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Subject: FW: Dynegy vs. Enron: A "Tale of Two Companies"
Date: Wed, 24 Oct 2001 17:21:24 -0500
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Thread-Topic: Dynegy vs. Enron: A "Tale of Two Companies"
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From: "Kaminski, Vince J" <Vince.J.Kaminski@ENRON.com>
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-----Original Message-----
From: Corey, Paula 
Sent:  Wednesday, October 24, 2001 3:51 PM
To: Kaminski, Vince J; Mihura,  Brian
Subject: FW: Dynegy vs. Enron: A "Tale of Two Companies"  
Thought you might find this of  interest
 
See  you both at 5:00
-----Original Message-----
From: Rhonda Brown  [mailto:rhonda.brown@divine.com]
Sent: Wednesday, October 24, 2001  3:49 PM
To: Paula_Corey@enron. net; Marcinkowski,  Danielle
Subject: Dynegy vs. Enron: A "Tale of Two Companies"  
fyi, and my apologies  if you already received  this.   
 

Dynegy vs. Enron:
A "Tale of Two Companies"  
By Will McNamara
Director, Electric Industry Analysis  

Facts: Dynegy Inc. (NYSE: DYN) beat expectations in  the third quarter, reporting that its earnings rose to $286 million, or 85 cents  per diluted share, from $177 million, or 55 cents per diluted share, for the  same period in 2000. This represented a 22-percent increase from 3Q 2000 and  boosted the company's 2001 earnings estimate. Dynegy has a market capitalization  of $14.5 billion. Its stock is currently trading at about $43 down from a5 2-week high of $59, although it is important to note that for year-end 2000 the  company's stock was one of the top performers among Standard & Poor's 500  companies with a total shareholder return of 218 percent. Dynegy employs 5,778  people. 
Enron Corp. (NYSE: ENE) reported $638 million in losses for  the third quarter, after taking $1.01 billion in charges associated with several  of its non-core businesses. The company's 3Q recurring net income (before the  write-offs) increased 35 percent to $393 million, or 43 cents a diluted share,  and revenue in the quarter rose to $47.6 billion from $30 billion in 3Q 2000.  Enron has a market capitalization of $14.8 billion. Its stock is currentlyt rading at about $16.0, which represents a six-year low for the company and is  considerably lower than the peak of $82 hit in August 2000. Enron employs 20,600  people. 
Analysis: Dynegy closed out a banner year in 2000 and  appears to still be on a roll in terms of its financial performance. In  contrast, Enron faced an unprecedented year of turmoil, and is presently  languishing in a low ebb, characterized by a strategic crossroads and heightened  scrutiny of the company's financial reporting. While the two companies operate  in the same market space of power trading and are fierce competitors,  Dynegy-ironically the younger and smaller of the two companies-is an industry  success story while Enron's status remains rather uncertain. The questions to be  addressed in this article are: What is Dynegy doing "right"? What is Enron doing  "wrong"? What lessons can other power and natural-gas marketers learn from this  "tale of two companies"? 
Although they are often referred to as "cross-town rivals,"  Dynegy and Enron are worlds apart in terms of their competitive positions. Their  divergent approaches to the global marketplace illustrate what could be thes ingle-most important element related to their disparate positions at the end of  2001. Put more simply, the two companies have vastly different strategies,a nd-hindsight being 20/20-a strong argument can be made that Dynegy's strategy  is the winner at this juncture. Throughout this article, I will focus on two key  areas in which Dynegy and Enron differ dramatically. Those two key areas are the  ownership of physical generation assets and the extent to which the companies  have expanded (and invested) into non-core sectors. 
Both companies started out as natural-gas companies and  converged into the power market in the 1990s. However, that is essentially where  their similarities end, and over the last few years Enron and Dynegy havef ollowed decidedly different paths. In an attempt to make the complex rather  rudimentary, let me summarize the two paths this way: Enron does not believe it  needs to own physical assets to be a success in the power and natural-gast rading sector; Dynegy, on the other hand, not only believes in the ownership of  physical assets, but has set a goal that could ultimately establish the company  as owning one of the largest generation arsenals in the industry. 
Let's look at the companies separately. We'll discuss Enron  first since it is the older of the two. Enron readily admits that its strategy  is difficult to define, but a close approximation is that Enron literallyc reates commodity markets so that it can deliver physical commodities to  customers. The participation and success in commodity markets, according toE nron, does not necessitate ownership of physical assets. In fact, the company  has routinely sold physical assets that are not considered to be strategic to  its wholesale business. Rather, Enron has concentrated on developing a newp hilosophy of risk management excellence, in which it will merely buy and sell  the commodities it needs to participate in trading venues. 
As an example, Enron bought Portland General (which owns  2,000 MW of generation and 41,600 kilometers of electric T&D lines) in 1996  as a way to launch its penetration of the West Coast power markets. When  competition fizzled in that region, Enron put Portland General back on the sales  block (a sale of Portland General to Northwest Natural is pending at thisw riting). Likewise in Europe, where it is one of the most prominent tradingc ompanies, Enron has disposed of generation assets such as Sutton Bridge inE ngland and, unlike other U.S. competitors, has refrained from buying additional  generating units in opening countries such as Germany and Italy. According to  its most recent 10K report filed with the Securities and Exchange Commission,  Enron owns or controls 2,015 MW of generating capacity (including joint  ownerships), which is drastically lower than the average among other companies  operating in the power trading sector. 
Dynegy's approach to the market is crystal clear andr adically different from Enron's. In the words of CEO Chuck Watson, "Dynegy's  long-term strategy is to focus on marketing and trading around physical assets,  which supports earnings sustainability." Ever since going public in 1995, Dynegy  has been on an acquisition binge, with each purchase significantly increasing  its generation capability. Dynegy presently owns or controls about 27,000 MW of  generating capacity in the United States, 26 gas-processing plants and 14,000  miles of pipelines, which are located in geographically competitive areas. The  company's goal is to own or control 70,000 MW, or 10 percent of the U.S. market,  within the next five years. Sometimes, Dynegy has acquired assets throughp artnerships with other companies such as NRG Energy, but just as often it has  purchased assets independently. Most notably, when Dynegy acquired Illinova in  early 2000, the purchase doubled Dynegy's generating capacity. Dynegy is now  attempting to replicate this approach in Europe, where it is presently planning  to purchase natural-gas storage facilities in England. Dynegy executives have  argued that natural-gas storage is the best way to back up a natural-gas trading  operation. There's no question that the approach is working. Out of the $286  million that Dynegy reported in the third quarter, $263 million of it came from  the company's main wholesale business. 
The issue of asset ownership is probably the centrald efining difference between Enron and Dynegy, and its significance should not be  overlooked. It is not difficult to make a case that supports Dynegy's approach.  Owning physical assets often enables a trading company to gain information in  the course of operating power plants that can help the company to gauge markets  and anticipate small changes in price. In other words, by controlling the actual  output of generation instead of just being involved in buys and sells, a trader  such as Dynegy will theoretically know what the load is going to be in a  particular region, how much power can be produced to meet that load and when  shortages might occur. In addition, in markets that are short on infrastructure,  it may be difficult for a trader to participate in the market unless theya ctually have ownership of physical assets in the region. By the same token,  those companies that do control physical assets often have greater communication  with grid operators, and possible insight to spreads (the difference between  various energy prices). In fact, Dynegy's CEO Watson fully acknowledges that his  company excels at being able to trade around the volatility of price, and being  capable of resolving balances when shortages exist. This may be more difficult  for a company such as Enron to accomplish when it has no physical generation of  its own to meet discrepancies in power bids. Dynegy's strategy of acquiring both  natural-gas pipelines and power plants also gives it the flexibility to trade on  both commodities. 
On the other side of this argument, a case could be made  that Enron's approach provides more flexibility in reacting to trading  volatility. Certainly, by investing less in power generation facilities, Enron  has less capital on the line when compared to a company like Dynegy. Under a  scenario when market prices suddenly drop, a company such as Enron that does not  have heavy capital invested in power generation could actually fare better than  an asset-laden company because Enron does not face the pressure to meet thef ixed payments of a generation facility. Asset-heavy companies also may find  that their earnings could be impacted by the investment in generation facilities  in times of extreme price volatility. As the industry becomes increasinglyf ocused on bottom-line results, this could be seen as a potential concern for  investors. Further, some would argue that Enron's approach of establishingp urchasing contracts with various parties to meet its buy and sell requirements  is the rough equivalent of owning a generation facility. What Enron gains by  this approach is the presumed flexibility it has by not being tied down to a  specific generation unit and being able to build its own portfolio. 
Consequently, the issue of asset ownership can perhaps be  considered the "great debate" among power traders. However, although Dynegy's  overall performance in the third quarter was better than Enron's, that does not  necessarily provide a clear endorsement of Dynegy's strategy toward acquiring  new generation facilities. Keep in mind that Enron's 3Q losses resulted  primarily from non-recurring charges related to its non-core businesses  (broadband and water in particular). Without these charges, Enron's core  wholesale trading business continues to perform well. This is a point that CEO  Ken Lay has been quick to reiterate to investors. "Our 26-percent increase in  recurring earnings per diluted share shows the very strong results of our core  wholesale and retail energy businesses and our natural-gas pipelines," Lay said.  "The continued excellent prospects in these businesses and Enron's leadingm arket position make us very confident in our strong earnings outlook." 
Moreover, perhaps even more than ownership of physical  assets, the key issue that played a role in the current disparity between Dynegy  and Enron earnings in the third quarter is the companies' approach to developing  new lines of business. Telecom is a perfect example to illustrate the point.  Enron, which prides itself as usually gaining a first-strike advantage, plunged  into the telecom sector well ahead of other energy companies. Under the  leadership of then-CEO Jeffrey Skilling, Enron sunk large sums of capital into  purchasing broadband capacity on the expectation that the market would quickly  become lucrative. Now Lay admits that the company "could have gotten into the  broadband business with less capital" and that Enron "spent too much too soon"  in this sector. Nevertheless, Enron recorded an $80-million non-recurringw rite-down for restructuring its broadband unit in the third quarter and isp resently attempting to stop the bleeding in this sector by reducing futurec osts in this sector to $40 million a quarter. 
Dynegy took a much more cautious approach toward expanding  into the telecom sector and made a comparatively small amount of investment when  compared to Enron. Dynegy has likewise been impacted by the slowdown of thet elecom sector, but in the third quarter took a $15-million loss in its  broadband business compared to the $80-million loss that Enron reported.  However, Dynegy clearly specializes in marketing and trading two commodities  (electricity and natural gas) and seems to add other businesses in a verym ethodical way that merely supplements its core business. 
It is also important to note that Enron gained the  first-strike advantage when it developed EnronOnline, an electronic tradinge xchange. In fact, Enron was the first to create such an exchange in the energy  space, well ahead of its competitors. Dynegy later followed this trend withc reating Dynegydirect. The two exchanges are different in terms of their  trading standards, but it is important to acknowledge that in this particular  case Enron was successful in launching into the electronic trading space well  ahead of its competitors. The latest available information indicates thatE nronOnline has recorded transactions that exceed $590 in notional value. Since  its inception in November 2000, Dynegydirect has recorded $33 billion in  notional transactions. 
At this juncture, Dynegy and Enron are very different with  regard to their approaches toward financial reporting. Enron, which has often  been accused of not providing a balance sheet to investors, is currently  struggling from a serious image problem as the Securities and Exchange  Commission pursues an investigation of possible mishandling of funds by Enron's  CFO. To my recollection, no one has ever accused Dynegy of not providing ab alance sheet, and thus the company's status with investors is arguably more  solid. As I don't expect either company to radically alter its competitives trategy any time soon, my projection is that (at least in the near term), we  will continue to see a wide disparity in Wall Street performance between Dynegy  and Enron. That is not to say that anyone should count Enron out of the game. As  noted, the company's core business of wholesale business remains strong, but  clearly has been tainted by the impact of other non-core businesses. Thatd oesn't mean Enron is down permanently, but it will have to find a way to strike  a better balance between the businesses that it does best and those businesses  that former CEO Jeffrey Skilling believed were advantageous. 
In many ways, the comparison between Dynegy and Enron is  rather like the tortoise and the hare parable. I am sure you can guess which  company is the tortoise and which is the hare in this analogy. The race between  the two is far from over, although Dynegy is taking the lead at this point,b ased on its more methodical approach. What will be fascinating to observe is  how both companies continue to adapt to changes in the marketplace and possibly  modify what up to this point have been adamantly espoused philosophies.  
 
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