Part 6 (1/2)
It turned out that we had otten to include the value of some additional fiber-optic capacity that Frontier Corporation had decided to buy from Qwest We had also overestimated the coed the new information into our models, we arrived at a new valuation of 18 billion, in line with Cy Harvey and his gang but still 400 iven that oing on? Merrill banker Tom Middleton and his team looked closely at the Salomon numbers and found that Salomon had not accounted for what is called a ”private-to-public” discount, which is the fact that virtually all publicly traded stocks trade 1525 percent below their theoretical value, also known as ”private market value”
Did a summer intern prepare these numbers? It seemed nuts to all of us We also noticed that Jack's valuation h assumption for an arcane but important input called a terher than our ed our assumptions on those two items into their model, Salomon's model fell to 188 billion-very close to our valuation The bankers called Qwest's CFO, Robert Woodruff, and walked hi that all three of us (Merrill, Qwest, and Salomon) had almost the same number Hopefully, we'd avoid soreet back in January
Silly me Joe Nacchio and his teaardless of itsthe value of the IPO So the word came down: Joe Nacchio wanted to talk to ht There was just one proble to be around to listen to it After all, it was spring-II ca to keepseason-and even Joe Nacchio wasn't going to keepmy clients
I had just had dinner with the telecom analyst at Franklin Funds in San Mateo, California, and had hopped a flight to Portland, Oregon As I checked in to the Heathman Hotel there at about 11:30 PM PM, the clerk handed es were charts coes of Mark's and Megan's analyses, then six pages of news clips and stock prices and four pages of copied phone-, a Merrill banker It confirmed that a conference call had been set up with Joe and his CFO, Robert Woodruff, for the next , Thursday, April 3, at 9:30 New York time, which meant 6:30 AM AM in Portland in Portland
As brutal as that sounds, the ti was intended to accommodate my schedule, which included a breakfast presentation to Portlandwith Colue, a ht to Seattle for a lunchwith Bank of Aht hoht hell of a day indeed-especially now that I would have the pleasure of beginning the day by getting reaest loudet soot up at 5:00 AM AM, checked my voice mails, and skimmed The Wall Street Journal The Wall Street Journal Then I showered and reviewed the valuation charts that Megan had prepared I kneeren't going to be bullied; ould only e if it turned out that we had overlooked so Then I dialed in to the conference call Megan and Joe were already waiting Then I showered and reviewed the valuation charts that Megan had prepared I kneeren't going to be bullied; ould only e if it turned out that we had overlooked so Then I dialed in to the conference call Megan and Joe were already waiting
Nacchio's voice booht?”
”Yep, I' a yawn
Nacchio didn't waste any time ”I don't understand why you are so ht tothat ”Why can't you be like Jack” crap? I cleared ed, instead of the cranky one who just wanted to put the blankets back over my head
”Joe,” I said, ”I don't know if you have seen the latest co around 1819 billion e apply co soressive and, frankly, indefensible assumptions”
One of the bankers then offered to walk Joe through the models, but he wouldn't have it He was stuck on Saloy or didn't want to hear about it He siot it from one bank, he wanted it from all of the banks ”Dan, I don't understand why you would be lower than the other analysts,” he whined ”We're gonna beat all these nu to him drone on for a while, et to my breakfast on time ”Look, Joe,” I snapped, ”we can debate this all day and all night and you can tell me I'm too conservative and I should beto price this deal Theto price it, and that means that Fidelity, Capital Group, Alliance, and a few others are the ones you should be lobbying” In other words, it didn't ultiht the IPO would be worth Itto pay for it-and that was sohly unpredictable in this bullto ses I'd just created ”If the portfolio ers think we've undervalued your shares, Joe,” he said, ”they will place larger orders and we'll raise the IPO price to clear the ree on an exact price”
”But wait,” said Joe, ”there'sthan the 18 billion reflects! We are soon going to announce an investment in Mexico, an expansion into the southeastern US, and three or four new executives All of these should increase the value of the company” Sizzle? I had no idea what ”sizzle” meant in a financial context and still don't Joe, however, was a salesman at heart, and a salesman lives for sizzle I excusedhad been resolved
Joe didn't get e ht than I could ever have i circus in which Qwest's top executives traveled around the world, visiting institutional investors in 10 cities in the US and five in Europe, to try to sell the stock-it went public on June 24, 1997, at 22
Jack's 22 billion and our 18 billion esti, when the stock closed at 28, valuing the company at an unbelievable 28 billion We had all draure in to our models at all: the market's appetite for new econoree to which an association with the Internet-a big part of Qwest's road shoould propel valuations Yet Jack, even though he had blown up his numbers with an air pump, was still closer to reality than I was It killed me Ultimately, Qould peak at 66, three years later It didn't matter how meticulous our research was in an environet close to this new reality would be to add a line to our valuation model and label it ”adjustment for 'irrational exuberance'”
5 MERGER MANIA MERGER MANIA
JULY 1997 JANUARY 1999
Our once-sleepy industry was suddenly looking like Barbarians at the Gate Barbarians at the Gate all over again, with breathtaking hostile takeover offers fueled by a stockpossible In four short years, a tiny upstart coyue as old Ma Bell WorldCom symbolized how the telecommunications industry had transforirl of the Street all over again, with breathtaking hostile takeover offers fueled by a stockpossible In four short years, a tiny upstart coyue as old Ma Bell WorldCom symbolized how the telecommunications industry had transforirl of the Street
The Case of the Secret Docunaled a new phase in the telecoan to have ood old-fashi+oned analysis I loved to do It orriso to act irrationally? I didn't know In addition, the frenzied pace of anticipating and analyzing every deal to conaled a new phase in the telecoan to have ood old-fashi+oned analysis I loved to do It orriso to act irrationally? I didn't know In addition, the frenzied pace of anticipating and analyzing every deal to cohway had worn me out
So in July of 1997, Paula and I went to Italy for a long-awaited vacation We headed to JFK as soon as our kids boarded their bus to suht days of wine, pasta, and- the shores of Lake Como Fro e arrived at the Grand Hotel Villa Serbelloni in Bellagio, formerly the country ho position on the pro for three days straight We spent , and, at dinnerti, umbrellas in hand, to various restaurants near the hotel
We decided to pack up and head south Our plan was siht and cloudless skies, which happened as we entered Tuscany With no reservations and not uidebooks, we found a hotel in Siena and spent a day touring there, learning about the special horse race called the Palio di Siena that happened in the main square once a year We then drove south to Montepulciano, a beautiful walled city on a hilltop
I did call , and for once in my Wall Street career, I felt coriturismo, a bed-and-breakfast on a farm This seemed like the perfect place to unwind for a few quiet, sunny days The guest rooe forroouest bar, to check my voice mail a bed-and-breakfast on a farm This seemed like the perfect place to unwind for a few quiet, sunny days The guest rooe forroouest bar, to check my voice mail
The serenity lasted for about 36 hours We had spent a day and a half playing tennis, swies One,that MCI had just announced it was having a conference call for analysts and investors at 4:00 PM PM EST, which would be 10:00 EST, which would be 10:00 PM PM in Italy It was now 9:50 in Italy It was now 9:50 PM PM I instinctively knew that this meant trouble for MCI Why else would a company hastily set up a conference call just a week before it was slated to release its second-quarter earnings? As I had learned s release, but the stock market had to be softened up for bad news I wondered if it could have so to do with British Telecom's (BT's) deal to buy the company
That transatlantic deal, which had been announced with great fanfare the previous November, was a 21 billion transaction, one The Wall Street Journal The Wall Street Journal called ”colossal” called ”colossal”1 If completed in the next few n takeover of an American company in history and the telecoer MCI shareholders would receive a whopping 36 per share, a 40 percent pre My relaxed state evaporated into the starry Tuscan night If completed in the next few n takeover of an American company in history and the telecoer MCI shareholders would receive a whopping 36 per share, a 40 percent pre My relaxed state evaporated into the starry Tuscan night
I ran back to our room to find Paula I told her I had to deal with so to the farestures, since I spoke no Italian, how sorry I was, but there were sos back in the States and I needed to use his phone for a while He and his wife stared atcard, I settled into a creaky wooden chair in the far room, with my pen and notebook ready, and dialed in to the conference call
As I heard Doug Maine, MCI's CFO, being introduced, the farnal that the bar was closing and it was ti to miss this call The farmer came into the room and stared at me, first confused, then perturbed, as I proceeded to spend the next 45notes in my notebook I doubt he had ever seen anyone spend 45 le word Was this so had to say was not good He said that the challenges of entering the US local market, a 2 billion, 20-city initiative MCI had announced in 1994, were proving to be far more difficult and expensive than anticipated The punch line: MCI would earn in the range of 120 per share next year, instead of the 200 most of us had estimated With one exception, this 40 percent cut in expected earnings was by far the largest cut I had seen in my 14 years in the teleco finished, the moderator announced that the lines were open for questions I had plenty and I was anxious to get started Soured it ht as well be me Not that that was an easy task On calls like these, with upward of 1,000 listeners (analysts, institutional ers, journalists, and others), those of us ere lucky enough to be allowed a question had to speak fast and get our follow-ups in before they old I have a question” I had finally spoken, and o ahead with your question,” Doug said Jack had a tendency to spout off for a while and give his spin on e had just heard, leaving everyone on the call wondering what his question was His spin blamed the evil Baby Bells, not MCI Of course, Jack had a Buy rating on MCI and had looked very astute when the BT-MCI deal had been announced eight months earlier Meanwhile, I had looked pretty bad with a Neutral rating on MCI Unlike Jack, I had argued that the best partners for BT would be the Bells or the new startups, not an incu-distance company like MCI
”Next questioner please,” theto Jack's non-question
”It's Dan Reingold, I have a question,” I blurted again as quickly as I could
”Go ahead, Blake,” said Doug Blake Bath was the telecom analyst at Lehuy orked for me at MCI for a few ht tome to be drowned out by the other questioners' voices or if Doug siive me a chance
Blake's question was also innocuous, perhaps intentionally Like Jack, he, too, was a bull on MCI shares and I suppose they saw no point inand MCI look any worse than they already did Or perhaps he was simply as stunned as I was
When the old, question, can I ask a question please?”
”Dan, it is hard to hear you, but go ahead with your question,” Doug finally said
”Thanks Doug,” I responded ”I actually have several questions First, you're cutting your forecast by 80 cents, or 40 percent Can you split that between your long distance business and your local initiatives?” Doug see to spin us to believe that the entire problem was in the local business But I knew that MCI's stock price was fardistance produced 100 percent of its earnings and cash flow
The farhed again, mollified At least this weird American understood that the purpose of a telephone was to talk as well as to listen He was probably terrified that I would stick hi's ansas a study in obfuscation, designed to give the appearance of answering the question without actually doing so I remembered his approach well from my days at MCI I needed to know more, but hell would freeze over before they'd let me ask another question Fortunately, there were a lot of BT shareholders on the call, and they kept ha much added information
It was obvious to everyone on the call that both BT's and MCI's shares would be hit hard in the s outlook translated into a noticeable earnings hit for BT as well BT'sthat a struggling MCI would be its savior
After severalfinally admitted that somewhere around 20 to 30 cents per share, or one-third of the shortfall, would co distance division It seemed like a disclosure of minor importance, but it would turn out to be a 's statement clearly contained a key piece of infornored by virtually everyone on the US side of the Atlantic Ocean-the arbitrage coers, and most of my sell-side competitors