The next step may be bankruptcy court for Enron Corp. after Dynegy Inc., its merger partner for 18 days, officially called off the deal Wednesday. The news, somewhat expected following a series of unparalleled events earlier in the day, snuffed any hope that Enron could rise again after a spectacular fall in less than two months. In a subdued 10-minute conference call in which no questions were taken at midday, Dynegy CEO Chuck Watson cited Enron’s “breaches of representations, warranties, covenants and agreements,” and announced Dynegy had ceased trading with Enron.

“Our first priorities are to protect our shareholders and our financial position,” said Watson, who pursued his downtown rival Enron to merge beginning in mid-October. “We have never been willing to risk the franchise on credit or credibility. We know when to say no, and this morning, we said no.”

Watson, joined by Dynegy COO Steve Bergstrom, said it was “regrettable to see a leading industry player in difficulties,” but added that Enron’s demise “does not reflect a failure of the energy merchant business.” Watson, who had first approached Enron about a possible merger when Enron’s troubles began escalating in October, considers himself a personal and professional friend of Enron Chairman and CEO Kenneth Lay, and had been joined on the podium with Lay the night of the merger announcement.

“The industry has reacted and adjusted well to the potential loss of a market participant over the past several weeks,” said Bergstrom. “Dynegy and its industry peers are ready to absorb any added volatility in the energy markets.” Because Enron’s problems had “drug on for a while, industry has had several weeks to prepare for this event. The market as a whole has shown no signs of degradation.”

Bergstrom said Dynegy’s exposure to Enron through trading is about $75 million, which he said had changed in the past few weeks because of normal business events. “We will continue to assess this exposure as we have over the past 30 days as we do with any party,” he said, but said that until Enron could produce credit ratings that proved it was a worthy trading partner, Dynegy would no longer do business with it.

Enron, in a press release, acknowledged the notice of termination from Dynegy, and said it was taking actions designed to preserve value in the company’s core trading and other energy businesses in light of the downgrade of its bond ratings by several ratings agencies and collapse of the proposed merger. Chief among its actions is a “temporary suspension of all payments other than those necessary to maintain core operations.” The company said it was reviewing Dynegy’s claim to Northern Natural Gas Co., which it obtained with an equity stake when the merger was announced.

“Uncertainty during the past few weeks with respect to the merger has dramatically lowered the market’s confidence in Enron and its trading operations. With Dynegy’s termination of the merger and the ratings agency downgrades, we are evaluating and exploring other options to protect our core energy businesses,” said Lay in a statement. “To do this, we will work to retain the employees necessary to the continuing operations of our trading and other core energy businesses.”

The announcements on Wednesday spiraled throughout the trading community, with several devastating news items pouring more pain on Enron’s future. Its once dominant online energy trading platform EnronOnline ceased operations before midday Wednesday, the three major credit-ratings services had reduced Enron’s ratings to junk status, and for a brief period, the New York Stock Exchange (NYSE) halted trading on the stock for about 35 minutes.

Enron’s share price, meanwhile, took a beating throughout the day, losing about 70% of its current value in heavy morning trading, hovering for a while just above a dollar before finally diving to 61 cents by the close of the markets. Dynegy also suffered, losing 12% to close at $35.97, and other traders also took hits on the news (see related story).

Dynegy, which had ceremoniously announced its acquisition in a joint announcement with Enron officials on Nov. 9, used $1.5 billion from its shareholder Chevron Texaco Inc. to purchase 100% of the preferred stock of one of Enron’s most prized hard assets, subsidiary Northern Natural Gas Pipeline, which owns and operates 16,500 miles of interstate natural gas lines from the Permian Basin to the Great Lakes. On Wednesday, the pipeline became Dynegy’s, said Watson, and the company has exercised its option to purchase “all of the membership interests in the entity,” which indirectly owns all of the common stock of the pipeline.

Watson said Enron has 180 days from the day of the merger agreement Nov. 9, 2001 to repurchase Northern Natural for $1.5 billion, plus interest. However, as analysts explained, there are few avenues for Enron except to bankruptcy court. Enron has few hard assets that are not heavily indebted. Most of its earnings — 90% in the third quarter alone — came from its wholesale energy and marketing unit, fueled in large part to EnronOnline, which on a daily basis was contributing about 60% of the trades.

One week ago, Enron revealed it had only $1.6 billion in cash, despite the $1.5 billion infusion from Dynegy, and nearly $1 billion more from a bank consortium led by J.P. Morgan Chase & Co. based on Enron’s Northern Natural and Transwestern Pipeline Co. pipeline assets — loans Enron has received since Nov. 9. One expert pointed out, however, that if the company were to go into Chapter 11, the court is likely to focus on payment of current obligations, while holding off interest payments on debt.

Before Dynegy delivered a final blow, the big three credit-ratings services, Moody’s Ratings Service, Standard & Poor’s Ratings Group (S&P) and Fitch had reduced Enron’s ratings to junk grade. With its ratings falling below investment grade, it basically means that about $3.9 billion of Enron’s outstanding debt has to be immediately repaid. S&P noted that Enron faces the “distinct possibility” of bankruptcy, and indicated it could cut Enron’s ratings further, potentially destroying the company’s ability to meet its global obligations. Noting it had a “loss of confidence” that the Dynegy merger would be completed, S&P said a voluntary Chapter 11 filing by Enron was on the horizon if Dynegy pulls out.

Fitch downgraded Enron’s senior unsecured ratings to “CC” from “BBB-“, which indicates that “default of some kind appears probable.” Moody’s downgraded the senior unsecured debt to “B2” from “Baa3” and noted that for Enron to “remain a viable acquisition candidate, its core energy trading operation must be able to sustain profitable trading volumes; the company cannot withstand abnormal cash requirements.”

On Wednesday Moody’s Investors Service also downgraded the long-term credit ratings of Portland General Electric (PGE) Co. (Sr. Sec.To A3) and also lowered the company’s short-term debt rating for commercial paper to Prime-2 from Prime-1. The actions affect about $1.l billion of PGE debt. The ratings agency said the action was being taken to reflect Moody’s concerns surrounding Portland General’s ability to remain fully insulated from the many financial challenges currently being faced by its parent, Enron Corp. Moody’s said Enron’s challenges could lead to higher than anticipated demand on PGE’s cash flow in the near-term, The agency is continuing to review the utility’s long-term and short-term ratings for possible further downgrade.

On Wednesday, RBC Capital Markets analysts lowered their estimates and rating for Enron based on a “deterioration of confidence…on the energy trading business.” Mark Easterbrook and Neal Dingmann noted that “customers and counterparties are reluctant to use Enron for various transactions, which should significantly impact fourth quarter profitability and results going forward.” While companies continue to trade with Enron, most are making only short-term trades, which typically carry a thin margin, compared to longer term deals. Also, some companies have limited their trading with Enron to purchases, fearing they will not be paid for sales if the company collapses.

The RBC analysts reduced their fourth quarter estimate and 2001-2003 estimates along with its price target and rating. The fourth quarter estimate was lowered to $0.17 from $0.48, noting that “management has warned there should be severance and restructuring charges during the quarter.” Annual earnings estimates were lowered in 2001 to $1.25 from $1.85; 2002 were lowered to $1.35 from $2.15; and 2003 were lowered to $1.70 from $2.55.

UBS Warburg also lowered its rating on Enron to “hold” from “strong buy.” Analyst Ronald Barone said, we have been highly cautious of the precarious state of Enron ever since this mess accelerated. Albeit after the fact and more of a symbolic call at these levels, the forma rating reduction today (Wednesday) reflects our growing concern that these companies are not getting together in a timely enough manner to hammer out a revised merger agreement.”

Curt Launer, an analyst with Credit Suisse First Boston, said Enron’s lack of disclosure appeared to cinch Dynegy’s reason to back out of its merger. However, he warned that “the suddenness and finality of the ending of the deal may stimulate legal action from Enron in an attempt to compel Dynegy to follow through with original deal terms.” That, however, would be an unlikely scenario, he said.

Beyond what Launer said will be the “first few days of uncertainty and reorganization markets,” the companies expected to benefit most from Enron’s demise will be American Electric Power, Duke, Dynegy, El Paso Corp. and Williams, which will receive most of Enron’s redistributed trades.

Before escaping from the deal, Dynegy and Enron apparently were close to renegotiating their merger agreement, working through the Thanksgiving holiday. According to The Wall Street Journal, “talks between Enron and Dynegy were said to be tense and occasionally acrimonious” as the Houston rivals’ top executives worked on salvaging a deal to combine the companies.

Watson did not indicate during the conference call as to when his company decided to pull out of the merger. As the call ended, he almost apologized for not opening up the call to questions, but said that he hoped to discuss other aspects of Dynegy’s plans in the near future.

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