Enron's Sliding Stock Price Prompts Analysts to Examine Details of Deal
November 26, 2001
Major Business News
By REBECCA SMITH and ROBIN SIDEL
Staff Reporters of THE WALL STREET JOURNAL
With the stock market telling Dynegy Inc. that energy trader Enron Corp. isn't worth even half what Dynegy has offered to pay, analysts and investors are paying close attention to the circumstances under which Dynegy could bargain a lower price or even walk away from the merger deal.
Earlier this month, Houston-based Dynegy offered to buy its far larger cross-town rival in an all-stock deal that currently values Enron shares at $10.85 apiece, or a total of about $9.2 billion. But in the wake of post-agreement disclosures by Enron that its future earnings are likely to be substantially less than expected, the company's stock has been hammered. In 1 p.m. trading on the New York Stock Exchange on Friday, Enron shares fell 30 cents to $4.71. The stock is down 94% so far this year and far short of the per-share takeover price. Dynegy shares rose 64 cents to $40.40.
Although Dynegy and Enron both say they are going ahead with the deal under the terms negotiated, Dynegy does appear to have other options. The agreement with Enron contains a broad "material adverse change" clause as well as some specific trigger points that could be invoked.
Dynegy officials performed "due diligence" throughout the holiday weekend, seeking to learn more about the intimate workings of Enron, which has suffered a series of damaging blows. Since mid-October, Enron has disclosed that some of its officers participated in personally enriching deals that moved assets off Enron's balance sheet, for a time, to several private partnerships. Those deals are now the subject of a Securities and Exchange Commission investigation. Past treatment of some of those deals has been termed an "accounting error" by Enron and it twice has rejiggered its earnings since Oct. 16. At one point, Enron restated downwards nearly five years of earnings.
0See a timeline of Enron's recent woes.
An Enron spokeswoman said the company was proceeding in the belief that the deal would be completed as agreed. Dynegy spokesman John Sousa said the two sides are forging ahead although he acknowledged that the walk-away provisions "are broad, by design, to ensure adequate protection for Dynegy shareholders." Shareholders of both firms must still vote on the merger agreement.
Clauses related to a "material adverse change," also known as a "material adverse effect," have been the focus of much attention among merger professionals this year, due, in part, to the stock market's fluctuations and the economic slowdown that have caused some buyers to reconsider planned acquisitions.
But such clauses rarely are invoked by a buyer or seller because they are considered extremely difficult to prove. Both parties typically are reluctant to lay out specific terms for canceling a deal, much the way a bride and groom often balk at negotiating a prenuptial agreement since it appears to envisage a breakup of the marriage even before it begins.
Furthermore, a key court case earlier this year affirmed widespread views that a buyer can't easily walk away from a merger. In that case, meat-processing concern Tyson Foods Inc. sought to cancel a planned acquisition of meat-packer IBP Inc. due to a drop in IBP's earnings and a write-down of an IBP subsidiary. But a Delaware judge refused to let Tyson cancel the pact, saying Tyson had been aware of the cyclical nature of IBP's business and the accounting issue.
In a lengthy June 18 opinion, Delaware Chancery Court Vice Chancellor Leo E. Strine Jr. wrote that "... the important thing is whether the company has suffered a Material Adverse Effect in its business or results of operations that is consequential to the company's earnings power over a commercially reasonable period, which one would think would be measured in years rather than months."
That interpretation has created ripples in the deal-making community, prompting some transactions to include more details about circumstances under which deals can be terminated. Since the Sept. 11 attacks, for example, a handful of merger agreements have specified that future terrorist activity would qualify as a "material adverse change," or MAC.
A key issue for any firm alleging there has been a material adverse change is "whether the new facts go to the guts of the strategic opportunity or is it just a hiccup," says Meredith Brown, co-chairman of the mergers and acquisitions group at law firm Debevoise & Plimpton in New York. He adds that a court "may be skeptical" if Dynegy claimed that Enron's post-merger agreement disclosures were a surprise.
The Enron-Dynegy merger agreement includes several triggers permitting either side to seek termination. Enron can quit the deal if it receives a substantially better offer, although it is prohibited from soliciting one. In such a case, it could be required to pay a $350 million "topper fee" to Dynegy and its co-investor, ChevronTexaco Inc.
Dynegy can alter the deal if Enron faces "pending or threatened" litigation liabilities that are "reasonably likely" to cost Enron $2 billion. If those liabilities hit $3.5 billion, "an Enron material event will be deemed to have occurred," presumably allowing Dynegy to call the whole thing off. In some situations, Dynegy would be liable for a $350 million fee, as well.
Karen Denne, the Enron spokeswoman, said her firm doesn't believe that losses arising from the normal course of business would qualify as a material event. The liability must result from litigation. Currently, the company faces more than a dozen shareholder suits alleging breach of fiduciary duty by officers and directors, issuing false and misleading reports and other offenses.
Deal makers who aren't involved in the combination say the steep drop in Enron's stock price since the merger agreement was signed wouldn't by itself give Dynegy the ability to cancel the pact or force Enron to renegotiate its terms. Instead, they say, Dynegy would likely have to prove that Enron's worsening financial condition was an unanticipated event, which could be difficult in light of the company's highly publicized problems and Dynegy's frequent statement that it clearly understands Enron's businesses. Still, there is another standard clause in the merger document that would allow Dynegy to terminate the deal if "any representation or warranty of Enron shall have become untrue."
Other energy companies have abandoned deals following a widening gap in stock prices that changed an acquisition premium. Western Resources Inc. of Topeka, Kan., last week sued Public Service Co. of New Mexico seeking hundreds of millions of dollars in damages after it failed to buy Western's utilities. The lawsuit accused Public Service of breaching its "duty of good faith and fair dealing" and said the New Mexico company tried to "sabotage" the deal as the two companies' stock prices diverged. Public Service denies the accusations.
Write to Rebecca Smith at rebecca.smith@wsj.com1 and Robin Sidel at robin.sidel@wsj.com2
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Enron's Odyssey:
Oct. 163: Enron takes $1.01 billion charge related to write-downs of investments. Of this, $35 million is attributed to partnerships until recently run by CFO Andrew Fastow. Enron also discloses it shrank shareholder equity by $1.2 billion, as a result of several transactions including ones undertaken with Fastow's investment vehicle.
Oct. 194: The Wall Street Journal discloses that general partners of Fastow partnership realized more than $7 million last year in management fees and about $4 million in capital increases on an investment of nearly $3 million in the partnership, set up principally to do business with Enron, according to an internal partnership document.
Oct. 225: Enron announces SEC will begin a probe of company's "related party transactions," including those with Fastow partnerships. Enron says it will fully cooperate.
Oct. 236: Enron's treasurer acknowledges the company may have to issue additional shares to cover potential shortfalls in investment vehicles it created, although he says the company believes it can repay about $3.3 billion in notes that were sold by those investment vehicles without having to resort to issuing more stock.
Oct. 24:7 Enron replaces Fastow as CFO with Jeffrey McMahon, the 40-year-old head of the company's industrial-markets division.
Oct. 258: The company draws down about $3 billion, the bulk of its available bank credit lines. The Fitch rating agency puts Enron on review for a possible downgrade, while another, Standard & Poor's, changes Enron's credit outlook to negative from stable. A noninvestment-grade rating would throw the company into default on obligations involving billions of dollars of borrowings.
Oct. 299: Moody's lowers its ratings by one notch on the Enron's senior unsecured debt and kept the company under review for a possible further downgrade.
Oct. 3110: The SEC elevates to a formal investigation its inquiry into Enron's financial dealings.
Nov. 111: Enron says it has secured commitments for $1 billion in financing from units of J.P. Morgan and Citigroup.
Nov. 5:12 Enron has held talks with private-equity firms and power-trading companies for a capital infusion of at least $2 billion as it faces an escalating fiscal crisis.
Nov. 813: Enron reduces its previously reported net income dating back to 1997 by $586 million, or 20%, mostly due to improperly accounting for its dealings with the partnerships run by some company officers.
Nov. 914: Dynegy announces a deal to buy Enron for about $7 billion in stock. Chevron Texaco will inject $1.5 billion into the deal immediately, and an additional $1 billion upon closing.
Nov. 1315: Enron Chairman Kenneth Lay decides to forgo a severance payment of $60.6 million that could be triggered by Dynegy's planned acquisition of Enron.
Nov. 20:16 Enron warned that continuing credit worries, a decline in the value of some of its assets and reduced trading activity could hurt its fourth-quarter earnings.
Nov. 23:17 The Wall Street Journal reports that Enron is being sued by members of its employee-retirement plan, which has suffered losses because of its plunging stock price. Separately18, the slide in its share price and mounting financial problems puts increasing pressure on Dynegy to renegotiate or walk away from its deal to acquire the firm.
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