording anyway. What a Rosemary Woods moment.
None of this was necessarily illegal—just underhanded, unethical, and unfair—but it was about to become so. Just the month before, in August of 2000, the SEC, under Chairman Arthur Levitt, had approved a new rule aimed at ending exactly this process of “selective disclosure.” This meant, according to the SEC, situations “whereby officials of public companies provide information to Wall Street insiders prior to making the information available to the general public.”
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Levitt had correctly argued that such leaks, or “whispers” as they were known, disadvantaged not only the general public but also those professionals who were not the first to get important information from a company.
Once Regulation FD (Fair Disclosure) went into effect in October of 2000, all of these whispers from a company to an analyst became illegal. A lot of analysts—and their bosses at their firms—worried that the new rules would make it very hard for them to do their jobs. These new rules would make clear just how much of their vaunted expertise came from having access to executives and information that others didn’t. As experts able to interpret news and information, research analysts still had value. But for anyone who relied on tips rather than analysis, Reg FD meant big trouble.
I supported FD as one of the few things Arthur Levitt had done since coming into the job in 1993 that might help investors. I figured that it would make analysts do their own homework instead of relying on management guidance. I also thought it would have an unintended effect of creating more stock-price volatility because companies would hold back information until there was enough to merit issuing a press release, which would then create a shock. This was because Reg FD made it no longer acceptable to do a slow leak à la MCI in the old days.
By the Fall of 2000, it was obvious that what many people had believed was just another protracted episode of volatility was, in fact, a true market crash—at least on the NASDAQ, which had dropped 39 percent since its March 10 peak. Dot-coms such as Pets.com and Boo.com were in dire straits or had already gone under; layoffs had replaced luaus; and tech funding was rapidly drying up. But even though tech and telecom had in many ways become fully entwined, now the two paths seemed to be diverging, in my view.
I had been cynical about many of these tech startups from the beginning, so I didn’t find the news of their demise particularly surprising. So many of the newly public dot-com companies were just ideas, with hardly any customers or assets and virtually no barriers to entry by other competitors. The telecom companies that I covered, on the other hand, were for the most part proven businesses with real customers, revenues, cash coming in, and assets. And those that weren’t, like Qwest and Global Crossing, had purchased real companies in US West and Frontier, which hedged their new-economy bet. So while the phone companies weren’t looking nearly as good as they had early in 2000, they were still looking pretty good.
But the long distance sector of the market was suddenly in real trouble, starting with AT&T. Mike Armstrong’s attempt to plow over the soil and grow an energetic new culture at AT&T was failing. Having cobbled together a telecommunications company that seemed to have all the parts—long distance and local, voice and data, wireless and wired, video and high-speed access—in the hope of getting a head start on the Baby Bells, Armstrong found that integrating them was a lot harder than buying them. Huge turf wars inside AT&T continued to rage among people fighting to defend their various fiefdoms, and the company was filled with antiquated computer systems that didn’t talk to each other and people running them who didn’t either.
For example, even though AT&T had purchased McCaw in 1993 and made it the core of its cellular offering, AT&T Wireless and AT&T long distance customers were still, seven years later, not receiving one unified invoice because the two units were still using different billing systems. Armstrong had been trying hard to bring some entrepreneurial verve to this company, but it turned out that AT&T didn’t have the ability to absorb it in its DNA.
At the same time, competition had intensified in the traditional long distance business, the business that provided virtually all of the company’s earnings and cash flow. There were just too many rivals now, ranging from the Bells to WorldCom to Qwest and numerous wireless companies offering free long distance. Ironically, it was AT&T that, in 1998, had first introduced free long distance for its wireless customers, called the One Rate Plan. This had quickly turned long distance into a commodity, with perhaps the most corrosive effect on AT&T itself.