Part 8 (1/2)

My Multibillion-Dollar Mistake: AT&T PERHAPS IT WAS si with so inning to feel out of step with a stock market that knew no bounds Perhaps I ayed by the charisma of a new, uberconfident chief executive Whatever the reason, I kicked off 1999 with a multibillion-dollar mistake-one of the worst decisions ofwith so inning to feel out of step with a stock market that knew no bounds Perhaps I ayed by the charisma of a new, uberconfident chief executive Whatever the reason, I kicked off 1999 with a multibillion-dollar mistake-one of the worst decisions of my professional life

Way back in October 1997, AT&T's board had finallyseries of events First, CEO Bob Allen had bullied the board into choosing the corporate e Then, when it became clear Walter was a disaster, the press had excoriated the board for paying him 26 million in severance for nine ht in a new CEO, C Michael Arhes Electronics Corporation The market loved this choice, and AT&T stock leaped more than 16 percent, from 43 to nearly 50, in the teeks between the tian and the decision beca, i sy, quickly charmed the press and the Street, in part because he had hes Electronics from a defense contractor to a satellite TV business, DirecTV Ininherited in 1991-a dying giant with a need to spend enoreover at Hughes had been painful, involving huge eet the satellite TV business underway, and enored that it was a bet-the-coy, and it had paid off

After his predecessors, dull powercrat Bob Allen and the woefully underqualified John Walter, Mike Ar had the aura of a savior He tackled AT&T's proble to discourage the increasingly popular belief that if anyone could fix this broken co he said and liked what I heard Still, I reht that AT&T had si and that Arreat and too costly So I leftat Neutral for quite some time, even as my institutional investor clients became enamored of Mike and AT&T shares rocketed to 7575 at the end of Decee run-up

Fro pro local access to add to its established long-distance prowess and expanding its international reach His first big ht Teleport, the startup local phone coaining an instant presence in the market for local phone service for business custoht cable company Tele-Communications International And finally, in December 1998, just before Bell Atlantic's run at AirTouch, Ar IBM Global Network, an IBM business unit that provided coe multinational corporations around the world He had filled AT&T's ic holes in less than a year I started to wonder if this guy really was the knight in shi+ning armor for this antiquated old bureaucracy, and whether I should think about upgrading the stock

So I did what I always did in these circuan a debate with myself and with all of the people whose opinions I respected, such as Bill Newbury, TIAA-CREF's (Teachers Insurance and Annuity association-College Retirement Equities Fund) telecom and cable analyst and a major client ofthat I was s It was always fun to argue an unpopular position, and since I had actually been quite right for a long tiraded it three and a half years earlier, when it was trading at 55), I wasn't too concerned But the conversation did add toon at AT&T

The other point that gotwas that it had been widely reported that AT&T was considering using a tracking stock tracking stock to separate its cable and wireless divisions fro stocks allows a company to create separate stocks for different units It would separate the big startup losses of AT&T's fast-growing cable and wireless businesses fro distance business This ca incredible pres, while devaluing old ”traditional” assets-in this case, AT&T's voice long distance business to separate its cable and wireless divisions fro stocks allows a company to create separate stocks for different units It would separate the big startup losses of AT&T's fast-growing cable and wireless businesses fro distance business This ca incredible pres, while devaluing old ”traditional” assets-in this case, AT&T's voice long distance business

With Ar's recent acquisitions, the coht the tracking stock, if it did what it had done for Sprint and others, would give AT&T her stock valuation I set up awith Dan Somers, AT&T's CFO, to discuss AT&T's future I asked hi to be announced at next ly

So with the tracker as the news hook, in late Decehts during that family vacation in Florida before I was interrupted by the Bell AtlanticAirTouch negotiations I knew there was an AT&T analyst ht the upgrade should coot off Bell Atlantic's jet, I had started typing up the AT&T draft report on the way to Ivan Seidenberg's office That Saturday, of course, was taken up by the over-the-Wall ot hohts editing the draft We went out with the AT&T upgrade on Merrill'sthe stock one notch, from Neutral to Accun, I figured, that , I got a call from the Merrill banker responsible for the AT&T relationshi+p, telling ht over the Wall on Thursday for an AT&T rehearsal in order to help it prepare for its Friday analyst , which would have several hundred analysts, ers, and journalists in attendance It was a hectic week for rade, a trip to Arkansas, and two over-the-Wall sessions for two different companies within four days

I showed up at AT&T's bucolic Basking Ridge, New Jersey, headquarters and strolled into the boardroo to predictable slide presentations The sell-side analysts had the best seats, and I was seated directly across fro, with Jessica Reif-Cohen, Merrill's cable analyst, to my left and Jack Grubht, with Denny Leibowitz, the legendary DLJ cable, media, and wireless analyst who had been rated nuory on the II II list for over 15 years, to the right of hi with a few other analysts, there were several bankers I was just about to settle into my seat when the Merrill banker pulled ht of hi with a few other analysts, there were several bankers I was just about to settle into my seat when the Merrill banker pulledaround with pleasantries, ”the tracker is canceled”

It was one of those moments that see fro to wobble How could that be possible? I had just upgraded AT&T in large part because of the likelihood of a tracking stock for AT&T's wireless and cable units I would look like a co stock plan Geez, Connie Weaver, who several years earlier had left MCI and beco Tracker!

Just then, Mike Ar with confidence as usual, and sat directly across from the other analysts and me, flanked by AT&T's key executives The bankers in the roo the periphery Mike asked everyone to take their seats and took a small piece of paper out of his shi+rt pocket on which he'd handwritten his own notes No cue cards or telepro everyone for co from his crumpled piece of paper He explained that he'd decided not to do the tracker because AT&T shares had done very well lately, and since the point of the tracker was to attract investors, perhaps it wasn't necessary

Ar emphasized that he could always return to the tracker if he thought the company or its stock price needed it I tried to look i about how everyone in the rooup, he said he'd like soave us a preview of the next day's presentation ”How do you react to what I just said?” Ar asked ”Hoill the ht All I could think about hat a fool I was going to look like the next day, and if he really wanted to hear what I thought, it wasn't going to be pretty I watched as the analysts, one after another, each told Arht decision I waited for the others to finish speaking, partly because I wanted to hear as many perspectives as possible, but also because I desperately needed ti as if I was chewing on a bunch of sour grapes Finally, it was's mind ”In this rowth butAT&T of future growth opportunities” I added that I thought that ree that Sprint's two trackers together had achieved a higher stock market value than otherould have been achieved, and that this gave Sprint PCS, the wireless portion, the ability to spend more money and to build out its network more rapidly Everyone was silent for aa bit perturbed, thanked me It was clear that his decision was final and he was just practicing his speech

Finally, at the end of the day, Connie Weaver, AT&T's investor relations head, toldwanted to meet with me in his office She took me in and closed the door as she left It was unprecedented for Connie to leave me alone with an AT&T executive-she was infa wanted this to be totally private I walked in and took a seat on his couch He sat down in the lounge chair to ht

I didn't knohat to expect If it were Joe Nacchio, I would have received a verbal spanking: ”Who are you to question a decision that ement committee, and 29 well-trained bankers and analysts in that rooree with?” But that would have been Joe Mike Arined he'd say so like, ”You know, Dan, you have the respect of many people in this industry, but in the future if you don't agree with an aspect of what I', please tell me privately”

But he was a lot subtler than that In fact, he hardly acknowledged my earlier comments and reiterated his excitement about AT&T's future ”Dan, you know you can callthat if I had called hiivenscrapped? I doubted that, but I didn't knohat he really meant I told him I appreciated that, but it was not ement before I published

It turned out that AT&T investors didn't see the decision as a problem Much tothe analyst n that investors still liked AT&T, tracking stocks or not Ehud Gelblum, the most recent addition to , titled ”AT&T: The Magical Mystery Tour Continues: More Notes froeven when he flip-flopped Indeed, the stock continued to soar, h of 95 over the next thirty days and bailing me out-for the moment Thank God for this crazyBoat on Level 3”

The Internet boo a phenoan to define telecoer were the companies I covered relevant because of the traditional phone calls or voice communication they transrowing at what appeared to be an exponential rate Data transe data files-you name it-over the Internet Just as the railroads had unleashed the power of A muscle a century earlier, the telephone, cable, and wireless co the tracks (fiber-optic, in this case) to connect the virtual economy Or so went the hype

I had been fully aware of the Netscape IPO, Al Gore's inforhway, and, of course, the stock ht hadn't really begun to click on insidewith Jim Croas then the CEO of MFS I first heard at that y that would be built into the telecommunications networks of the future and could truly transfor ti trouble because of corowth in data traffic from the Internet could possibly make up for the pressures on the voice side If the demand for this stuff was as dra, perhaps it wasn't just the Baby Bells that would be the winners; perhaps everyone would win Still, I was skeptical that anything could grow at the rate that so In 1997, Michael O'Dell, the chief scientist at UUNET, the Internet services provider that WorldCoht a year earlier, was the first ofevery 100 days Later that samore, WorldCom's vice-chair every 35 months By early 1998, even the US Depart O'Dell's 100-day stateress on the Internet's potential1 And these nu presented a year and a half later In May 1999, Sidg presented a year and a half later In May 1999, Sidgazine that ”the Internet continues to grow at 1,000 percent a year in terazine that ”the Internet continues to grow at 1,000 percent a year in terms of bandwidth deain, I thought to est Internet transmission service in the world, so it was not unreasonable to view its traffic growth as a rough approxirowth, even if it wasn't sustainable forever Reinforcing the bullish point of vieas the fact that even the sloing Baby Bells were reporting 30 percent growth in their data services divisions, far beyond the 46 percent growth rates of o on to becoospel without knohere they came from or whether they were actually true

In May of 1998, I attended the grandly naether organized by Bob Metcalfe, the scientist from Xerox's famous Palo Alto Research Center who invented Ethernet, today's standard for rapid co, and later founded 3Couel, California, a gorgeous resort south of Los Angeles overlooking the ocean But no one there cared much about the surf The conference was chock-a-block with new co their technology, and, of course, bankers, analysts, and investors

The speakers included John Chae Gilder, and others Frank Quattrone, tech banker extraordinaire, was there, er partners Sol Trujillo, CEO of US West, was there, trying desperately to gain some credibility as he tried to transfor old Baby Bell into a ”new-economy” superstar And Ji the Internet word again, but this time on behalf of his new company, Level 3 Communications

One afternoon as we sipped cocktails by the Ritz's pool overlooking the Pacific Ocean, Ji to provide the tubes through which the infor distance network that would carry only data, not voice By this ti been early to the gae premium for WorldCom stock, which then soared The response to his new company was as frenzied as a Michael Jackson concert in the Thriller Thriller days days

As we sat by the pool, Jim sketched out on a piece of paper his vision of the Level 3 network in the hope of convincinghis company I looked at the paper, which had a lot of swirls and chicken scratches, and saw nothing To et it And although it et it, I wasn't going to start coverage of a stock if I couldn't fathom what the company actually did

Some clients tried to convince me of Level 3's merits One was Bill Newbury of TIAA-CREF, who had helped talknew-econoroup, loved the stock so ers wouldn't even meet with ured I would dis the co to feel like a Luddite, stubbornly sticking to the stuff that could be ht, or was I?

Level 3 was a virtual fee machine for Wall Street fir bonds and stock Making matters worse was the fact that Croho obsessively quantified everything, also quantified the performance of the banks he hired He developed a bizarrefrom the number of calls a banker made to Level 3's CFO or treasurer each month to try to drum up business to the number of calls an analyst made to buy-side clients to talk about Level 3's stock How he got that data, I have no idea

A Level 3 document I received in 1999 listed the criteria he used to measure the banks' performance Number two on the seven-point list was ”Equity Research Co ways: ”analyst calls made to institutions/investors analyst one-on-ones with investors Perceived strength of analyst and analyst's understanding of, and confidence in, Level 3's Plan Ongoing research coverage of Level 3”3 All of these factors were compiled into one total score that would presumably determine the portion of Level 3's business each bank would be awarded Clearly, Cro the analyst and the banker as inextricably entwined It was troubling I never heard of another co its investment banks But this was Ji fan of ot much business from him

By March 1999,a major problem for Merrill, made even worse by two rah-rah reports issued by Jack Gruber on February 18 that raised Jack's target price to 70 from 54, cae secondary stock offering-underwritten, of course, by SSB

Four days later, he put out a e report titled, ”Level 3 Co a Layer of the Telecom Value Chain: The Intel Inside of Teleco how bandwidth was the ”enabler of the Internet,” he exclaimed that bandwidth-centric co, Qwest, and a startup local carrier called Metro how bandwidth was the ”enabler of the Internet,” he exclaimed that bandwidth-centric co, Qwest, and a startup local carrier called Metroood values at any price” Jack's reasoning? Internet-based applications were growing exponentially, he said ”This is e believe Jack's reasoning? Internet-based applications were growing exponentially, he said ”This is e believe the value of these stocks will perpetually rise the value of these stocks will perpetually rise as long as ement executes”

The National association of Securities Dealers (NASD), the securities industry's self-regulatory organization, requires that all Wall Street research reports have a ”reasonable basis” for their conclusions How could a view that stocks will rise ”perpetually” and that soood values at any price” be reasonable? This wasn't analysis by any stretch of the iination It was hyperbole and should have been stopped by SSB's compliance department, its research directors, or the NASD If he had stood outside on a street corner yelling these inanities at the top of his lungs, people would have thought he was completely bonkers But, when this stuff showed up in a Wall Street report by a big-naers with Harvard MBAs lapped it up

Jack's target price increase looked to me like an overt atte by building demand for the new shares And condition it did! Despite the fact that announces almost always te to The Wall Street Journal, The Wall Street Journal, his target price increase caused the stock to juet price increase caused the stock to ju demand, Jim Crowe decided to up the number of shares offered by 25 percent, to 25 million By my calculations, without Jack's report, Level 3 shares norhly 50 per share So, in effect, Jack netted Level 3 a cool 100 million because Level 3 was able to sell its 25 million shares at a price of 54 each, approxiher than it would have otherwise Advantage: Level 3 and its bankers Disadvantage: s on and paid 4 per sharewas that this was happening in plain sight of everyone, froulators to the readers and writers of The Wall Street Journal The Wall Street Journal-and no one seemed to mind No wonder every CEO wanted Jack on his side!

Jack's lock on Level 3 didn't stop et a seat on its gravy train Although Level 3 did most of its business with Salomon, Crowe also liked to spread the business around a bit, with the expectation that the research side would play ball On one deal, with no help froer, and Frank Maturo, a pushy banker who had just moved to Merrill from Salomon, decided to pay me a little visit He sat down in reatest ”fucking couys, you're reat fucking relationshi+p with Crowe” Lots and lots of business would co its stock He even said that Jack was not responsible for all the business Salo was” Frank had quite a broad vocabulary

I decided to do what had always served s,” I said, beginning with a nice one ”One, it's very nice to meet you You are truly different froh energy level and aggressiveness ht be needed in this soreatest company in the world And three, we're pretty busy here and Level 3 see hyped up all over the Street Its stock is very high, so it may be too late to recommend the shares anyway If we can find some time, we'll take a look, but no promises”

Frank didn't hear a word I'd said He just kept repeating what an incredible stock Level 3 was going to continue to be, hoell connected he was, and how much money he could make for Merrill Lynch if only the telecoet on board He wasn't there to listen to an analyst He looked on analysts as the first wave of privates on Oood But this was one war I wanted to sit out

”You Know He Can't Keep His Mouth Shut”

March 1999 was a tense ti and ere in the final stages of panic, praying, as we did every year, that our key speakers wouldn't cancel This year, I had invited everyone fro to Ed Whitacre, SBC's chairman and CEO, as speakers On Thursday, March 11, just four days before the conference was to begin, I was on the way back froot a call from Michael Costa, Merrill's teleco you over the Wall on so tomorrow afternoon Will you be back in ti at theat the midtown offices of [top law fir in a conference room with Jack Grub's pending confidential offer to acquire Frontier, the for distance, data services, and Web-hosting to its repertoire of phone services These assets made Frontier a very attractive acquisition Both Saloues at Morgan Stanley were the bankers representing Frontier Talk about incestuous!

Global Crossing was the new international long distance coust 1998 It had laid cables under the Atlantic Ocean and intended to run fiber-optic cable all the way around the world todemand for Internet and teleco had sold just 25 percent of its cable capacity under the Atlantic Ocean-the ”Atlantic Crossing”-and had already recouped 90 percent of its costs

In March 1999, Global looked like a ho doubled in the first three months of this year alone Before Global's IPO, forave a speech to the company's most important custo his usual 80,000 honorariu's founder was Gary Winnick, a former junk-bond salesman at Drexel Burnham Lambert, Michael Milken's hotshot firuilty to securities law violations in 19906 Winnick was a heavyset, wide-shouldered Long Islander ould have looked right at ho shares with a ”2,” or Accu I predicted a rise of 1020 percent over the next 12 months-fairly uni to ories Yet I was intrigued by what appeared to be very strong demand for the company's undersea fiber Winnick was a heavyset, wide-shouldered Long Islander ould have looked right at ho shares with a ”2,” or Accu I predicted a rise of 1020 percent over the next 12 months-fairly uni to ories Yet I was intrigued by what appeared to be very strong demand for the company's undersea fiber

Because Global was perhaps the premier ”new-economy” company in the telecom sector and had been seen as purely an international play, its decision to acquire Frontier was a shocker Frontier was an old-economy real telecoy change for Global Crossing The deal, which preceded the AOLTier by ale corowth expectations used its high stock valuation to buy a traditional co a very rich price for Frontier of 62 per share, 413 percent above Frontier's current price of 4388 I was very happy with the transaction It validated et price of 60 on Frontier, and my view that Frontier was a takeover candidate Moreover, the Luddite in ht it was terrific for Global, since it noould own a traditional company with real assets, real custos

The bankers told us that the deal would likely be announced the following Wednesday, after both companies' boards ht Thiswould interfere with an and Salomon folks were probably thrilled, as an unsuccessful conference ht mean fewer votes for me and a lower stature for Merrill's teleco to let the two co We would shuffle some speakers around and create a one-hour slot early in the 's and Frontier's CEOs could present the deal and the new coet far greater attention with all the e investors in one place We even offered to let my competitors from other Wall Street fir, which nor the schedule change, since it was confidential infor was up Last-minute events such as CEO or CFO cancellations atched closely by professional investors because they often signaled i I did not tell er, nor did they have any reason to suspect anything