-----Original Message----- 
From:   Monley, John M 
Sent:   Tuesday, October 30, 2001 11:04 AM 
To:     Immer, Ingrid 
Subject:        Enron III 
October 28, 2001 
Once-Mighty Enron Strains Under Scrutiny 
By ALEX BERENSON and RICHARD A. OPPEL Jr. 
 <<...OLE_Obj...>> 
S time running out for Enron (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=ENE >)?
At the beginning of this year, the Enron Corporation, the world's dominant energy trader, appeared unstoppable. The company's decade-long effort to persuade lawmakers to deregulate electricity markets had succeeded from California to New York. Its ties to the Bush administration assured that its views would be heard in Washington. Its sales, profits and stock were soaring.
And under the leadership of Jeffrey K. Skilling, its chief executive, Enron's arrogance had grown even more quickly. 
The company, based in Houston, dripped contempt for the regulators and consumer groups that stood between it and fully deregulated markets - for electricity, water and everything else. Everyone would win under deregulation, Enron said - especially its shareholders, whose stock would soar as the company profited from creating new markets.
"We are on the side of angels," Mr. Skilling said in March, dismissing those who saw the company as a profiteer in California's energy crisis. "People want to have open, competitive markets. They want fair competition. It's the American way."
But less than a year later, everybody seems to have lost, especially Enron's investors. Enron's stock is plunging, and questions about its finances are mounting.
Some experts in the energy industry worry that if the crisis at the company worsens, trading in natural gas and electricity could be seriously disrupted and energy prices could grow more volatile. In a worst-case outlook, Enron could become the 2001 version of Long-Term Capital Management, the huge hedge fund whose collapse roiled financial markets during the fall of 1998. Enron's shares have fallen more than 80 percent this year, erasing $50 billion in shareholder value.
Enron closed on Friday at $15.40, down 95 cents, after hitting a 52-week low of $15.04 earlier in the day. 
The future of electricity deregulation is in doubt, thanks to blackouts and soaring power prices in California earlier this year - a crisis that ended only when that state contradicted deregulation's basic tenets by intervening deeply in the power market. Enron's efforts to become a profit-making water supplier and to create a new market in broadband communications capacity have been expensive failures. In August, Mr. Skilling quit, forcing Kenneth L. Lay, his predecessor as chief executive and still Enron's chairman, to resume day-to-day control of the company.
The company declined to make senior executives, including Mr. Lay, available for comment, and asked that questions be submitted in writing. Mr. Skilling could not be reached.
Enron's problems boiled over earlier this month, when it disclosed that its shareholders' equity, a measure of the company's value, dropped by $1.2 billion in the last quarter because of a deal disclosed only very hazily in Enron's regular financial statements. The Securities and Exchange Commission is looking into the company's financial reporting, and some investors question whether Enron has overstated profits at its primary business of trading electricity and natural gas.
THE slump in the company's shares accelerated after Enron revealed the fall in its shareholders' equity. On Wednesday, the company forced out its chief financial officer, Andrew S. Fastow, who is at the center of the controversy over Enron's confusing finances. The company, which six months ago seemed to be reaping billions of dollars from California's energy crisis, today faces a potential cash crunch.
The surprise about shareholder equity inflamed investors' smoldering concern about Enron's opaque financial statements. Now, with Wall Street analysts and bond-rating agencies demanding more information about the complex transactions that have fueled the company's profits, Enron has been reduced to issuing news releases assuring investors that it has adequate access to cash.
Enron does not appear to be in immediate danger of running out of cash. On Thursday, the company drew down a $3.3 billion credit line it had previously arranged with a group of banks led by Citigroup (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=C >) and J. P. Morgan Chase, which have each extended at least $400 million. But because of Enron's importance in the natural gas and electricity markets, industry experts say that any problem at the company could disrupt energy trading nationwide.
The supply of natural gas and electricity would probably not be affected even if the company failed, because Enron is mainly a trader, rather than a producer, of energy. But a crisis at the company might increase the volatility of energy prices, which have swung wildly in the last year.
Philip K. Verleger Jr., an energy- markets economist, emphasized that he thought Enron would survive this crisis. But he said it was not clear what would happen if Enron ran out of cash or if traders that use the company's EnronOnline Internet trading marketplace defaulted on their obligations.
"You suddenly have all these positions they have taken on there - are they good? Are the firm's hedges good? What's the situation?" Mr. Verleger said. "It's got everyone scared."
In the short run, Enron's credit rating may be its biggest problem. If the company's rating falls below investment grade, Enron could be forced to issue tens of millions of shares of stock to cover loans that it has guaranteed. But creating new shares would make the shares that already exist less valuable, because those shares would no longer represent full ownership of the company.
A drop in the company's credit rating could also prompt other energy traders and producers to back away from doing business with Enron, hurting the company's sales and profits.
Enron's credit rating stands several notches above the critical point. But its bonds, which are publicly traded, have fallen so low that they are now offering interest rates of almost 10 percent, comparable with many junk bonds. Two of the three major credit-rating agencies, Moody's Investors Service and Fitch Investors Service, have put Enron's bonds on review for possible downgrades.
"The issue that's in the front of everybody's mind right now is credit," said Mark Gurley, senior vice president and general manager for trading at Aquila Inc. (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=ILA >), one of the nation's largest energy traders. Aquila is based in Kansas City, Mo.
For now, Aquila and other major energy traders and producers, including Reliant Energy (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=REI >), the El Paso Corporation (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=EPG >) and Dynegy (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=DYN >), are continuing to do business with Enron. And Mr. Gurley said that Enron's own trading in the electricity and natural gas markets did not suggest the sort of frenzied selling reminiscent of the collapse of Long-Term Capital Management in 1998.
"They haven't done anything trading-wise that gives me any indication they are closing their books down," he said. 
Still, some executives at other companies said they were looking more carefully at transactions with Enron, especially long-term contracts. They also said risk-management and credit officers were calling each other regularly to discuss the situation.
Mark Palmer, an Enron spokesman, said on Friday that no energy- trading company had stopped doing business with Enron. He declined to say whether any of the company's trading partners had suspended or altered credit terms. He said the company was continuing to see normal volumes of business.
But the crisis that Enron will face if its credit rating is downgraded is just a symptom of the bigger problem the company must confront. For years, the details of Enron's finances have been a mystery even to the Wall Street analysts whose job it is to follow the company, and to the investors who own its stock and bonds. When Enron's profits were soaring and it was creating lucrative new markets, shareholders did not seem to care about the impenetrability of its financial statements.
Now they do. Yet the company seems incapable of offering straight answers to the questions investors ask. 
To others in the industry, the opaqueness of the company's financial statements parallels Enron's efforts to keep its energy-trading business lightly regulated and free of disclosure requirements. Though they do not expect Enron to crumble like Long-Term Capital Management, they say that, like the giant hedge fund, Enron uses a lot of debt, regulatory oversight is limited and outsiders have a difficult time figuring out its finances.
The most pressing concerns are a series of partnerships and trusts Enron created to move some of its assets and debt off its balance sheet. With names like Marlin and Osprey, the partnerships have at least $3.3 billion in bonds outstanding, backed by assets like a stake in Azurix (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=AZX >), Enron's water company subsidiary. Enron has promised that if the partnerships' debts exceed the value of their assets, Enron will issue enough new shares to make up the difference.
DEALS with partnerships formed by Mr. Fastow, who was chief financial officer when they were organized, led to the $1.2 billion write-off in shareholders' equity that Enron announced last week. The company has offered only skimpy details of its transactions with those partnerships. 
Enron ended its relationships with those partnerships in the last quarter, after being criticized by shareholders. In the process, it wrote off a promissory note that it had carried on its books, reducing its shareholders' equity by $1.2 billion. But, because of complex accounting rules, the transaction was not apparent in Enron's quarterly earnings report.
The transaction disturbs investors because it suggests that Enron may have found a way to hide losses, throwing the accuracy of its financial statements into question. When Enron released third-quarter earnings on Oct. 16, it reported a loss from $1 billion in write-offs on failed investments. The earnings statement did not mention the additional $1.2 billion equity write-down. But the company said its core business had been solidly profitable, and its shares rose.
In a conference call with analysts after the announcement, Mr. Lay, Enron's chairman, also disclosed the reduction in shareholder equity. The reference was a brief one, however, and some listeners did not catch it. Those analysts were angered when they found out the next day what Enron had done, and many were confused by the accounting procedure. Enron's stock began to slide, and investors clamored for more information about the write-off. But so far, the company's efforts to clear up the situation have further unnerved investors.
Mr. Lay has met with investors during the last two weeks to try to explain the deals, but some on Wall Street say they have come away with doubts about Mr. Lay's grasp of the situation. They say that the two people at Enron who appear to have been most knowledgeable about the deals - Mr. Skilling and Mr. Fastow - have both left the company.
In an interview in late August, Mr. Lay said he did not know some details about the deals involving Mr. Fastow. In response to one question about them, he said, "You're getting way over my head."
Mr. Palmer of Enron disputed any suggestion that Mr. Lay did not have a grasp of the investments at issue, saying Mr. Lay was handicapped in talking about them because of the S.E.C. investigation. "There is not a whole lot we can say, or should say, about them," Mr. Palmer said. He also said the company expected to generate about $3 billion in cash through asset sales by the end of next year.
In a conference call on Tuesday, analysts pressed Mr. Lay and other top Enron executives to reveal more information about the LJM write- down and its other partnerships. Instead, they offered only vague explanations of the deal, leaving Wall Street worried that more write-offs might be coming.
David Fleischer, a Goldman, Sachs analyst and a longtime supporter of the company, was among those who came away concerned. "If Enron is unable to clarify its off- balance-sheet transactions and restore confidence in the very near term by assuring investors that no more surprises are forthcoming that would affect the balance sheet or liquidity position, then the company will likely lose access to the capital markets," he wrote in a research note after the call.
To try to reassure investors, Enron said late Thursday that EnronOnline, its Internet-based trading exchange, executed more than 8,400 trades that day, a higher-than-normal volume.
"We know we have our work cut out for us if we are to rebuild our credibility with the investment community - and we're working on that," Mr. Lay said in a statement. "But in the meantime, the best evidence of our strength is the willingness of customers to bring their business to Enron."
But those reassurances apparently are no longer enough for Wall Street. Enron's stock tumbled almost 6 percent Friday, to its lowest levels in six years.
Now analysts are scrambling to figure out the extent of Enron's off- balance-sheet debt and to assess the risk that the company will have to issue new shares to make good on its partnership guarantees.
Carol Coale, an analyst at Prudential Securities in Houston, calculates that Enron may have close to $9 billion in off-balance-sheet debt. She said that Enron had for two years been trying to sell about $6 billion in foreign assets - including properties in Latin America and a power plant in India embroiled in a dispute with the state government - and she worries about those prospects for sale in light of Enron's problems and the souring economy. 
"As Enron is forced to sell assets to keep the ratings agencies off their backs, they may have to write those assets down," Ms. Coale said. On Wednesday, she downgraded her rating on Enron to "sell" from "neutral."
"The bottom line is, it's really difficult to recommend an investment when management does not disclose the facts," Ms. Coale said.
Short-sellers, who attacked Enron's accounting even before the company disclosed the write-off, say the company's problems may run even deeper than analysts fear. Enron may have used the partnerships not just to finance money-losing investments but to hide losses in its core trading business, they say.
"The company still isn't disclosing enough to know whether the core business, the trading business, is profitable," said Mark Roberts, director of research at Off Wall Street, which recommended shorting Enron's stock on May 7, when it stood at $59.43. "The issue remains: why are they doing these transactions? Our theory has been that the core operations aren't that profitable."
James Chanos, a leading short- seller who has bet that Enron's stock will fall, said, "Is Enron booking gains when it has real profits, but hiding the losses when deals go against it?" Mr. Palmer of Enron said the company stood by its reported energy-trading profits.
Even traders at other energy companies say they do not have a clear picture of Enron's positions. Enron maintains that it is in no danger of being wiped out by a sharp move in electricity or gas prices because it keeps its trading book balanced - meaning the energy it has agreed to sell is offset, in roughly equivalent amounts, by energy it has agreed to buy.
"With these guys, they tell us - and all you've got is their word - that they're hedged," said Mr. Verleger, the economist.
IN fact, Enron has lobbied forcefully over the years to limit regulation and disclosure of its trading operations. Last year, the company successfully lobbied Congress to effectively ensure that its Internet- trading platform would be exempted from regulation by the Commodity Futures Trading Commission.
Enron and other power traders do file limited information in reports to the Federal Energy Regulatory Commission, the agency that oversees wholesale electricity and natural gas markets. But the commission does not keep track of specific transactions and prices.
Large-scale energy trading has existed for only about a half-dozen years. Enron pioneered the business, and now dominates it, accounting for about one-quarter of all trading in the United States.
Before Congress and federal regulators opened up the market for wholesale electricity, a process that began in earnest a decade ago, the power business was a simpler affair. Utilities were given areas of monopoly service, and their rates - and ability to deliver enough electricity - were overseen by state regulators. But with the move to deregulate the business, independent and unregulated generators and traders have flourished, providing an ever-growing portion of the nation's power.
Beginning in the 1980's, the sale and transportation of natural gas was also deregulated, spurring Enron, which used to be primarily a gas-pipeline company, to move into the trading business.
The company's shift to trading gas and electricity accelerated in the mid-1990's, with the ascension of Mr. Skilling, who became chief executive in February, just six months before his unexpected resignation. Underscoring the change in direction, in securities filings this year Enron described its principal business as "security brokers, dealers and flotation." Before, it had said it was in the business of "wholesale-petroleum and petroleum products."
For most of its ascent, Enron reported outstanding profit figures and Wall Street accepted them with pleasure. A year ago, when it disclosed the first transactions with partnerships led by Mr. Fastow, the company's former chief financial officer, analysts who asked questions were told that the deals were routine and were being disclosed only because of Mr. Fastow's involvement.
Enron does not appear to face an immediate cash crunch. But the bank credit lines that it drew on last week to pay off its short-term debt will have to be renegotiated next spring. The controversial partnerships do not have to pay their debts until the following year - unless Enron loses its investment-grade credit rating before that.
ENRON will also need to maintain its large trading positions, which could suffer if participants in those markets grow more nervous about Enron's credit. When Long-Term Capital was stumbling in 1998, some Wall Street rivals sold the securities they thought Long-Term owned, trying to force Long-Term to sell its positions quickly and at a loss. Something similar in energy markets might be possible. If so, Enron might find, as Long-Term did, that positions that should offset each other do not.
Enron's new chief financial officer may yet persuade investors that in fact the company's profits are real, and that its condition is better than the short-sellers believe. As questions are answered, confidence, and the share price, could rebound.
But for now, investors are skittish, and some competitors are eager to take advantage of Enron's plight.