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Enron, IBM, AOL Form Retail Energy Venture

Enron, IBM, AOL Form Retail Energy Venture

A new "dream team" of companies formed last week appears to have more than enough market muscle and expertise to succeed where others have failed in the retail energy market. Enron Corp., IBM and America Online have launched an ambitious plan to build a major national retail energy company with IBM as back office manager, Enron as energy supplier, and AOL as the key link to the small customer marketplace.

While Enron has come down this road before and had to turn back, this time it has a lot more help, a much better plan and a lot less to lose. According to analysts, Enron will have a 60% stake in The New Power Company, which will be based in Greenwich, CT, with a branch office in Houston. IBM, AOL, General Electric and others will be the other equity partners.

Most of Enron's financial commitment to the new company will be through value-in-kind investments. Enron will provide the new company's energy commodity pricing, risk management, and government regulatory affairs. IBM will build the corporate infrastructure, man the call center and build the company's web site, and AOL will give the company access to its 22 million customers via a six-year strategic alliance covering access to three AOL brands --- AOL, CompuServe and AOL Digital City.

The company also will get a $120 million initial investment from Donaldson, Lufkin and Jenrette, CalPERS pension fund and the Ontario Teachers Pension Plan.

"We've studied the residential and small business market for several years and believe this is the optimal way to provide value to these customers," said Enron CEO Kenneth Lay. "By assisting in setting up an independent company, Enron is able to leverage its core competencies of energy and risk management, while partnering with other industry leaders to give The New Power Company extraordinary and immediate depth and capability." Lay will serve on the company's board.

H. Eugene Lockhart, former president of AT&T Consumer Services, president of Bank America's Global Retail Bank and former president and CEO of MasterCard International, has been brought on board as the new company's CEO. Lockhart has been joined by a number of high-level executives from the telecommunications and financial services sectors, including William Jacobs, former executive vice president of MasterCard International; Marc Manely, former chief counsel at AT&T Consumer Services; and Tony Watt, former vice president of operations technology and planning at AT&T. Several Enron executives also will be coming on board, including among others, Lou Pai, CEO of Enron Energy Services; John Hendersen, Enron's vice president of risk management, Kathleen Magruder, Enron's director of government affairs; and Jim Badum, Enron's chief marketing officer. Lockhart said this team of companies and people will make the difference between winning and losing in the retail energy market.

"What we get from each of those players is scale," Lockhart said in an interview with NGI. "You think about it. Each of these institutions has put in the distinctive advantage of what they do best. Enron has put in a commodity master service agreement, which guarantees us their best wholesale price [for gas and power]. That's locked in margin right there. IBM has put in their processing capability so we get scale advantages from day one, and that is a tremendous advantage. I will be able to cut a bill for The New Power Company and collect the money and answer a care service call cheaper than I could at AT&T on a per-unit basis. Third is AOL; they put in their distinctive confidence, the Internet, and we'll be able to acquire and serve customers for a fraction of what it would take if we were to do that by more manual means. So that's where the difference is."

One major feature that will be supporting New Power's retail marketing efforts will be Enron's guaranteed best commodity price over at least the next three years. "We then can trade against [that] or pass it on and sell to our consumers," said Lockhart. Enron also is providing significant administrative and financial accounting support as well as licenses for commodity purchasing, trading and risk management software.

To back up its marketing efforts with solid corporate infrastructure, the New Power Company has signed a 10-year, $1.5 billion service agreement with IBM Global Services, which will build, staff and run core components of its back office functions. IBM will provide systems integration services and numerous hardware and software products. It also will help develop The New Power Company's e-business strategy and delivery capability.

"This is a unique opportunity to build a world-class back office infrastructure to support The New Power Company's first mover strategy," said Doug Elix, IBM senior vice president and group executive, IBM Global Services. IBM will develop and host the company's web site from its Southbury, CT e-business hosting center and plans to add another center in Charlotte, NC. It also will provide billing and revenue management functions.

Thomas Cotney, vice president of the utility and energy services industry for IBM Global Services, said the job eventually should require a large IBM staff. "Over time it will depend on how much market penetration they actually achieve. The deal size that we put out is sort of a conservative estimate of how many customers they will acquire and the service generated for us as a result of that," he said. "I'm not at liberty to tell you what that number is. Our revenues are almost all variable. We receive fees when we service customers, answer a question on the phone and when we produce a bill. If they get next to no new customers, I get next to no incremental revenue. So we grow as they grow. Our interests are very closely aligned."

He said a key part of the deal with IBM was the risk-sharing arrangement. IBM ended up taking a single digit percentage ownership in The New Power Company. "It was a deal point for them, if you will, to prove that we were aligned with their interests."

IBM has been in this line of work for some time and holds a 14% market share in the services and consulting business for the energy industry. Its last retail marketing partner was PG&E Corp.

"Frankly one of the reasons we won was the lessons that we've learned, not necessarily from PG&E, but just from being involved in a deregulated energy market," Cotney added. "One of the big lessons that we've learned was that the California market deregulated with no standards about how the IT operations should take place. What you saw was an ad hoc, highly expensive method of communication evolve through happenstance more than careful planning.

"The industry needed a clearinghouse function and that's one of the biggest components of this deal [with New Power]. We developed a service offering called VeriTRAN that will move the customer data about how much energy was actually consumed and ship that data over to the energy marketing company or any subsequent company in its accurate form. We maintain the data integrity, and we offer everybody involved the opportunity to do one simple interface instead of the 36 that took place in California."

"The New Power Company will use our clearinghouse function in all of the markets that they enter and I'm absolutely convinced they will be in every market in the U.S.," said Cotney. "That, more or less, makes [my VeriTRAN] product the defacto standard. The clearinghouse is created for their use and they are charged a prorated share of the cost, but it's there once they've entered a market for anybody else to use."

Deal Titillates Analysts

Merrill Lynch analyst Donato Eassey is practically convinced this combination will finally be the one that succeeds in the small-customer energy markets. "Obviously with top-shelf companies like AOL, IBM, GE Financial and some other players," this company has the best chance to succeed, he said. "...What package has the best opportunity for you to reach the most potential customers? AOL brings that. What software package company would you rather do business with than anybody? Good chance it's IBM, right? What trading company do I want to align with? On the gas side there are several of them, but the two that stand out are Dynegy and Enron.

"I think it's way too early to predict [the growth of the new company]," he said, "but I think it will be substantial. Keep in mind what has happened to retail [e-commerce] on any product so far. It's just started to get accepted. But if I can go in and buy clothes and cars or anything online, why can't I go in there and buy energy, be it for a day, a month, a year. Keep in mind that as [Enron does] this they are going to build another conduit of market intelligence on which to trade off of on the wholesale side for [energy] marketing. Again, I think the effective way to do it is on-line, and America Online is a good way to go about it."

PaineWebber energy analyst Ronald Barone focused on the good timing of the transaction in addition to the companies involved. "...[R]ecurring operating profits in the residential/small business energy arena have been the exception not the rule," Barone noted. "In fact, while Enron was one of the first players to get in and get out of this market a few years back, many other small players have since continued to make little economic progress in their efforts. However, with the: 1) economies presented by effective online initiatives; 2) exiting of marginal players competing for customers; 3) ever-increasing number of states providing consumer choice; and 4) fairly rapid roll-off of transition charges, margins in the 'mass market' operating environment have been improving lately." Barone notes that Dynegy has done well in retail lately through its Georgia Natural Gas marketing alliance with incumbent utility Atlanta Gas Light and Piedmont Natural Gas in the Georgia market, where the company has amassed 500,000 customers.

"Overall, [an] improved environment, combined with what appears to be a compelling national team-based strategy leveraging off of the expertise of some of the most widely respected companies in the world, could place Enron on track to dominate yet another facet of the energy industry," said Barone.

He also noted that "with little (if any) future direct investment from Enron" in the New Power Company, Enron's near-term earnings have little risk exposure from this deal. "However with annual residential energy marketplace revenues estimated at greater than $125 billion per year (even before the potential for non-energy cross selling); as well as Enron's traditional 10-20% market share capabilities... there is potential for sizable incremental income streams down the road."

With plans to launch in two states, New Jersey and Pennsylvania, in August, The New Power Company intends to grow rapidly, crossing 10 more states by the first quarter of next year, Lockhart said. "We would expect to be in the millions of customers over the next four or five years," he added.

While it plans to sell gas and power initially, New Power will broaden its product offering eventually, said Lockhart, to include "energy-driven" products, such as appliances, air conditioners, water heaters and the like, supported by customer service and warranties. Lockhart said fuel cells currently are not on the list. "There are a few other things that are more proven with a higher near-term margin for us. I'm kind of intrigued by fuel cell technology, but I'd like to give it a chance to mature."

Rocco Canonica

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