Forward this to your friends and coleauges who are starting to wonder if you experimented on small children while at Enron.

GAC


Could Enron's Business Model Actually Work?

January 28, 2002 

By DANIEL ALTMAN


 

Is Enron (news/quote)'s business model still a good one?
With fuzzy financing and arcane accounting stripped away,
the answer may be yes. Despite Enron's collapse, its goal
of merging the best thinking in energy, finance and
information technology as an online commodity trader still
garners respect. 

"Enron failed because they were scamming, but the basic
virtual market part was fine," said Dale Kutnick, chief
executive and research director of the META Group
(news/quote), an information technology consultancy. "There
is still a real market for virtual trading companies, no
question about it." 

Enron traded contracts for electricity and natural gas and,
later, other products like rights to high-speed
telecommunications networks and financial hedges against
changes in the weather. It used a sophisticated online
platform backed by a financial apparatus meant to hedge the
company's bets. In the words of Kurt Launer, an analyst who
follows Enron for Credit Suisse First Boston, the company
had "the pioneering online venture for real-time
availability of information" used in trading commodities. 

*  
Enron's basic business model, in other words, may yet
serve as a model for other companies. In the wake of
Enron's bankruptcy filing, some of the best support for
that model model came from its competitors. 

Reliant Energy (news/quote) is one of several companies
that followed Enron in offering online exchanges for
electricity and natural gas. 

"Our commodity markets worked just fine the day after Enron
went away," said Joe Bob Perkins, president and chief
operating officer of the wholesale group at Reliant. 

"Everybody got gas, everybody got power, and prices stayed
basically the same," Mr. Perkins said. "The loss of one
intermediary just proves that these competitive markets
work." 

Other companies offering similar services rushed to fill
the gap after Enron suspended its trading. "We've picked up
market share," said Stephen L. Baum, the chairman,
president and chief executive of Sempra. He noted, though,
that unlike Enron, "our trading, although extremely
important and a big income earner for us, is not the
centerpiece of our business." 

Another company that sees continued value in the Enron
approach is UBS Warburg, the Swiss investment bank, which
bought Enron's electricity and gas trading business in
bankruptcy proceedings and plans to restart them under its
own brand. 

"We're confident we can re-establish the business," David
Walker, a UBS Warburg spokesman, said. "It is a first-rate
trading platform." 

Similarities between UBS Warburg's financial derivatives
business and Enron's trading of energy contracts were one
factor that made the deal appealing, Mr. Walker said. "The
characteristics of trading these types of products and
betting on interest rates, which is a core ability of UBS,
are similar," he said. "They're kind of neighbors." 

Mr. Kutnick, the research chief, added that Enron had
"outstanding" information technology organization that was
backed by "tremendous amounts of money." In that way as
well, he said, the company "was certainly comparable to the
best financial companies out there." 

Because of Enron's technological advantage, Mr. Kutnick
predicted, UBS would have little difficulty regaining
Enron's market share. "They were far enough ahead that it
shouldn't be an issue," he said. "If you are a couple
seconds faster in terms of spotting and executing a market
inefficiency, obviously you're going to make money." 

According to experts who consulted for Enron in the field
of finance, the company did not necessarily come up with a
lot of powerful new ideas. Its strength was in synthesizing
existing ideas, which sometimes led to innovative methods. 

"They took a lot of finance theory and applied it in the
context of their business," said Ramesh K. S. Rao, a
professor of finance at the University of Texas who once
consulted for Enron. "There was no magic to what they were
doing." 

Robert L. McDonald, a professor of finance at Northwestern,
advised Enron on the use of derivatives from 1993 to 1995.
He said the company needed advanced financial tools to
price its derivatives, which specified energy products to
be delivered at various times and sites while demand was
uncertain. "That's a hard problem, so they were probably
breaking some new ground trying to deal with that," he
said. "It's the kind of thing that's easy to describe and
may be hard to do." 

Peter Tufano, a professor at the Harvard Business School
who studied Enron, said the company had been using what
would be considered "best practices" for using derivatives
by any "serious financial firm" in the early 1990's. 

Had Enron stuck to those practices, Mr. Kutnick said, it
might still survive today. 

"Enron could have done extremely well with betting on
market inefficiencies and hedging bets," he said. "People
stop hedging because they get too enamored of their own
theories." As a parallel, he cited Long- Term Capital
Management, the hedge fund, which failed in 1998 when it
could no longer cover the ever-higher risks it began
taking. 

Enron also betrayed its success, Mr. Launer said, by
throwing money at ventures that failed to generate cash
flow. For example, Enron spent around $2 billion on its
network capacity, or bandwidth, exchange, which never
turned a profit. "The fact that Enron became a dot-com,
financed itself like a dot-com, and then suffered a demise
like a dot-com," he said, "is one of the central parts of
this story." 

But Enron's failed attempts to expand its online trading
system to products beyond electricity and natural gas might
not rule out future, similar endeavors. 

"In any commodity, there are always people who have too
much and others who have too little, so there's always
going to be a need for them to trade and exchange,"
Professor Tufano said. 

Mr. Launer suggested that Enron's efforts were simply
ill-timed. "These things take a while to get going," he
said. He noted that the deregulation of electricity and
natural gas led to a long period during which the market
for energy products and their derivatives evolved. "It does
take a while before users of a commodity get comfortable
with the idea that they should risk-manage and out-source
their use of that commodity." 

http://www.nytimes.com/2002/01/28/business/28NECO.html?ex=1013231198&ei=1&en=b419a4892b911727



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