A Bubble That Enron Insiders and Outsiders Didn't Want to Pop
nytimes.com
January 14, 2002
NEWS ANALYSIS
By GRETCHEN MORGENSON
The New York Times
What the world is now awakening to is that the Enron Corporation (news/quote) was not much of a company, but its executives made sure that it was one hell of a stock.
In recent years, Enron came to exemplify the productivity miracle that new technologies were thought to have bestowed on astute companies across America. Now in bankruptcy, with the odor of scandal all around it, Enron, once an innovative energy company, has instead become an indictment of the anything-goes approach to business that characterized the late 1990's. The bull market euphoria convinced analysts, investors, accountants and even regulators that as long as stock prices stayed high, there was no need to question company practices.
"Enron is the prime example of all the things that were allowed to go wrong during the stock market mania," said William Fleckenstein, president of Fleckenstein Capital, a money management firm in Seattle. "This wall got built brick by brick in broad daylight in the 1990's by companies doing whatever they had to do to make their numbers, being willing to sacrifice the long-term well-being of the company so that the executives could get rich."
And the Enron insiders became rich indeed. Thanks largely to munificent stock option grants, which they turned into shares, they sold $1.1 billion worth of stock from 1999 to mid-2001.
Mostly on the strength of the highflying shares, Enron executives were able to convince investors, bankers, analysts, accountants, debt-rating agencies and even Enron's own employees that its promise was real, its financial results genuine and its growth never-ending. Never mind that the way it accounted for trades, as is common at energy trading companies, made its revenues appear to be far larger than the economic reality of its business.
Now the spotlight in the Enron follies is trained on the nation's capital. But the story of the company's rise and fall, and the retirement savings its workers lost, inevitably leads back to Wall Street.
Enron's executives were surely smart enough to know that once they had convinced bankers, brokers and accountants of the company's strength, all parties could pretty much be counted on to keep the myth of solidity alive, even after problems arose. When questions were first raised about partnerships that should have been listed in financial statements, true believers could be relied on to drown out naysayers.
Naturally, given the millions of dollars Wall Street firms generated selling Enron's shares and bonds to investors, analysts were among the most vociferous defenders of the company, even after its stock began to fall. David N. Fleischer, who followed Enron for Goldman, Sachs, recommended it until Oct. 17, the day after Enron disclosed that it had lost $618 million in the most recent quarter and that because earlier financial statements had been inaccurate, it was lopping $1.2 billion off its net worth. Even with the stock at 68 cents, Mr. Fleischer currently rates Enron a market performer.
Across town at Lehman Brothers (news/quote), Richard Gross continues to rate Enron a strong buy. Raymond C. Niles at Salomon Smith Barney did change his rating on Enron from buy to neutral, but not until Oct. 26, when the stock closed at $15.40. During the previous 12 months, Enron had traded as high as $84.63.
Of course, if a company wants to mislead its investors, analysts and accountants, there is probably little that can be done to stop it. Arthur Andersen, Enron's auditor, has said that it was misled.
But what is becoming evident about Enron is the decidedly ephemeral nature of its operations and its revenues. Beginning as a mundane natural gas pipeline company in the 1980's, Enron had morphed into a financial services firm by the late 1990's. It traded things like oil, but created new markets to trade oddities like weather and bandwidth.
Because Enron operated in a largely unregulated arena and because of the way energy trading firms are allowed to account for their operations, the company recorded revenue that made the economic status of its business appear larger than it really was. Under accounting rules, when an energy trading company trades electricity or gas, it can count as revenues the whole amount of every transaction rather than simply the profit or loss, as a brokerage firm does.
It is similar to the way Priceline .com counted as revenues the whole sale price of plane tickets sold online rather than just commissions, as traditional travel agents do.
That is largely how Enron, a relative newcomer to the trading of commodities and related financial instruments, was able to produce $101 billion of revenue in 2000, up from $40 billion in 1999. By comparison, Goldman, Sachs, a highly regulated firm with a long history of trading in the field, generated $6.5 billion in trading revenue last year.
Enron appears to have done nothing wrong in accounting for trading revenues, unlike its almost certainly improper accounting for dealings with entities off its balance sheets. But the larger-than-life revenue numbers allowed Enron's executives and other advocates to promote the idea that its operations were far grander than they were, worthy of a ranking near the top of the Fortune 500.
To a Wall Street obsessed not with earnings but with revenue growth, the performance propelled Enron's shares into the stratosphere, enriching executives and investors. "The way these revenues were accounted for at Enron essentially made them pro forma revenues, which have little basis in reality," one institutional money manager said. "Yet the size of the revenues allowed the company to expand its balance sheet by piling on debt. That is why the company unraveled so quickly."
The moment that rival trading firms and other customers at Enron began to lose confidence in the company, its business dried up. But its onerous debt of at least $31 billion remained, forcing it to make the largest bankruptcy filing in United States history.
Mr. Fleckenstein and some other investors are concerned that other bombs like Enron's may be ticking, but that investors will have little help in spotting them before they blow. The combination of aggressive accounting — like Enron's method of shifting big obligations off its balance sheet — and a conflicted auditing firm, he said, are not limited to Enron. Aggressive accounting has become much more common in recent years, and as auditors have increased their consulting business among the companies whose books they vet, their willingness to sign off on debatable practices has grown.
And as investors know only too well, analysts on Wall Street cannot be relied upon to dig deeply into companies' books. Eager to help their firms generate business selling securities to investors — and reap their own rewards in bonuses — Wall Street analysts have made a habit of missing corporate misdeeds altogether or ignoring what they see.
"Enron proves how meaningless financial statements have become," Mr. Fleckenstein said. "Until someone makes sure that financial statements have meaning, we will never get this problem behind us." |
