Enron Corp. and Dynegy Corp. remained mum on whether a merger deal was imminent late Thursday, but in the background, the investment community began digesting the possibility that the smaller Dynegy, which has stuck to a path of high-quality asset acquisition to accompany its modest trading arm, could sit at the same table money-wise with Enron, well known for shedding acquisitions as fast as it has amassed the largest trading and marketing business in the world. Now, however, Enron faces a credibility problem larger than its operations, and has begun to slowly dish out details of its complex financial operations before it sheds even more assets or is consumed by another company.

In an 8-K statement filed with the U.S. Securities and Exchange Commission (SEC) Thursday, Enron finally disclosed what many have suspected — something was not right in some of its many related-party transactions. Though there were no intimate details of what was actually going on, Enron revealed in the filing that the treasurer and one of its general counsels, both apparently involved in the titan-toppling, off-balance sheet transactions, have been fired.

However, for those hungry for the “who knew what and when,” the filing left some craving more about how the once mighty company has come undone in just a few short weeks. The inquisitive, who have circled Enron like impatient buzzards since third-quarter earnings were reported Oct. 16, were left to wonder whether Enron will serve up another plate of financial information soon.

Dynegy and Enron did confirm Thursday that they were negotiating a merger agreement, which has Dynegy and its 27% stakeholder ChevronTexaco apparently interested in a stock swap and premium along with some cash for Enron. Word on the street is that Dynegy would pay Enron about $10 a share, putting the value on a deal at about $7-8 billion. ChevronTexaco also would kick in another $1.5 billion in cash to alleviate Enron’s credit crunch problems Less than a year ago, Enron had a market value of nearly $70 billion.

However, neither Dynegy nor Enron would confirm details or numbers. Dynegy spokesman John Sousa told NGI Thursday that he could only confirm that the companies were having discussions about a possible business deal, however, he said he could not confirm any other information. Enron issued a written statement.

Enron restated its financial statements for the years ending Dec. 31, 1997 through 2000 and for the quarters ending March 31 and June 30, 2001, and said that as a result, “The previously-issued financial statements for these periods and the audit reports covering the year-end financial statements for 1997 to 2000 should not be relied upon.” However, Enron notes in the filing that “these restatements have no effect on Enron’s current financial position.”

In the 8-K, Enron reduced its net income by $591 million, or 22%, from 1997 to 2000, and increased its debt over the period by $628 million, or 6%, after two partnerships’ financial statements were folded into Enron’s earnings.

Enron restated its debt for 2000 to $10.86 billion, up from $10.23 billion, adding $628 million in debt for the consolidation of two questionable partnerships, the Joint Energy Development Investments LP (JEDI) and Chewco. Reported revenues in 2000 were more than $100 billion, and Enron also reported assets of $65.5 billion. For the first three quarters of 2001, there was no debt change.

Said Enron Chairman and CEO Kenneth Lay in a statement, “We believe that the information we have made available addresses a number of the concerns that have been raised by our shareholders and the SEC about these matters. We will continue our efforts to respond to investor requests for information about our operational and financial condition so they can evaluate, appreciate and appropriately value the strength of our core businesses.”

Among the details offered in the 14-plus page document are restatements of prior-period financial statements to reflect the recording of: the previously announced $1.2 billion reduction to shareholders’ equity reported in its third quarter 2001 statement as well as “various income statement and balance sheet adjustments required as the result of a determination by Enron and its auditors (which resulted from information made available from further review of certain related-party transactions) that three unconsolidated entities should have been consolidated in the financial statements pursuant to generally accepted accounting principles.”

Included in the restatement is information regarding Enron’s related-party transactions with LJM1 and LJM2 limited partnerships formed by Enron’s then-CFO Andrew Fastow, “the former CFO’s role in the partnerships, the business relationships and transactions between Enron and the partnerships, and the economic results of those transactions as known thus far to Enron…and transactions between Enron and other Enron employees. ”

In the filing, Enron explained in detail its special purpose entities (SPEs) and related-party transactions, noting that “like many other companies, (Enron) utilizes a variety of structured financings in the ordinary course of its business to access capital or hedge risk.”

Enron noted that LJM Cayman L.P. (“LJM1”) and LJM2 Co-Investment L.P. (“LJM2”) (collectively “LJM”) “are private investment limited partnerships that were formed in 1999. Mr. Fastow, then executive vice president and CFO, was (from the beginning through July 2001) the managing member of the general partners of LJM1 and LJM2.”

Enron’s restatement of its financials now “reflect its conclusion that three entities did not meet certain accounting requirements and should have been consolidated; reflect the adjustment to shareholders’ equity; and include prior-year proposed audit adjustments and reclassifications (which were previously determined to be immaterial in the year originally proposed).” Specifically, Enron said that it has concluded that based on current information: “The financial activities of Chewco…a related party which was an investor in …JEDI, should have been consolidated beginning in November 1997; The financial activities of JEDI, in which Enron was an investor and which was consolidated into Enron’s financial statements during the first quarter of 2001, should have been consolidated beginning in November 1997; and the financial activities of a wholly-owned subsidiary of LJM1, which engaged in derivative transactions with Enron to permit Enron to hedge market risks of an equity investment in Rhythms NetConnections Inc., should have been consolidated into Enron’s financial statements beginning in 1999.”

Enron stated that its decision that the LJM1 subsidiary should be consolidated in 1999 and 2000 is based on its assessment that the “subsidiary did not qualify for nonconsolidation treatment because of inadequate capitalization…This consolidation has the effect of reducing Enron’s net income in 1999 and 2000 and shareholders’ equity in 1999 and increasing shareholders’ equity in 2000, thus eliminating the income recognized by Enron on these derivative transactions.”

Enron also explained in detail the $1.2 billion reduction in shareholder equity that was announced in mid-October when its third-quarter earnings were released, and said that “prior period financials will be restated to adjust shareholders’ equity for all periods affected.”

The filing also explains Enron’s recent decision to set up a special committee to conduct an independent investigation and review of transactions between Enron and its “certain related parties.” Enron noted that the special committee also was charged with “taking any disciplinary action that it deems appropriate, communicating with the Securities and Exchange Commission (which has commenced a formal investigation of these matters), and recommending to the board any other appropriate actions.”

Explaining the LJM partnerships, Enron stated in the 8-K that under the partnership agreements, “LJM1 and LJM2 were described to the Enron board of directors as potential sources of capital to buy assets from Enron, potential equity partners for Enron investments, and counterparties to help mitigate risks associated with Enron investments. The board also was informed that LJM1 and LJM2 intended to transact business with third parties. Prior to approving Mr. Fastow’s affiliation with LJM1 and LJM2, the board determined that Mr. Fastow’s participation in the partnerships would not adversely affect the interests of Enron. The board approved the initial transaction with LJM1 and recognized that Enron may (but was not required to) engage in additional transactions with LJM1.

“The board directed that certain controls be put into place relating to Mr. Fastow’s involvement with the partnerships and transactions between Enron and the partnerships. The board required review and approval of each transaction by the office of the chairman, the chief accounting officer and the chief risk officer. The board also recognized the ability of the chairman of the board to require Mr. Fastow to resign from the partnerships at any time, and directed that the audit and compliance committee conduct annual reviews of transactions between Enron and LJM1 and LJM2 completed during the prior year. Whether these controls and procedures were properly implemented is a subject of the special committee’s investigation.

“Enron believes that, as of July 31, 2001, Mr. Fastow sold his interests in LJM1 and LJM2 to Michael J. Kopper, and that Mr. Fastow ceased to be the managing member of their general partners. Prior to that time, Mr. Kopper reported to Mr. Fastow as a non-executive officer of an Enron division. Enron believes Mr. Kopper resigned from Enron immediately before purchasing Mr. Fastow’s interests in LJM2. Mr. Fastow is no longer working for Enron.”

In December 1999, LJM2 acquired a 90% equity interest in an Enron entity with ownership rights to certain natural gas reserves for $3 million. As a result, Enron recognized $3 million in revenue from an existing commodity contract. Subsequently, LJM2 assigned a portion of its ownership interest in the entity to Enron and another related-party, Whitewing, at no cost (to achieve certain after-tax benefits). Enron stated that LJM2 continues to own its remaining interest.

“Enron now believes that Mr. Kopper also was the controlling partner of a limited partnership that (through another limited partnership) in March 2000 purchased interests in affiliated subsidiaries of LJM1,” it said in the filing. “Enron also now believes that four of the six limited partners of the purchaser were, at the time of the investment, non-executive officers or employees of Enron, and a fifth limited partner was an entity associated with Mr. Fastow. These officers and employees, and their most recent job titles with Enron, were Ben Glisan, Managing Director and Treasurer of Enron Corp.; Kristina Mordaunt, Managing Director and General Counsel of an Enron division; Kathy Lynn, Vice President of an Enron division; and Anne Yaeger, a non-officer employee. Enron is terminating the employment of Mr. Glisan and Ms. Mordaunt. Ms. Lynn and Ms. Yaeger are no longer associated with Enron and Enron believes they are now associated with LJM2. At the time these individuals invested in the limited partnership, LJM1 had ceased entering into new transactions with Enron. However, some pre-existing investments involving LJM1 and Enron were still in effect, and Enron believes that these investments resulted in distributions or payments to LJM1 and to the limited partnership in which these individuals invested.

When rumors of the merger hit the street, Dynegy’s stock rose throughout the day Thursday, gaining more than 10% to close at $36.50. Meanwhile, Enron’s shares continued to lose value and closed at $8.41 after losing another 7% of their value.

Some of the flash coming off of Dynegy’s stock could be CEO Chuck Watson’s “knack for making accretive acquisitions,” said analysts Mark Easterbrook and Neal Dingmann of RBC Capital Markets. They pointed to Dynegy’s acquisition of Illinova, which has proven to be a winner. “In addition, Dynegy has a similar culture to Enron.”

However, Merrill Lynch analyst Donato Eassey indicated that “barring any merger or private equity announcement,” the focus should be on Enron’s September 10-Q, expected to be filed by Nov. 14. He also referred to the entire Enron story as a “media circus,” calling its stock fluctuations “likely the result of media barbs and speculation…We believe this is somewhat of a mischaracterization and in the end, given our expectation of not seeing private equity for at least the next several weeks, we think it is premature to declare this process over.”

Enron, said Eassey, “with its tremendous trading prowess and the venerable EnronOnline, presents a premiere energy marketing franchise and thus, makes for a viable merger and acquisition candidate at current levels.” However, he noted, “bottom line, we maintain that Enron is only suitable for high-risk profile investors.”

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