by Sian Green
Enron is growing accustomed to eleventh-hour deals following its sudden demise in November: first Dynegy stepped in with a $9bn rescue package to save it from bankruptcy, then the company brokered a deal to defer repayment of a $690m note until mid-December.
How the mighty fall: Enron’s six month share price and trading volume trend.
Yet the company remains in a precarious position. There is no guarantee that the deal with Dynegy will succeed, and its credit downgradings have increased pressure to strengthen its financial position and improve cashflow.
The downfall of Enron – the original market maker – came as a shock to analysts and shareholders alike. In spite of some recent troubles relating to its operations in California and India, and problems in its bandwidth trading unit, there are not many who would have believed that a $1bn special charge and a $1.2bn writedown in shareholder equity would bring Enron to the verge of bankruptcy.
The disclosure of these charges in the October 16 analyst conference call revealed some unusual activity and for the first time the analysts were able to see behind the scenes into Enron’s complex accounts. It quickly became apparent that Enron had built up a number of off-balance sheet deals, some linked to private equity funds run by former chief financial officer, Andrew Fastow.
What happened next is well-documented and stems from a complete loss of confidence in Enron by the market. The US Securities and Exchange Commission began an informal inquiry into Enron’s financial dealings, and it became apparent that Enron had itself been running an internal inquiry for two months. The company’s stock fell rapidly from around $33/share and as of November 21 stood at $5 – just a fraction of its $82 high at the beginning of the year. Ratings agencies downgraded the company’s credit rating, but, critically, stopped just short of grading it junk status.
Just as Enron was close to breaking point, cross-town rival Dynegy stepped in with a ‘rescue’ package. On 9 November the two companies announced that they had agreed terms for an all-stock merger to “unleash the value of Enron’s core energy business”.
The transaction values Enron stock at just over $10 per share. It will bring an immediate $1.5bn asset-backed equity infusion to Enron from Dynegy, and $2.5bn in new equity from ChevronTexaco, which owns 26 per cent of Dynegy’s stock.
So the Enron name will disappear if the deal succeeds. Dynegy will become North America’s largest energy company with $200bn in revenues and $90bn in assets including 40 000 km of natural gas pipelines and 22 000 MW of electricity generating capacity. Dynegy expects the deal to be strongly accretive to earnings from the first year onwards.
But while these are obvious benefits to Dynegy, the fact is that it was placed in a difficult position by Enron’s problems. It had a large exposure to Enron and chose to save its rival rather than face the consequences of Enron’s bankruptcy. “Out of everybody, Dynegy had the biggest exposure to Enron,” explains David Kurtz, director of analysis of Datamonitor’s energy practice area. “If Enron had failed then the implications would have been pretty serious for Dynegy.”
And given Enron’s famed opacity, does Dynegy face the risk of further surprise revelations? It certainly did not have a great deal of time to examine the company before agreeing the deal.
According to Kurtz, one of the biggest risks that Dynegy now faces is the size of Enron’s debt and what it might have to write down for the non-core businesses. “Dynegy dived in there to rescue Enron and I don’t think it really did all the maths that it could have done. Maybe it hasn’t properly estimated the size of the equity write-downs,” said Kurtz.
In addition, says Kurtz, Dynegy has probably assumed that Enron’s trading business is profitable, yet there is no way of actually telling for sure because the trading business is wrapped into Enron’s overall wholesale business. “There is nothing actually in the accounts that shows how profitable the trading business has been. However, knowing how fast the trading volumes on EnronOnline have grown over the past few years is a good indication that it is a fairly solid business.”
It is now important for Dynegy to restore the market’s confidence and the credibility of the business that it has bought. Dynegy has been careful to point out that the new business will maintain focus, be asset-backed and “will keep a strong balance sheet and straightforward financial structure”.
Important in restoring confidence has been the equity injection by ChevronTexaco, according to Kurtz. “ChevronTexaco is highly regarded in the market, and it’s a good thing that Dynegy has it on its side.”
In spite of this, the deal still hangs in the balance. Enron will continue to face pressure from bankers, customers and investors to improve its financial standing, and with the company’s share price continuing to fall, Dynegy will come under pressure to renegotiate the terms of the merger. This would not be a good strategy, says Kurtz: “As soon as Dynegy looks to renegotiate, there will be an even bigger slide in Enron’s share price and its credit rating.
“Investors would lose confidence and traders would not want to do business with them. Dynegy is probably better off not renegotiating at the moment.”