Boom and bust: Telecom's trajectory a symbol of an era

CEDAR RAPIDS, Iowa — Before their money vanished with their faith, Clark McLeod's investors could sometimes find him just by glancing skyward. It was spectacular to stand there on the edge of a cornfield, crane the neck and look up at his cream-colored jet hurtling by. A Gulfstream G-5, with sleeper cabins and a flight attendant, it glinted in the sun, the $39.5 million chariot of a chief executive who had joined the ranks of American technology demigods.

A snapshot of an epoch: the great American ride, not long before the crash.

A self-made billionaire who had risen from hard days when he drove a Volkswagen, McLeod seemed above them, somehow, and this they didn't mind. McLeod's luck seemed to float down to his hometown, so even when he exercised stock options worth about $98 million in February 2000, who could begrudge him when middle-income investors in his company, McLeodUSA, sometimes made $50,000 in a day? And he was one of their own, after all, a former schoolteacher who grew up just three miles away in the middle-class home of his educator parents.

Speed and ascent, ambition and acquisition: They were the paramount ethics during the 1990s in technology and telecommunications, where a titan's climb seemed limitless and his fall improbable. Up in the pantheon of American chief executives, McLeod pushed hard, and harder still — too fast, as he later acknowledged — and on borrowed wings at that.

Competing in the Midwest and Rocky Mountain region against the established Baby Bells, McLeodUSA had gained an impressive 20 percent to 30 percent market share of local phone business in several key markets. By early 2000, offering local, long-distance, data and Internet access, the company had grown to 10,700 employees, a fivefold increase in four years, as it headed toward becoming a 25-state operation and eventually a national network.

Lifestyles of the rich

At Clearwater Farm, where McLeod and his wife, Mary, raised thoroughbred dressage horses, cars stopped and dreamers furtively spilled out to stare, able to see the horses roaming in meadows near McLeod's recently built equestrian arena, with exotic Teflon-coated, dust-free gravel. Inside, his friends reported with awe, a mirror nearly the length of a football field offered a rider a flattering view of himself atop his steed.

His house sat behind white pines and evergreens he had ordered uprooted and trucked in from out of state, only heightening the sense of a great man's remove. Tucked out of sight were man-made ponds he had stocked with bass and koi, near a 20-foot waterfall. He lived like Gatsby.

A few called it garish, but many didn't mind any of it, not the ponds or his stock options — not then, anyway, not with their own portfolios so fat. "You thought with Clark, well, here's a real chance to change things in a big way for yourself," recalled Doug Bean, a Cedar Rapids real-estate agent and investor. A new paper millionaire who had decided that his stock gains in McLeodUSA could fund his retirement, Bean happily sought out McLeod at the Cedar Rapids Country Club, congratulating him on his vision and helmsmanship.

Hold on to your stock, McLeod told anyone who asked, and when the price began dropping slightly in early 2001, Bean did just that, his faith in McLeod's talents absolute even as the company's debts ballooned and worries escalated.

Only later, after the company's investment money ran dry and the resulting panic took Bean's stock down from its $35-per-share to less than $1 a share, did he and others even begin to think about the options McLeod had exercised in 2000.

In October 2001, McLeodUSA laid off about 1,600 employees, 400 of them in the Cedar Rapids area. But company officials assured everyone that rumors of financial calamity were groundless, assuaging jittery investors, even buoying the faithful, like Bean, who responded by buying more stock. Its price rose, to 77 cents, before quickly sinking.

By early this year, McLeod's wealth looked like spoils to many ruined investors. By then, McLeodUSA was in bankruptcy, the stock was worth 18 cents a share and the 55-year-old McLeod had retired to Clearwater Farm.

Since then, the company has emerged from Chapter 11 protection from its creditors, with $3 billion of its debt wiped out. McLeodUSA officials have argued that they should be individually exempt from liability lawsuits filed by shareholders, to which a federal judge answered no. Shareholders could go after McLeod if they wished.

The lawsuits charged that McLeod had not said what needed to be said when it was not easy to say it — that he had failed to be candid when the company began careening, and that when he did speak, he and others materially misrepresented the company's ills.

McLeod has not spoken publicly for months, and McLeodUSA officials refused to communicate messages to him. It was left to his 84-year-old mother, Jane McLeod, to defend her son. "Clark's always had integrity," she said.

In 2000, when he was riding high, McLeod talked about the virtues required of a great CEO in a self-published book called "This Way Up." Integrity was high on his list, he wrote, but it was also the value that people "fail at most." He pledged to lead the way to success.

"Integrity is doing what's right. Always. ... Integrity requires saying what needs to be said, when it needs to be said, even when it's not easy to say it."

'He could really sell you'

McLeod's story radiated ambition and tenacity: the restless schoolteacher who, 25 years ago, was bagging groceries to supplement his $6,000 annual income. He led his first company, TeleconnectUSA, through a merger in the late 1980s to create TelecomUSA, the fourth-largest long-distance company, before it was sold to rival MCI Communications for $1.25 billion in 1990.

His eponymous company, founded in 1991, appeared to be his second major telecommunications triumph, and McLeodUSA stock jumped from $20 to $25 a share on its first day of trading in 1996. Buying was frenzied. "We didn't have to say anything to pump (the stock) up," a Cedar Rapids broker recalled.

Admirers believed McLeod had astutely taken advantage of what would be a new wave of deregulation in telecommunications, taking on the Baby Bells by contracting to use Bell equipment and then selling the phone service for less than the Bells would, presumably ensuring a steady, if smaller, margin of profit.

A similar strategy had worked for him in the '80s, when his long-distance Teleconnect had seized upon the breakup of AT&T to buy lines and undercut rivals. But this time, in the '90s, there would be more competition, not only from the Bells but from other telecom upstarts, known, like McLeodUSA, as CLECs — competitive local exchange carriers.

McLeod's ambition dwarfed that of most of his rivals and gave him an early advantage. Determined to build his own network to handle phone calls and data services, video transmission and Internet connections, he had his company embark on laying and acquiring the necessary fiber-optic cable — nearly 31,000 miles' worth across 25 states. In the meantime, he looked to buy companies with their own fiber-optic systems and data networks, evidence of his commitment to expansion, McLeod officials told pleased investors.

He was usually low-key, even shy to the point of being aloof, in many social settings. "But when he started talking to 600 people at a business meeting about telecoms, he could hold them good," recalled Bean. "He could really sell you. And he had the city's respect."

Wealth alone inspires envy, but wealth that bears others aloft makes a man a patriarch in a small city like Cedar Rapids, and this, McLeod had become. About 8,000 of the locals worked for him. He gave millions to charities and, still dabbling in education, opened his own school, the McLeod Academy, in 1993. It closed five years later because of lack of revenue.

Winning market share and acquiring networks became essential for sustaining analyst support and investor confidence. A company's stock price could not rise, otherwise. Debt was viewed less as a liability in the late '90s than as growth's instrument, a necessary precondition for building the networks and subscriber bases that, theoretically, would lead to extraordinary profitability later. The outlook fueled short-term stock gains but courted long-term disaster, especially if patience with debt, and love of EBITDA or — earnings before interest, taxes, depreciation and amortization, were to wane.

For a long time it looked like that day would never come. "Our EBITDA number came in above expectations for the first quarter," McLeod confidently said in a taped interview with Bloomberg News in April 2000, three months after his company spent $2.1 billion buying Splitrock Services. The acquisition gave McLeod a large data network — a "broadband platform" — that put his company closer, he proclaimed, to its goal of expanding into a national operation. Within another three months, he would finish a $532 million acquisition of CapRock Communications, another broadband provider.

But the Splitrock numbers in particular raised questions about whether, at $2.1 billion, the executive had bitten off too much. He responded by citing more positive EBITDA, declaring with verve that new revenue projections were strikingly higher.

He spoke in his slow, resonantly authoritative Midwestern voice. In retrospect, his declarations had an emperor-has-no-clothes quality. But on that day, the financial analysts, investors and venture capitalists were still deeply in love with EBITDA and growth.

Doubt, when it arose at all, was veiled. In a pipey, innocent voice, a reporter asked the simplest of all the day's queries, but one seldom posed to a telecom executive in the 1990s.

"When will you break even?"

There was something childlike and electric about the moment. The nakedness of McLeod's dilemma revealed itself. His voice softened. He kept his answer short and unresponsive. "We are not going to put out specific projections or bottom-line numbers, and we wouldn't care to do that today," he said.

Hitting a brick wall

Throughout the winter of 1999 and spring of 2000, McLeodUSA stock climbed, tripling its price from the year before. The analysts at big brokerage houses were enamored. Citing the company's acquisition of Splitrock, David Heger of A.G. Edwards & Sons gave McLeodUSA stock a favorable "buy" rating.

Any worries about the debt load borne by McLeod's buying spree had been allayed by reports of new venture capital streaming in, money that meant the company would be able to expand its growing network. James Henry of Bear Stearns, another analyst giving McLeodUSA stock a "buy" rating, said the company had demonstrated its "free-flow access to capital markets."

Free flow. No single phrase said more about the headiness of the times. "The economy was hot and the banks were killing each other trying to loan (McLeod) money," said an ally of Theodore Forstmann, a New York venture capitalist and buyout specialist whose firm led a mammoth investment in McLeodUSA in 1999.

Soon, each dollar of equity he raised from shareholders was more than offset by $3 to $4 of debt — most in high-yield-bond debt, but tens of millions in bank notes, which did not include hundreds of millions in annual interest payments owed. About two years later, when his company would file for bankruptcy protection, its debt would hit $4.57 billion. But on his best days, McLeod always found the money, as with the Forstmann investment.

In the first of several investments, the firm of Forstmann Little bought a 12 percent stake in McLeodUSA, a merging of Theodore Forstmann's instinct and Clark McLeod's need. "He looked me in the eye," McLeod later recalled, "and said, 'How much funding do you need to execute on your existing plan?' "

"A billion dollars," McLeod answered.

"That's what we want to put into the company," Forstmann said, and it was done.

With news of Forstmann's intervention and analysts' delight, the stock, heading toward its all-time, post-split high, climbed another dollar a share to $32.75.

No assessment of the company at that time left a greater impression on Bean than that of the star telecom analyst of Salomon Smith Barney, Jack Grubman, currently under investigation by both federal and New York state authorities for writing flattering reports of McLeodUSA, WorldCom and several other Salomon investment-banking clients headed toward fiscal catastrophe.

"People cited Grubman as a big authority," Bean remembers, "and I really paid attention. I remember this one teleconference when I could hear this voice on the phone say, 'This is Jack Grubman from Salomon.' People talked about him on TV. Jack Grubman. And then he said to the McLeod (officials), 'Congratulations, guys, on a great quarter. Nice to see a company that meets its promises.' You knew that if Grubman said something good, that was good" for the stock price.

Salomon's kindnesses to McLeod, documented in a 1999 internal Salomon memorandum obtained by congressional investigators, included giving him what it offered to WorldCom's former chief executive, Bernard Ebbers, and other prominent corporate executives: the first opportunity to buy shares in initial public offerings of limited, highly prized technology stocks, a favor tantamount to free money.

McLeod took advantage by receiving shares in Rhythms NetConnections, which opened at $21 per share in April 1999 and hit $93 in a week before heading toward bankruptcy.

Early this year, with his credibility in tatters, Grubman left Salomon.

By then the investment spigots had run dry and McLeodUSA was in ruins. "Beyond 2000, a lot of dot-coms had failed; it was a bad time for tech," observed a former telecom analyst who once enthusiastically trumpeted McLeodUSA. "The market wasn't ready for any more investment. ... EBITDA had made a few telecoms popular for years. But none was net positive. Suddenly debt was a big consideration, capital was harder to get and people started screaming, 'We want profitability.' If McLeod made a mistake, it was that he didn't see it coming; he ran right smack into a brick wall. ... By midyear (2001), you could see he and the company were done."

Giving up on national network

In early October 2001, the announcement came during a teleconference that 15 percent of company employees had lost their jobs. The company, said officials, would abandon McLeod's plan to build a national network.

In what many listeners regarded as a swipe at the vision of the company's leader, McLeodUSA's new chief operating officer, Chris Davis — who had helped preside over a successful reorganization of the ailing Gulfstream Aeronautics for Forstmann and would later become McLeodUSA's chairman and chief executive — reported that McLeodUSA suffered from "operational inefficiencies." Privately, a pair of Forstmann's colleagues later said that McLeod had overspent. McLeod remained as chairman for the time being, but the teleconference spelled his end as the leader.

In April, McLeod announced his "retirement" from the company he founded, looking drawn and forlorn as he stood next to Forstmann, whose firm had taken 58 percent voting control of the company.

The once stoic people around Cedar Rapids started talking, bitterly: A grandmother complained that the tens of thousands she'd invested for her grandchildren's education was gone; a once heavily invested McLeod employee lost a house, settling into a trailer. "One morning the realization comes it's all gone," Bean said, "and that's a big hill to climb."

He felt betrayed. "I believe we were being misled by McLeod people, especially during (2001)," he said, wondering why McLeod did not or could not rein in colleagues when they fervently denied the company's ills. "I don't expect people to say, 'We're in trouble.' But I do expect them not to say, 'We're not in trouble,' if there is trouble. Don't tell me you're going to be funded if you're gonna be bankrupt in a couple of months. Somewhere along the line someone like Clark had to know that what they were putting out was not true. Maybe there's a moral obligation not to just save your own skin. People got greedy. Maybe I got a little greedy, too."

What McLeod mostly does these days is maintain a low profile and keep moving, part of the new American Diaspora — that trail of failed and ousted CEOs pondering their next moves.

Neighbors report they have seen him walking alone around Clearwater Farm, lingering in meadows where the grass nowadays sometimes looks higher, leaving them to wonder whether he is cutting back on mowing and maintenance.

"He's still busy," his mother said. "But things are complicated now."

Tomorrow: The Reporter