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ENRON
Is Enron Overpriced?
It's in a bunch of complex businesses. Its financial statements are nearly 
impenetrable. So why is Enron trading at such a huge multiple?
Bethany McLean
Mon Mar 05 00:00:00 EST 2001

In Hollywood parlance, the "It Girl" is someone who commands the  spotlight 
at any given moment--you know, like Jennifer Lopez or Kate  Hudson. Wall 
Street is a far less glitzy place, but there's still such a  thing as an "It 
Stock." Right now, that title belongs to Enron, the  Houston energy giant. 
While tech stocks were bombing at the box office  last year, fans couldn't 
get enough of Enron, whose shares returned 89%.  By almost every measure, the 
company turned in a virtuoso performance:  Earnings increased 25%, and 
revenues more than doubled, to over $100  billion. Not surprisingly, the 
critics are gushing. "Enron has built  unique and, in our view, extraordinary 
franchises in several usiness  units in very large markets," says Goldman 
Sachs analyst David Fleischer. 

Along with "It" status come high multiples and high expectations. Enron  now 
trades at roughly 55 times trailing earnings. That's more than 2 1/2  times 
the multiple of a competitor like Duke Energy, more than twice  that of the 
S?500, and about on a par with new-economy sex symbol  Cisco Systems. Enron 
has an even higher opinion of itself. At a  late-January meeting with 
analysts in Houston, the company declared that  it should be valued at $126 a 
share, more than 50% above current levels.  "Enron has no shame in telling 
you what it's worth," says one portfolio  manager, who describes such 
gatherings as "revival meetings." Indeed,  First Call says that 13 of Enron's 
18 analysts rate the stock a buy. 

But for all the attention that's lavished on Enron, the company remains  
largely impenetrable to outsiders, as even some of its admirers are  quick to 
admit. Start with a pretty straightforward question: How  exactly does Enron 
make its money? Details are hard to come by because  Enron keeps many of the 
specifics confidential for what it terms  "competitive reasons." And the 
numbers that Enron does present are often  extremely complicated. Even 
quantitatively minded Wall Streeters who  scrutinize the company for a living 
think so. "If you figure it out, let  me know," laughs credit analyst Todd 
Shipman at S&P. "Do you have a  year?" asks Ralph Pellecchia, Fitch's credit 
analyst, in response to the  same question. 

To skeptics, the lack of clarity raises a red flag about Enron's pricey  
stock. Even owners of the stock aren't uniformly sanguine. "I'm somewhat  
afraid of it," admits one portfolio manager. And the inability to get  behind 
the numbers combined with ever higher expectations for the  company may 
increase the chance of a nasty surprise. "Enron is an  earnings-at-risk 
story,'' says Chris Wolfe, the equity market strategist  at J.P. Morgan's 
private bank, who despite his remark is an Enron fan.  "If it doesn't meet 
earnings, [the stock] could implode." 

What's clear is that Enron isn't the company it was a decade ago. In  1990 
around 80% of its revenues came from the regulated gas-pipeline  business. 
But Enron has been steadily selling off its old-economy iron  and steel 
assets and expanding into new areas. In 2000, 95% of its  revenues and more 
than 80% of its operating profits came from "wholesale  energy operations and 
services." This business, which Enron pioneered,  is usually described in 
vague, grandiose terms like the  "financialization of energy"--but also, more 
simply, as "buying and  selling gas and electricity." In fact, Enron's view 
is that it can  create a market for just about anything; as if to underscore 
that point,  the company announced last year that it would begin trading 
excess  broadband capacity. 

But describing what Enron does isn't easy, because what it does is  
mind-numbingly complex. CEO Jeff Skilling calls Enron a "logistics  company" 
that ties together supply and demand for a given commodity and  figures out 
the most cost-effective way to transport that commodity to  its destination. 
Enron also uses derivatives, like swaps, options, and  forwards, to create 
contracts for third parties and to hedge its  exposure to credit risks and 
other variables. If you thought Enron was  just an energy company, have a 
look at its SEC filings. In its 1999  annual report the company wrote that 
"the use of financial instruments  by Enron's businesses may expose Enron to 
market and credit risks  resulting from adverse changes in commodity and 
equity prices, interest  rates, and foreign exchange rates." 

Analyzing Enron can be deeply frustrating. "It's very difficult for us  on 
Wall Street with as little information as we have," says Fleischer,  who is a 
big bull. (The same is true for Enron's competitors, but  "wholesale 
operations" are usually a smaller part of their business, and  they trade at 
far lower multiples.) "Enron is a big black box," gripes  another analyst. 
Without having access to each and every one of Enron's  contracts and its 
minute-by-minute activities, there isn't any way to  independently answer 
critical questions about the company. For instance,  many Wall Streeters 
believe that the current volatility in gas and power  markets is boosting 
Enron's profits, but there is no way to know for  sure. "The ability to 
develop a somewhat predictable model of this  business for the future is 
mostly an exercise in futility," wrote Bear  Stearns analyst Robert Winters 
in a recent report.
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