A Look Inside a Modern Telecommunications Company

by Peter Pfeiffer

December 15, 2003

The Denver cable company—it just switched from AT&T to Comcast—is performing work on their network and for the past several months there have been outages and degradations in performance.  Comcast informs its customers of the work, which is intended primarily to upgrade the system in order to offer higher or additional revenue services, and they acknowledge the outages.  Comcast policy requires customers to call the company daily to report problems and then they may receive a bill credit of approximately eighty-five cents.  The company’s behavior clearly attempts to bill as many customers as possible for normal, uninterrupted services when it knows that those are not being provided.

This is an example of what A. Larry Elliott and Richard J. Schroth, in How Companies Lie:  Why Enron is Just the Tip of the Iceberg, refer to as “managed mendacity.”  In the case of Comcast it concerns only one specific program or policy:  refunds during periods of system upgrades and outages.  For Martha Stewart it involved only one stock trade.  In the case of Nextel Communications it was a way of operating, operating in terms of the stock, and it clearly affected markets and the company’s bottom line.  Elliott and Schroth contend that “Managed mendacity, systematically applied to the investing public, has become the new science of publicly traded corporations” (p. 14).  It is not a coincidence and it does not happen by mistake, and it certainly does not involve only financial statements as instruments to deceive investors.

The events at Nextel documented here took place in 2001 and 2002, with the main cover-up occurring in the first half of 2002.  The incidents in 2002 coincide perfectly with the layoffs of thousands of employees and millions of dollars in stock and stock option losses.  These events can be truly understood only by reconstructing the period paying particular attention to:  a) the actual events; b) press, public relations, and official company communications; c) insider trading;  d) employee lay-offs and stock option expirations; and e) the price of Nextel stock.  What emerges is an amazing pattern of planned deception and insider profiteering.  Such actions may be corporate fraud and stock manipulation as well as violations of fair disclosure and insider trading laws—they were clearly misleading to investors and profitable to a select few.  The culprits have remained unexposed and “they” and “it” are free to continue.

Although declaring the case primarily about insider trading and notifying the SEC, the FBI currently maintains an open investigation based on the circumstances described here.  The SEC is also currently investigating.

Background

At the beginning of 2001 the technology bubble was showing signs of bursting.  2001 would mark the second straight two-digit decline in the NASDAQ and Nextel was very much a part of its rise and its fall.

U.S. cellular companies were already experiencing significant stock price declines and some were starting to lay-off employees.  The industry had grown from some 25 million subscribers—10% penetration, or “pops,” the percentage of subscribers in the general population—in the mid 1990’s to about 40% pops and 105 million subscribers at the start of 2001.  The most ominous sign was that growth was expected to level off after 50% penetration.  This meant that the industry could no longer rely on subscriber growth to make up for the large numbers of customers who discontinue service every month due to “churn”—about 3% per month or a third every year.  The major carriers, of which Nextel was the fifth largest, had to find a way to survive in the different, slow-growth, operations-driven environment of a mature industry.  Market maturity included intense competition and price declines for wireless plans.

Nextel in particular was facing a need to become profitable.  It had launched the beginnings of nationwide digital service in the Summer of 1996 and had now grown to around 7 million customers; in 2000 it grossed $5.7 billion with some $23 billion in assets and $15 billion in debt.  The rule of thumb for cellular in the high-growth ‘90’s was seven years to become profitable, but Nextel, with it’s industry-leading ARPU (Average Revenue Per Unit or gross dollars per phone per month) had predicted, and was expected to deliver, better results.  The Summer of 2001 would mark year five, debt was still increasing, and the company had yet to show a profit.  The stock price, from a high over $80 (post split), was under $30 and declining steadily.  At the beginning of 2001 Nextel had approximately 19,500 employees and was in the Fortune market cap 100.

In the Spring of 2001 every indication was that the short- and long-term futures looked bright.  The company continued to reach subscriber, revenue, churn, and cash flow targets.  Employees had just received full bonuses and customary raises and stock option grants, all based on company metrics.

Like a lot of technology and telecommunications companies of the late ‘90’s, Nextel had a tendency to tell stockholders, potential investors, and employees only good things.  Company performance during this period was typically not judged by profitability, it was assessed in terms of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and in the wireless industry specifically, subscriber growth, churn, ARPU, and revenue growth.  Nextel almost always excelled at meeting and reporting these.  But the company also amassed huge debt, debt that looked worse and worse as its market cap fell.

In reporting key quarterly metrics there were ways to cheat, and over time, it became a way of operating.  Some were okay business practices, but poorly planned-for and not implemented uniformly; for instance, it was common to have end-of year rebudgetings, canceling holiday parties, and crackdowns on less essential items such as travel, but these cutbacks seldom affected higher-level executives.  Another end-of-year tactic stretched gross add numbers and at the same time lowered CPGA (Cost Per Gross Add, or the cost of putting a phone in users’ hands).  These holiday programs sold phones only through employees, for friends and families, with very low rate plans of around $10 per month.  They provided an instant boost in quarterly adds but were never reported to stockholders, particularly with respect to the hit they caused in ARPU.

Part of the reason for the massive debt was an incessant need to spend.  These were boom times and money was flowing everywhere:  capital spending, departmental and travel budgets, employee compensation, etc.  Nextel always had several executives on the Washington Post’s annual list of top local executive pay (six in the top 100 in 2000, with CEO Tim Donohue number ten at over $20 million).  Nextel was pouring money into wireless data, a complex suite of services and a difficult one for a carrier to develop and launch, and they were features with a record of limited mass market acceptance.  On a broader level, wireless carriers were spending billions upgrading to 3G or even “2.5G” networks, both to keep up with each other and in the hope that the next technology breakthrough would be their savior.  This was an industry and these were executives accustomed to having almost everything they touched turn to gold, specifically, more subscribers and more revenue.

Key Events and Information Provided to Stockholders

As 2001 began Nextel was still growing and still spending.  The company reported a net loss of $428 million for the first quarter of 2001 compared with a $435 million loss during the same quarter of 2000. At the same time, Nextel revenues rose 48 percent from a year ago, reaching $1.74 billion per quarter, and its global customer base expanded 9 percent to 8.3 million customers.

The year 2000 would be the last boom year, and as things would become tougher, the deception would increase and the gap between “in” and “out” stockholders would widen.

The Mooney Period

Jim Mooney joined Nextel as COO in April, 2001 and left quickly in September of 2002.  Previously, the upper executives at Nextel had been virtually all industry veterans, most serving somehow with Craig McCaw.  There is a constant emphasis in the wireless industry on sales and top Nextel executives, including Tim Donohue (CEO) and Steve Dussek (COO), had sales backgrounds.  Nextel's were not particularly educated or diversely-experienced executives and Mooney, an outsider, was an anomaly.

Mooney was either an extremely forceful personality and achiever or he was brilliant at carrying-out a plan already set up for him; it is likely the latter.  He immediately presided over a “5% reduction in the workforce” (i.e., firing 900 employees), then:

·         During the second half of 2001 Nextel reported positive results, “continued improvement,” and “greater confidence.”  Nextel international performance, reported with quarterly results, was upbeat, with exceptional, 100% year-to-year growth.

·         On January, 11, 2002, a new fiscal year, NII Holdings, Inc., Nextel’s international subsidiary, missed a $384 million payment to creditor Motorola.  Nextel said nothing and it was reported only by financial blurbs in non-mainstream media.

·         On 1/18/02 and 1/25/02 the company announced outside contracts for customer care and IT support staffing; the real news, skillfully played down, was that it meant firing some 4,500 employees or one-fourth of the workforce.  A large asset consisting of customer care telephone centers located throughout the country was now gone.  The huge size of the contracts presented an image of financial strength.

·         From January, 2001 to January, 2002 Nextel stock fell from $30 to under $8 and the company gave no warnings or explanations for the decline.  Nextel reverted to a tactic that it used skillfully:  hiding behind technology in its public and stockholer relations to appear positive, new, and successful.  Mooney, benefiting from the notoriety of IBM, his former employer, made several announcements about mobile data and “enterprise marketing” successes.  Nextel even utilized its old stock speculation standby—merger and acquisition talk.

·         Quarterly financial reports in the first half of 2002 were noticeably sparse and without explanations.  Finally, in May, 2002 Nextel released financial results and its annual report and 10-K for fiscal/calendar year 2001.  Steven Pearlstein of the Washington Post apparently had a feeling about the situation and wrote an appropriate for the time newspaper article.  In it, William Conway, Nextel’s venture capitalist CEO, mentions that a reason for the company’s action was a fear of shareholder lawsuits. The Pearlstein piece only told part of the story in that it failed to tie insider trading into the events and it did not mention lay-offs, losses by ex-employees, and the tremendous losses suffered by shareholders not in the know.

·         On 5/24/02, about two weeks after the 2001 disclosures and the Pearlstein story, late in the day on the Friday before the long Memorial Day weekend, NII Holdings Inc. filed for bankruptcy protection.  Nextel made its first statement on NII basically saying that the worst was over.

·         In July 2002 Nextel announced its first profitable quarter ever.  The stock price has risen steadily since.  At lows below $4 William Conway began accumulating his personal holdings in Nextel stock.

On 9/19/02 Jim Mooney unexpectedly resigned and eleven days later he was gone.  In 2001, having worked at Nextel only nine months out of the year, Mooney reached number fourteen on the Post’s income list at over $13 million.

During this period up until Spring, 2002, with the stock price approaching all-time lows and ex-employee options expiring, Nextel steadfastly refused to communicate the NII situation to shareholders.  The most severe problems seem to have occurred during 2001, and that is the fiscal period during which they were written-off, but not a word was said then.  Instead, company communications during this period can best be described as “spin.”  Numerous press releases, articles, and public relations pieces were devoted to joint ventures, new products, awards, and outside contracts and company performance was always reported positively.  An example of this deceptive communications approach is a news story on a pilot project with XSVoice, an “Internet streaming audio company” announced in the The Nashville Business Journal on 11/16/01.  Overall, the communications effort was effective at hiding, rather than explaining, the problems at NII.

These events—the general discrepancy between company communications and actual events—are shown graphically in the attached timeline charts (timeline charts).  Exhibit 1 contains the major events that occurred during this period and Exhibit 2 summarizes Nextel public announcements.

Shareholder Communications

During the period of the NII bankruptcy, with Nextel stock falling from around $10 to under $3, information provided to stockholders was more deceptive than it was informative.  Outside of annual report and 10-K mailings—which are not timely and per the Washington Post exposé were highly suspicious in Nextel’s case—there were no direct communications with stockholders.

While it is certainly not a proactive, uniform disclosure to stockholders, the Nextel investor relations website provides an incriminating look into the real story.  This is the best and most up-to-date information available to stockholders.  It is, in essence, a concise disclosure of Nextel’s shareholder communication plan, including the strategy behind it.

The following chart contains Nextel investor relations press releases, from Nextel's website, during the period of stock lows and the NII bankruptcy.  This is a period in which the company would lose almost $2 billion due to NII, in addition to the approximately $1 billion it was losing annually through operations.  It is also a period in which Nextel would lose ownership control of its international properties, arguably among its most valuable assets.  Almost all of the “releases” are marketing promotions, most of which—e.g., partnerships with United Airlines, Federal Express and IBM, developer contests, and new products—are of almost no significance to stockholders.  Some of these deals were subject to drastic changes and others never happened at all.  The announcements are basically sales hype and an attempt to impress stockholders with new technology.  The chart contains no mention of NII until Memorial Day weekend 2002 and the actual filing for bankruptcy protection.  The gigantic staff reductions are reported in the 1/18/02 and 1/23/02 blurbs.  Operational and financial releases during this period began to report just domestic results and are designed to highlight potential positives going forward instead of explaining current conditions relevant to shareholders.  Finally, also included in the chart, is an announcement for an investor relations conference call, a communication method that reveals a lack of fair disclosure to all Nextel stockholders.

 Nextel Investor Relations Communications, 10/30/01 – 6/3/02

The preceding chart provides a simple, unambiguous look into the information that Nextel selectively provided to investors.  It is, in essence, its communications blueprint.  Overall, it contains an air of self-promotion and circumvention.  Again, this was a crisis period that may have been the worst in the company’s history.

This information was especially misleading given the massive layoffs that took place at Nextel both before and during this period.  Exhibit 3 (timeline charts) shows the actual and estimated dates for the expiration of ex-employee stock options.  Clearly Nextel reaped savings due to non-redeemed, worthless ex-employee stock options.

This is a look into the deception that can occur in modern corporate public and investor relations.  In this case one event in particular, the bankruptcy of NII Holdings, Inc., aka, Nextel International, provided a specific set of circumstances that put this behavior over the top, that turned a lack of disclosure into something potentially criminal.  Ultimately, the events can be directly converted into dollars, more specifically, losses in stock options by ex-employees, losses attributable to individual and institutional investors, and, as described in the following section, insider gains by selling before this period and by buying at low points.  It is possible to quantify the figure, but regardless, it is clear that some (insiders) profited while others—outsiders, or all others—lost.

Nextel Insiders

If the first part of this story is about deceiving stockholders—and causing them to suffer losses—this second part is about insider profiteering.

Corporate Governance

Nextel was, and may still be, an oligarchy in terms of its steep, hierarchical managerial structure, its ownership, and especially its inner circle of those in the know, consisting of the board and the highest-level executives.

Its ownership and director make-up could not be more complicated.  Craig McCaw and his Eagle River Holdings, Digital Radio, and other affiliates owned approximately 15-20% of the stock; the situation is so complex that Mr. McCaw’s exact holdings are difficult to determine.  Motorola, Nextel’s largest supplier, owned another 14%.  Some 70%—the overwhelming majority of the remaining shares—were institutionally owned and the company only had about 2,000 shareholders altogether.  Senior executives in particular receive huge awards of both shares and options, and through various other deals, investments, and redemptions the number of shares grows rapidly.  The company had approximately 800,000,000 shares in March, 2002 and now has over one billion. 

In April, 2002 the company had seventeen “directors and executive officers,” of which only thirteen were mentioned by name in its proxy statement.  Of those named, several were McCaw associates, one represented Motorola, there were a few outsiders—seemingly chosen to support management—and the rest were Nextel executives.  Jim Mooney and Paul Saleh, both of whom joined the company well into 2001, immediately joined this inner circle.

Nextel Stock

Nextel’s deceitful PR machine, its insistence on saying positive things while failing to take responsibility for the negatives, its efforts to conceal the bankruptcy of NII Holdings, its massive layoffs with their attendant stock option expirations, and the overt greed of its executives caused unnatural, non-free market influences on Nextel stock.  Thousands of investors may have been negatively affected.  With stockholder information, interviews, sales records, and company layoff and stock option information, it would not be difficult to piece together an accurate picture of who suffered, and how.

It is not hard to identify a clear trend of insider trading records during the period of the NII bankruptcy.  A summary of this information is contained in Exhibit 4 (timeline charts).  It is logical to assume that there could be as many as several hundred more individuals, employees and cronies, who engaged in similar trades based on non-public information.

Two individuals’ behavior is especially audacious.  Tom Kelly, then chief marketing officer and now COO, sold shares toward the end of 2001, shortly before NII missed its first major debt payment to Motorola.  At a dinner, in Sao Paulo, Brazil in December 1998, Mr. Kelly acknowledged that he was in charge of international marketing and operations, as well as the Motorola relationship.  In 2001 Mr. Kelly had to know that severe NII problems were occurring, and he redeemed shares.  Similarly, William Conway, Nextel’s board chairman, aggressively bought Nextel stock at its absolute, historic lows in the Summer of 2002.  Based on company events at the time, these were lows that other investors had no way of knowing would not be sustained.  Mr. Conway surely knew that NII prospects would soon be resolved and that very soon, as it turned-out within six weeks, the company would announce its first quarterly profit ever.

Also in the Summer of 2002, per SEC filings, Craig McCaw entities made huge “planned sale” announcements but instead Mr. McCaw actually purchased shares during low points in the company’s stock price.

At the very least investors suffered, and insiders benefited, from control over timing.  Insiders benefited by timing their trades while other stockholders, investors who had no reasonable way of knowing what was happening, could not.  Such timing is an inherent part of the value of stock options—particularly ex-employee stock options which are going to expire—because they have dates associated with them.

The events at Nextel represent a type of scheme that has not yet been revealed in the myriad of corporate scandals that have surfaced so far.  This one revolves around information provided to stockholders during a period of extraordinary movement in the company’s stock:  The mismanagement surrounding the failings at NII Holdings created a potential crisis situation for Nextel stock and, in reaction, company insiders delayed and concealed this information from shareholders.  With startling audacity senior executives and directors sold and purchased shares during this period and benefited from the timing of their own trades.

Afterward

There are really two stories here:  the first is the chronology of misdeeds at Nextel and the second is, at least so far, that they have been able to get away with it.

Company insiders benefited while other investors, of which I was one, suffered.  I am not an ordinary investor but instead am an MBA-educated ex-employee with a considerable knowledge of the wireless industry.  I am also extremely inquisitive and spent weeks studying the events described here, both before and after the collapse of the stock price.  Still, I was deceived and lost a staggering 90% of my investment in Nextel.  Logic suggests that there are others who were also at a disadvantage and also lost money.  It is inconceivable for me to believe that current employees, especially high-ranking ones or company insiders, lost a significant portion of their holdings as I did.

Like the Enron and Worldcom atrocities this story about Nextel speaks to the way the company was run, with inappropriate direction and behavior coming from the highest levels.  Like all the corporate and investment scandals occurring around us the Nextel story is about people in positions of great responsibility who shirked their duties and looked-out mostly for themselves.  The culprits are in the news virtually every day in forms ranging from individual egomaniacs to illicit dealmakers to corporate plotters.  What they share is that they all had responsibility for others but they put themselves first.  By definition the primary “others” are stockholders.

This is a sad story and it is an unpleasant one to write about.  It is about deception and profiteering and it deals with the bad sides of people, or worse yet, individuals gone completely bad.  It speaks to how large business organizations, entities that we should hold in esteem because they are so important to our way of life, can go awry and earn our disrespect.  For those of us who worked in high technology or telecommunications at the turn of the millennium it disparages an entire, formerly so promising industry as well as the boom times it helped create and then destroy.

The situation is getting better due to micro, reactionary efforts such as law enforcement, media exposés, bankruptcies, etc.  This is another one of those.

This is a story about all of us and it is as much about the time as it is about the individuals.  I may have done it myself.  I knew as much about market demand or rejection of new products as anyone at Nextel and the information I knew may have guided my trading in company stock.   It would have been virtually impossible not to.  I was given stock options and when they matured and were in the black I was faced with decisions as to what to do with them.  I was an investor and seeking return was my duty.  It is the same opportunity and motivation that is behind bigger, much more significant dollar amounts and blocks of stock.  It is based on trading in company stock based on non-public information.  Supposedly it is illegal.

As an investor this is not the kind of company—one that seeks individual, not stockholder gain—where I want my money.  There has to be a reason, a bad one, for people to lie.  And if they’re willing to lie for me then they are willing to lie to me.  I do not believe they are going to do well in the long term and I do not want to be a part of it.  Lying is a lousy precedent.

In this case the wrong people were too greedy.  The people whose job it is to look after everyone didn’t do that and they didn’t give the rest of us information to make up our own minds, to look after ourselves.  There is more evidence suggesting that their primary motivation was themselves than there is that they cared about stockholders.  In the meantime they have increased their stake and they sit prepared, ready, willing, and able to do it again.

What happens after the story is a big part of this story.  When it happened everyone—the media, stockholders, employees, and government watchdogs—was deceived.  The Washington Post and Mr. Pearlstein partially exposed the situation in May of last year and the SEC was alerted; but still, nothing happened.  I remember frequently looking to see if Nextel would sign-off on its financial statements, to find out if there were any stockholder uprisings or class action lawsuits, and to see if anyone else had figured out the deception as I did.  I do not understand how they can get away with it.  Now that the story is out let’s take a good look at what happens next.

 Personal Experience Appendix

Timeline Charts

A Little Update

April, 2005

People tell me that there are learnings in this story and I consider that a compliment.  It was originally written in the Summer of 2003 for an FBI investigation; my motives were well-intentioned but I was ignorant:  "Corporate fraud" is very difficult, maybe almost impossible, to investigate, prosecute, and prove.  Perhaps the best one can expect from governments is an occasional, high profile case with some deterrent potential.  "Insider trading" is seemingly more common or accessible, but even that appears at times an unobtainable ideal.

Obscure critics have said that I had sour grapes or that it was my fault; to the former I can honestly say that isn't the case because cellular had already been created and the boom was over.  To the latter, you are right:  I had too much faith and too much of an investment in one company.

© 2003 - 2005  Peter C. Pfeiffer

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