Anxious Houston-based employees Friday were waiting for formal news that their employer, Enron Corp., had filed for bankruptcy, expected to be the largest in U.S. history, and waited to learn whether layoffs will begin in the United States as they have in Europe. Across the country, others kept an eye on whether Enron would file a lawsuit against its short-term merger partner Dynegy Corp. for backing out of the transaction last week. Meanwhile, companies that had once dealt with the former trend-setting energy trader began tallying their own expected losses should Enron go under, and in Washington, DC, legislators announced they would begin investigating exactly who knew what when.

If there was any good news, it could have been the additional business some of Enron’s former competitors, notably IntercontinentalExchange, were picking up following Enron’s demise (see related story). While many energy traders expected to pick up business that was lost by Enron and its near departure from the trading field, other predators began eyeing some of Enron’s hard assets, including pipelines and power plants. Though it could not be confirmed, another rumor surfaced that Enron was negotiating with its banker consortium, led by JP Morgan Chase Co. and Citibank, to take over its once untouchable trading portfolio, the notional “book” of energy and commodity trading positions and undoubtedly the company’s most valuable asset.

What was once Enron began to completely unravel last week, flush on the news that Dynegy wanted to renegotiate the terms of its original $9 billion stock and cash offer made less than three weeks before (see NGI, Nov. 12). Teams from Enron and Dynegy met with investment bankers in New York City over the Thanksgiving holiday to renegotiate terms of the deal, which apparently included an offer from Dynegy that was less than half of its original transaction. However, on Monday, no announcements were forthcoming from either side.

Tuesday passed, rumors continued to circulate, and meanwhile, Enron’s stock found no support, falling to just above a dollar by Wednesday morning. Still there were no announcements, and the investment community began to digest the news that the merger was probably dead. Dynegy’s pull out, which finally was announced at midday on Wednesday 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 Wednesday, 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 also 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. By the close of trading Friday, Enron shares were down to 26 cents. Dynegy shares 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 in early November, had 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.

However, Enron has already indicated that it will not lose Northern Natural without a fight. Watson indicated Wednesday that Enron has 180 days from the day of the merger agreement Nov. 9, 2001 to repurchase Northern Natural for $1.5 billion, plus interest. Then on Friday, Dynegy was even more direct.

In a prepared statement, Dynegy’s CFO Rob Doty warned Enron not to try and prevent Dynegy’s plans to buy the pipeline subsidiary. Dynegy said Enron could not seek bankruptcy court protection on the pipeline “without the consent of Dynegy as a preferred stockholder.” Said Doty, “Dynegy had contacted Enron to begin a transition of the pipeline’s management and expects Enron’s full cooperation.” Doty also said it still has the right to buy all of the common stock of Northern Natural, and intends to close on the transaction on Dec. 12.

“Our preferred stock in Northern accrues a 6% annual dividend from the date of issue on Nov. 9, 2001,” Doty said in a written statement. “As a result of this purchase, Northern Natural Gas cannot take certain actions, including seeking bankruptcy court protection.” He also stated that it has exercised its option to purchase 100% of the equity in the pipeline. “Upon closing, approximately $950 million of Northern Natural Gas debt will remain in place.”

Formerly part of InterNorth, which merged with Houston Natural Gas Co. in the mid-1980s to form Enron, Doty stated that Northern Natural “has been a separate entity for more than 20 years and operates as a separate business, with separate FERC tariffs, offices, management and customers.”

Said Doty, “Northern Natural Gas will be an excellent addition to our asset-backed customer-focused energy delivery network. This network enables us to provide reliable supply, risk management and logistics to our customers, as we have done for the past 16 years.”

Enron may put up a court fight for the pipeline, but as Merrill Lynch analyst Donato Eassey explained, Enron signed a contract with Dynegy when the merger was announced, and the pipeline deal was part of the transaction. As other analysts have explained also, the pipeline, along with most of Enron’s other hard assets, is heavily in debt. 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.

Less than two weeks 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 $1.1 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. 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.

Analysts across the board signaled that bankruptcy was the only route Enron would be able to take. RBC Capital Markets analysts 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 continued to trade with Enron, most were making only short-term trades, which typically carry a thin margin, compared to longer term deals. Also, some companies limited their trading with Enron to purchases, fearing they would not be paid for sales if the company collapses.

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.

Overseas, Enron’s European employees received the bad news Friday morning, when Enron Europe managers informed most of the 5,000 based there that they were “redundant,” although some managers were expected to be kept short term. One employee, leaving the Enron Europe headquarters in London, told Reuters, “Everyone has been fired from the companies that have been put under administration although there will be some staff kept to help administration.” Enron employs 1,400 in London.

Along with other energy traders that suffered fallout last week from Enron’s demise, Dynegy also lost momentum — and now faces possible downgrades in its own credit. Moody’s Investors Service last week kept the ratings of Dynegy and its subsidiaries under review for a possible downgrade after it announced it would terminate its merger agreement with Enron.

“Despite Dynegy’s termination of the merger agreement with Enron, it remains uncertain whether the company will face legal challenges from Enron. In its rating review, Moody’s will continue to monitor any potential consequences of the merger termination and any subsequent impact on Dynegy’s capital structure and liquidity,” said Moody’s.

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