Message-ID: <28425454.1075858866305.JavaMail.evans@thyme> Date: Mon, 22 Oct 2001 11:36:12 -0700 (PDT) From: issuealert@scientech.com To: issuealerthtml@listserv.scientech.com Subject: Enron's Departure from Core Business Takes a Toll on Performance Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: quoted-printable X-From: IssueAlert@SCIENTECH.COM X-To: ISSUEALERTHTML@LISTSERV.SCIENTECH.COM X-cc: X-bcc: X-Folder: \SKEAN (Non-Privileged)\Kean, Steven J.\Deleted Items X-Origin: Kean-S X-FileName: SKEAN (Non-Privileged).pst Today's IssueAlert Sponsors:=20 SCIENTECH is currently interviewing 1,500 utilities on CIS/CRM and customer= care in the United States and Canada to determine:=20 The leading software providers=20 Drivers of utility technology decisions=20 Analysis of license sales versus ASP sales=20 New market opportunities=20 Growing/shrinking software markets=20 Download a sample prospectus for an introduction to this new survey at: and=20 contact Jon Brock at 505-244-7607 for more details. =20 Miss last week? Catch up on the latest deregulation, competition and restru= cturing developments in the energy industry with SCIENTECH's IssuesWatch =20 October 22, 2001=20 Enron's Departure from Core Business Takes a Toll on Performance=20 By Will McNamara Director, Electric Industry Analysis=20 [News item from Reuters] Enron Corp. (NYSE: ENE) stock sustained further he= avy losses on October 19 as investor confidence in the former Wall Street f= avorite remained at a low ebb after it reported its first quarterly loss in= over four years. The energy giant's stock was off $3.32 or 11.45 percent a= t $25.68 per share at mid-day trade on Oct. 19, making a cumulative loss of= 28 percent for a week in which it reported a third-quarter loss of $638 mi= llion. As of early morning trading on Oct. 22, Enron shares were priced at = $21.99, a reflection of new developments (including a new Securities and Ex= change inquiry) that have caused uncertainty about the company among invest= ors.=20 Analysis: Enron's first financial report since the departure of former CEO = Jeffrey Skilling in August has not done much to once again instill investor= confidence in the company, which has experienced one of its most turbulent= years in recent memory. While Skilling cited personal reasons for his depa= rture, many analysts suspected that a significant drop in Enron's share pri= ce and financial losses in its diversified businesses also played a role. A= t the time of Skilling's departure, Enron's stock had tumbled to a 52-week = low. However, based on the new 3Q report, it now appears that Enron's downw= ard turn may be continuing despite the return of Kenneth Lay to the company= 's top spot. In essence, Enron's financial problems have been caused by bus= inesses that the company has established as a way to diversify from its cor= e focus on wholesale power sales. It appears that Enron is learning a costl= y lesson-namely that investors are not responding favorably to the company'= s innovation, especially if bottom line performance is in any way compromis= ed. The road ahead may remain uncertain for Enron, as a good number of unre= solved issues and a new Securities and Exchange Commission (SEC) inquiry in= to financial dealings of its chief financial officer continue to overshadow= the company.=20 Let's first establish the financial losses that Enron has reported in the t= hird quarter. As noted, as a whole the company reported $638 million in los= ses, after taking $1.01 billion in charges associated with several of its n= on-core businesses. When we break down the losses, it becomes clear that En= ron is struggling with its operations in three businesses: water, broadband= and the retail power market. Specifically, Enron reported $287 million in = charges from Azurix, its water and wastewater business; $180 million in cha= rges related to the downsizing of its broadband operations (including sever= ance costs and losses on inventory sales and customer contracts); and $544 = million in what the company is calling "investment losses." Evidently, abou= t half of the $544-million figure is related to Enron's investment in NewPo= wer Company, the retail electricity and natural-gas provider that Enron lau= nched about two years ago with partners America Online and IBM. Enron owns = 45 percent of NewPower. In addition, Enron's debt to total capitalization r= atio reportedly will increase to about 50 percent, although Lay says that p= ending asset sales may reduce that amount to 40 percent by the end of 2002.= However, it is important to note that Enron's 3Q recurring net income (bef= ore the write-offs) did increase 35 percent to $393 million, or 43 cents a = diluted share, and revenue in the quarter rose to $47.6 billion from $30 bi= llion in 3Q 2000.=20 The losses associated with NewPower are particularly interesting. As one of= the leading investors in the company, Enron drove NewPower's aggressive bu= siness focus on retail residential power sales, despite ongoing concerns ab= out the development of retail competition across the United States. NewPowe= r went public last year at an opening price of $21, and in the early days o= f its initial public offering was trading above that price. However, the co= mpany's stock has experienced a devastating drop in value, and is currently= priced at $1.25. NewPower is not scheduled to release its own 3Q financial= statement until early November, but it is expected that the company will c= ontinue to incur significant losses for the foreseeable future. Specificall= y, NewPower recently reiterated its earlier expectations of a 3Q loss of $6= 5 million to $70 million, or $1.12 to $1.20 a share. Third-quarter revenue = reportedly will be slightly lower than the $60 million to $65 million that = the company had forecast in August.=20 In analyzing NewPower's 2Q financial losses (see IssueAlert from 8/8/01 at = www.scientech.com/rci ), I argu= ed that the company is really struggling from a mix of positive and negativ= e factors in its efforts to become the leading retail energy provider in re= sidential and small business markets in the United States. On the positive = side, NewPower has recently secured a large number of new customer accounts= , most significantly from its purchase of customers and related assets from= AES Corp. and DTE Energy. These purchases prompted an impressive growth sp= urt for NewPower, and the company reportedly now has a customer base in 22 = markets in 10 states. However, the bad news for NewPower is that its losses= continue to widen, apparently resulting from a combination of weather fact= ors and financial hits absorbed in several of the states in which the compa= ny operates. This dichotomy does not appear to be getting any better, and t= he company's stock has continued to drop as a result.=20 In an effort to alleviate some of its financial woes, NewPower recently rev= ised an existing master netting agreement with Enron Corp. and several of i= ts subsidiaries. The revised agreement essentially lowers the amount of cas= h collateral that NewPower is required to post to the Enron subsidiaries th= rough Jan. 4, 2002. With the lowered financial obligations that it must mak= e to Enron, NewPower believes that it will have sufficient financial resour= ces to conduct its business in the near term until it secures ongoing asset= -based financing.=20 However, from Enron's perspective, the losses associated with NewPower (and= , by the same token, the losses in water and broadband) have contributed to= a steady drop in its own stock price. The message is clear: The businesses= that Enron plunged into as a way to diversify have tainted the company as = a whole. Further, what some analysts perceived as brash hubris on Enron's p= art has not translated into measurable profits, and consequently Wall Stree= t has reacted by sending Enron's stock to a level that is about half of whe= re it was a year ago. The individual sectors that Enron has pursued are all= unique, but they share the common denominator of taking Enron away from wh= at was a successful core business. Further, they are similar in that Enron = aggressively sunk large sums of capital into new business lines for which i= t arguably had unrealistic expectations for growth. The problem with Enron'= s bandwidth unit is that the company has faced an unanticipated excess of f= iber-optic lines, which has prevented the demand for the division's service= s from materializing as anticipated. The problem with Azurix, which has bee= n losing money since its formation in 1998, is that privatization of the wa= ter sector has not materialized as quickly as Enron and other companies ant= icipated. In addition to these problem areas, Enron also faces challenges r= elated to its investments in India (where it is locked into a legal battle = with the state government) and California (from which Enron has yet to rece= ive full payment for previous power sales).=20 In addition to the losses outlined in the 3Q report, there are new issues t= hat are brewing at the start of this week. First, the SEC has requested tha= t Enron provide information regarding "certain related party transactions."= Not much additional information is presently available about this inquiry.= However, it is probably connected to earlier reports about concerns relate= d to the dealings of Enron's Chief Financial Officer Andrew Fastow, who up = until very recently had run a limited partnership that bought assets from E= nron. Ken Lay has said that Enron will cooperate fully with the SEC's reque= st. In a separate development, several mutual funds (including AIM Constell= ation that once held large positions in Enron) have either liquidated or re= duced their holdings in the company, which has further weakened Enron's sto= ck value. Portfolio managers of the mutual funds have cited concerns about = Enron's ability to balance its new businesses with its core strength as an = energy trader.=20 The present challenge for Enron is to convince investors that the company r= emains on solid ground despite the losses. Thus, Lay has been quick to reit= erate that earnings from the company's energy and gas-pipeline business are= still strong. Further, Lay says that the charges reported in the third qua= rter should be seen as a way to "clear away issues that have clouded the pe= rformance and earnings potential of our core energy businesses." Neverthele= ss, the fact remains that Enron has invested huge amounts of money toward i= ts diversification effort, and in addition to water and broadband the compa= ny has invested into the steel and pulp and paper sectors as well. Thus, se= veral questions remain at this juncture. Are the losses reported in the thi= rd quarter only a temporary setback for Enron that will clear the way for t= he company to return to a primary focus on its core business of energy trad= ing? Or, will the losses continue into the fourth quarter and 2002? Moving = forward, will Enron once again reshape its business model and eliminate the= various businesses to which investors have reacted less than favorably? On= ly time will tell as the industry continues to watch the developments at En= ron, which is clearly a company in the midst of another wave of change.=20 An archive list of previous IssueAlerts is available at www.scientech.com =20 We encourage our readers to contact us with their comments. We look forward= to hearing from you. Nancy Spring Reach thousands of utility analysts and decision makers every day. Your com= pany can schedule a sponsorship of IssueAlert by contacting Jane Pelz . Advertising opportunities are also available on o= ur Website.=20 Our staff is comprised of leading energy experts with diverse backgrounds i= n utility generation, transmission & distribution, retail markets, new tech= nologies, I/T, renewable energy, regulatory affairs, community relations an= d international issues. Contact consulting@scientech.com or call Nancy Spring at 1-505-244-7613.=20 SCIENTECH is pleased to provide you with your free, daily IssueAlert. Let u= s know if we can help you with in-depth analyses or any other SCIENTECH inf= ormation products. 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