VideoPrecisely a year ago, Enron unveiled its master plan for domination of the universe. Not content with changing from an obscure gas-pipeline concern into the world's biggest energy trader, Enron's bosses set their sights higher. Jeffrey Skilling, then president, vowed to skyrocket past ExxonMobil to become the world's leading energy firm — quite an ambition, given that Exxon had just posted a quarterly profit of over $4 billion. But even that was not enough for Mr Skilling. He had a business insight so powerful that it would transform Enron into the world's leading company, period: the "disintegration" of the traditional corporation.
Mr Skilling believed that deregulation and market forces would force traditional, asset-heavy companies to break up into thousands of niche players. Rather than being vertically integrated, companies would be "virtually integrated" — by enterprises such as Enron that would "wire those thousands of firms back together cheaply and temporarily."
As things have turned out, it is Enron that has disintegrated. The company filed for Chapter 11 bankruptcy on December 2nd. The story behind the most spectacular corporate roller-coaster ride in memory is impossible to tell in full detail yet, thanks to the secrecy and opacity for which Enron is notorious. The principal actors involved are staying mum, though the dozens of lawsuits and official investigations now under way should eventually shine a fiery spotlight on Enron's murky doings. Even so, a rough outline is now clear.
Pride Before the Fall
What drove Enron into bankruptcy in what seems like just a matter of weeks? In fact, signs of trouble had surfaced much earlier. Rebecca Mark, a rising star in the 1990s, launched Enron on ill-fated forays into asset-heavy businesses overseas such as the Dabhol power project in India and Wessex Water in Britain. During the first half of this year, Enron's shares fell to around half their peak of $90, after the firm was burned in the fallout from California's botched power deregulation and from losses on its investments in such exotica as bandwidth trading.
These events raised questions about Enron's direction under the brash Mr Skilling, who had become chief executive in February. But he disliked criticism: when, during a conference call, one analyst dared to ask a pointed question, Mr Skilling snapped that he was an "asshole". Unable to take the heat, and perhaps seeing an even worse financial crisis ahead, he unexpectedly resigned in August. That forced Kenneth Lay, the chairman, to take back day-to-day control of the company he had founded a decade and a half ago.
Shareholders hoped that the return of Mr Lay, who promised more financial disclosure, would revive Enron. But within weeks, it was mired in a financial scandal that rapidly ran out of control. By October, it was on the brink of collapse, and had to accept a most unpalatable notion: a takeover by Dynegy, a smaller energy-trading rival based down the road in Houston.
The biggest crack in the façade came with the release of third-quarter results in mid-October that showed a $1 billion write-off on broadband, water and other bad investments. Worse, Mr Lay slipped in the news that Enron had taken a $1.2 billion reduction in equity capital, stemming from a hedging deal with a related private-equity fund. Almost nobody outside Enron was aware of the terms of the deal with this "structured-finance vehicle", which turned out to be just one of many off-balance-sheet devices. Enron's failure to offer details about the risks from these murky partnerships led many to fear the worst about its finances.
Accounting for Growth
The bad news kept coming. Enron's chief financial officer, Andrew Fastow, who had set up and profited from some of these partnerships, was pushed aside. The company restated its accounts for the past five years, and in the process wiped out nearly $600m of profits, about a fifth of the total. The news triggered an investigation by the Securities and Exchange Commission. Yet the firm still refused to come clean. More than any actual financial liability, that obfuscation proved the last straw.
Once investors and counterparties started to doubt — even slightly — that Enron was profitable, its survival became an immediate issue. Enron had been able to raise loans because its debt was rated as investment grade; but the loans had clauses requiring Enron to make additional payments if it was downgraded. As this prospect loomed nearer, the idea of this highly leveraged company having to raise fresh money scared off even more customers.
The proposed merger with Dynegy should have restored confidence, and thus halted the unwinding of Enron's trading book. In the event, Dynegy took a closer look inside Enron's black hole and decided not to proceed — making the downgrading of Enron's debt and its bankruptcy inevitable. Chuck Watson, Dynegy's boss, argues that even another $1.5 billion would not have saved Enron, given the management's refusal to be open about its financial position even with its rescuer. "It is incredible that they continued in this manner...Enron never understood that business is not just about numbers and the balance sheet: it's about your brand, and the confidence you inspire."
This potted history may tell what happened, but it raises a question: how did Enron manage to pull off its confidence trick? The key to understanding its collapse is contained in its annual report for 2000. The company, the report says, "is laser-focused on earnings per share (EPS), and we expect to continue strong earnings performance." EPS is a number that is watched obsessively by investors and analysts, and so is often crucial to share performance. It is also relatively easy to manipulate.
Reader Comments» Post a comment