Dynegy Chairman Chuck Watson said last Wednesday his company was “encouraged” by Enron’s success in extending a deadline on a $690 million obligation until mid-December and is “working to accelerate the regulatory approvals required to complete the merger with Enron Corp.” in light of the continuing free fall of Enron’s stock. The stock fell more than $2 early Wednesday morning to $4.75 but moved back above $5 following Enron’s announcement that it was able to find some breathing room.

In a 10-Q filing made to the SEC after the close of the stock market last Monday, Enron revealed it would have to find some collateral to guarantee some of its debts, or could be forced to pay off a $690 million note by Nov. 27, and a total of almost $3.9 billion more if its credit ratings drop another notch. Enron also indicated that fourth quarter “profitability” will be negatively affected by the “recent deterioration in Enron’s credit rating… This is primarily the result of a reduced level of transaction activity by Enron’s trading counterparties, particularly longer-term transactions.” The debt repayment by Nov. 27 was revealed as required by the SEC, after Enron’s credit rating on its senior unsecured debt fell on Nov. 13 — lowered by Standard & Poors to BBB-.

The news surprised analysts and investors last week and continued the free fall of ENE stock as investors considered the possibility that the company could run out of money before its merger with Dynegy is completed next year.

However, several analysts now say the merger most likely will have to be renegotiated for it to proceed. The current merger agreement stipulates a fixed exchange ratio of 0.2685 DYN shares for each share of ENE at closing. But at that ratio, the deal could be dilutive to Dynegy, said UBS Warburg’s Ronald J. Barone.

Furthermore, the merger has a condition that Enron should not incur a material adverse change to its operations. “We believe the odds of Enron incurring a material adverse change on its operations is soaring, which suggests that — assuming Dynegy wants to continue to move forward with the deal — the 0.2685 ratio will not hold,” said Barone. He added that a more likely scenario would be a much lower exchange ratio “of say 0.15 DYN shares or less for each ENE share.”

Another veteran energy analyst, who asked not to be named, said “this deal (with Dynegy) has to be re-traded or it’s going to blow.” He gave it a 50-50 chance of getting done. He said he read Dynegy’s announcement Wednesday as “lukewarm” toward the merger. “Watson wasn’t out there saying what a great deal it was. He wasn’t leading any cheering squad. He said they were continuing their due diligence.”

The analyst said the main danger to Dynegy is in the partnerships and in dilution of its own stock. If the sale of an asset held by one of Enron’s partnerships comes up short, Enron has to make up the difference with its own stock, he said. That would mean Enron, or subsequent to a merger, Dynegy, would have to issue more stock. In Enron’s case this would simply contribute to the downward stock price spiral. The analyst also said he believed Dynegy could use the surprise $690 million debt obligation as an out.

If the merger were to run into further obstacles, ENE shares could come under “severe pressure as investors may question its ability to sustain liquidity (and normal business activities) for an extended period of time,” Barone noted. “Under such a scenario, bankruptcy would not be out of the question.”

If the merger falls through, Dynegy also would basically be able to buy Northern Natural for the equity stake. The merger also could be called off by Dynegy if shareholder lawsuits against the company total more than $2 billion.

A bankruptcy scenario would have a ripple effect through the energy markets, severely crippling other energy companies and causing others to fail, one veteran market source said.

“I’ve been trying to find out if a market maker of this size has ever failed before. So far, I haven’t found one. If Enron fails it will probably take some companies with it,” the source said. Beyond that, “Enron is probably a party in just about every deal,” he said, explaining that a parcel of gas or power can go through as many as eight or 10 transactions from the production point to the end user. Since Enron is likely somewhere in the chain, the deals could fail and winter is coming.

Also, most companies have hedged and booked results and reported earnings on deals for the future that could come apart without Enron in the middle.

While a few companies are refusing to trade with Enron now, most are simply limiting their business, the source said. “I can’t imagine a company that doesn’t have an edict from its chief financial officer to keep trading to a minimum.” The next question, he said, is at what price point for Enron stock will other loans, for which the stock is collateral, be triggered for payment, or what value must the stock have to avoid rating downgrades to junk bond status. “Trading companies won’t trade with a company whose bonds are junk. They just can’t. At that point, Enron’s toast.”

“At this point it seems if they stick one finger in the dike, the water starts spurting out of another hole.”

The analyst, who asked to remain anonymous, said he didn’t think the market would suffer much in the long term if Enron were forced to declare bankruptcy. “Would there be turmoil for awhile? Absolutely. Would there be volatility? Absolutely. Margins likely would widen because of the increased risk, but there are a number of big companies out there which will step in and fill up the holes.”

Also, if Enron were to go into Chapter 11, it wouldn’t have to make interest payments, “and a lot of liquidity comes back into the market. Bondholders go to the back of the line. Any bankruptcy trustee is going to work to keep its day-to-day trading business going.” The court’s first order of business would be to make sure the company honored its obligations in the market, he said.

John Olson, an analyst with Houston-based Sanders Morris, said if Enron fell into bankruptcy, he believes “it would have fairly widespread ripple effects” on the energy trading market. Although the day-trading market for prompt gas needs would be little affected, he said it would be a different story in the term market (three months and more) where EnronOnline has “maintained the most liquid markets with the tightest spreads.”

He also said the EnronOnline trading operation “might be better off in bankruptcy because it would have much better access to debtor-in-possession financing, which would give them more breathing room to re-schedule all of the maturities of their debt.”

When asked what level Enron stock would have to fall to trigger possible bankruptcy, he noted that Enron has “long since gone through those triggers” in the stock market when its stock fell below the $28-$35 range. Once it fell below that range, he said it constituted one part of a default on various securities. When the company’s credit ratings go down to junk status — which they are “one more notch” away from — banks will start calling in their loans.

He also noted that the stock market is telling a different story than the comments made by Watson and Enron officials Wednesday. The market is convinced the merger deal is “definitely going into the toilet,” he said. This, he noted, “may turn out to be one of the biggest head fakes [sports term] in modern time.”

In Enron’s announcement Wednesday, CFO Jeffrey McMahon said, “We have been in continuous contact with our banks and believe we can identify a mutually beneficial restructuring to enhance our cash position, strengthen our balance sheet and address upcoming maturities. For example, we have been informed by the lead bank on the facility that the maturity on our $690 million note payable obligation, disclosed on Nov. 19 in a Form 10-Q filed with the Securities and Exchange Commission, will be extended to mid-December, providing the time necessary to restructure the facility. We expect that extension to be formalized shortly.”

“We believe the interests of Chase and Enron’s other primary lenders are aligned in this restructuring effort,” said James B. Lee, vice chairman of JP Morgan Chase & Co. “We will work with Enron and its other primary lenders to develop a plan to strengthen Enron’s financial position up to and through its merger with Dynegy.”

Enron also said it has closed on the remaining $450 million of a previously announced $1 billion in secured credit lines from JP Morgan and Salomon Smith Barney. The $450 million credit facility is secured by the assets of Enron’s Northern Natural Gas Company. A $550 million credit facility, secured by the assets of Enron’s Transwestern Pipeline Company, closed on Nov. 16. Proceeds are being used to supplement short-term liquidity and to refinance maturing obligations.

Houston-based Reliant Energy believes “Enron’s credit situation has not substantially changed. We continue to trade with them on a daily basis,” spokesman Richard Wheatley told NGI Wednesday. “Our net exposure is not significant and we’re being careful. We’re not going to increase it, but, we’re comfortable.”

Wheatley said that a lot of the reaction was in the equity market and not in the energy commodities market, which is continuing to trade as normal, given it’s the day before a long holiday.

Meanwhile, Goldman Sachs dropped it rating on both Enron and Dynegy Wednesday, moving both off its “recommended” list to “market perform” because of its looming debt obligations. Although Enron was successful in extending one of its debt obligations until December it has other debt repayment problems looming as well, according to the SEC filing. With another drop in its debt rating, which would put it below investment grade, the company would be required to repay another $3.9 billion in debt for two affiliated companies. With another credit rating drop, the Osprey Trust debt, amounting to $2.4 billion, and a Marlin Water Trust debt, totaling $915 million, also would have to be repaid, Enron said in the 10-Q. Both the Marlin Water Trust and the Osprey Trust are said to be part of the SEC’s investigation of Enron’s related-party transactions that led to the loss in investor confidence in mid-October.

Goldman Sachs analyst David Fleischer said an even greater issue than Enron’s ability to meet its debt obligations, however, “may be the lack of confidence that customers now appear to have in Enron as a counterparty and their increased requirement for collateral before engaging in transactions.”

Dingell Wants Closer Look at Arthur Andersen

Michigan Rep. John Dingell (D), ranking member of the House Committee on Energy and Commerce, last week called for an investigation of Enron’s accounting firm Arthur Andersen LLP, regarding the audits it performed at Enron as well as Waste Management Inc. Dingell sent a letter last Monday to the Public Oversight Board.

In the letter, Dingell asked for “an oversight review or special investigation” of the Chicago-based Big Five accountant. He also asked the board to look into peer reviews of the accounting firm in recent years by other accountants, including Deloitte & Touche, and asked about the triennial peer review process that has been in place since 1978.

“The best accounting standards in the world are meaningless if the accounting and audit processes are so inept or corrupt that they produce unreliable numbers and untruthful reporting,” according to the letter from Dingell, noting that his request included an “investigation or review” of “adequate, transparent and public disclosure of all significant issues identified.”

Andersen was auditor to Enron, which now is facing a probe by the SEC of its related-party transactions, which in turn sent the company’s stock price plummeting and led to its announced merger with rival Dynegy Dingell’s criticism is not the first for Anderson, as critics have charged that the accountant should have done more as Enron’s auditor to draw investors’ attention to Enron’s unusual finances. A lawsuit filed in Oregon against Enron and its board alleges Andersen’s judgment was questionable because of the high consulting fees that it received from Enron, while it was also paid as auditor. Enron shareholders have lost about $19 billion over the last month as the company’s stock price went into a downward spiral.

Enron named Deloitte & Touche as part of its special committee to investigate the company’s transactions after the SEC launched its probe in October. However, Dingell wrote in his letter that Deloitte is conducting a triennial peer review of Andersen, under a system to ensure quality accounting. The Public Oversight Board supervises the peer review process. Dingell said the review by Deloitte of Andersen raises questions about a conflict of interest.

“Given the appearance of conflicts of interest, the public record to date regarding allegations of professional malpractice or worse by Andersen in both the Waste Management fraud and the evolving Enron Corp. accounting debacle, as well as the considerable damage to investors, there appears to be little reason for the public to have faith in Andersen or the peer review process,” wrote Dingell. Andersen was fined $7 million in June by the SEC to settle charges that it filed false and misleading audit reports of Waste Management. Andersen did not admit or deny the charges.

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