Subject: Hanover GKH Merger Idea
From: [email-masked]
To: [email-masked]
Cc: [email-masked], [email-masked]
Date: Mon, 9 Apr 2001 13:01:00 -0700 (PDT)

Jeff, 

The following provides background information for your call with Mel Klein at GKH (ref: the GKH memo you sent to me).  Over the past year, a number of groups/individuals have assessed the merits of acquiring GKH's interest in Hanover and all have declined due to strategic as well as financial considerations.

Please give Dick or me a call if you have any further questions.

Regards,
Brian

---------------------- Forwarded by Brian Redmond/HOU/ECT on 04/09/2001 09:51 AM ---------------------------

Richard Lydecker@ENRON
04/06/2001 01:53 PM
To:	Brian Redmond/HOU/ECT@ECT
cc:	 
Subject:	Hanover GKH Merger Idea

The following is a quick review of the GKH merger analysis and the reasons we do not support it.  It is also important to keep in mind that GKH is motivated to create a short-term exit from Hanover due to the exigencies of their investment partnership expiration.  Klein's agenda is transparent.

1.	While Hanover is a well-managed, growth company, it is not a "turnaround" or "special opportunity" situation for which application of Enron's business model would promise the extraordinary returns required in order to justify an investment of $3 billion.

2.	As Enron's stock price has declined, the attractiveness of using it as a currency in any acquisition has decreased.  The PE decline also tends to make stock deals more dilutive to Enron.

3.	The GKH analysis asserts $128 million in initial year synergies and cost savings.  However, these benefits are largely predicated upon (a) use of the Enron NOL (which is an asset Enron already owns and can be applied to earnings from any acquisition)--$55 million and (b) speculative economies of scale, i.e. higher revenues and margins and significant SG & A reductions--$38 million.  

The remaining $36 million of cited benefits relates to a proposed decapitalization of Hanover from a proposed transfer of assets to a non-recourse trust (although credit enhancement and operational guarantees would be required).  Achieving these benefits would require obtaining the best possible outcome on a number of accounting, financial and credit issues.  However, even if all of these issues were resolved, the economic result is insufficient to justify the transaction.  The GKH analysis does not consider transaction, transition or capital costs.

4.	 After taking into account the capital expenditures required for Hanover to achieve its aggressive growth targets, the Company appears to be at best cash flow neutral or slightly cash flow negative for the three years presented in the GKH analysis (even including all claimed synergies and cost savings).

5.	Enron and Hanover could achieve and share many of the synergistic benefits claimed for the merger in a properly structured joint venture.  (However, this would still require finding an internal Enron "sponsor" to assume ownership of the relationship).

6.	Much of Hanover's growth in the future is predicated upon an aggressive expansion and expenditure program internationally.  Given Enron's domestic opportunities, this international orientation in a non-core business is inconsistent with our present strategy.

7.	Like GKH, Enron has been a seller of our Hanover position.  An abrupt reversal of strategies could create significant uncertainties and confusion on the Street about Enron's strategic direction.

Additional background to demonstrate the magnitude of the  limitations of the GKH analysis with respect to increasing Enron's  EPS:

1.	If pooling of interest accounting is available, any acquisition Enron makes of any company that has a lower PE ratio than Enron is accretive to Enron's EPS.  There is nothing "remarkable" about this, it is simple mathematics.

2.	If purchase accounting is required, even if the entire purchase price were accounted as "goodwill" and never amortized, this would only replicate the results of pooling of interest.  However, in actuality, a significant proportion of the purchase price would have to be allocated to assets (tangible and intangible such as contracts) which would produce additional depreciation and amortization expense not mentioned in the GKH analysis.

3.	The largest single "synergy" by far in the GKH analysis is usage of Enron's NOL to shield Hanover's taxable earnings.  Enron can obtain the benefit of its NOL by acquiring any profitable company.   GM recorded about $3.4 billion in income tax expense last year which would offer even greater opportunity to utilitize this Enron asset.

4.	The GKH analysis is totally silent with respect to the biggest single immediate risk of a transaction, i.e. the potential negative impact on Enron's own PE.

Dick