Raymond James & Associates expects another wave of mergers and acquisitions in the wake of the Enron catastrophe, as marketing and trading companies come to the realization that hard physical assets are much more desirable than heavily leveraging a balance sheet to a trading desk.

“We believe the fall of Rome could in fact spur a much needed round of merger and acquisition (M&A) activity, as well as lead the energy complex toward significantly improved balance sheet profiles,” said Fred Schultz of Raymond James. Schultz believes the best energy companies are those that establish a balance between hard assets (power plants, pipelines, reserves) and soft assets (marketing and trading). “It allows a company to take advantage of the true convergence between natural gas and electric power.

“In fact, those of you familiar with our notes know that we have compared Enron to the Evil Empire with regard to where the energy complex was headed. We believe Enron’s involvement in the energy complex created a false sense of security for many market participants who watched as trading volumes grossly outpaced the advancement in actual physical production.”

Schultz noted that each quarter, companies book marketing and trading revenues of more than $100 billion, yet bottom line figures total only in the hundreds of millions. “For example last quarter the top five power marketers tallied quarterly revenue of $92 billion and posted a completely under whelming $410 million in net income,” he said. “That’s and eye-popping 0.44% (less than one-half of 1%), a terrible return on investment especially given the risk involved. Much like the 1980s, every now and again you have to sit down and have a reality check.”

It’s about time for the market to begin rationalizing where capital is employed each day, he said. Trading firms leveraging billions to make millions “ought to be passed over, given the bumpy outlook for 2002.” Instead investors should look to those companies that are beefing up their physical presence in the market with hard assets.

The marketing and trading business is going to shrink, said Schultz. “Suffice it to say, we believe the eventual winner [of the gas marketing crown] will behold a kingdom that will certainly not grow as fast, nor be as liquid, as the one that included Enron.” And the companies that catch the investor’s eye will be those that focus on adding hard assets rather than rapidly growing their trading and marketing volumes.

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