Following the collapse of the Dynegy rescue deal Enron has sought protection from its creditors under US bankruptcy laws, and given itself time to reorganise its debts, with a Chapter 11 filing. Simultaneously it has launched a $10 billion dollar suit against Dynegy, claiming that it acted unlawfully when it dropped its offer for Enron and seeking an order preventing Dynegy from exercising an option to buy Enron's most valuable asset, the Northern Natural Gas Pipeline. Dynegy have called the lawsuit "frivolous and disingenuous" and insist that it has no merit whatsoever in law or fact. The merger, it says, went into crisis mode when Enron's November report to the SEC (Securities and Exchange Commission) revealed less cash and more debt than had hitherto been disclosed.
As Asian, European and US financial institutions scrambled to play down their exposure, the first fallout victims became apparent, 5000 Enron employees who have been laid off in the US and Europe. And although first assessments indicate that a total market collapse will not ensue in the short term, the wider implications are causing ripples in the financial and accountancy worlds. US legislators are already signalling that investigations would go beyond the collapse itself and examine the implications for companies, markets and the accountancy profession, in particular securities law and regulation, including the role of auditors. House of Representatives investigators have already questioned Enron officials. And a senior Congressman, John Dingell, the ranking Democrat on the House Committee on Energy and Commerce has stepped up the pressure on the SEC to clamp down on accountants. The SEC has started an investigation into financial dealings at Enron and the role of Andersen, its auditor. Dingell is concerned about remarks by the SEC's chairman implying that he would be softer on accountants than his predecessor.
A brief history of decline Enron's fall can be attributed to two interlinked weaknesses: its overvalued assets in under-performing businesses and dubious financial structures aimed at maintaining Enron's credit rating. These two factors, combined with an aggressive attitude toward the public and its investors, sparked a crisis of confidence after a series of negative announcements and a year of declining stock prices. The fall of Enron was not linked to its highly profitable energy trading business, which was specifically targeted by Dynegy's purchase offer, although Enron's position as a market maker exposed it to significant risk. But trading counter-parties did stop trading actively with Enron to reduce their exposure, especially in medium and long term contracts, ending Enron's market-maker position and effectively killing Dynegy's purchase offer.
During the mid-1990s, Enron applied its successful trading model from the gas and electricity sector to other fields, such as water and broadband. Enron's potentially most damaging non-energy ventures were in the area of telecommunications, where it lost over $400 million, and, through affiliate Azurix, in the water industry. That venture exposed Enron to $900 million of debt. While many of Enron's international generation investments were fairly astute and profitable, it made several questionable ones, such as the 65 per cent holding in Dahbol Power Company, India,whose power project has been at a standstill for years owing to the non-payment of delinquent bills. Enron has had little luck in its attempt to sell its share for $1.2 billion.
To support its dramatic growth and its significant asset base Enron increasingly turned to complex off-balance sheet financing, through which it would create limited partnerships with outside parties, contributing assets so that the partnership could borrow large sums without the debt showing up on Enron's books. More than 30 such partnerships exist. Its purpose was to maintain a strong credit rating, which was of crucial importance to its future growth related investments and its business as a trader, and to protect its quarterly earnings and its stock price from volatile investments.
As the financial demands of Enron's growth grew, its contractual and financial transactions became increasinglycomplex. Its SEC disclosures became so confusing that Wall street analysts were unable to completely decipher them. After consecutive negative financial announcements and the abrupt resignation of its president Jeff Skilling, worrying details about Enron's partnerships emerged. Many of these financial vehicles should have been consolidated into Enron's financial statements and were not. Moreover, Enron's executives were found to be heading some of the partnerships. Once these problems became public, Enron was forced to rework its financial statements for the last four years, resulting in a decrease in earnings each year by $100 million. And after Enron's off-balance sheet transactions were consolidated it owed $12.8 billion on its balance sheet and $8 to $10 billion in off-balance sheet liabilities, as well as a currently unestimable amount in derivative transaction-based liabilities. These disclosures, unexplained by Enron, sent their stock price plummeting. From its record level of $90 per share last year, it dropped to $10.41 early in November when Dynegy made an all share offer of $9 billion.
But even as the deal was being struck doubts were raised. First, investors wondered whether Dynegy would remain committed once they knew the true position of Enron's off-balance sheet financing, particularly where financing has been hedged with affiliated companies. Second, investors feared that it could take much longer than the average 6 to 9 months for the regulatory approval process to settle the question of competition, given that the combination of Enron and Dynegy would control 20-30 per cent of the power and gas trading market. Investors and counter-parties correctly feared that the deal would fall apart, and that Enron would have to file for bankruptcy.
Enron's trading business saw increasingly lower volumes in the second half of November as traders curtailed their interaction with the company, and Enron was being forced to pay higher prices. In addition, it faced a series of monthly settlements, further threatening liquidity. Business stumbled through to 28 November, when Standard & Poors downgraded Enron's debt to junk status and Dynegy withdrew its purchase offer, despite frantic attempts to restructure the deal, citing "misrepresentation" on Enron's part.
The stumbling block was Enron's complex and often incomprehensible financial records. Until that point, Enron had paid all of its obligations, but the downgrading of its debt-triggered credit-worthiness allowed counter parties to accelerate payment of $3.9 billion in obligations. Enron is so debt-ridden that it has few options left for borrowing. Enron's shares were at $1.19 when the NYSE stopped trading the stock on 28 November.
Linkedin
