Message-ID: <32109781.1075855425057.JavaMail.evans@thyme> Date: Fri, 2 Nov 2001 10:07:34 -0800 (PST) From: m..schmidt@enron.com To: karen.denne@enron.com, meredith.philipp@enron.com, j..kean@enron.com, vance.meyer@enron.com, pr <.palmer@enron.com>, sarah.palmer@enron.com, courtney.votaw@enron.com, mary.clark@enron.com, pat.radford@enron.com, leslie.hiltabrand@enron.com Subject: Business Week: The Enron Debacle Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: quoted-printable X-From: Schmidt, Ann M. X-To: Denne, Karen , Philipp, Meredith , Kean, Steven J. , Meyer, Vance , Palmer, Mark A. (PR) , Palmer, Sarah , Votaw, Courtney , Clark, Mary , Radford, Pat , Hiltabrand, Leslie X-cc: X-bcc: X-Folder: \Steven_Kean_Jan2002\Kean, Steven J.\PR-Crisis Management X-Origin: Kean-S X-FileName: skean (Non-Privileged).pst NOVEMBER 12, 2001=20 FINANCE=20 Business Week The Enron Debacle Byzantine deals have shattered the energy outfit's credibility http://www.businessweek.com/premium/content/01_46/b3757078.htm Graphics: http://www.businessweek.com/premium/content/01_46/b3757079.htm http://www.businessweek.com/premium/content/01_46/b3757080.htm Executives at high-flying Enron Corp. (ENE ) never seemed overly concerned = with how the rest of the world viewed their business practices. Earlier thi= s year, the California Attorney General had to get a court order to collect= documents in an industrywide investigation into energy price fixing. And w= hen an analyst challenged former CEO Jeffrey K. Skilling in a conference ca= ll to produce Enron's balance sheet, Skilling called him an "ass----." Stil= l, even some Enron executives worried that the company had gone too far wit= h two complex partnerships set up in 1999 to buy company assets and hedge i= nvestments. With Enron's then-chief financial officer acting as general man= ager of the partnerships and in a position to personally benefit from their= investments, the potential for a conflict of interest and backlash from in= vestors seemed overwhelming. "Internally, everybody said this is not a good= idea," says a source close to the company. But no one could have predicted such a jaw-dropping outcome for the nation'= s largest and most innovative energy trader. Since Oct. 16, when Enron reve= aled a $35 million charge to earnings to reflect losses on those partnershi= ps and was forced to knock $1.2 billion off its shareholders' equity, the c= ompany's stock has plunged 60%. The Securities & Exchange Commission is inv= estigating Enron's accounting for its partnerships and whether it properly = disclosed them to investors. Suddenly the company, which brought high-tech and complex finance to energy= trading, is essentially trying to avoid a run on the bank. Moody's Investo= rs Service has already downgraded the company's debt. Enron says it is meet= ing with credit agencies to calm their fears, and analysts say Enron is wor= king on a turnaround plan that would likely include accelerating asset sale= s, issuing shares, and obtaining new credit lines. Enron's board has set up= a special committee to look into its controversial partnerships. But analy= sts also worry that Enron's trading partners could pull the plug if they lo= se confidence that it can honor its trades. "ON CRACK?" Inside Enron, once-cocky employees are reeling. They were still= puzzling over the abrupt Aug. 14 departure of CEO Skilling when the compan= y announced on Oct. 24 that CFO Andrew S. Fastow, architect of the controve= rsial private LJM investments--which got their name from the first initials= of his wife and children--was removed from his post and on leave. In a ten= se meeting held at a Houston hotel after the latest financial disclosures, = soft-spoken Chairman and CEO Kenneth L. Lay faced 1,600 employees, with ano= ther 5,000 hooked up via the Web. One irate worker asked if he was "on crac= k." Lay, an economist by training, turned over day-to-day management in 199= 7. Until Skilling quit, citing personal reasons unrelated to Enron, Lay was= talking about retirement, sources say. Now he is facing his biggest fight = ever. "Ken is looking at a 30-year career of accomplishment going down in f= lames. This is just awful," says one friend. On the surface, at least, Enron's off-balance-sheet maneuvering hardly seem= s the stuff that would crater a company. Amazingly, sources close to Enron = claim that one rationale for Fastow's deals was to save an estimated $30 mi= llion a year in investment-banking fees. Fastow's involvement in the partne= rships, which bought assets from Enron, including stakes in telecom and ene= rgy, was supposed to make the deals simpler for the investment bankers and = thus cheaper. They were also meant, according to sources close to the compa= ny, to hedge Enron's investments in potentially risky assets while allowing= it to maintain some control over them. Enron says Fastow made money for hi= mself on some of the deals, but insiders insist there were less controversi= al ways to enrich him if that were the aim. Fastow did not return calls see= king comment. Lay, who declined to comment for this story, has said that th= e partnerships were properly vetted by Enron's attorneys and internal and e= xternal auditors and were approved by its board. A source familiar with Enr= on agrees: "We had the best lawyers in the world saying, `It looks fine."' But whatever Enron's reasons for creating the LJM partnerships, the problem= s were compounded by scanty disclosure. The deals were first revealed in a = 1999 proxy, raising concerns from investors and analysts. By this summer, w= hen Enron's stock was falling and its bets in broadband were souring, compl= aints about LJM grew louder. So in June, Fastow pulled out of the partnersh= ips. When the write-offs came, Enron enraged analysts and investors further= by failing to disclose the hit to equity in its third-quarter earnings pre= ss release. Instead, Lay mentioned it in a conference call with analysts. "= We found it disconcerting that the company waited to disclose the additiona= l $1.2 billion charge to equity in a fleeting comment in the middle of its = conference call," says UBS Warburg analyst Ronald Barone. BAD BETS. Still, Enron's credibility did not vanish overnight. Analysts hav= e been lobbying for years for more information about how and where Enron ma= kes its money in its often byzantine trading business. While the company's = revenues were soaring from $9.2 billion in 1995 to $100.8 billion in 2000 a= nd its stock was returning 500% during the same six-year period, Enron's ag= gressive, even arrogant managers could ignore Wall Street's complaints with= impunity. But after its stock price collapsed this year (chart), the compa= ny's attitude and operational missteps quickly caught up. And there was ple= nty to worry about. The company's $3 billion power plant in India wasn't pa= ying its bills amid a political controversy; its highly ballyhooed business= for trading high-speed communications capacity was crippled by the telecom= industry meltdown; and its calamitous foray into the water business with A= zurix Corp. has already cost Enron at least $574 million in write-offs. These bad bets and the expensive LJM shock have investors worried about wha= t else might be lurking at Enron. Many aren't sticking around to find out. = "I think the lack of disclosure on their financial engineering killed the c= redibility of the management team," says Richard A. Giesen, who manages the= Munder Power Plus fund, which dumped its Enron shares about a month ago. It's not clear just how many off-balance-sheet financing vehicles Enron has= used over time. Some were created years ago to finance oil and gas produce= rs. Analysts and sources close to the deals say there's no particular risk = in these to Enron shareholders. Other interconnected entities, such as Whit= ewing, Osprey, Atlantic Water Trust, and Marlin Water Trust, were a way to = get assets no longer central to Enron's strategy off its balance sheet, fre= eing capital and credit for the core energy business and ventures like broa= dband (table). To entice institutional investors such as pension funds and insurers into t= hese deals, Enron promised to kick in equity if asset sales weren't enough = to cover debt. Such "mandatory equity" deals have been used by at least a h= alf-dozen others in the energy and telecom industries, including El Paso (E= PG), Williams, and Dominion, says Standard & Poor's director Todd A. Shipma= n. "Nobody's going to find anything that's particularly unique or below boa= rd" in such deals, says one investment banker specializing in the energy bu= siness. Worst case, which Shipman considers unlikely, Enron could be on the hook fo= r about $3 billion in its mandatory-equity deals. That could mean diluting = its shares by more than 25% at today's prices. Analyst John E. Olson at San= ders Morris Harris Inc. (SMHG ) figures a 9% dilution is more likely. Even = if this $3 billion in debt were included on Enron's balance sheet now, the = debt-to-capital ratio would climb to 54% from about 49% at the end of June.= Such a change would pressure Enron's credit rating but not push it below i= nvestment grade, says Shipman. HUGE HIT. Fastow's LJM, a private equity fund, was a different kind of anim= al, according to sources familiar with the arrangements. It bought energy a= nd other assets from Enron, which booked gains and losses on those deals. L= JM was also involved in complex hedging that was supposed to reduce the vol= atility of some of Enron's investments, including stakes in high-tech and t= elecom businesses and an interest in New Power Co., which markets power to = consumers. When Enron terminated these deals in September, it took the $1.2= billion hit to equity. But the more immediate question is whether trading partners will stick with= the company. The first place that might show up is in Enron's highly succe= ssful online platform, which trades everything from gas and electricity to = weather derivatives. To reassure its partners, Enron is scrambling to shore= up its liquidity. It has already tapped $3 billion in credit lines and is = trying to arrange another $1 billion. Shipman says he has seen no signs of = massive customer defections or drastically worsened credit terms. Still, ri= val traders are wary. "We certainly have taken a closer look at Enron in th= e last week to 10 days and will continue to manage the credit risk, but we'= re still doing business with the company as usual," says Keith G. Stamm, CE= O of power and gas trader Aquila Inc. (ILA ) "SPEEDING TRAIN." Still, with the stock battered and rating agencies consid= ering further downgrades, that could rapidly change. In recent days, the un= certainty about Enron's future has reduced investors' appetite for Enron de= bt. "No one wants to speculate on the direction or their likelihood of surv= ival," says a credit-derivatives salesperson. "It's really difficult to get= in front of a speeding train." Even if Lay can calm his trading partners, he and his management team face = a much tougher task of restoring their credibility on Wall Street. With the= stock now hovering around $14--down from a high of $90 in August, 2000--so= me even believe that Enron could be a takeover target for the likes of GE C= apital or Royal Dutch/Shell Group. (RD ) Both declined to comment. Would En= ron sell? One source close to the company says Enron has talked about possi= ble mergers and strategic alliances in the past with Royal Dutch/Shell, amo= ng others. "If they're really worried about liquidity, they might take the = easy way out," he says. If Enron does pull through this crisis, some suspect it will be a humbler, = more risk-averse place. The company that once believed it could expand its = trading and logistics empire to all manner of commodities--from advertising= space to steel--will be forced to scale back its grandiose visions. That's= something some investors applaud. "The company should focus on its strengt= hs," says William N. Adams, senior energy analyst at Banc of America Capita= l Management, a major shareholder. But that's a far less exciting place tha= n Enron's energy cowboys ever hoped to roam.=20 By Stephanie Anderson Forest and Wendy Zellner in Dallas, with Heather Timm= ons in New York NOVEMBER 12, 2001=20 FINANCE=20 Business Week Derivatives Danger? http://www.businessweek.com/premium/content/01_46/b3757081.htm Lately, owners of Enron's (ENE) equity, bonds, and loans have been struggli= ng to understand how exposed the company is to risks of losses that they di= dn't know about before. Now, as a fuller picture of Enron's entanglements w= ith partnerships begins to emerge, investors have something else to worry a= bout: credit default swaps, known as CDSs for short. That's financial marketspeak for insurance on bonds and bank loans. Their o= wners pay a premium for coverage that reimburses them for any losses they h= ave if their investments go bad. The CDS market has existed only for about = two years, but it's growing fast. Goldman, Sachs & Co. (GS ) and others est= imate that bonds and loans with a face value of between $1 trillion and $1.= 5 trillion are covered. Not surprisingly, big banks with hefty balance shee= ts such as J.P. Morgan Chase (JPM ), Merrill Lynch (MER ), and Deutsche Ba= nk (DB ) dominate the market. Enron, however, is a player--and the only significant one that isn't also a= bank. Competitors say that although Enron has issued only between $500 mil= lion and $700 million worth of CDSs so far this year, it had ambitious plan= s to offer them online. "They don't belong in this market," says one trader= . "They don't understand the implications." Enron did not return calls seek= ing comment. Of course, neither Enron nor others will have to pay out unless the loans a= nd bonds they're insuring turn bad. Trouble is, this year is potentially a = doozie for losses on corporate debt. Corporate defaults could reach a recor= d of $100 billion, says Standard & Poor's, like BusinessWeek a unit of The = McGraw-Hill Companies. Regulators say shaky bank loans hit a record $193 bi= llion by early October. If Enron has insured any of the bad debt, it might have to take charges for= losses if they exceed the premiums it has been getting. With all that has = been happening in recent weeks, that's the last thing it needs.=20 By Heather Timmons in New York NOVEMBER 12, 2001=20 FINANCE=20 By Mike McNamee Commentary: Enron's Clout Won't Sway the SEC=20 http://www.businessweek.com/premium/content/01_46/b3757082.htm For Securities & Exchange Commission Chairman Harvey L. Pitt, the SEC's inv= estigation into Enron Corp. (ENE) could hardly have come at a worse time. T= he future of Pitt's ambitious agenda of reforms in securities regulation co= uld depend on how well he handles this case. Enron's political clout and close ties to President George W. Bush create r= eal risks for the SEC. Enron CEO Kenneth L. Lay is a longtime Bush backer, = and the company was the biggest corporate contributor to the President's ca= mpaign. A Bush appointee, Pitt is attempting a delicate balancing act. He h= as made it clear he wants to speed up the SEC's enforcement, in part by rew= arding companies that cooperate with probes. But he insists the SEC will st= ill come down hard on true corporate miscreants--and knows that any signs o= f let-up could jeopardize the rest of his reform agenda. Enter the Enron probe. The fine shadings of securities enforcement--where m= ost cases are settled by negotiated penalties, not court-imposed fines--oft= en make it hard for outsiders to tell whether the SEC is being tough or len= ient. But Pitt must go out of his way to make it clear that the Enron case = is handled by the book--getting the same strict scrutiny from the SEC as an= y other, less connected company. For now, top SEC aides say that's happening. The SEC Enforcement Div. in Wa= shington is looking into whether Enron adequately disclosed to shareholders= the risks of its complex deals with Andrew S. Fastow, the company's former= chief financial officer. Agency insiders say Pitt and his fellow commissio= ners will be briefed on the case as it proceeds. But they insist Pitt hasn'= t heard from the White House or Enron's other political allies. TOP LOBBYIST. Enron's connections are numerous. Besides Lay's links to Bush= , an Enron director, Wendy Lee Gramm, is the wife of Texas Senator Phil Gra= mm, top Republican on the Senate Banking Committee. And Enron spreads its l= obbying budget--$2.13 million in 2000--across both parties. Just this year = it hired four lobbying firms with Democratic roots. Enron says it lobbies h= eavily because it operates in regulated industries. It notes that electric = utilities outspend it 35 to 1. On Oct. 31, a special committee of Enron's board hired William R. McLucas, = former SEC enforcement director, to represent it. McLucas should know that = any attempt to muscle the stock cops is likely to backfire. Pitt, who joine= d the SEC out of law school in 1968, "remembers how the [Nixon-era] SEC tai= nted itself by turning a blind eye to [fugitive financier] Robert Vesco," s= ays an agency veteran. Pitt has too much riding on the Enron probe to let i= ts connections sway his judgment.=20 McNamee covers finance in Washington.