Jack Grubman: The Power Broker
In February, 1998, senior executives of SBC Communications Inc. were weighing a decision that would rattle the rafters of the telecom industry: Should they buy Ameritech Corp.? Before they decided, they wanted the advice of Salomon Smith Barney analyst Jack B. Grubman. So they whisked Grubman to a corporate powwow in Scottsdale, Ariz., to get his vision of the industry and what SBC should do to survive. Grubman didn't mince words. He told SBC's top guns that the company needed to get bigger--fast. Sure enough, three months later, SBC ponied up $72 billion for Ameritech and made plans to invade 30 markets outside its territory. "We were very concerned about the Street's reaction to the deal, and we wanted Jack's advice and counsel," says James Kahan, SBC's senior executive vice-president for corporate development.
They're not the only ones. Back in 1997, the lanky Wall Street analyst was hip-deep in plotting with WorldCom Inc. CEO Bernard J. Ebbers for the hostile takeover of MCI Communications. When it came time for Philip A. Anschutz, the railroad magnate, to hire a chief executive for his telecom upstart, Qwest Communications International Inc., whose counsel did he seek? Grubman, who urged the hiring of Joseph P. Nacchio, the tough-talking chief of AT&T's consumer business.
And it was Grubman who helped Salomon do more telecom initial public offerings (18) for a total of $5.7 billion than any other firm since 1997, according to Securities Data Co. Indeed, when AT&T raised a staggering $10.6 billion on Apr. 27 by selling stock in its wireless business, Salomon played a leading role, thanks in part to Grubman. That let the firm share in the $310 million in investment-banking fees generated by the offering. "He's almost a demigod," says Robert Knowling Jr., CEO of startup telecom carrier Covad Communications Group Inc. "He's the king of telecom."
You don't know Jack? You should. In the past four years, as the deregulated telecom marketplace has exploded with possibilities, so too has the influence of Jack Benjamin Grubman. The son of a municipal worker for the city of Philadelphia, the 46-year-old analyst has become so powerful that he's playing a central role in the transformation of the telecom world. A self-described "telecom junkie," Grubman envisions an industry that will double in size, to $2 trillion, over the next six or seven years with the boom in Internet and data traffic. Those companies that hit it big, he bets, will be the ones that bulk up and invest in bandwidth-rich phone networks that can pump out Net and special phone services to businesses.
"VIRTUOUS CIRCLE." It's a vision that is earning him entree into executive suites far and wide. Grubman secretly meets with the most powerful CEOs in telecom, wheeling and dealing, matchmaking, chiding, prodding--their Wall Street "consigliere," in the words of one associate. He can move billions of dollars into or out of a stock with just one research report. When he increased his price target for Level 3 Communications Inc. on Jan. 20, the stock surged 13%, to 110 1/2. After he boosted his target for Metromedia Fiber Networks on Mar. 14, the stock jumped 16%, to 45 15/16. And his Apr. 27 bullish report on Winstar Communications Inc. lifted the company's shares 15%, to 35 9/16. "I'm sculpting the industry," says Grubman. "I get feedback from institutions and CEOs. It feeds on itself. It's a virtuous circle."
Not in everyone's eyes. There are some academics and telecom industry insiders who say that what Grubman is doing is nothing short of scandalous. Critics argue that the Salomon star is turning the role of stock analyst inside out. Instead of simply offering up objective opinions about the companies he covers, he is helping those companies make crucial decisions. When an analyst is that entwined with a company--at times even helping to craft its strategy--questions are raised about whether it's possible to offer objective analysis. "The issue is, how unbiased can you be?" asks Steven N. Kaplan, a finance professor at the University of Chicago's Graduate School of Business.
The issue was brought into sharp relief with the IPO for AT&T's wireless business. While Grubman had been bearish on AT&T since 1995, he reversed himself last November after the giant telecom company decided to sell stock in its wireless unit. Later, AT&T picked Salomon as one of three investment banks to lead the offering.
Some industry insiders suggest that Grubman may have reversed himself so that Salomon could get a slice of the offering fees. Grubman denies this. Rather, he says prospects for the stock have improved because the company has quantified its goals for offering telephone service over its cable networks. "They've put stakes in the ground," he says. "They've said there will be half a million paying cable telephony customers by yearend. If they get roughly that number and they don't blow up their cash flow doing it, the stock is going to be a big stock." Grubman acknowledges that AT&T's warning on May 2 that its 2000 results would be below expectations is disappointing, but he doesn't plan to change his recommendation. For its part, AT&T denies that it tapped Salomon for the IPO because Grub-man changed his recommendation.
No question, analysts tiptoe across the line all the time. Any Wall Street stock picker whose firm does investment banking faces a conflict of interest. If an analyst's firm handles an IPO or acquisition, there is a financial incentive to recommend the stock. And, all too often, they do. A recent study by professors at Cornell University and Dartmouth College found that Wall Street analysts tend to recommend stocks that perform pretty well when their firm isn't involved in the IPO. But the same analysts tend to be lousy stock pickers if it's their firm that took the company public. "Their bias gets in the way," says Kent Womack, a finance professor at Dartmouth University's Tuck School of Business, who is one of the study's authors.
But when it comes to Grubman, it's far more complicated than that. The most sensitive legal issue is when Grubman finds out about still-secret developments that could affect a company's stock. That happens whenever he's brought over what Wall Street firms call the "Chinese Wall" between research and investment banking to advise on a deal. At that point, he's barred by law from talking to money managers about that company. "To the extent analysts become part of investment-banking activities, they have restrictions on what they can say," explains Richard H. Walker, chief of enforcement for the Securities & Exchange Commission. For example, when Grubman was helping WorldCom plot the takeover of MCI, he couldn't talk about either company. And he couldn't comment on Global Crossing last year after he began advising the company on how Wall Street would react to its bids for US West and Frontier Communications.
And there are other issues. If the CEO at one company runs an idea past Grubman, he has to trust the analyst not to share it with any rivals. Some say Grubman could start to feel like he has to support a company because he helped hone its strategy. "Would he ever trash WorldCom?" wonders one telecom executive. "Or is he just too close to Bernie?" As evidence, Grubman's critics point out that he lowered his revenue growth estimates for MCI WorldCom Inc. only after many other analysts had recognized fierce long-distance competition would take a toll on the company this year. MCI WorldCom's stock has slid 18% over the past year, while the Standard & Poor's 500-stock index has risen 10%.
REDEFINING THE ROLE. Grubman has one word for his critics--which is unprintable here. He says his active involvement in the industry helps him provide better analysis to institutional investors--or what's called the "buy side" of the investment business. "What used to be a conflict is now a synergy," he says. "Someone like me who is banking-intensive would have been looked at disdainfully by the buy side 15 years ago. Now they know that I'm in the flow of what's going on. That helps me help them think about the industry." The notion that keeping your distance makes you more objective is absurd, he says. "Objective? The other word for it is uninformed," he snorts.
The institutional investors who deal with him agree. They want him eyeball-deep in his companies. "He's the best analyst I've ever worked with," says John Lathrop, vice-president at MFS Investment Management. "A lot of other analysts listen to what the companies say and parrot it back. He's such a strategic thinker that companies talk to him about what they should do." These money managers consider themselves grownups when it comes to picking stocks. "No analyst [whose firm does investment banking] is objective," says one mutual-fund manager. "Sure, his motivation may be mixed, but they all are." Rob Gensler, portfolio manager for the T.Rowe Price Media and Telecom Fund, says Grubman's stock-picking is almost beside the point: "There are others who may model better. There are others who may pick stocks better. He knows more about what's going on in the industry than anybody."
Like it or not, what Grubman is doing is redefining the traditional role of a stock analyst. It's not just about smart stock picks anymore. In fast-changing industries such as telecom and the Internet, analysts can end up with more information about a broader range of developments than anyone else. That makes them a critical cog in how capital gets allocated, which business plans get green-lighted, and which ones hit the dustheap. It's a role not unlike the one played by Mary G. Meeker, Morgan Stanley Dean Witter's standout Internet analyst. "Mary Meeker has pixie dust. Jack Grubman has pixie dust. You can't ignore what they say," says Covad's Knowling.
Pixie dust doesn't come cheap these days. After Goldman, Sachs & Co. tried to woo Grubman away in 1998, Citigroup, the parent company of Salomon Smith Barney, responded with a pay package that totaled about $20 million last year. In comparison, the average analyst on Wall Street makes $1 million or $2 million. "Jack probably knows more about the business than anybody I've ever met," says Sanford I. Weill, Citigroup's chairman and CEO. And Weill thinks an analyst can benefit from being closely involved with companies. "The more knowledge and understanding an analyst has, the better job they can do in analysis," he says. "If they lose their objectivity, they will lose their credibility."
CREDIBILITY GAP? While Grubman has managed to keep his professional credibility intact, it's a different matter in his personal life. His official biography at Salomon Smith Barney says that he received his undergraduate degree from the Massachusetts Institute of Technology when, in fact, he graduated from the less prestigious Boston University. The deception "was a stupid mistake on my part," says Grubman, who says he made the change 10 years ago while he worked at PaineWebber Inc. "At some point, I probably felt insecure, and it perpetuated itself." Citigroup declined to comment on the issue.
And Grubman has regularly said that he grew up in South Philadelphia, but he is really from a neighborhood in northeast Philadelphia called Oxford Circle. The difference may seem slight, since both are blue-collar neighborhoods in the city of Brotherly Love. But South Philadelphia has a certain romance for a onetime boxer like Grubman: It's the neighborhood of Rocky Balboa of the Rocky movies and of famous singers like Frankie Avalon, Fabian, and Bobby Rydell. Grubman says the reason for the deception is largely because South Philly "is more historic."
Whatever the details, Grubman has come a long way from his youth in a Philadelphia row house. He was the only child of parents who had to work hard to make ends meet. His dad, Isadore "Izzy" Grubman, boxed professionally for six years and later worked for the city--first as a construction worker, ultimately as a engineer. "[Jack] didn't have to worry about meals or anything, but I wasn't a wealthy man," says Izzy.
The elder Grubman had a bent for numbers that he passed on to Jack. To this day, if you tell Izzy the date and year of a birthday, the 82-year-old can tell you within seconds which day of the week you were born. Jack, a math whiz, was a tad reckless with his talent during his teenage years. When Jack was a high-school senior, he won a national math award--at the same time his mathematics teacher wanted to flunk him because he had cut some 25 classes in a row. Ultimately, an assistant principal overruled the teacher, and Jack passed the course. He went on to earn an undergraduate degree in mathematics at Boston University in 1975 after taking some premed courses. Later, Grubman received a master's degree in math from Columbia University.
Izzy gave his son another gift: fearlessness. The elder Grubman won a Golden Gloves light-heavyweight champion in 1935 at 18 and then fought professionally for "$15, $25, or $100 a fight," he says. Izzy sparred with his son and encouraged him to box in local clubs as a teenager. "He learned how to take care of himself," says Izzy. No argument from Jack. "When your dad is someone who was very much involved in the rough-and-tumble aspects of the South Philadelphia construction industry, you're not going to be intimidated by white-collar executives who had a much cushier upbringing," he says. From his early experience, boxing has become Jack's passion. In his office, he has a sprawling painting of the Jack Dempsey-Luis Firpo fight, a signed photo of Muhammad Ali in the ring, and two pairs of boxing gloves. To this day, Jack continues his father's ritual of a morning workout: He does 100 push-ups and 100 sit-ups at about 5:30 a.m.
It was Grubman's mother who instilled in Jack the ambition to do more than follow in the footsteps of the policemen and firemen who lived in the neighborhood. Mildred worked in a dress shop, but she liked to explore the world beyond Philadelphia, especially traveling to New York for Broadway shows. "She was someone who would think big thoughts," says Jack. And she focused a lot of them on her only son. Mildred, who had had three miscarriages before Jack was born, gave Jack the attention and care that made him believe he could accomplish anything.
In the corporate world, Grubman first showed the competitiveness that drives him today. He joined AT&T after Columbia University in 1977, fully intending to finish his doctorate at Columbia so he could one day be a college professor. But he threw himself into his work and didn't have time for his studies. "I felt like I needed to be at the top of my game," he says. "I refuse to let anyone topple me. That's why I'm so myopically focused." Part of what pushes him to put in 14-hour days is his desire to prove that he can beat other Wall Street analysts who were born with more advantages. "I didn't grow up in Greenwich [Conn.]," he says. "I didn't go to prep school."
At AT&T, he quickly demonstrated a tenacious independence that would make his father proud. Back in the 1970s, AT&T used an enormous computer model to predict how demand would be affected by changes in telephone prices. In his mid-20s at the time, Grubman checked out the model, decided the math behind it was faulty, and started arguing against using it. In part because of Grubman, the company eventually stopped using the model. "He made some enemies," says Daniel Hesse, the former chief of AT&T's wireless operation, who worked with Grubman at the time. "But Jack, in the end, was correct."
GUTSY CALL. That experience set a pattern that Grubman continued when he moved to Wall Street in 1985: Say what you think, and don't hold back for fear of upsetting people. Shortly after joining PaineWebber, he lit into SBC for paying a sky-high price for a paging business. "He was quoted saying we couldn't have done any due diligence," says SBC's Kahan, who chuckles about the incident today. In the early 1990s, Grubman so pointedly criticized Sprint Corp. for its lack of an international strategy that CEO William T. Esrey complained to senior executives at PaineWebber. Grubman had to explain himself to his bosses, but stuck to his guns.
At the same time that he laid into telecom's giants, he urged investors to put money into startups that were building high-capacity phone networks to compete with the established players. "He has had a thesis for creating value in the telecom sector that's been dead right: Build it and they will come," says Eduardo Maestre, Salomone's co-head of investment banking. "It wasn't a foregone conclusion that that thesis would be correct."
The call that distinguished him most from other analysts came in 1995 when he downgraded AT&T to neutral from a buy. That wound up costing Salomon dearly. It was blocked from playing a role in the spin-off of Lucent Technologies Inc., which generated $103 million in investment banking fees, according to Securities Data. But as AT&T underperformed the market in the next few years and the upstarts Grubman favored soared, he earned a sterling reputation with institutional investors. He has been the top-ranked analyst in telecom services in the prestigious Institutional Investor rankings for the past three years. When Grubman visited Boston one time in 1998, crowds of money managers gave him such warm hugs and handshakes that "it was like the Messiah coming to town," says Royce J. Holland, CEO of the competitive local-phone company Allegiance Telecom Inc., who was with the analyst at the time.
Grubman's influence is rooted in that kind of trust from the money managers who invest billions of dollars in telecom stocks. Many telecom insiders believe Grubman can make or break newcomers to the industry. Part of the reason is that investors are anxious to scoop up shares of the telecom companies Salomon takes public. Just as important, if Grubman's firm isn't playing a key role in an IPO, that raises red flags with some investors. "If Salomon doesn't lead an IPO, I want to know why," says one institutional investor who can't be quoted because of his firm's press policies. "I assume that if Jack isn't on the cover, he has turned them down."
Grubman holds sway over established telecom companies, too. AT&T tried to persuade him to boost his recommendation for years, and top AT&T executives spent several hours with him in Denver explaining their cable strategy last year before he upgraded the company to a buy. Howard S. Jonas, the chief executive of international phone carrier IDT Corp., says he has gone to Grubman's office numerous times to try to get the analyst to cover his company--once waiting for six hours without success. "I wish he covered me," says Jonas. "He makes the world go 'round." One telecom executive who knows Grubman well says the CEO of a telecom company recently came to him to beg him to put in a good word with Grubman. "His company is in trouble, and he thinks that Jack can save him," says the executive.
With that kind of influence, Grubman's opinions are helping shape the telecom world as we know it. His overarching view is that the communications industry has strong growth potential, and more capital should be invested in it. "Investors haven't yet grappled with the notion that telecom services is a tech industry. It's very much going to be part of the Web-centric society," he says. While the boom in Internet and other data traffic will help many companies, he thinks a handful of favorite strategies will create the most value. One example is upstart companies, like Nextlink Communications Inc. and Allegiance, that are growing fast with offers of fat communications pipes for businesses. He also thinks companies such as MCI WorldCom that are providing Net services will see tremendous growth. And he's backing Qwest, Global Crossing, and Level 3 Communications because they're building high-capacity networks to carry the boom in traffic. "We think the demand for bandwidth is basically insatiable," he says.
What he doesn't like is just as telling. He thinks telecom companies such as BellSouth Corp. that stick to one region are in trouble. He believes that it makes more sense to serve corporate customers than consumers--there's less profit in the consumer market because their phone service is subsidized. And he thinks that it's corporate suicide to sell telecom services without your own facilities. His favorite example is USN Communications Inc., a Chicago-based reseller of phone service to consumers. The company bought capacity from Ameritech at wholesale prices and then marketed it to individuals in the Midwest. It was taken public at 16, fell to less than 1 within a year, and now trades at less than 10 cents a share. "It was a disaster," says Grubman. "We didn't even pitch for the business."
MISTAKES, TOO. Not that Grubman hasn't had his own stock-picking embarrassments. In November, 1998, he recommended the stock of Pacific Gateway Exchange Inc., a phone company based in Burlingame, Calif. After he suggested a 12-month price target of 60 for the stock, which was then at 29, it zoomed 46%, to 42 5/8, over the next couple of days. Investors are sorry now: After missing analysts' estimates for several quarters, Pacific Gateway has retreated to 5 1/2. Howard A. Neckowitz, its CEO and a friend of Grubman's from their days working together at AT&T, says: "The folks that hang in there will definitely be rewarded." Grubman concedes the company hasn't performed well. "But you can't be afraid to be wrong," he says. "That's part of the job."
Grubman is busy working with the industry's newcomers to take full advantage of what he sees as a golden opportunity. Take Global Crossing Ltd., one of the industry's hottest startups. He and Salomon took the company public with Merrill Lynch in August, 1998, and Grubman advised the company on its failed bid for US West, as well as its successful purchase of Frontier Communications. He also regularly talks strategy with Gary Winnick, Global Crossing's founder and chairman. "Jack's passion doesn't shut down after 6 p.m.," says Winnick. "It's always there." One reason companies find his advice so useful is that he spends a lot of time with companies. "He probably knows me and my senior guys better than all the other analysts combined," says David C. McCourt, CEO of RCN Corp.
While Grubman thinks the upstarts will create the most value because they're growing so fast, he believes that ultimately they need to be combined with the existing telecom players. "You have to marry networks and customers," he says. "Older companies have to be willing to blow up their financial models to acquire these new networks or these newer players are going to buy the older companies."
Once the pace of change in the industry finally slows, Grubman vows that he will, too. He says he won't consider covering another industry. Instead, he wants to spend more time with his wife, Luann, and his twins, a boy and a girl who are nearly 3. He may move into an administrative job at Salomon Smith Barney or he could take a job in the industry he has been covering. Either way, the king of telecom will probably have to relinquish his crown before the controversy surrounding him dies down.