For anyone holding Enron Corp. stock one year ago this week, things could not have seemed better. The closing price on Oct. 30, 2000 was $80.68, and the following day, Halloween, shares gained almost $2 to close at $82.06. Today at Enron, however, things look a lot spookier. And despite the plethora of information unmasked by the Houston-based company in the past two weeks, the investment community still seems anxious about any other tricks still to be revealed within the energy trading giant’s complex financial holdings.

By late Friday, confidence in the once untouchable company, considered the largest energy trader in the world, still appeared lost. The stock slid for the eighth consecutive day in heavy trading, finally closing down about 5% to stand at its lowest level in a year at $15.50.

Before the closing — in yet another attempt to calm investors concerned about Enron’s short-term liquidity issues — the company tapped into its $3 billion credit line late Thursday to provide cash liquidity of more than $1 billion. It also is said to be in talks with lenders to secure another new multi-billion dollar credit line.

“We are making it clear that Enron has the support of its banks and more than adequate liquidity to assure our customers that we can fulfill our commitments in the ordinary course of business,” said CFO Jeff McMahon in a written statement. “This is an important step in our plans to restore investor confidence in Enron. Additionally, we will update investors over the next several days regarding our plans to maintain our long-term credit rating.”

However, the draw on the credit facility still unnerved the market when it opened Friday. Shares have dropped more than 50% in less than two weeks, and concern centers on whether Enron will have enough good credit to raise the daily cash it needs to keep its trading partners from demanding collateral to settle transactions. Although rumors abounded, no companies apparently had stopped doing business with Enron by Friday.

Signaling what may be a frequent question-and-answer in the industry in the near future, Sempra Energy’s CEO was hit Thursday with questions from financial analysts on the firm’s exposure to Enron in its future business dealings as part of a third-quarter earnings conference call. Stephen Baum said the company is monitoring very closely Enron’s unfolding financial woes and the impact on its stock price.

Baum insisted in response to questions that he is not worried at this point, using the term “attentive” to describe Sempra’s current level of interest in the still-new saga. He acknowledged that he thought other industry leaders like himself were thinking a lot about their dealings with the Houston energy giant.

“It is a question on everybody’s mind today,” Baum said in response to an analyst’s question. “We do a significant amount of business with Enron, as does most anybody in the energy trading business. Enron is a very large counterparty with us over a variety of delivery points and variety of terms (lengths of time) for both gas and electricity.

“We’re very attentive to those positions. They are all margins, and we have what we consider excellent positions in place with respect to those margins. We are monitoring that situation, but we are not overly concerned at this point.

“With Enron being a very significant player and Enron Online being a major factor in the liquidity of the market, it is a situation we are monitoring very carefully.”

On Thursday, the ratings agency Fitch placed Enron’s securities on a negative rating watch for a potential downgrade. Standard & Poors affirmed Enron’s ratings but revised its long-term outlook to negative. Moody’s Investor Service already has placed Enron’s credit under review. Fitch on Friday also placed the ratings of Enron’s Marlin Water Trust II, with about $915 million senior secured notes due in 2003, and Osprey Trust’s $2.4 billion senior secured notes due in 2003 on Rating Watch Negative. Both Marlin and Osprey apparently relate to transactions between Enron and its Azurix Corp., which were set up by Fastow.

Fitch’s Ralph Pellecchia said the negative rating watch is related to the “negative capital market reaction” to Enron’s disclosures, made first during the release of third quarter earnings and the subsequent conference calls with Enron executives and the investment community over the past two weeks.

“The loss of investor and counterparty confidence, it if continues, would impair Enron’s financial flexibility and access to capital markets, therefore, impacting its ability to conduct its business,” Pellecchia said. “The company has attempted to quell rumors and has publicly stated that it has adequate liquidity to conduct its business,” but he noted that “investors have voiced concerns.” Pellecchia said that Fitch had no information that would indicate Enron had “fundamental problems with core wholesale, retail and pipeline businesses,” but said Fitch would be “in contact with the company on a continuing basis to both monitor ongoing events and address strategic, longer-term issues.”

In the Fitch negative rating watch issued on Friday, Pellecchia said that the Marlin II trust rating is supported by the overfund account and equity commitment from Enron in the form of mandatorily convertible preferred stock. The overfund account is invested in Enron debt securities, with payments used to service interest to noteholders. The Osprey I notes also are supported by the Enron assets in the share trust for interest payments.

In both cases, said Pellecchia, primary credit support is derived from Enron’s obligation to remarket the stock if an amount sufficient to repay the notes has not been deposited within the maturity date, which is a Note Trigger Event. If the preferred stock issued yields less than the amount to redeem the senior notes, Enron has to deliver additional shares, and if it “cannot or does not deliver,” then the amount becomes an Enron payment obligation. And, as Pellecchia noted, Enron “has not verified that the underlying assets have adequate market value to fully pay down the associated debt.”

S&P revised Enron’s outlook also to negative, but it affirmed its long- and short-term credit ratings. The ratings agency said it was also closely monitoring Enron’s capital needs and liquidity position — both considered crucial to the success of the company’s core business operations.

“Assurances from the top levels of Enron management that the company will maintain its commitment to its credit quality and that no steps are being taken to support the company’s common stock price at the expense of credit quality provide further support for Enron’s ratings,” wrote S&P. The drop in Enron’s market capitalization last week has damaged the company’s financial flexibility and could impede management’s ability to rebuild the balance sheet and sell assets in a timely manner. “The negative outlook acknowledges the potential for erosion of the company’s credit quality as investor confidence in the company’s management has waned.”

Enron’s investment-grade 6.40% notes are due in 2006. In mid-October, the notes were quoted at 2.3% points more than five-year U.S. Treasury Bonds. On Friday, they were quoted at a dollar price, similar to junk bonds. On Friday, they bid at 80 cents on the dollar with a yield to maturity of 12.09% — about 8.34% more than the Treasury bonds.

The crux of the controversy centers around Enron’s complex off-balance sheet arrangements, apparently to finance shorter-term transactions, such as technology updates or pipeline construction. The off-sheet transactions were formed by CFO Andrew Fastow, who also acted as general manager until last July, and many are questioning the legitimacy of Fastow acting as both an Enron officer and as someone who stood to benefit financially from the off-sheet arrangements. The transactions came to light following the third quarter earnings release and subsequent earnings call with the investment community (see NGI, Oct. 22).

Subsequently, the U.S. Securities and Exchange Commission (SEC) requested information from Enron on its related-party transactions, and last Monday, Enron announced that it had agreed to provide the documentation. On Tuesday, Enron Chair Kenneth Lay held court on another conference call with analysts, and expressed confidence in his embattled CFO. However, by Wednesday, Lay had backtracked, announcing that Fastow would take a leave of absence.

The call with investors on Tuesday and press releases issued were designed to bolster investment confidence, but they seemed to have an opposite effect on the tight-lipped company, which failed to return telephone calls from the media all week. Instead, rumors and innuendo ran almost unabated, filled in only with the scant information offered by Enron, including the press release concerning new CFO McMahon, who formerly chaired and was CEO of Enron’s Industrial Markets Group.

“In my continued discussions with the financial community, it became clear to me that restoring investor confidence would require us to replace Andy as CFO,” said Lay in a statement. From 1998 until 2000, McMahon, 40, had been Enron’s treasurer, and he also spent three years in London as CFO for its European operations.

But there were more than personnel changes at Enron. On Thursday, the company’s London office announced it would close its broadband operations there and move them to Houston within six months. But the worst news was the licking Enron took from both analysts and credit ratings firms, with some analysts moving the once stellar stock into the “hold” or “sell” category.

On Friday, Salomon Smith Barney downgraded the stock to neutral from buy; on Thursday, Banc of America Securities, to market perform from strong buy; on Wednesday, Prudential Securities to sell from hold, JP Morgan to LT buy from buy and FAC/First Albany to buy from strong buy; on Tuesday, Prudential Securities to hold from buy; and on Oct. 19, AG Edwards to hold from buy.

The investment downgrades followed a terse teleconference between Lay and the investment community last Tuesday. Sounding clearly concerned, Lay reiterated that Enron was cooperating fully with a request by the SEC. “We welcome this request and we are cooperating fully with the SEC,” said Lay. As he said in a statement on Monday, “We believe everything that needed to be considered and done was considered and done.”

The chairman and also CEO said the company is “going forward in this environment, and we are very much in a disciplined mode. Projects continue to move ahead.” However, because of the recent bad press reports and speculation surrounding the company’s business practices, Lay committed to have more conference calls “on a regular basis for a while,” and said that answers to frequently asked questions would be posted on the company’s web site beginning Tuesday. “There are a lot of rumors getting out…a lot of speculation getting out. It is doing a lot of damage to us, and we want to get the facts out.”

Lay explained that some of the most recent rumors related to the third quarter conference call in mid-October, where he offered information that the company would have a $1.2 billion reduction in shareholder equity. That information normally would have been filed “in mid-November” when the company was expecting to release its balance sheets for the quarter. He said that report will “clearly spell out” what the reduction is. The 10-K is expected to be filed on November 13.

The chairman further explained that other questions regarding Enron’s related-party transactions revolve around an established structured finance vehicle to “mitigate volatility with certain energy merchant investments,” including short-term investments such as technology upgrades and construction. However, he said that “in conjunction with the termination of some of these vehicles, we adjusted” the equity, which ended some of the obligations of the company. The termination equated to 62 million shares of Enron stock, and Lay said the “obligation to issue shares in the future on [those obligations] no longer exists.”

Lay then turned the call over to then-CFO Fastow to discuss Enron’s current liquidity position, and at the time, defended Fastow’s reputation and stake in Enron. Fastow’s involvement on two related-party transactions with Enron and companies he set up and managed until last June — LJM Cayman and LJM2 Co-Investment — appeared to have set off the most recent controversy and resulting lawsuits. Lay said that he had “heard investor concerns” about Enron’s partnership with the LJM entities, and said, “LJM is no longer a related-party instrument. In the third quarter, we terminated the related-party transactions.”

To “unwind” itself from the partnership, Enron took a $35 million charge as part of its quarterly earnings, and also took an equity reduction of $1.2 billion along with a corresponding reduction in notes receivable. The obligation equaled 62 million shares, which will not be factored into quarterly results, Lay said. He also apologized for the confusion associated with the reduction. Fastow said Enron “expects to continue to have sufficient liquidity for normal continuing operations,” answering calls about Enron’s ability to raise money. He said Enron currently has commitments from bank loans to use uncommitted lines of credit, and all total, about “$1.5 billion of liquidity sources available today.”

Fastow said Tuesday that Enron’s policy under its committed lines of credit remains in effect, and in addition to the unused $1.5 billion in liquidity sources, Enron also will gain about $600 million from asset sales by the end of this month. By the end of 2002, Enron also will pick up almost $1.9 billion in its Portland General Electric sale to Northwest Natural, he said.

The call was soon turned over to a barrage of phoned in questions from investors and analysts, who, for the most part, were sympathetic to the recent adverse news stories, but also critical of Enron’s lack of clear communication regarding its operations. Answering each question as well as he could with regard to pending litigation, Lay for the most part retained his composure until Richard Grubman, managing director of Highfield Capital Management, asked for more explanation of Enron’s dealings with its water subsidiary Azurix and its trust structure. Grubman, who manages a Boston-based hedging fund, had gotten into an argument with former Enron CEO Jeffrey Skilling last spring, in a contentious discussion where Skilling called Grubman “an asshole” (see NGI, April 23).

Grubman questioned how Enron reconciled the value of the water assets held by an off-balance sheet transaction held by its Marlin II trust, another complex arrangement within the Azurix holdings that were included in the third quarter writedown. Following an explanation about the Azurix arrangement by Lay that Grubman apparently considered inadequate, he again asked Lay to provide him with more detail. Lay shut off his call.

“I know you want to drive the stock price down, and you’ve done a good job,” Lay told Grubman. “Let’s move on.” Grubman, answering said, ” I think everyone understands why you want to move on.” But Lay interrupted him, “you won’t accept our answer. Move on. Next caller.” With that, the call was interrupted. But Grubman’s questions were among several by investors and analysts questioning Enron’s business practices. Throughout, Lay remained steadfast to answering questions as best he could.

David Fleischer of Goldman Sachs & Co. didn’t have a question, but may have spoken for the listening audience when he offered some advice to Lay and Enron. “With all due respect, what you’re hearing from others is that the company’s credibility has been severely questioned, and there is a need for much more disclosure.” Fleischer said, “There is an appearance that you are hiding something that you don’t want to disclose…maybe there is something that may be questionable, [but] you need to do everything in your power to explain to investors and demonstrate to investors that you are above board.”

Fleischer added, “I urge you to have daily conference calls or almost daily conference calls…it’s absolutely critical to the company. I, for one, find the disclosure is not complete and is not complete enough for me to understand and to explain the intricacies of those transactions. You are now in a position where you need to give us a lot more information.”

Lay, who acknowledged the limits of what could be disclosed while there are pending “lawsuits and potential lawsuits,” said, “We are trying to be as transparent as we can. We are not hiding anything. We have scrubbed and rescrubbed and rescrubbed in the last few months more than we have in a long, long time. [In the third quarter release], we broke things out in more segments, offered more operating data. We are sorry for the misunderstanding on the $1.2 billion equity reduction, but we made the decision to put it out at the same time as the earnings. My commitment is to get everything out there and make sure that the analysts and the shareholders know what’s going on there.”

Analyst John Olson of Sanders Morris, who said it was “important in terms of credibility,” asked for specific detail on Fastow’s involvement and oversight by Enron as general partner in the LJM deals. “How closely was he monitored and what kind of review was imposed on the general partner?”

Lay responded that the “SEC is going to come in and look at this and we welcome it and it will finally put issues to rest. I prefer Andy not get into too much detail [of his relationship] with LJM and Enron,” but he said safeguards had been put in place by the Enron board of directors to ensure there was a process where Enron’s and shareholder’s interests “would be paramount” before any projects were put in place. “It was strictly discretionary, but it had to have Enron’s best interests before [anything] was put in there.”

Following the call, analyst Curt Launer of Credit Suisse First Boston said that he expects to see the “issues and inquiries that surround Enron for some time.” Ultimately, however, the analyst expects the business units to gain value again, resulting in a “significant” recovery next year.

Energy analyst Ronald Barone of UBS Warburg said Thursday that Enron is “still the market maker,” adding that if “push comes to shove” as far as Enron’s liquidity, the company could “generate substantial cash” if it sold other assets such as its pipelines segment. However, he warned that “at a minimum, if Enron’s shares were to deteriorate much further, we would view it as a potential acquisition target for other substantially larger and better capitalized entities looking to immediately become a sizable player in the global unregulated wholesale/retail energy space.”

While Barone admits that even though there are no guarantees, “the odds of this company becoming completely illiquid are low,” and the odds of it “regaining some level of stature or returning an attractive return to shareholders from current levels over the next 12-18 months are medium-to-high.” With all of its current problems, there are few companies that could even handle the type of business Enron has succeeded in building, and no one so far is naming any names.

As Enron’s stock fell last week, other energy merchants — many with stellar third quarter reports — watched their stocks fall as well. But Barone does not believe the shadow cast by the stock decline will last long. “The collateral damage to the rest of the space, such as Dynegy Inc. and El Paso Corp., is overdone,” Barone said, offering instead, “an attractive buying opportunity.”

Launer agreed, noting Thursday he had raised Dynegy’s rating from “buy” to “strong buy” in recognition of the valuation opportunity created by its 13% stock decline on Wednesday. “Dynegy was the focus of speculation related to Enron that had Dynegy cutting off business with or limiting credit to Enron,” but Launer said his information and analysis showed that those types of speculations were not correct, adding that Dynegy had “emphatically” denied cutting off Enron’s credit on Wednesday.

“Our contacts in the industry indicate that business in the merchant arena is progressing normally, despite Enron’s issues,” said Launer. “We continue to view the merchant business as capable of producing in excess of 20% growth rates for industry participants, including Enron.”

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