Established in 1985, Enron was created by the merger
of Houston Natural Gas and InterNorth. It was one of the leading Energy
Companies in the world and one of the biggest companies in the USA. Kenneth Lay
was the CEO of Enron and was very close to George W. Bush. Bush Sr. had helped
get Enron lots of high subsidies. Kenneth Lay holds a PhD in Economics and was
one of the major voices in the Deregulated Energy Markets.
In the year 2000, the dot-com bubble burst and all
Internet Companies started to fall but Enron was the Shining Star in the Stock Market. According to Fortune Magazine, in
the year 2000 for the 6th consecutive year as the most Innovative
Company. All of that was about to change as Enron filed for Bankruptcy under
Chapter 11 on December 2nd, 2001. In the mid 2000s the shares of the
company had reached the heights and were being traded at $90.75 and while
filing Bankruptcy it had reached a low of $0.26.
An example of the cooked-up books that Enron had
created, while Louis Borget was the President of the company would be that they
had a lot of Off-Shore Accounts. But the trail of a transaction led from the
conversion of the shares of Mr. Tom Mastroeni into currency and was transferred
to an anonymous Lebanese speculator named Mr. M. Yass. Later, it was revealed
by an ex- accountant of Enron that there was no Mr. M. Yass, but it was just a
play with the words “MY ASS”.
The traders of Mastroeni played gambling on the oil
prices and in turn lost all the reserves of Enron, on the orders of Borget (the
president of the company). Borget was jailed for a year.
Kenneth Lay was finding a man who could do all the
dirty work and then came in Jeffery Skilling. Jeff Skilling had an idea to not
be bound to the pipeline but to convert the oil and natural gas into financial
instruments so that they can be traded as stocks. Jeff Skilling, before
joining, had just one condition that was the use of Mark-to-Market Value where
the company would value shares at Market value and not the book value.
Then Enron adapted Hypothetical Future Value (HFV),
when Jeff Skilling was the CFO. Using HFV came the result that Enron created
earnings, on the deals made, whether the cash was coming in. For example, Enron
tried to sell Bandwidth as a commodity with Blockbuster Entertainment for Video
on Demand. The idea was a critical failure and even though they didn’t earn
even a penny they recorded on the day of the deal a Revenue of somewhere around
$100 Million and they recorded a profit of $53 Million. All based on HFV.
All of this happened but none of the Stock Analysts
asked where all the revenue was coming from. The analysts said that there was a
black box in the system that gave them the earnings report and they just took
it in good faith.
The question was raised by a reporter named Bethany
McLean from Fortune Magazine. Her question was simple “How exactly was Enron
making money?”. This agitated, the then CEO of Enron, Jeff Skilling. The
reporter rattled Jeff, so much so that, he sent Andrew Fastow (CFO) and the
Accounts Manager to hold a meeting with Bethany McLean and the Editor of
Fortune. The meeting went on for more than 3 hours. After the meeting ended,
while leaving, Andrew Fastow turned and said, “Write anything about Enron just
don’t make me look bad”.
What Andrew Fastow had done was, he had created subsidiaries
whose main aim was to hide Enron’s debt. The names of some of the companies
were Jedi, Chewco, Raptors, Death Star and LJM. The names of the companies were
taken from the Star Wars characters. Fastow was the CFO of Enron and the
General Partner of LJM, which further raised the question of Conflict of
Bethany McLean from Fortune released an article named
“Is Enron Overpriced?” which led to
the downfall of the company.
After the article, people started asking for Financial
statements. On a conference call with Jeff Skilling an analyst who worked for
Enron asked, “You’re the only financial institution that can’t produce a
Balance Sheet or Cash Flow Statement with their earnings”. In reply Jeff
Skilling said, “Thank You, we appreciate it, Asshole”, which further damaged
the image of Enron.
Some executives sold their stock before the downfall:
Kim Rice converted $53 Million, Kenneth Lay converted $300 million worth of
stock. Cliff Baxter converted $35 Million and Jeff Skilling sold his shares for
Arthur Andersen was one of the Big Five Accounting
firms with Deloitte, KPMG, PwC, Ernst & Young. Arthur Andersen during the
cooking of the books of Enron was paid a sum of one million per week. Arthur
Andersen was shut, and 29000 people lost their jobs.
Facts: 20000 employees lost jobs and medical insurance.
Average Severance pay was $4500. Top executives were paid bonuses totaling $55
Employees lost $1.2 Billion in Retirement Funds. Retirees lost $2 Billion in
Pension Funds. Enron’s top executive cashed in $116 million.
Financial Lessons Learnt:
1. Mark-to-Market Accounting: Any company that adapts
Mark to Market Accounting is not a good investing option as it values assets
and shares at Market Value rather than Book Value.
2. Hypothetical Future Value (HFV): It is system used
to determine the future value of transactions. It records the Hypothetical
Value rather than the actual Cash Flow.
3. Do Not Invest in What you don’t Understand: Do not
invest in businesses whose Business Model you do not understand. Investing in
companies which deal in derivative driven countries, you don’t understand.
4. Avoid Companies that employ Fancy Derivatives: The
company used fancy derivatives just to increase share value. Enron was the only
Energy Company of this size to declare Bankruptcy.
5. Beware of Excessive Leverage: Enron used excessive
leverage and took a lot of loans that weakened the company’s financial