Subject: fw : enron ' s departure from core business takes a toll on
performance
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sent : monday , october 22 , 2001 1 : 36 pm
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subject : enron ' s departure from core business takes a toll on performance
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october 22 , 2001
enron ' s departure from core business
takes a toll on performance
by will mcnamara
director , electric industry analysis
[ news item from reuters ] enron corp . ( nyse : ene ) stock sustained further heavy losses on october 19 as investor confidence in the former wall street favorite remained at a low ebb after it reported its first quarterly loss in over four years . the energy giant ' s stock was off $ 3 . 32 or 11 . 45 percent at $ 25 . 68 per share at mid - day trade on oct . 19 , making a cumulative loss of 28 percent for a week in which it reported a third - quarter loss of $ 638 million . as of early morning trading on oct . 22 , enron shares were priced at $ 21 . 99 , a reflection of new developments ( including a new securities and exchange inquiry ) that have caused uncertainty about the company among investors .
analysis : enron ' s first financial report since the departure of former ceo jeffrey skilling in august has not done much to once again instill investor confidence in the company , which has experienced one of its most turbulent years in recent memory . while skilling cited personal reasons for his departure , many analysts suspected that a significant drop in enron ' s share price and financial losses in its diversified businesses also played a role . at the time of skilling ' s departure , enron ' s stock had tumbled to a 52 - week low . however , based on the new 3 q report , it now appears that enron ' s downward turn may be continuing despite the return of kenneth lay to the company ' s top spot . in essence , enron ' s financial problems have been caused by businesses that the company has established as a way to diversify from its core focus on wholesale power sales . it appears that enron is learning a costly lesson - namely that investors are not responding favorably to the company ' s innovation , especially if bottom line performance is in any way compromised . the road ahead may remain uncertain for enron , as a good number of unresolved issues and a new securities and exchange commission ( sec ) inquiry into financial dealings of its chief financial officer continue to overshadow the company .
let ' s first establish the financial losses that enron has reported in the third quarter . as noted , as a whole the company reported $ 638 million in losses , after taking $ 1 . 01 billion in charges associated with several of its non - core businesses . when we break down the losses , it becomes clear that enron is struggling with its operations in three businesses : water , broadband and the retail power market . specifically , enron reported $ 287 million in charges from azurix , its water and wastewater business ; $ 180 million in charges related to the downsizing of its broadband operations ( including severance costs and losses on inventory sales and customer contracts ) ; and $ 544 million in what the company is calling " investment losses . " evidently , about half of the $ 544 - million figure is related to enron ' s investment in newpower company , the retail electricity and natural - gas provider that enron launched about two years ago with partners america online and ibm . enron owns 45 percent of newpower . in addition , enron ' s debt to total capitalization ratio reportedly will increase to about 50 percent , although lay says that pending asset sales may reduce that amount to 40 percent by the end of 2002 . however , it is important to note that enron ' s 3 q recurring net income ( before the write - offs ) did increase 35 percent to $ 393 million , or 43 cents a diluted share , and revenue in the quarter rose to $ 47 . 6 billion from $ 30 billion in 3 q 2000 .
the losses associated with newpower are particularly interesting . as one of the leading investors in the company , enron drove newpower ' s aggressive business focus on retail residential power sales , despite ongoing concerns about the development of retail competition across the united states . newpower went public last year at an opening price of $ 21 , and in the early days of its initial public offering was trading above that price . however , the company ' s stock has experienced a devastating drop in value , and is currently priced at $ 1 . 25 . newpower is not scheduled to release its own 3 q financial statement until early november , but it is expected that the company will continue to incur significant losses for the foreseeable future . specifically , newpower recently reiterated its earlier expectations of a 3 q loss of $ 65 million to $ 70 million , or $ 1 . 12 to $ 1 . 20 a share . third - quarter revenue reportedly will be slightly lower than the $ 60 million to $ 65 million that the company had forecast in august .
in analyzing newpower ' s 2 q financial losses ( see issuealert from 8 / 8 / 01 at www . scientech . com / rci ) , i argued that the company is really struggling from a mix of positive and negative factors in its efforts to become the leading retail energy provider in residential and small business markets in the united states . on the positive side , newpower has recently secured a large number of new customer accounts , most significantly from its purchase of customers and related assets from aes corp . and dte energy . these purchases prompted an impressive growth spurt for newpower , and the company reportedly now has a customer base in 22 markets in 10 states . however , the bad news for newpower is that its losses continue to widen , apparently resulting from a combination of weather factors and financial hits absorbed in several of the states in which the company operates . this dichotomy does not appear to be getting any better , and the company ' s stock has continued to drop as a result .
in an effort to alleviate some of its financial woes , newpower recently revised an existing master netting agreement with enron corp . and several of its subsidiaries . the revised agreement essentially lowers the amount of cash collateral that newpower is required to post to the enron subsidiaries through jan . 4 , 2002 . with the lowered financial obligations that it must make to enron , newpower believes that it will have sufficient financial resources to conduct its business in the near term until it secures ongoing asset - based financing .
however , from enron ' s perspective , the losses associated with newpower ( and , by the same token , the losses in water and broadband ) have contributed to a steady drop in its own stock price . the message is clear : the businesses that enron plunged into as a way to diversify have tainted the company as a whole . further , what some analysts perceived as brash hubris on enron ' s part has not translated into measurable profits , and consequently wall street has reacted by sending enron ' s stock to a level that is about half of where it was a year ago . the individual sectors that enron has pursued are all unique , but they share the common denominator of taking enron away from what was a successful core business . further , they are similar in that enron aggressively sunk large sums of capital into new business lines for which it arguably had unrealistic expectations for growth . the problem with enron ' s bandwidth unit is that the company has faced an unanticipated excess of fiber - optic lines , which has prevented the demand for the division ' s services from materializing as anticipated . the problem with azurix , which has been losing money since its formation in 1998 , is that privatization of the water sector has not materialized as quickly as enron and other companies anticipated . in addition to these problem areas , enron also faces challenges related to its investments in india ( where it is locked into a legal battle with the state government ) and california ( from which enron has yet to receive full payment for previous power sales ) .
in addition to the losses outlined in the 3 q report , there are new issues that are brewing at the start of this week . first , the sec has requested that enron provide information regarding " certain related party transactions . " not much additional information is presently available about this inquiry . however , it is probably connected to earlier reports about concerns related to the dealings of enron ' s chief financial officer andrew fastow , who up until very recently had run a limited partnership that bought assets from enron . ken lay has said that enron will cooperate fully with the sec ' s request . in a separate development , several mutual funds ( including aim constellation that once held large positions in enron ) have either liquidated or reduced their holdings in the company , which has further weakened enron ' s stock value . portfolio managers of the mutual funds have cited concerns about enron ' s ability to balance its new businesses with its core strength as an energy trader .
the present challenge for enron is to convince investors that the company remains on solid ground despite the losses . thus , lay has been quick to reiterate that earnings from the company ' s energy and gas - pipeline business are still strong . further , lay says that the charges reported in the third quarter should be seen as a way to " clear away issues that have clouded the performance and earnings potential of our core energy businesses . " nevertheless , the fact remains that enron has invested huge amounts of money toward its diversification effort , and in addition to water and broadband the company has invested into the steel and pulp and paper sectors as well . thus , several questions remain at this juncture . are the losses reported in the third quarter only a temporary setback for enron that will clear the way for the company to return to a primary focus on its core business of energy trading ? or , will the losses continue into the fourth quarter and 2002 ? moving forward , will enron once again reshape its business model and eliminate the various businesses to which investors have reacted less than favorably ? only time will tell as the industry continues to watch the developments at enron , which is clearly a company in the midst of another wave of change .
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