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Kalla is a telecom analyst at Friedman Billings Ramsey. She tells FRONTLINE that there's no way a company like WorldCom could have become the number two player in the telecom industry without outside help, and says that Bernie Ebbers could not have pursued his growth strategy for WorldCom "without Jack Grubman being highly aggressive to move the stock price up." In this interview, Kalla also describes several industry conferences she attended, including one in January 2000 in which former Treasury Secretary Robert Rubin -- an adviser to Citibank -- cautioned that there was a telecom bubble and the stock prices could not be maintained. "To have someone with that kind of profile give you that kind of warning is unprecedented," she says. This interview was conducted by FRONTLINE correspondent Hedrick Smith on Jan. 13, 2003.

Take me back to the middle 1990s. Take me into the heart of the telecom boom. What was it like? What was the feeling of enthusiasm? What was the expectation? What was the mood of the market?

... There was an incredible boom in telecom. There was a thought that the information superhighway was going to be enormous. It was going to be enormous. It was going to a huge build-out everywhere in broadband to every doorstep of every business, every doorstep of every house. It looked like an upgrade that people were beginning to think would be $300 billion to $500 billion in build out. So the telecom equipment companies were on fire. ...

Telecom is a very, very sophisticated technical and low-margin business. So to overcome the difficulties of the business and grow to become a number one or a number two player within 10 years, you couldn't do without a lot of help.

The stocks in every part of telecom took off -- in services, small companies, large companies and equipment, small companies, large companies, those that specialized in fiberoptics or telecom service providers, those that specialized in Internet gear. For enterprises, those that were doing second lines for DSL lines, for consumers -- every single one went up orders of magnitude.

What are you doing now? Are you going on television talking? [Are all] the telecom analysts out there?

I was a telecom analyst until 1998, and then I decided to manage my own money at home. So I started managing my own money, made a tremendous amount of money and bought a beach house. Then, after I bought the beach house, I decided to go back to the sell side. I went to work for a company named Bluestone, which was a small company. We thought we would have tremendous upside with the Internet upswing.

I went to one conference. It only took me one conference to realize this whole thing was going to come to a complete and total ugly end. I went to the fiberoptics engineering conference in Denver. There were about 2,000 telecom and optical engineers. It became very clear that there were way too many people trying to squeeze in way too small a space, and that the assumption that these people were using could not be possible in the best situation known to man in the next 3,000 years.

It became very clear the growth assumption for demand just couldn't be substantiated. Two thousand engineers were talking at this conference about demand growing, doubling every three months -- the demand for telecom services has grown perhaps 5 percent to 7 percent a year for 100 years. The fact that it could just get up and grow that much in one or two years would be virtually impossible; it's a mature business. So I realized that immediately that the assumptions were way, way too optimistic for the business. ...

What about Wall Street? What was Wall Street's role here? Some people have said that the boom in telecom, and indeed in other industries, was largely induced by Wall Street, that Wall Street suddenly saw a pot of gold in these booming new industries that needed lots of money, because that's what Wall Street does. It gets money from some people, and transfers it to others. So what's Wall Street's role in the telecom boom?

... Wall Street is supposed to channel capital where the biggest opportunities lie. In the case of telecom, there were many people that were early to get in and invest capital in certain opportunities, and those people did very well.

The problem is Wall Street is full of sheep. So once one sheep goes someplace, then the rest follow. By the time that the rest [of] the herd shows up, there may not be any grass left, but they don't know it until they get there. ...

So you're sitting there, and you're imagining Sandy Weill at Citibank or Jack Grubman at Salomon Smith Barney or Harrison and the guys over at JP Morgan Chase. When they see telecom, what do they see? [Do] they see an enormous opportunity?

Yes, they saw an enormous opportunity over time, and there's a few fundamental underpinnings of the growth and demand. So they believed that there was a whole new economy, a whole new way of doing business. There were going to be tremendous productivity enhancements. People were going to continue to spend on technology more than they would spend on anything else. Technology was going to become a bigger and bigger piece of the GDP, the gross domestic product, of the economy, and that even if the economy grew 6 percent, telecom and technology could grow significantly faster.

That was the underpinning of the entire movement of capital toward the telecom industry. It was assumed that all the buyers -- that is, corporations and consumers -- that are buying cable television, that are buying Internet services, that are buying e-business applications, would continue to buy at tremendous rates. ...

Where does a guy like Jack Grubman fit in? I mean, he has been described in Business Week and Forbes and Fortune and lots of other places as the Pied Piper of telecom, or the king of the hill in telecom and that kind of stuff. Maybe as another analyst, it's a little hard to think of it, but position Grubman for us. What's his role and his importance? Is it true that guy like Grubman could move markets?

Could Jack Grubman move markets? Absolutely, an unqualified yes. Did people believe him? Yes. Was he very good at putting together the details? Did he know the business, did he understand the players, did he understand investors? Yes to all of those. Would be somebody that worked really, really hard to get where he was over 20 years? Absolutely.

Was he the most influential stock analyst in telecom for the late 1990s?

Yes. In my view, he was the most influential, and then the second was Dan Reingold, who was a little bit more bearish in the market. But Jack Grubman was, by far, number one. ...

Talk a little bit about Grubman and his access to the CEOs, people like Bernie Ebbers and Joe Nacchio and the others who were running these companies. Before he gets to Salomon, when Grubman is at PaineWebber -- we're talking now up until about 1994 -- how plugged in is Jack Grubman as an analyst for PaineWebber?

Jack Grubman was very plugged in, even at PaineWebber. Most of the major deals that were done in the industry, which included the GTE merger with Contel, were done by PaineWebber. Those were deals that would have been out of the reach for a company like PaineWebber without Jack, in my opinion.

So he's the guy who brought the deals to PaineWebber?

He had the industry contacts. He was friends with most of the CEOs. He was very well connected within the industry. He maintained contacts throughout the industry, so he really worked the system very well. He was aggressive about it, and very good.

Would he have personally have known really well a guy like Bernie Ebbers at WorldCom at that point?

Well, everybody that was an analyst knew Bernie Ebbers. I don't know about Jack's relationship with Bernie Ebbers. But certainly on the face of it, in all the public meetings and on the conference calls, Jack was always the first to ask questions. The management, including Bernie Ebbers, would point him out in a crowd, and would always bring questions up.

If we were in a crowd at an analysts' meeting with a 1,000 or 2,000 people, Jack would be the first on the podium to be able to ask a question. He was clearly a favorite analyst. ...

At that point, how do you size up a guy like Bernie Ebbers? Did Bernie Ebbers know telecom? Is he a thinker? Is he a strategist? Is he a technical kind of guy?

Bernie Ebbers, in my opinion, was not technical, did not know the industry, and was just a very aggressive player that happened to be in this business. ...

His primary strategy was to take over companies and cut costs. He thought he could reduce costs enough that the merger would make a lot of sense in earnings growth over the foreseeable future.

Jack Grubman has testified publicly that he has attended meetings of the WorldCom board of directors. What is the nature of the relationship here? Are we looking at a situation where analysts -- in this specific case, a guy like Jack Grubman -- is the brains of the operation, not just evaluating WorldCom, but advising WorldCom, advising Bernie Ebbers? What's going on here from your standpoint? What do you think is happening?

Bernie Ebbers frequently used to refer to Jack's ideas as his when he was talking about new steps the company was coming up with. So you can only infer from that that Bernie thought that many of the ideas were Jack's. ...

You could read Jack's reports and realize where he was headed with his point of view on the industry. His point of view on the industry was that you needed to take a very long-term look for profitability, you had to make a logic leap, and the best way to be successful was to build out the biggest global network possible.

So suddenly you heard Bernie starting to talk about the same thing, when prior Bernie had just talked about taking out companies and taking out costs. ...

Who's pulling whom here? Can you think of it that way? Is it easier to understand? Because it looks as though Bernie is following strategies that he doesn't really fully understand, and it looks as though somebody else is the brains and somebody else is pushing him.

You can only take a look at what was going on in the industry. You had a very small player that came from nowhere, with a CEO that did not have a technical background, did not have a financial background and did not have an industry background, and he was being catapulted into number one. Telecom is a very, very sophisticated technical and low-margin business. So to overcome the difficulties of the business and grow to become a number one or a number two player within 10 years, you couldn't do without a lot of help.

Where did that help come from?

It's not clear whether the help came from just Salomon and Citibank, whether it came from multiple investment bankers, or whether it came from the companies. But in retrospect, in reading through some of the filings that were given in Congress, it becomes very clear that there was no strategic planning department at WorldCom. Many of the ideas and the details for doing the mergers and acquisitions were so time-consuming and complicated that WorldCom would have needed help. It's not clear where it came from, but it is clear it didn't come from WorldCom totally. ...

It was very clear that Jack Grubman operated both as a securities analyst and an investment banker. He said that publicly in the press. That, and he indicated that he got better information from the managements to give to investors, because he was considered an insider in the deals. He did know about transactions before everyone else did -- that was just looking at the numbers right.

That was an incredible competitive advantage for him. The investors listened to him more so than other analysts, because he had better information on what was going to happen in mergers and acquisitions, and the industry was on a major consolidation bent. So it served him very well during that period of time. ...

If you go back in the 1990s, it was not unusual -- or maybe it was unusual -- for somebody like Grubman to be actually suggesting strategies to a guy like Bernie Ebbers?

Not usual if it was a probably a pretty open exchange between managements and investment bankers and high-end securities analysts.

So you really almost think of these as partners: Ebbers and Grubman, WorldCom and Salomon Smith Barney.

I don't think you would think of them as partners. ... You can assume from the relationship that Bernie Ebbers had with Jack Grubman publicly that they had a very close business relationship

And from Grubman being at a series of WorldCom board meetings with other investors?

You can only assume that he was influencing a tremendous amount in where the company was putting its efforts to consolidate.

Was Grubman an advocate of the merger between WorldCom and MCI?

Yes, and before that, Salomon was involved with potentially [making a] hostile takeover of AT&T. Before the MCI acquisition, WorldCom considered taking out AT&T. But it's only when WorldCom decided that it wasn't possible to take out AT&T as an acquisition target that they went after MCI.

What is it that makes Bernie Ebbers believe that he's going to have the financial resources that he can take out AT&T or MCI?

They had stock currency. So the whole idea was to make the WorldCom stock rise faster than the other players in the industry, and then, by definition, WorldCom had greater currency or greater market cap. Then it could use stock to take out the other company.

Who was the key to the rising stock prices?

Jack Grubman was clearly the major cheerleader for WorldCom.

So Bernie Ebbers couldn't have pursued his strategy without Jack Grubman?

Not without Jack Grubman being highly aggressive on helping to move the stock price up. ...

Let's go back to this business about this fiberoptic conference that you went to. How did this hype take [over]? How did this idea that our demand for transmission facilities, for network, as you put it, was doubling every three months? Where did that come from? I mean, who was the principal initial spokesman for that?

I understand it originally came from UUNet.

And that would have been who -- John Sidgmore?

John Sidgmore at UUNet. But he originally said it, and then other people in UUNet started saying it. Then it just took off like wildfire. So by the time the fiberoptics conference came in September 2000, the thought had already been in the marketplace for perhaps nine months. By then, everybody had integrated it into their speeches.

But there were people saying that was wrong. ...

There were very few faint voices that were saying it was wrong. But by then, everyone was listening to the upside story. And why shouldn't they? They were all making so much money. The VC, the venture capital community, was printing money for engineers that had never known this kind of money. So nobody wanted to slow down the party. ...

Let's carry it a bit further forward. Grubman reverses himself on AT&T. ... What was your reaction when you saw Jack Grubman's double jump to a strong buy recommendation on AT&T in November 1999?

AT&T had made a few changes at that point. They had bought TCI, so I thought that his bet was on the euphoria that was built into AT&T -- that it could really make a local telephone business out of TCI.

So you thought there was good reason behind this change in the rating?

Well, I thought it was aggressive, because it's impossible to tell. There's too many variables that can go either way. So it's impossible to look out into the future and feel so strongly -- or at least for me, it would be impossible to look out in the future and feel so strongly -- about something where you had no track record.

TCI was a cable company that was getting into the telephone business. The recommendation was based on TCI being able to perform well in the cable television business, and add local telephone, while still operating a long-distance business at AT&T. There were a lot of things that had to go right to keep the wheels on this wagon.

Flash forward six or seven months later, after AT&T has floated its wildest offering with Salomon Smith Barney as the lead banker. Jack Grubman drops his rating on AT&T back down to where it was before. What was your reaction? You've been through the cycle. He ups it, they get the business. Then he drops it, not a month later, but four or five months later.

In telecom, the cycles are very, very long. They're 10-year cycles, up and down.

He goes from real negative to real strong, back to real negative, in a period of about seven months. What's your reading?

To go positive and negative in seven months -- a cycle is 10 years long. One or the other was wrong.

So what was he doing, do you think? Do you think he was making those judgments? Or do you think he was doing something else? I mean, we now have Grubman's e-mails, and we now have Sandy Weill saying, "I told him take a fresh look." Why do you laugh when I say, "Weill said, 'Take a fresh look?'"

I don't know. It's unusual.

You mean for a boss to say, "Let's take another look at a company" -- that's unusual?


Because he's the CEO and he's way up there, and Grubman is down here?

Right. Usually your research director doesn't get that involved with your opinion, one way or another.

Let alone your CEO?

Yes. ... In my experience on the Street, only once or twice has a research director asked me to take another look at a recommendation that I had. I've only interpreted that as they wanted me to change the recommendation, and the CEO of a company that I work for has never been involved with any of my recommendation. So I would say that it was highly unusual. ...

Let's switch to another topic here. The telecom industry gets together periodically, in various different forms. You were talking about the engineering conference and so forth. One of the annual events of the industry was the Salomon Smith Barney get-togethers every year. Talk about them for a moment. What was it like? Where was it held? Who was there? What kind of environment was it? I'm talking about the thing in Palm Springs. Just give us a description of the kind of conferences you went to.

It was a Who's Who of telecom, attended by perhaps 2,000 people. It was a day-in, day-out back-to-back meetings, followed by dinner meetings and big lunch meetings, where all of the industry luminaries spoke -- every single one of them.


Ted Turner, Michael Armstrong, Jerry Levin, everyone in the industry. Every CEO of every major company in telecom and the media spoke at these meetings.

As you're going through the 1990s and you're going to these meetings, what's the mood? What's the atmosphere?

Well, in 1999 it was pure excitement that was unprecedented. It was so exciting. It was like telecom had become a rock star. Everybody was there that was a major telecom investor, that was a major investor at all. Everyone you'd ever heard of in the Wall Street Journal or in Baron's or in the New York Times came to life, embodied, interested in everything that was going on at the conference. It was a beehive of activity. You walked into one person that was a superstar after another. ...

Did that include Bernie Ebbers?

Bernie Ebbers was a keynote speaker, had one of the best slots at the conference. A lot of the CEOs tried to get mind share at the conference, they tried to get good slots. They're either lunch keynote slots or dinner keynote slots, and good break-out sessions and to have a line-up of the key investors in the meetings.

This is a business with a very definitive pecking order, and the top is significantly above the mid tier. To move stocks and to get investors in, you need to get to the top people, and those are just certain individuals. So those individuals were all at the conference, and the CEOs were vying to get to them. ...

So what is Jack Grubman's role? He's the emcee. He's also a deal maker. I mean, he's bringing together these telecom companies, telecom equipment companies and investors.

He's the grease between the CEOs and the investors. So he was making sure that the companies that Salomon wanted to highlight had preeminent spots in the conference, so they could get mind share from the investors. He was making sure the investors had a framework to evaluate the companies, and that they were all in line with his point of view -- which was, basically, the way that you're successful is to build a global network, and every company that builds a global network was going to be outrageously successful.

So there was a lot of interest from the investors in everything that he had to say, because he was the single most important person in the industry during these conferences. ...

It's hard to imagine when you think of the term "stock analyst." I mean, it really is an explosion. Did this just happen in the 1990s, or had this been building?

It had been building. The late 1990s were telecom's day in the sun. It had been a slow-growth, no-growth, low-margin business for 20 years. Then everything rotates, so at some point, the sector rotation works in your favor. So this was the day of the geek. Every geek in the industry was getting $100 million.

It was hot.

It was. It was so hot, it was off the planet. I couldn't believe it. It's as if the elephant got up and started to dance.

The elephant being AT&T, or just the industry?

The industry -- big fat slow elephant, you know. All of a sudden it, it took on a whole new glory.

All of you, to a certain extent, became media stars. I mean, you, yourself, got a lot of media exposure, too, didn't you?

We got a lot of media exposure on our downside call. We did.

How do you mean "on your downside call?"

We called the end of the telecom boom. We said it was in September, October, 2000. We said the show was over, all these service providers were headed toward bankruptcy, and that the further down the food chain, the fiberoptic companies and the equipment suppliers would be taken down in a crushing blow.

Then you're taking the exact opposite position of Jack Grubman?

Exact opposite.

Did you get a response? Do you get a fight? I mean, Jack often takes people on.

Didn't get it directly from Jack. But I did hear about comments of the CEOs of the companies that we had downside recommendations on, that we had sell recommendations on. They would use the Salomon conferences -- not the main conference, but other forums by Salomon and other analyst meetings -- as a chance to try to knock down our recommendation. ...

What did they say?

They'd say I was wrong, that I was overly aggressive, that I didn't understand the upside, couldn't see the the future, had blurry vision. Then they tried to limit me from going to analysts' meetings.

Then there's a time in early 2001 -- I guess it was about March 2001 -- Grubman is out with a strong buy, even though WorldCom stock has come down. [What was your recommendation?]

... We were very concerned that WorldCom was in one business -- they were in the long-distance business. As we were surveying enterprises -- that is, large corporations, we surveyed 25 of them -- we talked with the third person down from the CEO, very high-level people that were managing huge networks in the hundreds of millions of dollars. We asked them what was going on with pricing. They said pricing was falling off a cliff, that they could use leverage from 11 to 14 different competitors that were coming in against WorldCom. They could use the prices that these new players were offering as leverage to beat down WorldCom's prices, and they were able to get the prices down 33 percent to 40 percent.

So we were seeing that the commodities market for bandwidth was falling 90 percent. The enterprise market was falling 35 percent, and we just knew that the revenues were going to fall off, because demand wasn't growing. So we saw the revenues shrinking; there was just no way around it. We came out with a call that said that the revenues are shrinking and that these companies are not going to be able to cover the cost of servicing their debt.

So you said "under-perform?"

We said under-perform, which was "sell."...

So what happens in the industry? I mean, Grubman and Salomon Smith Barney are still going the other way, hell-bent for leather.

Well, we couldn't understand it, because we were getting such a different point of view from every place that we looked. So we just thought time would tell.

Did time tell?

Time told.

Now I want to go back to one of those Grubman conferences, January 2000. [Tell me about Bob Rubin's speech.]

It was January 2000. I was at the Salomon Smith Barney media and telecom conference. We were at a very big dinner that probably housed 500 people. Everyone was packed in at the dinner. We were waiting to hear a keynote speech from Bob Rubin, who had just taken an executive position at Citibank, and had just come from the Treasury Department as the secretary of the treasury. So we thought he'd give a very good outlook on what was going to go on in the market. ...

We had had some wine at the dinner, and then Bob opens up, saying that Sandy Weill had asked him not to give the speech. So we thought that wasn't a very good precursor for what was going to come. ...

[He said] that the numbers had gone so wildly north that it couldn't possibly be sustainable. He asked everyone to take a look through history and check the risk rewards on all of their stock -- look at how they were trading now versus the historical averages. [He] reminded them that, throughout history, things don't go out of the norm for very long. He suggested -- in no uncertain terms -- that the stocks were way too high. They were on a levitation zone, and they couldn't be sustainable.

Ss he was speaking, my palms were sweating. ...

Does he say anything specific about telecom, or is he just talking about the stock market in general?

... He was talking about the bubble. He was making the case that there was a bubble, there was an Internet bubble. There was a telecom bubble, and this was three months before the Internet bubble collapsed. The Internet bubble fell apart in March 2000. So he gave every investor in this room -- which was every investor on the planet that mattered -- three months to recalibrate and to get out of these stocks. It was the single best advice that this group had ever gotten. It was the single shred of truth that they had gotten.

And what's your reaction? You're sitting there listening. How are you feeling?

I was stunned. I was stunned that he was making a case that was so definitively and well done to a group of people that were so on the opposite side of the point of view, and that he had the fortitude and the strength to continue to knock home this idea.

And I realized that he was right. So it was the first time that I had really sat down and realized that the Internet bubble couldn't last. ...

Did you talk to Grubman? What did Grubman say?

I did talk to Grubman afterwards. My hands were shaking. I said to him, "What did you think of Bob's speech?" And he goes, "Stocks go up, stocks go down. Doesn't matter." He was completely blowing it off. I thought it was the most important time in history. For me, it was a major turning point.

So nobody else paid any attention to this. You went around and you did your survey, nobody paid attention. What did you do with your investments?

The next day, I sold many of my holdings in telecom.

Because you took it so seriously?

I took it so seriously, and then I continued to ask people about the speech the next day just to get their reactions. No one was reacting.

So none of these people from the big mutual funds, the big pension funds, the investment houses and so forth can claim that they didn't know, that they got no warning. What you're saying is Bob Rubin, in January 2000, gave a very prescient, potent clear warning to the most important body of investors who care about telecom. Is that right?

Absolutely. Bob Rubin told them in no uncertain terms that the telecom bubble was just about to collapse. Now here's a man that had taken the executive position at Citibank, that came from being the secretary of treasury, and prior to that had been the co-chairman of Goldman Sachs. To have someone with that kind of profile give you that kind of warning is unprecedented. ...

So here is the guy who become, in effect, the number two guy -- or certainly one of the top handful of people at Citigroup -- and he is totally negative on the thing. Then you see Citigroup leading the syndicate of a WorldCom debt offering of about $7 billion in the spring of 2000, and $12 billion more in the spring of 2001. Does that make you wonder what Citigroup was doing, if this very potent guy who you just described is saying this is all a bubble? What are they doing, marketing $18 billion worth of bonds from WorldCom?

I could never understand it.

But there's no way they couldn't have known what was going on, because Bob Rubin himself told them -- isn't that right?


So what does that mean? Does that mean the insiders know that the game is up, but hey can still sell things to the public?

A lot of times, what happens inside the rooms is very different that what the face, the persona, is to the public. ...

What do you make of the settlement that Wall Street has reached with the regulators, including Attorney General Spitzer? Are these changes going to stick? Are they going to solve the problem of analysts in these large superbanks and investment banking houses, tilting their findings in favor of corporate clients? Are we still going to have that problem?

I think it changes them materially. I believe that there will be a split between research and investment banking. It would be very difficult for one side to cross over to the other. Before, the groups worked as teams, and I don't think that that's possible anymore under the new regulations. Right now, analysts can't talk to bankers without letting people know way up the chain within the brokerage organization.

So I think that that does provide the public with some assurances that the research analysts are doing their job on just looking at the company, at the stock, and not considering the investment banking opportunity. ...

A lot of this is routine to you. Part of this is the insider kind of thing, particularly when you get down to the point of the 92nd Street Y and all this stuff. What's your reaction? What do you think?

... What was shocking was that there were personal ambitions. I believe you know that Jack wanted to get his kids into preschool, and Sandy wanted to oust John Reed out of the board -- that these personal considerations seemed to take precedent over the bread and butter business of just making decisions about where capital should flow. I was shocked that the personal decisions took more precedence than the business decisions about really prioritizing what companies should be getting new capital.


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published may 8, 2003

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