Enron May Be Too Hot to Handle


By Heesun Wee After hitting a new 52-week low of $10.90 a share on Oct. 30, shares of troubled Enron (ENE) bounced back slightly at the end of last week. Some investors, it seems, just couldn't ignore the rock-bottom price. Also giving shares a boost was speculation that the Houston-based energy company's newly depressed stock has made it a cheap takeover target. So, with Enron shares trading at levels not seen since 1993 and a fraction of the $85 they brought about a year ago, is it time for bargain hunters to swoop? The answer: Only if you have a huge appetite for risk.

True, Enron announced on Nov. 1 that it had secured $1 billion in new credit lines. The company has already drawn down about $3 billion in an effort to shore up financial confidence and increase liquidity. But major concerns hanging over Enron will likely preclude any significant near-term recovery in the stock price. Chief among them: a formal investigation by the Securities & Exchange Commission into the termination of complex transactions between Enron and limited partnerships headed by Andrew S. Fastow, Enron's former CFO, who resigned suddenly on Oct. 24 (see BW, 11/12/01, "The Enron Debacle").

The unusual transactions raised concerns among shareholders about potential conflicts of interest. Why was the CFO apparently engaged in complicated hedging transactions involving company assets and millions of Enron shares? The deals and certain investments, it turns out, soured and forced Enron to announce a $1.2 billion reduction in shareholder equity for the third quarter. The stock has been in a tailspin since it released results for the period in mid-October.

REGULATORY PROBLEMS. "There are so many unknowns in the stock," says Carol Coale, who follows Enron for Prudential. She recently downgraded it to sell from hold and cut her price target to $9 from $15. As recently as early October, the target was $55. Coale says the SEC investigation could drag on for months and possibly longer. A resolution will be likely only if the partnerships in which Fastow participated open their books -- something she doesn't think is "likely to happen." Meanwhile, shareholder lawsuits against Enron are piling up.

In addition to the SEC probe, many investors are wary after massive write-offs for the third quarter, suspecting that more might be in store. Enron reported a $618 million loss for the third quarter, resulting from $1 billion in previously undisclosed write-offs -- including a $287 million charge from its investment in Azurix, a water company Enron spun off and then repurchased. Analysts speculate that Enron began to get into trouble when it used revenues from its booming trading operations to finance nontrading-related investments, such as the water company.

And Enron still has several items on its books that may have to be written off in part, notes Raymond Niles, an analyst at Salomon Smith Barney. (Salomon and J.P. Morgan arranged for Enron's recent $1 billion credit line.) They include Enron's investment in its Dabhol power plant in India, South American investments, and its remaining telecommunications assets. Nor does that that list of possible write-offs include off-balance-sheet vehicles that could further pummel shareholder equity.

STILL FAITHFUL. Based on 2000 values and conversations with management, Niles estimates items subject to partial future write-downs total $2.4 billion, with possible charges related to off-balance-sheet financial vehicles totaling $3 billion. Enron couldn't be reached for comment.

Despite the major obstacles facing Enron, Niles and some other analysts haven't completely lost faith in its future. That's largely because of the company's consistent overall performance in its key merchant-energy franchise, which includes its trading operations. Enron is the leading North American buyer and seller of electricity and natural gas. The merchant-energy group drives more than 80% of the company's earnings and has shown consistent 30% to 40% annual growth over the past three years, notes Niles, who has a neutral rating on the stock to reflect the latest troubles.

In the third quarter, North American trading volumes and profits were up at least 30%. And EnronOnline -- a Web-based e-commerce system widely used by energy traders -- offers a variety of commodity products beyond power and gas and handles billions of dollars in trades a day. But while Enron's trading prowess is hard to ignore, most investors are likely to remain on the sidelines until they see new information about the ongoing SEC investigation and learn more about possible future write-offs.

TAKEOVER BAIT? For now, Enron has little to offer by way of public explanation. Analysts who listened to the third-quarter conference call between company execs and investors on Oct. 23 describe CEO Kenneth Lay as somewhat defensive.

Still, some investors are speculating about a possible takeover of the company and are modestly bidding up Enron shares. On Oct. 31, they closed up almost 20%, at nearly $14. Possible bidders include GE Capital or Royal Dutch/Shell Group. Both companies declined to comment.

Prudential's Coale, however, is skeptical that any suitor will be willing to saddle itself with Enron's risks. "I would find the CEO of an acquiring company irresponsible if they bought Enron today," she says. Shareholders of an acquirer probably wouldn't be too excited, either. And on a technical level, calculating a breakup value alone would be difficult, since analysts can't place an exact price on Enron's assets.

BETTER BETS? Partially due to the complex nature and competitiveness of the wholesale energy trading business, Enron keeps many details about its operations under wraps. Analysts have been lobbying for more disclosure for years -- though less aggressively when the stock was flying high.

Investors, meanwhile, might consider steering clear of Enron while increasing their exposure to other energy companies with strong trading operations and growth prospects -- stocks like Duke Energy (DUK) in Charlotte, N.C., and Dynegy (DYN) and El Paso (EPG), both based in Houston. Coale notes that all three are market-share leaders in natural gas and power-marketing, making them prime candidates to grab more of the trading pie if credit concerns spark a decline in Enron's volumes.

Making Dynegy and Duke perhaps more appealing is the fact that Enron's woes also have dragged down its rivals' share prices. So, while the energy field may well have some good buys, only a brave investor would be likely to include Enron on the list. Wee covers financial markets for BusinessWeek Online in New York


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