Learn this lesson well or you could repeat it!
The mission statement of most major companies, at least until recession began to rear its head in the spring of 2001, can be pretty much summed up in three little words: Get Big Fast. And leading by example was Enron Corporation, one of the world's largest energy concerns. Formed in 1985 by the combination of Houston Natural Gas and Internorth Inc, Enron recorded $101 bn in revenues in 2000 and boasted assets of $67.3 bn. The company created its profits by buying and selling energy several times over in the privately-traded natural gas and electricity marketplace. Exactly how it did this was not always clear to its observers or its shareholders. What we do know now is Enron was amassing debt that was not always recorded on its balance sheets.
During six short weeks from mid-October to the end of November 2001, Enron virtually came apart at the seams. Was the handwriting on the wall when Jeffrey Skilling, the company's 47 year-old CEO, resigned in August after just six months on the job? Should analysts and investors have kicked up a bigger fuss when the company produced oversimplified earnings releases and repeatedly insisted its transactions were simply too complicated to explain in full?
The Enron story is an investor relations parable. The company coddled its shareholders with stratospheric valuations and told its analysts and critics that therein lay the proof of the pudding.
This epitomizes the antithesis of good IR.
This story was initiated in late October, before the now-collapsed merger with Dynegy was announced, and the interviews were conducted shortly before Enron declared bankruptcy. By the time the story appears in print Enron will undoubtedly have undergone several more mutations. But there are still valuable lessons to be learned. To illuminate them, Investor Relations interviewed six IR specialists, consultants and IROs. Listen and learn, for as the philosopher George Santayana warns, 'Those who cannot remember the past are condemned to repeat it.'
Disclosure in good times as well as bad
Larry Bishop, Genesis Inc
Larry Bishop is a counsellor with the Denver-based consulting firm Genesis Inc. He retired in February 1999 after seven years with the Boeing Company, where he was VP of communications and IR. Prior to that, he led IR for the Lockheed Corporation and communications for Frontier Airlines. He was interviewed on November 20.
Somewhere along the line Enron's senior management adopted an attitude of arrogance with respect to Wall Street. I don't know precisely what it was doing in terms of cooking the books but clearly it made no attempt to help people understand its businesses and its financials. From the get-go, even though its stock was doing well, it was still fielding complaints from analysts who said it was difficult to understand the numbers. The more pressure Enron faced from Wall Street to be more candid, the more reticent it became - and the more arrogant.
Well, no tree grows to heaven. When things began to crumble Enron had no platform to stand on. From a communications perspective Enron failed completely. At one time there was a tremendous market there, this whole concept of trading energy. Conventional IR wisdom is to make sure you don't clamp down on communications efforts when times are tough, to be forthcoming in bad times as well as good. In Enron's case, it's just the opposite. It said, 'Look at our stock price and trust us.'
Investors and analysts aren't entirely blameless. They should have asked tough questions and pursued the answers.
A fascinating case study
Bradley Wilks, Ogilvy Public Relations Worldwide
Brad Wilks is head of the Chicago office of Ogilvy Public Relations Worldwide, which he joined in 1999 after heading the IR and technology practice at Fleishman-Hillard and serving as IRO at Ball Corporation. He was interviewed on November 20.
Enron was a category-creating company with an extremely charismatic management team. It managed its earnings extremely well, but failed to provide financial visibility for investors. Most companies go beyond basic disclosure requirements, but not Enron.
When things started to go south, Enron's ultimate demise was triggered by a domino effect of failed business strategies - first, the broadband business, then the IPO, then there was this strange and sudden departure of its new CEO, which was never well explained to investors. When analysts called for the company to set the record straight, they ended up walking away with more questions than answers.
The company also established a pattern of revisionism; it would hold a conference call with investors and then there'd be a subsequent SEC filing that included material not disclosed in the conference call. You have to wonder if this was by design or coincidence. What's fascinating is Enron started as a wonderful company with a great franchise. But when you damage your credibility so much with your investors it can then seep through to damage your core businesses. What began as communications challenges ultimately become business challenges. Now Calpers is making statements that bring into question the fiduciary responsibility and role of the board at Enron.
Bottom line: Enron will be a fascinating case study for years to come.
Death by a thousand cuts
Cecilia Wilkinson, Pondel/Wilkinson MS&L
Cecilia Wilkinson is executive VP of Pondel/Wilkinson MS&L and deputy managing director of the IR practice of Manning Selvage & Lee. With more than 20 years at the firm, she has a specialty in financial crisis management. She was interviewed on November 28.
It's clear there was no concept of crisis management at this company . The first rule is you manage it or you die by it and Enron flunked this completely. The second rule is you get it all out and get it done with.
On the IR front, it's absolutely necessary as a first step to mitigate potential damage so you can thwart the erosion of shareholder value. Enron is experiencing death by a thousand cuts. The ripple effect through all its constituencies and the larger communities has already been horrible.
Why do we fail over and over to learn of the terrors of financial engineering?
Derivatives, junk bonds, the S&L crisis... When companies move away from easy-to-understand balance sheets it comes back to bite them. The other lesson here is that good crisis management doesn't always start with a crisis. It starts long before so you can plan. There should be a full physical of the company every year. You have to look at the company as a living, breathing entity and you have to understand that circumstances change. You have to be prepared.
Tell the truth and tell it now!
Sam Levenson, Cendant Corporation
Sam Levenson is senior VP, corporate and investor relations, at Cendant Corporation where he has helped rebuild the company's relationship with Wall Street in the wake of accounting irregularities dating back to 1997. Prior to joining Cendant in 1998, Levenson headed IR at Staples. He was interviewed on November 27.
Tremendous uncertainty has been created by three things. First, a lack of clarity on related-party transactions. Second, the company's inability to quantify exactly how large the problems were; there were repeatedly restated results which to date are still not finalized. The final straw: the company's declining stock price is leading to debt rating reductions which are creating a liquidity crisis impacting its ability to conduct trading, its core business. This is a potential death spiral for Enron.
Now you've got investors fighting to see who can exit the fastest, augmented by criticism from equity analysts and reductions in ratings even from Enron's most ardent supporters. There are leaks in the press.
Enron needs to staunch the pace at which it is losing credibility with its equity shareholders, debt shareholders, rating agencies, employees, trading partners and now merger partner. It needs to demonstrate financial strength and liquidity and maximize cash flow, which means resolving accounting issues and clarifying all off-balance sheet activities.
Enron should tell the truth and tell it all now. Investors trust IR and management to represent the company fairly. When a crisis hits your company then you draw on that reserve of credibility and respect. During normal times a well-managed IR program is essential. During a crisis it's absolutely critical.
Falling from grace
Hollis Rafkin-Sax, Edelman Public Relations Worldwide
Hollis Rafkin-Sax manages the worldwide financial communications practice at Edelman Public Relations Worldwide. Previously she was managing director at Gavin Anderson & Co and Ogilvy Adams & Rinehart. She was interviewed on November 28.
To me Enron's situation is so emblematic of market overvaluations that, in a way, it tracks the dot-com debacle. It even has overtones of the Long Term Capital Management crisis. Enron's unwillingness to open its books, the complex intertwined transactions, the lack of transparency all wrapped in incredible arrogance - these are the links that led to its undoing.
It's not as if absolutely everyone bought into the story. Back in March a Fortune article pointed out that this was a company with one of the highest multiples in the market, on a par with Cisco, with 13 buy ratings from the 18 analysts covering the company, and its financials were completely impenetrable. It was a big black box and even the analysts admitted it. But it was flying high so Wall Street went along with it.
As for the Dynegy-Enron merger, could this marriage have been saved? It was clearly an act of desperation on Enron's part and curiosity, I think, on Dynegy's part. Lack of transparency and financial engineering were certainly long-time issues. Enron was a fair-haired child and now it has fallen from grace. If back in the spring it had listened to the earliest detractors and been willing to respond it might have had a chance to reestablish some credibility.
At this point Enron is a restructuring story, a classic in a class all by itself. Without changing management and bringing on a new board of directors and going back to basics - sharing its roadmap for creation of long-term value - there isn't really a lot of hope for a sound recovery and rebuilding credibility.
Major questions still unanswered
Ralph Allen, Allen Advisors
Ralph Allen served nearly three decades with Kodak, ITT Corporation and then ITT Industries, where, until August 1999, he was VP of IR. Allen is now an independent strategic IR advisor. He was interviewed on November 15.
On October 16, Enron announced third quarter earnings and yet again said it was going to 'tell all.' In a management conference call on October 23 it repeated that the opacity would be removed. But it wasn't. When analyst Carol Coale from Prudential downgraded the stock after the call, she commented she was rating it a sell not based on what she knew, but because of what she didn't know. She hit it on the nose.
The question CEO Ken Lay will have to answer now is, if he was really on the ball all these years, how could he let this happen? He began the November 14 conference call by saying to investors that everything he knew he would tell them. But what's scary is, what doesn't he know?
I also don't like this board committee that's been set up to investigate the situation. This mess happened on their watch. Investors would be far more comfortable if an outside financial expert with impeccable credentials was hired - a Peter Lynch, for example - to undertake the internal investigation.
The combination of self-dealing and secrecy in an atmosphere of superiority is just deadly. Enron exuded an attitude that its business was too complicated for investors to understand. Management insisted that because the company was doing so well they didn't need to explain anything. Now, except for Ken Lay, they're all gone. The company's lasting contribution may be seen as adding a new verb to our business vocabulary: to Enron investors.
Milestones of a disaster
October 16 Enron reports $618 mn loss for 3Q 2001
October 17 Enron reports shareholder equity has diminished by $1.2 bn due to losses from partnerships
October 18 Media reports begin to filter through that Enron partnerships were directly benefiting Enron executives
October 23 SEC initiates informal inquiry
October 24 CFO Andrew Fastow is ousted
October 29 Moody’s downgrades Enron’s debt
October 31 SEC upgrades inquiry to a formal investigation
November 1 Enron secures $1 bn in new credit
November 8 Enron restates previously reported net income going back to 1997 by 20 percent
November 9 Dynegy announces merger intent as ‘rescue’
November 19 Third quarter financials indicate Enron may be forced to take a $700 mn pre-tax charge and repay a $690 mn note
November 28 Dynegy terminates merger
November 29 Enron is dropped from the S&P 500
December 2 Enron files for Chapter 11
January 9 Justice Department launches criminal probe