Posted on 08/26/2002 4:23:24 AM PDT by Libloather
Deals Within Telecom Deals
Sun Aug 25, 3:21 PM ET
By GRETCHEN MORGENSON The New York Times
In July 25, 2000, just as the hot air was starting to seep out of the technology bubble, Time Warner Telecom, which provided broadband data transmission and Internet access to customers in 22 metropolitan areas, announced a deal to buy equipment from Sonus Networks. Sonus, a newcomer to the industry, had gone public just two months earlier, immediately rocketing more than tenfold in price. On the Time Warner news, Sonus's shares rose an additional 4.6 percent, closing at $83.62.
Every Sonus shareholder was happy, of course, including Michael R. Rouleau, senior vice president for marketing and business development at Time Warner Telecom. Exactly two months earlier, Mr. Rouleau had received 4,500 shares of Sonus's initial offering as a "friend of the company," according to regulatory filings. He sold the shares last summer for $100,400. Sonus now trades at 88 cents a share.
Mr. Rouleau was not alone in his good fortune. During the telecommunications mania, many executives at large, established companies received similar sweetheart deals: They would invest in equipment suppliers, and their corporations would often put money in the concern as well. In the telecom gold rush, when companies with virtually no sales issued shares to the public that quickly soared and almost always just as quickly collapsed, executives like Joseph P. Nacchio, former chief executive of Qwest Communications, and Matthew Bross, former chief technology officer at Williams Communications Group, benefited personally from early stakes in the companies.
Many of the deals are not disclosed in company filings. But a search of records and filings turned up enough of them to show yet another troubling aspect of the tangled web of relationships that characterized the telecommunications industry in the late 1990's. They may also help explain why the industry grew so big so fast.
The deals demonstrate how executives, already making millions on stock options from their own companies, were able to enrich themselves through holdings in outside companies from which they bought equipment with shareholders' money. And because winning a contract from an established company was pretty much all an upstart company needed to become a stock market star, the transactions help explain why so many untested equipment makers were able to raise money from the public, only to collapse shortly thereafter.
Mr. Rouleau did not return a phone call seeking comment.
The main reason that telecommunications executives committed billions to building global or nationwide networks, of course, was projected demand. As the Internet caught on, data and voice transmission was supposed to explode. That never occurred, leaving many networks dark and unused.
But the fact that companies and their executives profited from investments in fledgling suppliers may help solve a mystery that dogs the industry: why there was such a gross misallocation of capital in the sector. The deals may also explain why networks that cost billions to build fetch far less in bankruptcy auctions.
A $4.5 billion investment in equipment by Winstar Communications, for example, brought just $15 million in bankruptcy a few years after its network was built. Global Crossing's $20 billion network sold for $750 million; Viatel's $2 billion in equipment went for $15 million.
"Looking back, it looks more and more like a pyramid scheme," said Susan Kalla, an analyst at Friedman, Billings, Ramsey in New York the age-old game in which early investors received their returns by selling out at higher prices to new investors.
"The deals explain why people weren't more diligent in making decisions about funding these small companies," Ms. Kalla added. "If the money was spread all over the place and everyone who participated early was almost guaranteed a return because of the hype, they had no incentive to try to differentiate the technology. And in the end, all the technology turned out to be identical and commodity-like."
Much about the telecommunications bubble remains unexplained. But law enforcement authorities and securities regulators trying to untangle the many telecommunications transactions in the late 1990's have already found that some swaps of network capacity by companies were improper. The swaps gave an artificial lift to company revenue and, therefore, also inflated share prices. The companies that made the swaps, like Global Crossing and Qwest, have been ordered to restate their earnings.
How Wall Street allocated shares in hot initial offerings of telecommunications companies is also the subject of regulatory and Congressional scrutiny. Investigators want to know whether favored executives were given shares as a way to cement investment banking relationships or to generate new ones.
But for those curious about the origins of the telecommunications debacle, the investment deals given to executives of large companies by less-established suppliers are a third area worthy of study.
The deals took a variety of forms: sometimes, they were warrants or options given in exchange for an established executive's participation on an upstart company's advisory board. At other times, as in Mr. Rouleau's case, they were initial offering shares designated by the issuer as part of the allotment destined for so-called friends and family. In still other cases, executives were allowed to buy convertible preferred shares at bargain-basement prices while a company was private; those shares were then converted to common stock just before a public offering.
While it is unclear when or if investors sold the shares, they clearly intended to profit from investing.
Many deals were unseen from shareholders. A company does not have to name the people on its friends-and-family share list; the lists are seen only by the company issuing shares and the brokerage firm that is underwriting them.
Neither must companies provide names of those invited to serve on their technical advisory boards. As the Corvis Corporation, a network equipment maker and former highflier, stated in its 2001 annual report: "Some of our customers have representatives that are members of this advisory board, and we expect that our potential customers and suppliers may also have representatives on this board in the future.
"In exchange for a participant's services on this advisory board," the statement continued, "we have granted, and may in the future grant, stock options to them, the terms of which are, and will be, fully disclosed to and approved by the advisory board members' employer."
Corvis did not identify its advisers. But Peter S. Cohan, head of a management consulting firm of the same name in Marlborough, Mass., said one was Mr. Bross, who was the chief technology officer at Williams Communications Group and the man responsible for building Williams's network. Mr. Bross, who is now senior vice president of the company, declined to comment. It is unclear how many shares he received from Corvis for his work as an adviser. Williams later struck a $200 million contract with Corvis and filed for bankruptcy protection in April. Corvis shares, which peaked at $108 just days after the company went public at $36 in July 2000, now trade at 70 cents. It is unclear if Mr. Bross sold the shares.
Tellium Inc., an optical switch manufacturer that went public in May 2001, noted in a preliminary filing that it had established an advisory board in early 2000. Seven board members were executives of a Tellium customer, according to the filing. One was Marc B. Weisberg, Qwest's executive vice president for corporate development, according to a regulatory filing.
In September 2000, Tellium and Qwest announced a "multimillion-dollar strategic relationship for optical switching."
Harry J. Carr, Tellium's chief executive, said: "We are gratified that Qwest determined that Tellium is a company able to meet their demanding criteria. We are very proud to be associated with such a leader."
Not mentioned in the announcement, but noted the next year in a regulatory filing, was that Tellium issued warrants to a Qwest subsidiary, letting it buy 2.4 million shares of Tellium at $14 each. The warrants were exercisable at different times until 2007 as Qwest met milestones in its contract with Tellium.
And for services rendered on Tellium's advisory board, Mr. Weisberg received options to buy 45,375 shares of Tellium at $14 each in March 2001, according to filings. Two months later, Tellium sold nine million shares to the public at $15 each. A few weeks after the offering, Tellium shares rose to $27. They are now at 52 cents. Because the shares were not registered, it is unclear whether Mr. Weisberg sold them; he declined to comment. He left Qwest last September and joined Tellium's board in February.
Mr. Weisberg sold $100,000 of shares in CoSine Communications, a network equipment provider, in December when the price was around $1.30. CoSine had issued shares to the public in September 2000 at $23. Mr. Weisberg noted in a filing that the shares were acquired in a private placement in March 2000, but the price he paid was not stated. Typically, investors in private placements receive shares at steep discounts to the public offering price.
In May 2000, before the public offering, CoSine said Qwest had chosen its products as part of the larger company's "Virtual Private Network Service." Last February, Drake S. Tempest, an executive vice president at Qwest, sold $100,000 worth of CoSine shares he had acquired in March 2001 by exercising some warrants. At that time, the shares traded at about $1.30.
About a dozen executives at Qwest or the Anschutz Investment Company also likely gained on their holdings in Chromatis Networks Inc., a privately held network equipment maker that Lucent Technologies bought in 2000 for $4.5 billion.
Qwest executives with Chromatis shares at the time included Mr. Nacchio, the chief executive; Robert S. Woodruff, the chief financial officer; and Lewis O. Wilks, the chief strategy officer until last October. Afshin Mohebbi, Qwest's president, also owned shares, as did Mr. Tempest and Cannon Y. Harvey, chief operating officer of Anschutz Investment, the largest shareholder in Qwest.
Although regulatory filings do not specify how these executives became investors in Chromatis, its products were being tested by Qwest around the time of the Lucent acquisition. Lucent recently wrote down the Chromatis acquisition to zero.
But at the time of the acquisition, the Qwest executives got shares of Lucent, which they then registered to sell in August 2000. According to the filing, Mr. Nacchio received 65,112 Lucent shares, worth $2.1 million at the time. Mr. Wilks, Mr. Tempest and Mr. Woodruff each held 60,404 shares. Mr. Harvey, who declined to comment, had almost 70,000 shares. Mr. Mohebbi held 12,080 shares, worth about $400,000. The Anschutz Family Investment Company's 2.1 million shares were worth about $67 million. It is unclear if they sold their Lucent shares, but when registrations to sell are filed, sales usually soon follow.
A Qwest spokesman said these situations were not conflicts of interest as long as the employees met company guidelines, which included asking the company's legal department to approve investments in advance.
Tyler Gronbach, a spokesman for Qwest said: "Mr. Mohebbi was a long-term investor in Chromatis and still holds the Lucent shares that were issued as a result of their acquisition of Chromatis."
Ms. Kalla, one of the few analysts to warn of a telecom bust long before one occurred, said the deals given to Qwest executives helped explain the large number of companies to which Qwest awarded contracts, an aspect of the company's operations that had long puzzled her.
"I went to this meeting once and they totaled the number of contracts Qwest had given," she said. "There were 50 companies Qwest had given contracts to for at least $200 million. These companies used this as a marketing tool to do their I.P.O. but the contracts had such tight performance specifications to sell the product that they couldn't possibly meet them. At end of day Qwest never had to meet any of the contracts. But the companies used Qwest as their main customer. Then they would go public and Qwest would flip out the stock," or sell it quickly.
Quest was hardly the only company striking such deals. According to a shareholders' lawsuit filed in 2000, in a state district court in Tulsa, Okla., two executives of the Williams Communications Group Mr. Bross and John Bumgarner, president of Williams's strategic investments group were able to buy cheap shares in the ONI Systems Corporation, an equipment maker, in November 1999. Mr. Bross, who later joined ONI's board, bought 322,000 shares at an average price of $3.30. Mr. Bumgarner bought 63,316 shares at $6.32 each.
Through a spokeswoman, Mr. Bumgarner declined to comment.
A month later, Williams Communications bought 1.58 million ONI shares for $6.32 each and in March 2000 agreed to buy $30 million of ONI's fiber optic switching products. On June 1, 2000, ONI made its stock debut at $25 a share. It soared to a high of $136.75 later that month.
Mr. Cohan, the management consultant, calculated that Mr. Bross's sales of ONI shares in 2001 generated almost $43 million. "Getting those shares was a huge financial inducement for Bross to buy from that potential vendor," Mr. Cohan said.
Mr. Bross also received friends-and-family shares in Sycamore Networks a few months after Williams agreed to buy $400 million of Sycamore products to expand its fiber optic network, according to the lawsuit, which contended that Mr. Bross has breached his fiduciary duty to Williams's shareholders.
The suit was dismissed in December 2000 for insufficient detail to make a claim, but the judge left open with possibility that it could be refiled. Robert L. Wheeler, the lawyer representing the shareholders, would not say if he planned to do so. Deb Trevino, a Williams spokeswoman, said: "It has been our policy since April of 2000 to prohibit participation by Williams Communications Group employees in directed share programs offered by other companies that do business or are likely to do business with Williams."
Another interesting transaction involves John W. Sidgmore, now chief executive of WorldCom. It dates to June 1999, when Mr. Sidgmore, then vice chairman, bought 713 shares of Alteon Websystems in a private transaction. Alteon, a maker of Internet infrastructure gear, went public three months later at $19 and soared to $158 a share the next year. It was acquired by Nortel Networks in October 2000 for $5.5 billion in stock. Mr. Sidgmore filed to sell 459 restricted Alteon shares in July 2000; their value was $42,295.
Alteon had been a supplier to UUNet, the Internet service provider bought by WorldCom Mr. Sidgmore had run. Brad Burns, a WorldCom spokesman, said: "John was not playing an operating role within WorldCom at that point, so he wasn't involved in purchasing decisions. Nor was he an adviser to Alteon."
Unfortunately, shareholders hoping to learn more about deals executives may have struck with suppliers or vendors will find disclosure spotty at best. As usual, the issue boils down to one of materiality, said Alan R. Bromberg, a professor of securities law at the Southern Methodist University School of Law. "It would depend upon the magnitude of the deals, relative to the size of the two companies," he said.
As for the disclosure of options granted to advisory board members, Mr. Bromberg said: "You're in a pretty murky area. It depends on how big the options were and how big the deals made with the advisory board companies were. There's no way to calibrate it precisely."
But, Mr. Bromberg said, the deals are things that reasonable investors would want to know about.
On national TV, McAuliffe called it, "Smart investing."
The guy is the epitome of sleaze...
You nailed him. Indict Terry!!!!!
Great (scary) article. I really liked the part where the UN head advocates currency transaction taxes, designed to raise approximately $200-300 billion a year.
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