Smaller Rival to Acquire Teetering Enron
Enron Corp., the once-highflying energy giant whose aggressive efforts to profit from California’s energy deregulation made it a target of consumer and political backlash, on Friday agreed to be saved from possible financial collapse through a proposed acquisition by rival Dynegy Inc.
The roughly $7.7-billion deal is a stunning plot twist for Houston-based Enron, which was vilified in California as it was being glorified on Wall Street. In only the last month, a series of disturbing financial revelations pushed to the edge of ruin this once-powerful company, whose top executives had lectured California on its energy foibles and who influenced the direction of national energy policy.
Enron muscled its way to the top of the energy heap using aggressive and, in the end, financially suspect strategies that proved its undoing.
Now, the company that late last year had a market value of $63 billion is worth one-tenth that and has agreed to be swallowed by a cross-town competitor one-quarter its size. Enron’s proud and influential chairman and chief executive, Kenneth L. Lay, who became a focus of bitter attacks by California politicians and regulators, would lose his job, as would many others at Enron.
Even the name would disappear. The combined company would be called Dynegy Inc. if the deal receives all the necessary regulatory and shareholder approvals.
California officials took no joy in Enron’s fate Friday, though there was perhaps some sense of retribution from its many critics in the state.
“This is basically a rogue corporation,” said Sen. Steve Peace (D-El Cajon), an outspoken critic of Enron for years who dealt with the company as he chaired the committee that hammered out the legislative portion of California’s landmark electricity deregulation plan in 1996. “It has from the beginning been a rogue corporation which answered in its mind to a higher law--a fundamental belief that there are laws of economics that supersede the law of the land.”
A Failed Experiment
Steve Maviglio, spokesman for Gov. Gray Davis, said that although Enron was never a major force in California’s doomed electricity market, it was outspoken in support of deregulation.
“In a sense, their experiment was much like California’s experiment--a failure,” he said.
Said Harvey Rosenfield, president of the Foundation for Taxpayer and Consumer Rights in Santa Monica: “Nothing could better illustrate the disaster of deregulation than the fact that one of its biggest proponents, which reaped the reward of deregulation, is suffering the consequences.”
Enron is the world’s largest energy trader, handling one of four energy deals in the United States through its online trading operation, EnronOnline. Since it reported a surprising third-quarter loss on Oct. 16, partly tied to shadowy investment vehicles, Enron has endured a huge loss of investor confidence, which brought on a massive cash crunch and some shrinkage of its trading business.
Under the deal announced Friday, Dynegy, invited in two weeks ago after Enron fell short in its efforts to line up new financing, would immediately help Enron by pouring $1.5 billion in cash into the company. The money would be provided by ChevronTexaco Corp., the San Francisco oil company that owns nearly 27% of Dynegy.
Enron shareholders would get 0.2685 Dynegy share for each Enron share, which values the company at about $7.7 billion based on Friday’s stock close. Dynegy shares surged $2.26 to close at $38.76 per share on the New York Stock Exchange; Enron added 22 cents to close at $8.63 per share, still off 89% year to date.
If the deal closes in six to nine months, as the parties expect, Dynegy and ChevronTexaco would invest $1 billion additionally in the combined company.
“This is just a financial bonanza really for both companies,” said Charles L. Watson, Dynegy chairman and chief executive, who will head the combined company. Watson said the merger would immediately add to Dynegy’s earnings.
Even so, the repercussions of Enron’s fall from grace could be far-reaching. Coming on the heels of California’s energy crisis, Enron’s troubles may slow the country’s march toward energy deregulation, which Lay and Enron championed for years as a potential boon to consumers and the economy in general.
But the deal announced Friday will prevent an even worse outcome, energy experts said: the threatened collapse of Enron, which would clog up for a time the business of buying and selling electricity, natural gas and oil. That could interfere with delivery of energy around the country, they said.
“This is an encouraging development for the energy industry,” said Stephen Baum, chairman of Sempra Energy, the San Diego-based parent of Southern California Gas and San Diego Gas & Electric. “The Enron-Dynegy combination will create a credit-worthy counter-party which will help preserve order in the marketplace. It also will reinforce confidence in the energy trading business going forward.”
But some in the industry are less pleased.
Raymond Plank, chairman of Apache Corp., a Houston-based natural gas exploration and development firm, said he is considering a motion to the Federal Trade Commission against the proposed merger.
“There are issues of concentration in a combination of the largest energy trader, Enron, and the fifth-largest, Dynegy,” Plank said. “California should be particularly concerned because Dynegy owns power plants there and Enron has pipelines and other interests.”
Troubles Mount as Stock Plunges
The swagger that was Enron is long gone. Consider:
* Enron’s brash chief executive, Jeffrey K. Skilling, touted only months ago as one of the young stars of American business, abruptly resigned in August, citing personal reasons. Enron’s stock already had fallen from its high of nearly $90 per share as investments in water and telecommunications turned sour, a fact that contributed to Skilling’s departure.
* The Securities and Exchange Commission has launched an investigation of Enron’s controversial dealings with a number of limited partnerships, some organized and run by Enron managers, including Enron Chief Financial Officer Andrew S. Fastow, who was ousted last month.
* In an extraordinary confession Thursday, Enron announced that it had overstated profit by $586 million, or 20%, during the last five years. The earlier financial statements reported to Wall Street and the investing public, Enron said, “should not be relied upon.”
* The company also fired its treasurer and a corporate lawyer, both of whom it said were investors in one of the limited partnerships. Yet some analysts questioned whether, even in its admission of accounting trickery, Enron wasn’t still holding something back.
* Credit-rating agencies, which already have downgraded Enron’s bonds to barely above “junk” status, continue to pore over Enron’s books. Analysts have said a further downgrade to the level of junk, or below investment grade, could precipitate a crisis akin to a run on a bank and threaten Enron’s survival while the merger is pending.
With its stock crumbling and trading partners leery about its ability to pay its debts, Enron was forced to walk hat in hand down Houston’s Energy Alley to negotiate a saving takeover by Dynegy, the rival once jokingly dismissed as “Enron Lite.”
In the trading markets where Enron still holds a leading but increasingly vulnerable position, other players already are stepping up to grab a bigger share of the business. Even if Enron’s trading operation survives more or less intact, under the wing of a Dynegy or some other company, experts said it may never regain its former level of dominance.
“Enron has been a very innovative shop, willing to spend considerably to establish new markets,” said analyst Andre Meade of Commerzbank Securities in New York. “If that culture is not kept, everyone loses.”
Skilling and mentor Lay had worked for a decade to create both a new kind of company and a new set of markets for it to play.
In large part, they succeeded. Enron transformed itself from a traditional gas pipeline company into a high-tech global trader of everything from electricity to pollution credits to aluminum. The company’s overarching strategy was to pare its physical assets to the minimum to get the maximum profit bang from its intellectual capital: the ranks of MBAs and PhDs that filled its Houston trading floor.
Rather than maintain its own expensive gas fields and power plants--which it relegated to stodgy utilities and oil companies--Enron would handle everything by contract, relying on a network of suppliers to obtain, store and deliver the goods while the company focused on squeezing out the best price.
Dynegy, in contrast, has invested in such energy assets, including three power plants in Southern California. It uses those assets to back its trading operation, which is much smaller than Enron’s.
Enron pulled off a migration from the “dirty” extreme of the oil patch, the asset-intensive domain of drillers and explorers, to the “clean” end, where all the deals are done on a computer screen. It also was a migration from lower profit margins and lower risk to high margins and high risk.
Shannon B. Burchett, chief executive of Risk Limited Corp., an energy-oriented strategic-management consultancy in Dallas, compared Enron to the investment bank Salomon Bros., where he used to work in the former PhiBro commodities unit.
Enron, Burchett said, embodies “a Wall Street culture that happens to be in Houston.”
Wall Street certainly “got it,” or thought it did.
Accounting Rules Pushed to the Limit
At Enron’s zenith last year, when its stock peaked near $90 a share and it was pushing into esoteric markets for weather derivatives and fiber-optic bandwidth, Enron seemed to be a one-company wave of the future.
Enron’s aggressiveness, brainpower and willingness to back radical new ideas with serious capital helped it acquire an aura that in some ways was its undoing, analysts said.
Investors accorded Enron’s stock a price-to-earnings valuation that was consistently higher than those of its peers, reflecting the view that its cutting-edge business model could consistently deliver faster-growing profit than its competitors.
To keep profits arcing ever upward to justify the outsize valuation, Enron began pushing the accounting rules as hard as it pushed competitors in the trading arena. It acknowledged as much in its statement Thursday, conceding that the operations of three of the limited partnerships should have been consolidated with Enron’s own financial statements instead of being held separate.
By raising capital and running deals through the limited partnerships, Enron could keep large amounts of debt and certain volatile assets off its own balance sheet, while simultaneously booking profit from the partnerships’ transactions, analyst Meade said.
Deals Backed by Costly Guarantees
One risky aspect of some of Enron’s deals through the partnerships was what Meade called a “double-trigger guarantee,” under which Enron would pledge a cash payout if either its bond rating fell below investment grade or its stock declined below a certain price.
The guarantees must have seemed a cheap way to sweeten a deal when Enron’s stock was flying high, but they came back to haunt the company later, when it had to pay cash to make good on its obligations, Meade said.
Other energy-trading companies use similar devices, but Enron carried it to an extreme and disclosed too little detail to make the process understandable to investors, he said.
Enron’s magic, like that of the Internet-stock phenomenon, had never been easy to understand in the first place. The company had a reputation among analysts for providing scanty financial detail and hard-to-grasp explanations of some of its dealings.
But as long as the reported profit kept climbing, Enron kept getting the benefit of the doubt.
M. Carol Coale, a respected Houston-based analyst for Prudential Securities, ruefully recalled a time last winter when she told Enron she could find “no positive catalyst for the stock” and was considering downgrading her investment opinion.
Skilling telephoned Coale and asked her to hold off, promising her that there was unspecified good news on the horizon that would justify her faith.
“I believed him,” Coale said last week in an interview in Houston. She held her rating steady at that time but has since downgraded Enron to an outright “sell.”
Instead of Skilling’s promised good news, questions mounted during the spring, and Enron’s stock continued a steady decline. Coale and other analysts were troubled that a large proportion of Enron’s earnings seemed to come not from its core trading operations but from unusual transactions involving the company’s own stock or that of affiliates.
In California, Enron played a key role as chief cheerleader for electricity deregulation and a key energy middleman in the state. As wholesale electricity prices soared and the state plunged into its energy crisis late last year, Enron and other out-of-state electricity generators and traders became favorite targets of California politicians and regulators, who said the companies were manipulating the market and charging too much for power.
But significantly, California was not a directly successful territory for Enron.
Markets in water did not develop as Enron subsidiary Azurix envisioned. And Enron’s plans for selling electricity to retail customers were deferred even as deregulation took effect in 1998 because the state’s deregulation formulas didn’t allow room for retail competition.
Lay complained about California frequently and met with the governor to try to influence the state’s moves to repair its energy problems. In an interview in his Houston office in January--overlooking Enron’s new headquarters building, which is still under construction as the company’s name disappears--Lay said he and other Enron executives had objected to the way California regulation was set up.
“We objected more vehemently than anyone. We opposed the concept of the pool,” he said, referring to the now-defunct California Power Exchange, in which most of the state’s power was bought and sold in an hourly market. “What competitive market in the world has a pool? We don’t buy our groceries through a centralized PX.”
Enron also backed away from building a small power plant in California last year when the state imposed price caps.
One of the loudest complaints by Davis and other California officials was that generators of electricity were playing “games” to get higher prices.
They criticized Enron severely, too, even though it was not a major generator, because the level of its worldwide trading operations--buying and selling contracts worth billions of dollars in electric power every day--gave Enron immense sway over pricing and supplies of electricity. They also believe that Enron and Lay helped play a part in the reluctance of federal regulators for several months to place restraints on the California marketplace.
CEO’s Future Role Uncertain
“Millions of people in California businesses lost money because this rogue company succeeded in controlling the government of the United States,” said state Sen. Peace, one of the architects of the state’s deregulation plan.
“Ken Lay was a mystic,” Peace said. “Whatever he said had to make sense because he was Ken Lay. It was hero worship.
“Many of the people working as economists at the Federal Energy Regulatory Commission worshiped Ken Lay. As a consequence, the things Enron promoted and pushed for were never challenged, intellectually and otherwise.”
Lay, who has been asked to sit on the board of the combined company, said Friday that he had not yet decided whether to accept.
He described his time building Enron as “a very long ride. It’s been a very good ride for the most part.
“I have to say the last few weeks have not been very much fun,” he said.
*
Rivera Brooks reported from Los Angeles and Mulligan from Houston and New York. Times staff writer James Flanigan in Los Angeles contributed to this report.
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