Enron Faces Collapse as Dynegy Bolts And Stock Price, Credit Standing Dive

November 29, 2001

Page One Feature
Enron Faces Collapse as Dynegy Bolts And Stock Price, Credit Standing Dive
By REBECCA SMITH and JOHN R. EMSHWILLER
Staff Reporters of THE WALL STREET JOURNAL

Enron Corp., the once-mighty energy trader at the center of the nation's vast deregulated market for electricity and natural gas, wobbled on the brink of collapse Wednesday after credit-rating agencies downgraded its debt to junk status.

Following the ratings announcements -- which force Enron to accelerate repayment of billions of dollars of debt from cash it doesn't have -- its smaller cross-town rival in Houston, Dynegy Inc., called off a planned merger. The $9 billion all-stock deal had been aimed at rescuing Enron after questions about a series of financial transactions involving company insiders shook investors and sent Enron's stock plunging. Dynegy Wednesday accused Enron of "misrepresentations" -- an allegation Enron denied and is expected to contest in court.

In a day that brought a series of devastating rapid-fire blows to Enron, its energy-trading business -- the nation's biggest, having handled $1 trillion in transactions since November 1999 -- shut down for two and a half hours. Soon after the downgrade announcements, price quotes on Enron's widely used online trading system went blank, as one trader after another at the company's Houston headquarters walked away.

Enron's breathtaking fall will reshape the U.S. energy business, casting doubt on the belief that gas and electricity markets should be lightly regulated, with their management largely left to freewheeling traders. The fiercest industry proponent of free markets, Enron was vilified by California officials earlier this year, when the state's deregulated market careened off course. California's largest utilities lurched toward insolvency, leaving the state saddled with billions of dollars of debt.

No Access

With no access to credit and its only potential savior on the fly, it now appears that Enron may well be joining PG&E Corp.'s Pacific Gas and Electric unit in U.S. bankruptcy court. That would be a striking irony, since Enron once was regarded as being in the vanguard of a new way of doing business that would relegate old-line utilities like Pacific Gas and Electric to second-class status.

On its books, Enron has assets worth $62 billion. But investors have little confidence in that number or in the company's accounting of its sizeable liabilities. Enron has recently been adjusting its financial figures, and many of its dealings are still poorly understood by outsiders. A week ago, the company said it had about $1.6 billion in cash -- a surprise to many analysts who thought it had $1 billion more than that.

The bottom line: Enron doesn't appear to have enough profitable assets to survive in its current form.

Under Chairman and Chief Executive Kenneth Lay, the company embarked on a revolutionary transformation, moving away from the business of running hard energy assets, such as power plants, and into the field of buying and selling contracts for energy. The crown jewel sought by Dynegy wasn't Enron's handful of power plants and pipelines around the globe, but its EnronOnline trading system.

Limiting Exposure

Since its start in November 1999, the system had become the dominant forum for U.S. electricity and natural-gas trading. As Enron's problems mounted in recent weeks, other trading firms began limiting their exposure to the company, causing its trading volume -- and hence, cash flow -- to dry up.

See full coverage of the rise and fall of Enron

See a chronology of Enron's recent woes

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See a timeline detailing the rise and fall of Enron.

See a map of where Enron's major assets, operations and interests lie.

The sudden decline of Enron's once-potent trading business is one big reason Standard & Poors Ratings Group, Moody's Investors Service Inc. and Fitch Inc. pulled the trigger Wednesday. Noting that the Dynegy merger probably wouldn't go through, S&P also said Enron's woes in recent weeks had caused "significant damage" to its trading and marketing operations. The company's market capitalization has fallen from a peak of about $70 billion in 2000 to less than $1 billion.

S&P said that a voluntary filing by Enron under Chapter 11 of the U.S. Bankruptcy Code is "a distinct possibility." Chapter 11 gives a company protection from its creditors while it reorganizes.

Unwilling to concede defeat, Enron's chief financial officer, Jeff McMahon, said the firm is "reviewing all our options" but isn't contemplating liquidation.

Enron's stock and bond prices fell hard Wednesday. Its shares, which had been hovering at about $4 as Dynegy and Enron worked to resuscitate the deal, closed at 61 cents in New York Stock Exchange composite trading. Enron's benchmark bonds fell to 20 cents on the dollar, down from their already-depressed level of 50 cents. Dynegy shares fell $4.92, to close at $35.97 in NYSE trading.

Enron, which has 21,000 employees, was dropped from the S&P 500 Index after the markets closed Wednesday.

The company's crash is likely to push regulators to keep a closer eye on such asset-light energy traders that have reported huge profits while generating relatively little cash from operations. The Federal Energy Regulatory Commission is considering applying tougher rules to wholesale-energy markets, while other regulators will look more closely at accounting practices used by trading firms. "If you don't have the Ten Commandments, it's hard to find a sinner," said Nora Brownell, a Republican FERC commissioner.

It was Enron's habit of opening new markets, using imaginative financial structures and employing aggressive accounting methods that first brought it great success -- and then contributed to its downfall. Enron became a bold player in everything from commodities, such as electricity, to exotic financial instruments, such as "weather derivatives," a form of insurance used to cover weather-related losses.

The company made much of its profit by buying and selling energy many times over, capturing the difference between buyers' bids and sellers' offers. Unlike a traditional commodities exchange, open to all, natural gas and electricity are traded privately, with many transactions involving just two players.

The company also borrowed heavily, sometimes recording the debt on separate operations off Enron's balance sheets, meaning that debt wasn't immediately apparent to many investors. Enron poured a lot of this money into building its new markets. Wall Street analysts and, in private, some company executives now say the company also priced some of the assets it kept on its books at inflated levels. The company repeatedly has said its accounting has been entirely proper.

By last year, Enron was in the middle of about one quarter of the electricity and natural-gas deals done by energy producers, traders and utilities. It had big operations as far afield as Bolivia and India, and it had a seemingly unstoppable ability to produce ever-higher quarterly earnings. Fortune magazine called it the most innovative company in America and ranked it No. 7 on the Fortune 500. With annual revenue of $100 billion, Enron had eclipsed International Business Machines Corp. and AT&T Corp.

Enron came unglued last month, after it disclosed a big quarterly loss and The Wall Street Journal reported that the company's chief financial officer and other executives had profited personally from partnerships that Enron used to move assets on and off its books. These profits apparently came at the expense of the company and its shareholders. The Journal also reported that the company was forced to shrink its equity base by $1.2 billion. The Securities and Exchange Commission launched an investigation.

Previously, even though Enron's practices had worried some regulators, the Bush administration had kept its distance. Over the last decade, the company and its chairman, Mr. Lay, have been Mr. Bush's biggest financial backers, donating nearly $2 million to his campaigns. Before the company's recent problems came to light, Mr. Lay enjoyed unusually good access to top administration officials, including Vice President Dick Cheney, who earlier this year drafted a new national energy plan that seemed to lean heavily on Mr. Lay's suggestions.

More recently, the White House hasn't stepped forward to defend Mr. Lay or Enron. And few members of the energy-trading fraternity, who have always seen Enron as sharp-elbowed, did anything to help the company.

Dynegy saw an opportunity, though, to acquire the company against which it had always been compared. Dynegy Chairman Chuck Watson agreed to buy Enron in an all-stock transaction that valued the firm at $9 billion, a pittance compared with its $70 billion peak market value.

But Enron's stock price fell further after more disclosures that future profits weren't likely to be as strong as expected and volume started to dry up at the company's trading desk. Dynegy sought to renegotiate the price downwards.

Executives of the two companies had huddled since Sunday, first in Westchester County, N.Y., and then in Houston, trying to come up with a formula that would allow Enron to survive until a merger could be completed. The talks fell apart when it became clear that even a proposed additional $1 billion investment from Dynegy and bankers J.P. Morgan Chase & Co. and Citigroup Inc.'s Citibank wouldn't be enough to see it through regulatory and shareholder approvals.

The disintegration of the Dynegy-Enron deal is a blow to the two huge banks, which were the leading cheerleaders and financiers behind the transaction. They had invested hundreds of millions of dollars to help get the deal done. Not only will the failure tarnish their status as merger-and-acquisition advisors, but they will also be on the hook, along with some 800 other creditors, in trying to recover several hundred million dollars in unsecured loans to Enron. J.P. Morgan shares were down $2.30, to $37.50, while Citigroup shares were down $2.75, to $47.80, in NYSE composite trading.

The breakdown of the talks will probably produce litigation. Dynegy used $1.5 billion of funding provided by its part-owner, ChevronTexaco Corp., to help provide liquidity to Enron. As a result of the collapse of the merger agreement, Dynegy said it planned to claim the collateral on that investment -- all of the preferred stock of an Enron subsidiary, Northern Natural Gas, which owns 16,500 miles of interstate natural-gas pipelines between Texas and the Great Lakes.

Enron isn't likely to let that go without a fight. Neither Dynegy's Mr. Watson nor the company's president, Steve Bergstrom, attended the Westchester meeting. Mr. Watson was at the Mexican resort of Cabo San Lucas. As Enron's Mr. Lay flew back to Texas on Monday, believing he had an agreement to preserve the merger, he received a phone call saying that Mr. Watson wasn't happy with the terms. Enron executives asserted that they didn't breach any of the covenants of the merger agreement and didn't make any material misrepresentations to Dynegy.

Mr. Watson said he told Mr. Lay in a phone conversation early Wednesday that the deal was off. "I told him I was very disappointed we couldn't put this together," said Mr. Watson. "We part as friends," he added.

Mr. Watson said, "We worked our butts off to make this thing work." But he said Enron's "sharp deterioration" couldn't be ignored. "I wasn't about to put our balance sheet in jeopardy," he said.

Natural gas prices on the New York Mercantile Exchange surged about 25 cents Wednesday morning on the Enron news, above $3 per million British thermal units, then dipped back into negative territory because of other factors.

Another big worry for Enron is keeping its bankers at bay. Enron's fall isn't expected to rattle credit markets in the fashion of the 1998 collapse of another financial high-flyer, hedge-fund Long Term Capital Management. But Enron has an estimated $13 billion in debt on its balance sheet and a further $7 billion in off-balance-sheet financings. It may be on the hook for additional debt in connection with four dozen investment partnerships.

Bankers and regulators said the risk of Enron's debt problems having a broader impact is limited by the fact that many lenders to the firm have syndicated the debt, spreading smaller chunks of it among many institutions.

Still, the credit downgrade brings immediate pressure. An estimated $3.9 billion of liabilities associated with two of those investment partnerships now will be triggered for repayment. Analysts estimate that even with the recent cash infusion from Dynegy and Enron's decision last month to draw down its remaining available credit lines, the company has less than $2 billion in available cash.

So far, it doesn't appear that Enron has started negotiations with lenders over a "prepackaged" bankruptcy-reorganization plan that could limit litigation. The company has hired Weil Gotshal & Manges, a New York-based law firm well-known for its bankruptcy practice. Wednesday, Enron engaged investment bankers with the Blackstone Group to come up with a restructuring plan.

As soon as word came Wednesday that the Dynegy deal had fallen apart, a "war room" staffed by lawyers was set up on Enron's massive trading floor in Houston, with the goal of trying to stop suppliers and customers from trying to get out of pending contracts. Other traders struggled to meet Enron's delivery obligations.

"The utilities are all calling and want to make sure that the customers still want to take our gas, and the suppliers are wondering if we will pay for their gas," said one Enron trader. "We are going to have to be very innovative."

In the short term, there are fears that Enron's crippled state will, in the words of Merrill Lynch analyst Steve Fleischman, cast a "cloud of uncertainty" over all of the energy traders that do business with Enron. Other big traders, such as El Paso Corp., Mirant Co., Entergy Inc. and Duke Energy Corp., were busy yesterday, trying to calculate what exposure they still have to Enron.

In recent weeks, many of those companies, including Dynegy itself, have been cutting back on their trades with EnronOnline, fearing the company would fail. They have shifted their business to the rival Intercontinental Exchange and other trading systems. Most big energy-trading companies saw their stocks fall Wednesday.

Some predict the energy-trading business will now shrink, with no clear successor to Enron's throne. They point out that stocks of competitors haven't moved up in anticipation of seizing market share from Enron. If anything, Enron's demise as a major trader will reduce the number of transactions possible -- not only for energy products, but also for such commodities as metals and pulp and paper.

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Enron's Recent Woes
Oct. 16: Enron takes $1.01 billion charge related to write-downs of investments. Of this, $35 million is attributed to partnerships until recently run by CFO Andrew Fastow. Enron also discloses it shrank shareholder equity by $1.2 billion, as a result of several transactions including ones undertaken with Mr. Fastow's investment vehicle.

Oct. 19: The Wall Street Journal discloses that general partners of Fastow partnership realized more than $7 million last year in management fees and about $4 million in capital increases on an investment of nearly $3 million in the partnership, set up principally to do business with Enron, according to an internal partnership document.

Oct. 22: Enron announces SEC will begin a probe of company's "related party transactions," including those with Fastow partnerships. Enron says it will fully cooperate.

Oct. 23: Enron's treasurer acknowledges the company may have to issue additional shares to cover potential shortfalls in investment vehicles it created, although he says the company believes it can repay about $3.3 billion in notes that were sold by those investment vehicles without having to resort to issuing more stock.

Oct. 24: Enron replaces Mr. Fastow as CFO with Jeffrey McMahon, the 40-year-old head of the company's industrial-markets division.

Oct. 25: The company draws down about $3 billion, the bulk of its available bank credit lines. The Fitch rating agency puts Enron on review for a possible downgrade, while another, Standard & Poor's, changes Enron's credit outlook to negative from stable. A noninvestment-grade rating would throw the company into default on obligations involving billions of dollars of borrowings.

Oct. 29: Moody's lowers its ratings by one notch on the Enron's senior unsecured debt and kept the company under review for a possible further downgrade.

Oct. 31: The SEC elevates to a formal investigation its inquiry into Enron's financial dealings.

Nov. 1: Enron says it has secured commitments for $1 billion in financing from units of J.P. Morgan and Citigroup.

Nov. 5: Enron has held talks with private-equity firms and power-trading companies for a capital infusion of at least $2 billion as it faces an escalating fiscal crisis.

Nov. 8: Enron reduces its previously reported net income dating back to 1997 by $586 million, or 20%, mostly due to improperly accounting for its dealings with the partnerships run by some company officers.

Nov. 9: Dynegy announces a deal to buy Enron for about $7 billion in stock. ChevronTexaco will inject $1.5 billion into the deal immediately, and an additional $1 billion upon closing.

Nov. 13: Enron Chairman Kenneth Lay decides to forgo a severance payment of $60.6 million that could be triggered by Dynegy's planned acquisition of Enron.

Nov. 20: Enron warned that continuing credit worries, a decline in the value of some of its assets and reduced trading activity could hurt its fourth-quarter earnings.

Nov. 23: The Wall Street Journal reports that Enron is being sued by members of its employee-retirement plan, which has suffered losses because of its plunging stock price. Separately, the slide in its share price and mounting financial problems puts increasing pressure on Dynegy to renegotiate or walk away from its deal to acquire the firm.

Nov. 26: Enron has advanced talks to cut the price of the all-stock acquisition by Dynegy by more than 40% to about $5 billion. Enron stock fell 70 cents to $4.01, its lowest level in over a decade.

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-- Alexei Barrionuevo contributed to this article.

Write to Rebecca Smith at rebecca.smith@wsj.com and John R. Emshwiller at john.emshwiller@wsj.com