Confessions of a Wall Street Analyst Part 3

Mack understood and wished me well. My mind was made up and he had plenty of other fish to fry. So I called Merrill's Andy Melnick and told him my decision was final. He arranged to send over movers in the morning to pack up my personal files and books. Then he called Rick Klugman, my a.s.sociate at Morgan Stanley, and asked him to come down to Merrill so he could make an offer to him in person.

As I walked out of the office, thankful that my experience had been so great but equally excited for what came next, Linda Runyon, a bright, ambitious new hire who covered the cellular industry, accosted me. "You promised you'd stay here," she said angrily, her piercing eyes staring into mine. I had recruited Linda six months earlier and she made me promise to stay put. I looked at her and said, "Just stay by your phone." She, too, ended up shivering at Fraunces Tavern one morning. She came to Merrill with a huge pay raise a few months later, rose to the number one I.I. I.I. spot in the wireless telecom category, and stayed there until her retirement in early 2005. spot in the wireless telecom category, and stayed there until her retirement in early 2005.

My move set off a wave of musical chairs throughout the entire telecom a.n.a.lyst community, mainly because the BT (British Telecom) deal was fast approaching and the British government had said they would hire only banks with I.I. I.I.-ranked telecom a.n.a.lysts. This musical chairs game was good for all of us because we all got major raises. There was a perception of scarcity out there, and we milked it for everything it was worth.

At Morgan Stanley, the executives scrambled to get a replacement for me. They went after Frank Governali at CSFB, a well-regarded a.n.a.lyst who had turned down the Merrill job because he didn't want the responsibilities of building a global team, especially the intense overseas travel that would entail. Frank agreed to take the Morgan Stanley offer, with a rumored price tag of $900,000, just one month after they had offered me $750,000. To add insult to injury, this one was guaranteed for two or three years and had nothing to do with the bankers making their budget. It was a nuclear arms race, with every a.n.a.lyst getting superpower status. Frank actually accepted the Morgan Stanley offer, but CSFB then matched it, agreed to let him relocate to Portland, Maine, and set up a one-man office just for him. So Frank decided to stay at CSFB.

Now it was April 1 and Morgan Stanley was losing valuable time. Someone suggested recruiting Jack Grubman from PaineWebber, since he was now ranked second, but Ed Greenberg put the kibosh on the idea, saying there was no way that Jack's style would fit at Morgan Stanley.

Panicking, Morgan Stanley hired Stephanie Comfort from Salomon Brothers, a young woman who had garnered enough votes to become an I.I. I.I. runner-up, behind two others and me. I'm not sure what she negotiated, but the rumors were around $800,000 per year. And her move opened up the Salomon position, which nine months later, in January 1994, ended up going to Jack Grubman. Jack scored a salary said to be the highest on the Street, rumored at more than $2 million per year. This made Jack, who had worked for PaineWebber, a retail brokerage with no significant banking business, suddenly part of a major investment-banking house. At the time, no one could have known what that would mean. runner-up, behind two others and me. I'm not sure what she negotiated, but the rumors were around $800,000 per year. And her move opened up the Salomon position, which nine months later, in January 1994, ended up going to Jack Grubman. Jack scored a salary said to be the highest on the Street, rumored at more than $2 million per year. This made Jack, who had worked for PaineWebber, a retail brokerage with no significant banking business, suddenly part of a major investment-banking house. At the time, no one could have known what that would mean.

Privatization Pandemonium I had negotiated a one-week vacation between jobs, but vacation when you work on the Street is all relative. Merrill had dallied so long trying to get someone in this job that it no longer had any time to waste. Privatization was happening right now, and the big deal on the table was the compet.i.tion to win a piece of British Telecom. The British government was preparing to sell off the last 22 percent of BT shares to the public.

The government would choose two banks, one British and one American, to lead the process, along with several "co-managers," banks that would play a smaller and much less prestigious role. BT would pay a total of 3 percent of the value of the offering proceeds as its fee, most of which would go to the lead managers. With the offering expected to total close to $8 billion, the partic.i.p.ating investment banks could collectively earn a total of $240 million. Merrill wanted to break into the top tier of investment banks, using British Telecom as a wedge to do so. It desperately wanted a piece of the action.

So my trip to St. Martin with Paula-the first time we'd gone away alone in years-was hardly relaxing. Several times a day, the hotel concierge brought me a stack of faxes from Mark Maybell, the head of telecom banking at Merrill, who was preparing Merrill's presentation to the British government. Maybell wanted to include my views on BT shares. So I sat on the beach calculating subscriber-line growth rates and marking up draft slides while Paula read a book.

I did have time to read one book that week-I Can See You Naked, by Ron Hoff. It wasn't p.o.r.nography, but rather a book intended to help inexperienced public speakers conquer fears of large audiences. The main suggestion was to imagine everyone in the audience is naked, while you remain clothed. This, the author said, would stop your heart from racing and your voice from quavering. I figured I'd need the naked trick with my new global responsibilities. by Ron Hoff. It wasn't p.o.r.nography, but rather a book intended to help inexperienced public speakers conquer fears of large audiences. The main suggestion was to imagine everyone in the audience is naked, while you remain clothed. This, the author said, would stop your heart from racing and your voice from quavering. I figured I'd need the naked trick with my new global responsibilities.

On March 10, 1993, I walked into the gla.s.s-enclosed towers of the World Financial Center, where Merrill had its world headquarters, directly across from the two World Trade Center towers that would be destroyed eight years later. I didn't feel the anxiety that I'd felt just four years earlier walking up Madison Avenue, but I wasn't exactly calm either. The money was great, and it was nice to be able to cover AT&T and to be out from under Ed's shadow. But the scope of the new job was much greater. Now I had global responsibilities and a global-level pay package too. I figured Merrill's top management would be on me like fleas on a dirty dog.

Moreover, unlike Morgan Stanley, Merrill had a huge retail system, the largest in the world-the most customers, brokers, and money under management. Although my research would remain directed at the sophisticated inst.i.tutional investor, there was no doubt that Average Joe also was going to hear about my calls. More than 10,000 Merrill brokers would pick up the phone as soon as I got off the squawk box and try to talk someone into making a trade.

Brokers needed action to make any money, since their compensation was based largely on transactions. a.n.a.lyst recommendations were jumped on and embraced like a new lover. Unlike inst.i.tutional clients, who made their own investment decisions and used my research as one of many inputs, these brokers and investors might actually take every word I wrote or said as the gospel. Now that was scary.

I had no time to dwell on it. It was time to see the world. About 10 days later, on a Sunday night, Mark Maybell and I flew to London so that I could meet Neil Barton, Merrill's London-based European telecom a.n.a.lyst, and Merrill's telecom bankers there before we all went over to see the key decision makers at Her Majesty's Finance Ministry and try to make a good impression. Upon arrival, we quickly showered and suited up at 47 Park Street, a posh London hotel, while our drivers waited outside. I was fried, having skipped sleep in favor of going over every last shred of research and information just one more time.

Staffers at the Finance Ministry had made it clear that the U.S. telecom a.n.a.lyst would play a major part in its choice of a bank. The British government-and many others, I learned-believed that a bank's U.S. a.n.a.lyst could create a positive halo effect by using his or her influence to get investors excited about BT's shares. To judge influence, government bureaucrats used the I.I. I.I. survey as well as feedback about a.n.a.lysts they received from the largest buy-side inst.i.tutions. They loved rankings because it gave them cover if things didn't turn out as planned ("Hey, that American magazine survey as well as feedback about a.n.a.lysts they received from the largest buy-side inst.i.tutions. They loved rankings because it gave them cover if things didn't turn out as planned ("Hey, that American magazine said said he was great."). he was great.").

But Merrill had a problem. It turned out that Neil Barton, Merrill's telecom a.n.a.lyst in London, had given BT shares a "3," or Neutral, rating. How, British Finance Ministry officials asked, could Merrill's brokers convince investors to buy a stock rated neutral? It was as if an IBM computer salesperson had to tell his customers that IBM itself had rated its own computers only "average" while giving other computers better marks.

Call me naive, but I actually thought it was admirable to pitch with a "3"-rated stock. To me, it proved Neil's and, by extension, Merrill's integrity. As a result, I thought, Neil's research would be more trusted and thus more influential. Clearly, the British officials and my colleagues on the banking side didn't see it this way. Nevertheless, no one asked me to push Neil to change his rating. As expected, we didn't win a lead-manager spot for the BT offering-Goldman did. But we managed to land a co-manager spot, that unprestigious b.o.o.by prize that generated very little work and equally little in the way of fees. It was a decent start, though.

The next morning (Tuesday), we boarded a chartered jet to Athens, where we had a "beauty contest," or a pitch meeting, at 2:00 PM PM to win the right to handle the privatization of the Greek national phone company. As with every meeting of this sort, before getting there I studied each phone company's history and growth rate. Then I modeled out the rate at which I thought compet.i.tion would develop, based on that country's unique regulatory rules. Then I'd make projections of the company's future earnings and calculate a fair price for the stock. to win the right to handle the privatization of the Greek national phone company. As with every meeting of this sort, before getting there I studied each phone company's history and growth rate. Then I modeled out the rate at which I thought compet.i.tion would develop, based on that country's unique regulatory rules. Then I'd make projections of the company's future earnings and calculate a fair price for the stock.

As I reviewed my slides on the plane, I could already see that there was a pattern to this stuff: virtually all foreign telcos were monopolies facing only the beginnings of compet.i.tion; all were fat pigs in terms of their inefficiency and gross waste, so had significant opportunities for improvement; and all were seeing a lot of increased demand, especially as cell phones came on the scene.

After our Athens pitch, we rushed back to the waiting private jet and returned to London, where I raced to catch an evening flight to Tel Aviv with another Merrill banker. The drill was the same there: meet as many people as I could who were involved in Bezeq, Israeli's telecom company, which was considering selling stock. Merrill's bankers had already spent many hours helping the government prepare. Now it was time to prove that we a.n.a.lysts knew a thing or two about the industry. I was wiped out-a four-hour overnight flight after the previous few days felt pretty brutal-but it was hard to complain, given what they were paying me. I spent a whirlwind two days in Israel, managing to have only a rushed dinner at Jerusalem's King David Hotel with my sister and her husband, who lived in that historic city, before heading back to the airport.

While waiting for my flight back to the U.S., I tried to call home, but my AT&T credit card wouldn't work. After several tries, an AT&T operator came on the line, asked me a few personal questions, and then informed me that the company's fraud detection computers had cut off my calling card. Apparently, the computers deemed it impossible for anyone to have made calls from so many countries in such a short time, so the only conclusion was that someone had stolen my code and sold it to people all over the world. It had to be fraud! But it wasn't. It was just life as a telecom a.n.a.lyst.

It was all pretty heady stuff: a.n.a.lysts were suddenly gaining the attention and respect of the top executives and the bankers, who for the first time saw us as the key to their winning ma.s.sive deals. And we were being brought into high-level meetings with government officials, including finance-ministry and regulatory commissioners, who would then look us in the eye and ask us how they should set up their own regulatory system.

I absolutely loved this part of the job; suddenly, I was the policy wonk I'd always wanted to be. Yes, there were bureaucrats just like those in the Department of Education, and sometimes, it turned out, their intentions were more about lining their own pockets than helping their country. But they were motivated to sell as much stock as possible at the highest price possible-and so were the investment banks.

The Perils of Papadam This type of whirlwind schedule became the norm for me for several years running. My head would hit the pillow on a runway in New York and I'd wake up in Asia, or Europe, or South America every week or two. In an era when the computer was beginning to make electronic communications an acceptable form of doing business, my job was still all about the face time. If you didn't show up in person, you couldn't understand a company's basic reality, or the style of its top executives. And if those managers didn't meet you in person, it was pretty unlikely that your bank was going to win any business. Wall Street, I learned, was as much about kissing the ring as it was about ma.s.saging the numbers.

With the really big deals, we needed to roll out the big guns. In Indonesia, for example, where we were competing to underwrite PT Indosat, the Indonesian international long distance company, Merrill's president, David Komansky, flew in to say h.e.l.lo to the company's executives and government ministers.

I had met Komansky for the first time a few weeks earlier while rehearsing our pitch back in New York. I liked him immediately. He was a hulking guy with a trader's mentality who had come up the ranks as a broker, ultimately running the equity desk. Komansky was paid $4.5 million in 1993, but he seemed to revel in his humble roots as the son of a postal worker in the Bronx. Next to "Danny Boy" Tully, he was the best flesh-presser I had ever seen. Merrill was lucky to have both, as government decision makers everywhere just adore that human touch.

All the investment banks brought in their big guns for these privatization presentations. Tully showed up in Germany in the battle for Deutsche Telekom's business, and Komansky and I flew to Madrid on one of Merrill's three private jets for a Telefonica de Espana pitch. We lost both of them. Win Smith, descendant of the venerable Smith family of Merrill Lynch, Pierce, Fenner & Smith and a Merrill executive vice president, came along on a privately chartered jet to Lima, Peru (we won that one). On my flight back from Germany, I sat across the aisle from Jon Corzine, then Goldman Sachs' co-CEO and future U.S. senator from New Jersey. He had just led Goldman's presentation to the German government and, like me, had to rush back to the Frankfurt airport and push through the crowds at the security checkpoint in order to make the day's last flight back to the States.

The funny thing about all of these meetings between senior bank executives and government officials was that the big guys never said anything of substance. Their job was to make small talk, jokes (nothing too culturally offensive), and then bring in the "experts" to show off the firm's technical qualifications. I was a straight man to their comedy routine.

Over my next six years at Merrill, as capitalist fever spread throughout the world, I traveled to virtually every country with a publicly-traded telecom company or with the near-term prospect of a privatization. My travels took me all over Latin America (Brazil, Chile, Peru, and Mexico), Asia (Malaysia, Thailand, the Philippines, Singapore, Hong Kong, China, j.a.pan, and Taiwan), Australia, New Zealand, Israel, and much of Europe (France, Spain, the Netherlands, Denmark, Sweden, Germany, Italy, Hungary, and Greece). Merrill became the number two global underwriter of telecom privatizations, behind Goldman.

It sounds exotic. But every trip was made in the shortest time possible-often just overnight, even if it meant traveling 24 hours each way for a two-hour pitch. After all, if I didn't get back and keep my investment ideas and face in front of my inst.i.tutional investor clients, I would have no chance of getting I.I. I.I. votes-which would send my career into a tailspin. votes-which would send my career into a tailspin.

Here's how a typical day would go: in order to get to Jakarta for a Monday morning meeting, I'd leave Sat.u.r.day evening from JFK and fly to Amsterdam on Singapore Airlines. Staying on the same plane, I'd lay over for an hour in Amsterdam, where I could check my voice mail and call in any changes to reports my team had drafted. Then I'd fly to Singapore, arrive around 6:30 AM AM, connect to a one-hour flight to Jakarta, and arrive at about 8:30 AM AM Jakarta time. Elapsed time: 24 hours. Jakarta time. Elapsed time: 24 hours.

There was no time to relax on the plane, because I'd have a stack of articles about the country ready for perusing plus, if it was a banking trip, a three-inch-thick briefing book. Fortunately, Singapore Airlines was one of the first major airlines to install fully reclining seats in its first-cla.s.s cabin, and that made a huge difference. I'd walk off the plane and be met by a driver, who would take me straight to the Park Hyatt or the Regent. I'd take what sometimes amounted to a $300 shower, since the room had been reserved from the night before.

After a change of clothes, I would rush to the first of many meetings that day. It was only as the day went on that things got brutal. Usually there were meetings stacked on meetings with the company executives from different departments-the marketing folks followed by the finance people, for example-and I had to stay alert and ask lots of questions.

Then came the hospitality portion of the visit: our hosts would insist on taking us out for a deluxe, booze-filled dinner showing off the culinary achievements of Indonesia. By this time, it was all I could do to keep my head from rolling off my neck, but it was time to be sociable. I didn't drink at these events, even though just about everyone else did. I could never keep up with the locals, not to mention the bankers. So I just didn't do it. Doubtless a lot of people thought I was a boring old teetotaler, but it was strictly for self-preservation.

The other problem I had was the food. I loved tasting every regional specialty, but let's face it: I am a guy from Buffalo with minor lactose intolerance. Sure, Buffalo is the home of spicy chicken wings, but add some funky spicy rijsttafel and papadam to my fast-developing jet lag and I was in big trouble. I'd sit there, listening to the local Merrill banker flattering the company's CEO and CFO, praying for the evening to end. "Please," I prayed to the G.o.d of digestion, "hang in there, stomach!" Getting back to the hotel was often a race to the bathroom. It was an unantic.i.p.ated downside of seeing the world.

But that wasn't the end of my day, either. By the time we'd get back to the hotel, it was 10:00 or 11:00 PM PM, which meant the markets were open in New York. So after calling home, I'd check in on how the telecom stocks were trading, get my messages, and read all my faxes, articles, and any draft reports.

Then there were the clients. Just because I was halfway around the world didn't mean I didn't have to carry on with their care and feeding. I'd stay up until 2:00 AM AM reading, checking voice mails, and returning calls. Finally I'd get in bed, but every few minutes I'd hear the scratchy noise of faxes being shoved under the door. I wouldn't be able to sleep much because of jet lag, so I'd regularly get up and check them, then check my voice mail again, and finally get up at 6:00 reading, checking voice mails, and returning calls. Finally I'd get in bed, but every few minutes I'd hear the scratchy noise of faxes being shoved under the door. I wouldn't be able to sleep much because of jet lag, so I'd regularly get up and check them, then check my voice mail again, and finally get up at 6:00 AM AM and start the whole process all over again. A long trip to Indonesia, believe it or not, would be two days. and start the whole process all over again. A long trip to Indonesia, believe it or not, would be two days.

Once, I had a few hours free, so I hoped on a flight to Bali and sat on the beach for an hour and then hired a driver to show me the religious shrines-just so I could say I had actually been to Bali and seen its treasures. Pathetic. I had to laugh: when they told me I'd be seeing the world, I didn't realize that meant I'd be seeing it through car windows.

Mississippi Madness Singapore Airlines it ain't. That's what I was thinking as Rick Klugman and I boarded the decrepit 16-seat propeller plane from Atlanta, Georgia, to Jackson, Mississippi, one October afternoon in 1993. Because there were no direct flights from New York to Jackson, we'd flown to Atlanta first and laid over for two hours. All this in order to see some tiny long-distance reseller Rick was interested in. I didn't quite see the appeal, but I trusted Rick and figured he knew what he was talking about. Plus I'd never been to Jackson. If my move to Merrill was about seeing the world, wasn't a hotel room in Jackson as exotic as one in Jakarta?

The company was called LDDS, an acronym for Long Distance Discount Services, which pretty much summed up exactly what it did. It leased excess long-distance capacity from AT&T, MCI, Sprint, or WilTel, a Tulsa-based wholesaler that installed fiber-optic lines inside its oil pipelines to carry phone calls. LDDS then resold the long distance service under its own brand to small businesses and residential customers. There were hundreds of these Mom-and-Pop-type long distance resellers, and the sector was ripe for serious consolidation. Merging many of these companies would create economies of scale in everything from sales to billing to technology. So keeping abreast of the most successful of these was critical for those of us who covered telecom. Although Rick handled most of the largest resellers, I'd often go with him when visiting a new company.

Rick had first brought this company to my attention right after we started at Merrill. Investors were asking about this LDDS outfit, he said, and he had to figure out what the deal was. I got the picture, although I already felt we were overextended: resellers were hot, in part because Jack Grubman had been the first of the rated telecom a.n.a.lysts to initiate coverage, with very positive ratings. Now the rest of us were playing catch-up while Jack enjoyed the better access and attention from these executives that came from having been the first to the party.

Our taxi pulled up to a seedy, sorry-looking Holiday Inn in the middle of downtown Jackson that just happened to be across the street from the equally forlorn LDDS world headquarters. We could have stayed somewhere more deluxe, but the choices were limited and I, by this time, valued 15 minutes more of sleep a lot more than some ultracreamy shampoo in a hotel room farther away. As I got ready for bed, I thought about this peculiar Wall Street ritual: the company visit.

The first visit to a public company is a weird combination of brownnosing and shoe-leather detective work. It's an a.n.a.lyst's obligation to thoroughly kick the tires of a company, to determine whether or not to launch coverage of the stock and, if so, where the gray areas and potential weaknesses lie. After all, the only thing worse than missing out on a hot stock is leading your clients into a bad investment and actually losing their money.

There was another side to the company visit too: the attempt to make nice with the management and gain their respect, or at least their belief that I could influence their company's stock price. If I was able to, they might be more forthcoming with information that would give my reports an extra edge, allow me to host meetings for them, or agree to speak at my conferences. Indirectly, there was the hope that they'd also do some of their banking with Merrill, which might reflect well on me.

Hence, the ideal scenario for a.n.a.lysts was to find undervalued stocks, recommend them to investors, watch the stocks rise by virtue of good earnings reports that the a.n.a.lyst, ideally, had predicted, humbly accept credit, intelligently talk strategy with company executives, and then let the bankers try to sell the company M&A (merger and acquisition) and financing services.

All of these things were on our minds the next morning, October 4, 1993, at 9:30, when we walked into the dingy headquarters of LDDS. It looked more like a two-bit actuary's office than a national telecom company. But that was the essence of this company, a no-frills, cheapskate approach to telecom founded by Bernie Ebbers, a one-time gym teacher and milkman who got the name for his company from a waitress in a diner. As the legend goes, she wrote LDDS, for "Long Distance Discount Services" on a paper napkin as she served Bernie and his three buddies coffee. Never would a napkin receive such iconographic status, as LDDS went on to become MCI WorldCom, the most celebrated-and later, reviled-company in telecom history.

We were led into a conference room, where we were joined by the CFO at the time, Charles Cannada. Rick had prepared a list of questions, and we spent about 90 minutes discussing virtually every aspect of the business, from the cost of local access to the various sources of revenue. LDDS had already made some 50 acquisitions, all of which, it claimed, had been successfully a.s.similated into the company's operations and generated lots of cost savings in the process. The strategy was cla.s.sic "roll-up:" buy the little guys, squeeze the costs out, and plow the savings into more acquisitions. When we probed further on the acquisitions front, Cannada suggested that we wait to talk to Bernie, the CEO, since he made all the major M&A decisions for the company.

Finally, Bernie Ebbers walked into the room. He was tall and thin, with an easy, long-limbed jauntiness about him that projected a casual confidence. Rather than the cla.s.sic business suit the rest of us wore to meetings, Bernie dressed in cowboy boots, slacks, and a narrow string tie. He was from western Canada originally, but had come down to Mississippi for college on a basketball scholarship and stuck around, becoming a gym teacher and then buying a motel business before giving the telecom sector a whirl. I couldn't decide whether he had deliberately dressed down to demonstrate how informal and approachable he was or whether he had dressed up in his very best duds.

Bernie didn't kiss our a.s.ses, probably because in the 10 months since Jack Grubman had launched coverage, the stock had shot up 63 percent. Jack had been the first to discover and tout the company to investors, and Bernie clearly appreciated it. LDDS had also just inked another acquisition-Advanced Telecommunications Corporation (ATC), a medium-sized Florida reseller whose CFO, a young man from near Albany, New York, named Scott Sullivan, would soon join the company as treasurer. A year later, in December of 1994, Scott was promoted to CFO, replacing Cannada. Bernie, Scott, and Jack would together create a partnership that would bring all of them riches and accolades for many years. Ultimately, however, that symbiosis would turn sour, creating a disaster not only for the three of them but for practically every investor and employee in the sector.

Bernie, Rick, and I had a pretty freewheeling conversation. We asked him whether there were more acquisitions to be made; yes, he a.s.sured us. We asked whether he'd have to sell out to a network company like Sprint or MCI at some point. He intentionally smiled at the selling selling question, but never in our wildest dreams did it occur to us that he'd end up actually trying to question, but never in our wildest dreams did it occur to us that he'd end up actually trying to buy buy both of those much larger, established companies. both of those much larger, established companies.

Bernie asked us questions, too; he seemed particularly interested in whether the Street preferred organic, or internal, growth to acquisition-fueled growth. He didn't ask us about how inst.i.tutional investors viewed telecom, but he did ask about the types of stocks that Merrill's brokers liked. He clearly saw Merrill as a conduit to the individual investor.

Rick thought Bernie was a cool guy. He might be cool, I thought, but there was also definitely something a little off. I couldn't get a handle on him. Was he a smooth-talking salesman or the real deal? He was so different from the other telecom execs, who to a man were b.u.t.toned up corporate straight men with long careers in the industry. But a former P.E. teacher? What could he possibly know about telecom-or P/E ratios, for that matter?

For lunch, Bernie and Charles took us across the street to the Jackson City Club, at the top of a local bank building. It was probably the best view in Jackson, but it wasn't the Rainbow Room. We helped ourselves to the buffet lunch (I took it easy-southern fried food did me in almost as quickly as Indonesian) and kept talking. When we returned, Bernie invited me into his office while Charles took Rick back to the conference room. Clearly, Bernie wanted to have a private chat with me. As I sat in front of Bernie's large, virtually empty desk, he looked me in the eye and pulled out a two-inch-thick loose-leaf binder. "Dan, you guys were asking a lot about additional acquisition opportunities," he said. "Let me show you our list." My eyes got big. Was he going to show me his planned deals? That would be absolutely proprietary information-info that, if I pa.s.sed it along, could make my clients millions. Of course, having that information in advance, if he actually went ahead with the deals, would be the textbook definition of insider information. I just looked at him.

But it turned out that Bernie was only trying to show me that he'd done a lot of advance work. The notebook faced him, so I could see the page it was opened to but not exactly what was written on it, as it was upside down. And yes, when I say written, written, I mean I mean written. written. The book was full of those green accountants' spreadsheets, and the figures and notations were all handwritten. Geez, I thought. It was 1993, 14 years after I had first learned to model financial forecasts on a desktop computer, and this company's CEO wasn't even working with Excel spreadsheets? Either this was one sharp old-school dude or he ran one very backward company. The book was full of those green accountants' spreadsheets, and the figures and notations were all handwritten. Geez, I thought. It was 1993, 14 years after I had first learned to model financial forecasts on a desktop computer, and this company's CEO wasn't even working with Excel spreadsheets? Either this was one sharp old-school dude or he ran one very backward company.

"For each potential acquisition," Bernie explained, "I have a single sheet. Each sheet lists the synergies [cost savings] we think we can get in each of the first three years after we buy it. Each sheet also lists the impact on the first year's earnings. If the impact is positive, we can do the deal anytime. If the impact lowers our earnings per share, we won't do it."

I was amazed, first at the utter simplicity of Bernie's strategy, and second, at the fact that he, the CEO, was so involved in the small details of every potential acquisition. In my experience, those kinds of details were always left to the CFO, and the CEO's job was more to guide overall strategy.

But Bernie cared about the little things. He was intimately involved in the cost-savings side of the equation as well, scrutinizing each salesperson's weekly productivity, for example, and, as I later heard, monitoring the company's expenses for coffee and other office supplies. As Dave McCourt, CEO of a startup telecom company called RCN and also, for a time, a board member at WorldCom, told me several years later: "Bernie manages very simply: he watches every cost item very closely and, to keep the sales force pumping, every month he fires the lowest-producing salespeople and gives bonuses to the highest producers. Believe it or not, it works extremely well."

Certainly, the numbers in Bernie's simple world were impressive: LDDS's stock price had a price-to-earnings ratio that was much higher than many other companies'. That was because LDDS's earnings were growing very fast and also because, thanks in part to Jack Grubman's support, it had attracted the momentum crowd, investors who were willing to pay high prices for companies that grew earnings rapidly and consistently beat investor expectations. It had a higher earnings growth rate because it kept buying companies that would actually add to earnings per share in the first year, and it was beating expectations, in part because it intentionally lowballed the cost savings from each acquisition. It was a virtuous cycle, so long as there were more and more acquisitions to make.

Having tempted me with his Stone Age spreadsheets, Bernie closed the notebook, moved it off of his spotless desk, and put it back on the credenza. As Rick and I headed downstairs for our taxi, I heard the parting words I'd hear from many executives in the years to come: "Dan, I sure hope you make us a Buy!"

We didn't. Rick initiated coverage of LDDS with an Acc.u.mulate rating, which was between a Buy and a Neutral. According to Merrill's definitions, a stock rated Acc.u.mulate was predicted to rise between 10 and 20 percent over the next 12 months. The report set a target price of $26.50, representing 11 percent upside from LDDS's current share price of $24. He also categorized it as "Speculative," the worst of Merrill's risk levels. Rick's report was fair, I thought, but not googly-eyed with admiration. It acknowledged all of the good things going on at the company but also mentioned the risk that the growth-by-acquisition story could run out of juice. I agreed with Rick's conclusions, but I hadn't told him what to write. He reported to me, but he was ent.i.tled to draw his own conclusions.

Two months later, after the stock had reached Rick's target price, he downgraded LDDS to Neutral. Using Merrill's definitions, this meant that he was predicting the stock would fluctuate somewhere around 10 percent above or below its current price in the next 12 months. Bernie wasn't happy. From that day forward we would have a very testy relationship. He clearly wanted a Buy rating from us, as it would bring in a whole new cadre of potential investors-Merrill's huge individual investor base-which might, in turn, boost LDDS's stock and enable it to be used to buy additional companies. Rick's rating did the opposite, since retail brokers were not about to waste their breath pitching a Neutral-rated stock with "speculative" risk to their clients. Even Acc.u.mulate-rated stocks, also called Outperform or even Buy at some firms, did not interest many professional money managers. After all, they wanted a few great stocks to put into their narrow list of stocks to own. As such, even 1020 percent upside sometimes didn't look so enticing, especially if it carried high risks as LDDS did.

I think that Bernie was also insulted by the fact that I delegated the lead coverage role to Rick instead of taking it on myself. This signaled to him that I didn't consider LDDS enough of a major company to merit my full attention. It was true: I never thought Bernie's company would become a major player. Moreover, I had my hands full and it was Rick who knew the reseller market best and who had brought this company to my attention. Rick had earned the opportunity to cover this strange company with the weird-or was it cool?-CEO.

Even when I later took over coverage and upgraded the stock for a while, my relationship with Bernie remained strained. My employers got very little banking business and it was always a struggle to get Bernie to speak at my Global Telecom CEO Conferences. The a.n.a.lyst's job, it turned out, was a lot more complicated-and personal-than simply writing reports and rating stocks.

3.RAINMAKER, DEALBREAKER.

19931996

The leak hurt my inst.i.tutional clients, too, not to mention the individual investors, who weren't privy to this kind of information. Or maybe it hadn't been a leak. Maybe she misunderstood what was said in the earlier phone call. Maybe he had called after the market had closed. I really hoped so.

Fraud 101.

AS I KNEW FULL WELL BY NOW, the Street stops for n.o.body. And this Tuesday in late May 1994 was no different. I had gone to the New York Eye and Ear Infirmary that morning to sit with my brother Mark, whose daughter Jennifer was having emergency eye surgery for a detached retina she got while boxing, believe it or not. I had meant to be a supportive brother and uncle, but I ended up spending the entire day oblivious to the surgery and glued to the hospital's bank of dirty pay phones. I was listening to a surreal conference call that would cause the fortunes of one of my favorite companies, IDB Communications, to implode as quickly as if it had been punched in the face by my niece. This was my first experience with corporate accounting fraud, and it wasn't an experience I ever wanted to repeat. the Street stops for n.o.body. And this Tuesday in late May 1994 was no different. I had gone to the New York Eye and Ear Infirmary that morning to sit with my brother Mark, whose daughter Jennifer was having emergency eye surgery for a detached retina she got while boxing, believe it or not. I had meant to be a supportive brother and uncle, but I ended up spending the entire day oblivious to the surgery and glued to the hospital's bank of dirty pay phones. I was listening to a surreal conference call that would cause the fortunes of one of my favorite companies, IDB Communications, to implode as quickly as if it had been punched in the face by my niece. This was my first experience with corporate accounting fraud, and it wasn't an experience I ever wanted to repeat.

Back in early October of 1993, about the same time Rick Klugman and I were visiting LDDS, I received a phone call from a San Franciscobased Merrill investment banker urging me to take a look at a rapidly growing company called IDB Communications. IDB was a global satellite company that transmitted such events as the first Gulf War and several major rock concerts. After an astounding string of early successes, it began to use its highly valued stock to buy up international long distance companies. By 1993 it had become the fourth-largest provider of international long distance services behind AT&T, MCI, and Sprint, with the fastest growth rates and highest profit margins in the industry. Now called IDB WorldCom, after its recent acquisition of a small company called WorldCom, the company was based in Los Angeles.

Around the same time, I received a similarly enthusiastic call about IDB from a Merrill broker in our Los Angeles office. I had made a habit of not returning retail broker calls because I saw my job as working with inst.i.tutional clients only. But for some reason, I returned this one. The company seemed interesting enough to warrant a quick look, so I flew to Los Angeles a few weeks later to meet its CEO, Jeffrey Sudikoff; president, Ed Cheramy; and CFO, Rudy Wann.

Jeffrey Sudikoff was smart and, though a newcomer to telecom, had developed an impressive understanding of international telecom. He had started IDB with a $15,000 car loan and had ended up with one of the fastest growing companies in the country and a piece of the Los Angeles Kings hockey team. Ed Cheramy was a very overweight, slick, jewelry-encrusted sharpie who had previously been a partner at Price Waterhouse, one of the world's largest and most respected accounting firms. Though loud, flashy, and hardly my type, he, too, displayed a thorough grasp of the arcane rules and economics of the international telephone regulatory system.

I did some math on the flight home and concluded that my team and I should dig deeper. It seemed like a great opportunity to get in on the ground floor of a small but rapidly growing company and to beat Jack Grubman and my other compet.i.tors to the punch by being among the first to cover the company. Plus, Merrill's brokers adored small companies with big, albeit risky, upsides, just like the typical retail investor, who for all of his claims to the contrary, just loved the romance and the possibility of a hot stock.

I asked Megan Kulick, a 24-year-old junior a.n.a.lyst whom Rick and I had recently hired from Arthur Andersen, to research the international market and to work up a forecast for IDB. a.s.suming just small market share gains, which was conservative given that IDB was adding service to two-to-three new countries per quarter, our forecast indicated that the stock had lots of upside.

I was excited-it wasn't every day that I had the chance to come out first on a stock-but d.i.c.k Toole, my colleague and Merrill's longtime telecom and utility a.n.a.lyst, wasn't. He warned me he had looked at IDB a few months before my arrival, and decided to stay away. Too flashy and too fast growing for a conservative old-timer like d.i.c.k, I said to myself.

I initiated coverage of IDB on November 16, 1993, with a Buy rating, the highest on Merrill's scale. I worked on the report with Megan, an independent-minded, hardworking woman with a great att.i.tude and a great work ethic, and I thought it was the most comprehensive a.n.a.lysis we'd ever produced. Merrill's inst.i.tutional salespeople loved the report and began taking me around to the professional investors who specialized in small and medium-sized companies often overlooked by Wall Street research a.n.a.lysts. I was introduced to a whole new cadre of buy-siders and, I hoped, I.I. I.I. voters. For a while, I looked like a frigging genius: in the four months since I had recommended buying IDB, IDB shares had surged 33 percent. voters. For a while, I looked like a frigging genius: in the four months since I had recommended buying IDB, IDB shares had surged 33 percent.

There was just one little problem. The company had a great business plan, but Jeffrey Sudikoff and Ed Cheramy had no idea how to execute it. As a result, the company's revenue growth started to slow dramatically just as the pressure to continue hitting its numbers intensified. If the company didn't make its revenue and profit estimates, the stock would surely tank. Such was the life of a high flyer.

So what did IDB do? According to federal prosecutors, it lied to its investors and the a.n.a.lysts who covered it. To hide the shortfall, the company faked revenues, among other things manually backdating a customer's order sheet so that an extra $5 million could be booked as revenue in the first quarter of 1994.1 In the kind of admirable accounting work that would later go out of fashion, Deloitte & Touche, IDB's auditor, discovered the fraudulent bookings and demanded that they be reversed. But Ed Cheramy, a former audit partner himself, simply refused to make the changes and tried to intimidate the Deloitte folks into staying mum. The company brazenly reported the fake first-quarter numbers anyway, announcing "record revenues and earnings." A few weeks later, on that May Tuesday, Deloitte resigned the account, and I heard the news when my pager vibrated as I sat at the hospital with my brother. In the kind of admirable accounting work that would later go out of fashion, Deloitte & Touche, IDB's auditor, discovered the fraudulent bookings and demanded that they be reversed. But Ed Cheramy, a former audit partner himself, simply refused to make the changes and tried to intimidate the Deloitte folks into staying mum. The company brazenly reported the fake first-quarter numbers anyway, announcing "record revenues and earnings." A few weeks later, on that May Tuesday, Deloitte resigned the account, and I heard the news when my pager vibrated as I sat at the hospital with my brother.

I bolted over to the bank of telephones and called Megan, who told me that the company was holding an investor conference call in 15 minutes. I was shocked and scared; I had had no idea that there was anything wrong at IDB, and this was my first run-in with numbers that weren't what they appeared to be. I had no idea whom to believe, nor whether I should have somehow been able to suss out the falsehoods. What would my clients think? Was my stodgy old friend d.i.c.k Toole right, after all?

Amazingly, on the investor conference call, Jeffrey Sudikoff and Ed Cheramy had the gall to rant about how unprofessional Deloitte was, insisting that IDB had done nothing wrong. Jeff was on the call from Germany, where he was, he declared, rustling up more international traffic deals and acquisitions. Ed was indignant, saying Deloitte had no right to question his and Jeff's integrity. This was simply a personality clash, Ed claimed, full of p.i.s.s and vinegar, not an indication that there was anything wrong with IDB's financial performance. Next, IDB's CFO walked through the accounting adjustments requested by Deloitte, some of which the company was making and some it simply refused to do.

I felt as if I'd been punched myself as I listened with one ear to the conference call and with the other, on another pay phone, to Megan relaying the panicked messages coming in from clients and brokers. Since I had been the most visible and was thus the most embarra.s.sed proponent of IDB shares, I asked tons of questions on the call.

I felt like a prosecutor interrogating a defendant. I went item by item: Why did Deloitte question this? What evidence do you have to refute them? How do we know there are not other things hidden underneath all this mess? I was midsentence in my stream of questions when the elevator opened and out rolled Jennifer on a surgical cot, head completely bandaged, en route to her recovery room. I would have waved, but both of my hands were holding phones. My relieved brother sarcastically thanked me for distracting him from the surgery.

It was obvious that this stock was going to crash as soon as it opened for trading the next morning, and that the situation was more than simply an embarra.s.sment. Merrill was also likely to be the subject of a variety of cla.s.s-action suits on behalf of its retail investors who had followed my advice. Clearly, I had to get rid of that Buy rating before the market opened.

But the company was truly una.n.a.lyzable. It did not have audited financial statements because the auditor had resigned, meaning that every line item on the financial statements was up for debate. It appeared that the executives were covering up a major revenue shortfall. And the nasty and public squabble with the company's current auditor meant that it was going to be extremely difficult to find another reputable firm willing to perform future audits.

I downgraded the stock to Neutral before the market opened the next morning. I told the Merrill sales force there was no way to know what IDB's true numbers were in the past, let alone to forecast its future. I said the stock was going to get crushed, perhaps cut in half, and that from that price, it would likely trade sideways for quite a long time-hence the Neutral rating. It was too late to put a Sell on it; the stock would react to the news before anyone heard my report. And to argue it was oversold and therefore deserving of an Acc.u.mulate or Buy rating would have been irresponsible, since there was no way to know what the company's real financial situation was.

Merrill's lawyers had worked all night reviewing my written report to ensure I didn't create even bigger problems for them. They told me to read the report verbatim at the 7:30 AM AM Merrill morning meeting and not to veer from the script. As soon as IDB shares opened for trading later that morning, they lost almost half of their value. Merrill morning meeting and not to veer from the script. As soon as IDB shares opened for trading later that morning, they lost almost half of their value.

Sudikoff and Cheramy were indicted on a litany of fraud charges, along with insider trading. I was subsequently interviewed several times by the U.S. Attorney's Office in Los Angeles. Yet despite what seemed to be clear evidence of extensive fraud at IDB, in a settlement with government prosecutors Sudikoff pleaded guilty to only three charges, including insider trading. In December, 1999, Sudikoff was sentenced to a year in jail and a fine of $3 million, though he allegedly made $4.6 million of profits on his IDB stock sales.2 He admitted to selling IDB shares through an offsh.o.r.e account when things were falling apart, but before the public knew. Cheramy pleaded guilty to only one charge of securities fraud. His sentence: three years probation, 500 hours of community service, and fines of $250,000, although he, too, sold millions of dollars worth of IDB stock before the accounting issues reached the public. Additional fraud charges-that carried much stiffer penalties-were inexplicably dropped by the government. He admitted to selling IDB shares through an offsh.o.r.e account when things were falling apart, but before the public knew. Cheramy pleaded guilty to only one charge of securities fraud. His sentence: three years probation, 500 hours of community service, and fines of $250,000, although he, too, sold millions of dollars worth of IDB stock before the accounting issues reached the public. Additional fraud charges-that carried much stiffer penalties-were inexplicably dropped by the government.3 For me, the whole experience was a very serious reminder that management can't always be trusted, that some executives think they are above the law, and that I needed to be more vigilant. Ironically, I also learned another lesson, one that would serve me very poorly later on: accounting firms can be trusted to stand up for the investor and resign when a client insists on using improper accounting. Deloitte had lived up to the auditing profession's principles and maintained its independence. Subconsciously, I suppose, I thereafter relied more on audited statements than before. Although it would take another six or seven years for me to realize this, it was exactly the wrong lesson to learn.

The one company that benefited from the collapse of IDB was LDDS, which snapped up the broken company's a.s.sets for a song. LDDS got something else from IDB WorldCom, too: a new name. Liking the sound of WorldCom, Ebbers and company absorbed it as their own. Its new name was LDDS WorldCom. They didn't seem to mind the fact that it had a whiff of scandal about it.

Tone and Notice It was around this time that the pressure on a.n.a.lysts to do extra little things that might help out a banking relationship began to build. In mid-1994, I got a call from Matt Bowman, the Merrill banker covering MCI. Matt was also a neighbor of ours, and our kids played on the same soccer team. We got along great. Matt was a vice chairman at the firm and an outstanding investment banker, one who orchestrated so many of Merrill's own M&A deals that "Danny Boy" Tully called him "my investment banker."

With a touch of embarra.s.sment in his voice, Matt told me that Doug Maine, MCI's CFO, had called him. Maine was serving on a committee set up by the American Electronics a.s.sociation to oppose the expensing of stock options on a company's income statement. The Financial Accounting Standards Board (FASB) had come out in favor of expensing the options. But later, under enormous pressure from Congress, which had been lobbied to death by technology companies and startups in particular-which saw the stock option as the ideal way to compensate employees-it backed down from its earlier opinion.

So why did Doug Maine call? It turned out that he wanted me, as a "respected a.n.a.lyst," to testify before Congress-and tell them that I thought it was a mistake to expense options. "MCI's an important client, Dan," Matt said, "and the entire tech industry's really concerned about this issue." The thing was, I had never thought much about stock-option accounting before and it was quite possible my conclusions wouldn't be the same as Doug's.

"Hmmm, Matt," I said, trying to wriggle out of it, "I guess I should be flattered that he thought of me, but I'm not really very comfortable in such a lobbying role. I'm not even an accountant. And once I study the issue, who's to say that I'll come out in support of Doug's position?"

Matt's response was extremely professional. He clearly was not surprised by my answer, and didn't complain about it, even though he knew he'd have to go back to Doug with a big no. I'd just made his job-and perhaps mine-more difficult. "All right," he said, "I'll tell Doug you're not comfortable doing that." I never heard another word about it.

A few months later, I was able to make good use of something I'd learned when I worked in MCI's investor relations department, though it didn't help my relationship with the company. One day in November 1994, when I had MCI rated as a Buy, Merrill's highest rating, I'd gotten to work, as I always did, at 7:15 AM AM, and spent the hours before the market opened returning phone calls and talking to salespeople and traders.

As 9:30 approached, the trading desks always became frenetic, with traders yelling orders and market rumors being tossed back and forth across Merrill's football field of a trading floor. For me, in the quiet of my office 16 floors higher, it was also a tense time of the day. Had any telecom companies issued press releases? Were any of my stocks making unexpected moves? Had I missed any news? Was anyone else announcing an opinion change? Ideally, I wouldn't find myself on the wrong end of the information flow, but it did happen.

And that was the position I found myself in that chilly morning of November 28 when, just 15 minutes after the market opened, a Merrill trader called, barking that he was seeing some large sell orders on MCI shares. Already, the shares were down 5 percent to $19 from $20. The sellers were offering MCI shares for sale in larger-than-normal blocks. The trader might have known who the seller was, but he was sworn to protect the confidentiality of his client's trading intentions.

Five percent down was a big move, yet there was no news out, so I went straight to the source, Connie Weaver, MCI's director of investor relations, to see if I had missed anything. I got her a.s.sistant, whom I knew from my days in the MCI IR department. Lucky me. "Hi, Dan," she said warmly. "Connie and Doug are in Boston today, visiting investors."