Who is to blame when a stock drops? Or an entire sector implodes?
It wouldn’t be fair to blame a single individual for such complicated events. But there are situations when one person’s contribution is impossible to overlook. And Jack Grubman is such a person.
You may recall that in the late 1990s, telecommunications stocks enjoyed a terrific run: New companies went public, old companies were recharged, growth was explosive. Demand for telecom capacity soared. No one no one warned that this demand was a mirage.
When the boom turned to bust, the investment dollars lost were extreme: Telecom companies large and small shed more than half a trillion dollars in market value in less than two years. Even if you hadn’t bought telecom stocks directly, you were likely affected. Fidelity’s domestic equity funds, for instance, had $25 billion riding on telecom at the end of 1999, according to Morningstar. Even investors in S&P 500 index funds indirectly owned Global Crossing, Qwest, WorldCom and 10 other telecom high fliers.
What’s more, telecom’s overexpansion and abrupt contraction had a ripple effect across the economy. Sure, there were plenty of other catalysts for the business-led recession that followed from interest rates to world events. Nonetheless, we can’t ignore the impact of the telecom blowup on the slowdown.
Now for Jack Grubman. As Salomon Smith Barney’s telecom analyst, he was at the heart of the telecom debacle. At about $20 million a year, Grubman is Wall Street’s highest-paid analyst ever and, until his recent fall from grace, he was the ultimate power broker in the telecom industry.
In the years leading up to the telecom boom, he forged a reputation for straight-shooting, penetrating analysis. He developed relationships with all the key players in the sector and had access to the best information. He had influence over companies and money managers and came to be seen as the validator of all that was going on in telecom.
If Jack said it was good, it had to be good.
Of course, it’s impossible to lay the creation of the telecom bubble, its disastrous bursting and the billions of dollars in investment losses at the feet of any one man. As Grubman responds in a series of e-mails to MONEY, “I don’t recall any other telecom analyst standing up in the last year or two declaring the demise of the sector.” But Grubman wasn’t just any analyst. And given his distinctive role in the industry’s rise and fall, it seems reasonable to ask: Is he the worst analyst ever?
The making of an uber-analyst
Jack Benjamin Grubman, now 48, grew up an only child in a family of modest means in northeast Philadelphia. His mother Mildred worked in a department store. His father Izzy was an engineer in the highway department. Jack worked summers, loading packages, busing tables and selling beach umbrellas, while the family vacationed in Atlantic City. “He wasn’t lazy,” says his proud father.
Izzy, a boxer who won the Golden Gloves in 1935, could rip the Philadelphia Yellow Pages into eight pieces with his bare hands. Jackie, as his dad still calls him, played clarinet in the marching band, joined the debating team and made National Honor Society. But father and son share one trait: a flair for numbers. Izzy used it to win bets by instantly naming the weekday of any date in history. Jack’s talent scored him a bachelor’s in math, cum laude, from Boston University and a master’s in probability theory from Columbia.
In 1977 Grubman joined AT&T, where he worked in strategic planning and financial management. Eight years later he left for Wall Street, joining PaineWebber. His start was inauspicious: Regulatory records show he initially failed the Series 7 exam required of all investment professionals. Strangely, Grubman faked part of his life history claiming to his employers that he’d attended M.I.T. and saying in press interviews that he’d grown up in gritty South Philly, the setting of Rocky. Confronted by BusinessWeek magazine two years ago, he explained, “I probably felt insecure.”
Nobody noticed. What mattered was Grubman’s experience. Covering telecom meant analyzing his ex-employer AT&T and the seven Baby Bells formed in 1984 by its court-ordered breakup. Grubman stood out by voicing caution on AT&T, and he soon gained a reputation for saying what he meant, even if it was negative. “He was a very dedicated, exceptionally knowledgeable analyst,” recalls Eli Lustgarten, then an analyst at PaineWebber and now at H.C. Wainwright. “He was not some dotcom kid.”
worked 13-hour days, spending weekends at the office, flying off to London for an afternoon of meetings. His dedication paid off. By 1991 he was reportedly making nearly $1 million a year. Three years later, when Salomon Bros. wanted a hot analyst to help it get in on the telecom bonanza, it lured Grubman to the firm.
By the time Salomon merged with Smith Barney in late 1997, Grubman was king of his sector, garnering the top spot in Institutional Investor’s annual analyst rankings. Money managers hailed him as the “ax” the most influential analyst in his sector. At telecom’s peak, he covered some 40 stocks with a combined market value that topped $1 trillion. As Grubman boasted, “I’m sculpting the industry.”
His stature helped vault Salomon Smith Barney into a powerful position in telecom just as it was taking off. In 1998 the firm raked in $343 million in fees from telecom M&A deals, and debt and equity offerings an 88 percent jump from the prior year, according to Thomson Financial. Grubman knew everyone from the top dogs at AT&T to entrepreneurs like WorldCom’s Bernie Ebbers.
Behind the scenes, he advised Ebbers on the hostile takeover of MCI and helped recruit Joe Nacchio as CEO of Qwest. Associates began calling him “consigliere.” He was profiled by the Wall Street Journal, BusinessWeek, even New York magazine. Quizzed about his closeness to the firms he was analyzing, Grubman crowed, “What used to be a conflict is now a synergy….Objective? The other word for it is uninformed.”
People hung on his every utterance. Salomon Smith Barney’s army of nearly 13,000 brokers shared his picks with clients. When Grubman’s e-mail updates hit the news wires, they’d be picked up, pronto, on CNBC. And when he spoke, stocks moved. On Jan. 20, 2000, after he raised his price target on fiber-optic networker Level 3, its stock rose 12 percent, pumping up its market value by $4.9 billion.
Grubman’s bullish telecom calls were making many investors rich. Metromedia Fiber Network, which he recommended in late 1997, ran up an astonishing 500 percent in only 10 months. In May 1998 he picked Qwest, which proceeded to double in 11 months. That September he recommended Global Crossing, which surged 375 percent in just six months.
“When Grubman said wonderful things about a company, it was like a narcotic everybody wanted it,” recalls Elliot Dorbian, a former broker at Salomon who is now president of AJ Investment Advisors. “He walked around like he was a god. And it was perceived in the industry that he was a god.”
Salomon Smith Barney was in hog heaven as telecom dealmaking exploded, hitting a peak of $223 billion in 1999. Companies were able to raise seemingly limitless funds, often with scant concern for whether their businesses were actually viable. Telecom equity underwritings peaked in 2000 at $74 billion, while debt issuance topped out in 2001 at $116 billion. Grubman’s firm raked in $1.8 billion in telecom fees in just four years.
In his e-mails, Grubman contends that he and his firm acted responsibly, rejecting many IPO deals they considered dubious. “Our best calls were the things we turned down,” he says. “We never did Covad, Northpoint and a bunch of other names. We could have done the 360networks IPO, but I, and only I, turned it down.”
Still, Grubman continued to champion the sector even after it began to plummet. In March 2001 he issued a 28-page report titled “Grubman’s State of the Union: Does He Ever Stop Talking?” that proclaimed, “Over the next 12 to 18 months, investors will look back at current prices of the leading players and wish that they had bought stock at these prices.” Of the 10 companies he picked, five now trade below $1 a share. Three of those Global Crossing, McLeodUSA and Winstar Communications have filed for bankruptcy.
“The State of the Union last year sans stocks was actually quite insightful,” Grubman argues. “Look, we said over a year ago [that there would be] no mergers, there would be bankruptcies and that capital spending would plummet.”
Yet you can’t ignore the track record. An analysis done by MarketPerform.com for MONEY shows just how disastrously his picks fared: If you had acted on each of Grubman’s buy recommendations since February 1999 and sold when he downgraded the stock, you would have suffered a 74.5 percent loss.
No telecom company exemplifies the industry’s dashed dreams and Grubman’s role in them better than Global Crossing. Founded in 1997, it had grandiose plans to lay the fiber-optic pipes over which data would be sent worldwide. In 1998 Salomon Smith Barney helped take the firm public, jointly raising $397 million. Grubman’s ties to the firm were tight. He advised it on a successful bid for Frontier Communications and an unsuccessful one for US West. From September 1998 through June 2001, Grubman issued at least 16 buy recommendations on the stock.
At first the stock soared, hitting a high of $61.38 in 1999. It traded at a sky-high 33 times sales, but Grubman wasn’t worried. In early 2000, when the stock began to slip, he continued to tout it. In April 2001 he recommended it again, this time in a report titled “Don’t Panic: Emerging Telecom Model Is Still Valid.” A month later, he reiterated his buy rating, calling Global Crossing one of “the new breed” and “well funded.”
Not quite. Last October, when the stock had collapsed to around $1 and the firm was on its fifth CEO in four years, Grubman finally cut his rating from buy to neutral. On Jan. 28, Global Crossing filed for bankruptcy, the fourth-largest Chapter 11 filing ever. In all, more than $55 billion in paper wealth had evaporated. The day after the bankruptcy filing, Grubman issued a terse note saying he had discontinued coverage of the stock. It was the Wall Street equivalent of a hit-and-run.
Grubman says that his record must be viewed in context: “If you took the emerging telecom names in total from their peaks in March 2000 to today, there was a total of $230 billion or so of market cap loss. Do you know during that time Cisco lost almost $450 billion of market cap by itself? My point is, obviously we wish the stocks had done better. But fact is, twice as much money was lost by far more investors in one stock than in the totality of our emerging telecom universe. And our universe was appropriately labeled as being speculative.” Did he learn anything from the experience? “You learn that even good management teams and macro industry trends being favorable does not always translate into equity returns being positive.” And what of the investors who poured money into the sector? “Hopefully, investors learned that stocks have risk, especially start-ups in capital-intensive industries.”
Paying the price
“Every time my broker mentions Grubman, I shudder,” Mike Thomas wrote on the Silicon Investor Web site last November. Thomas, a retired engineer and longtime client of Salomon Smith Barney, explains, “Every time I’d call them, for the past two or three years, they’d say, ‘Grubman likes WorldCom’ or ‘Grubman really likes Global Crossing.'” As a result, he now owns a total of 600 shares of these duds.
On the Internet, investors are seething. A post on Yahoo! reads, “Come on Jack, time to raise another trillion dollars for the telcos so that too can go to hell…the first trillion is just about gone.” Tracy Pride Stoneman, an attorney who represents disgruntled investors, snipes that Grubman is “the epitome of greed and conflict. He made millions while investors who relied on his opinions lost millions as a consequence of that reliance.”
In February, two ex-Salomon Smith Barney brokers, who used to handle stock options for many WorldCom employees, filed an arbitration case against him and the firm. They insist it’s not their fault that their disgruntled WorldCom clients lost a fortune when the stock plunged, but Grubman’s, because of his bullish reports. A Salomon Smith Barney spokeswoman dismisses the claim as “absurd.”
Of course, investors must also accept their share of the blame. “When we watch a television commercial for razor blades, we know they are putting the most positive spin on it they can,” says Kent Womack, a professor of finance at Dartmouth, who studies analysts’ conflicts of interest. “When it comes to investment research, we need to be equally skeptical.”
Still, we expect top-rate advice and stock picks from someone earning $20 million a year. Surely, Grubman once famed as the industry’s great seer should have warned that this epochal bubble was doomed to burst.
In October, Grubman lost his crown as Institutional Investor’s No. 1 wireline services analyst. The tone of his research reports once so cocky — has grown more hesitant. And he no longer receives top billing on his firm’s 7:30 a.m. conference calls. “His voice volume is down,” says a Salomon Smith Barney broker who has listened to these calls for years. “You can hear it. His confidence has been shaken.” So has ours.