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SCIENTECH's IssueAlert
Today's IssueAlert Sponsors: =09 [IMAGE] SCIENTECH is currently interviewing 1,500 utilities on CIS/CRM and= customer care in the United States and Canada to determine: The leadi= ng software providers Drivers of utility technology decisions Analysis of= license sales versus ASP sales New market opportunities Growing/shrinkin= g software markets Download a sample prospectus for an introduction to t= his new survey at: http://secure.scientech.com/specialpages/Multi_Client.as= p and contact Jon Brock at 505-244-7607 for more details.=09 [IMAGE] [IMAGE][IMAGE] Electric Power System & Natural Gas System Maps ar= e available from SCIENTECH, Inc. Click here for full descriptions and pric= es of Electric and Gas Maps.=09 [IMAGE] [IMAGE] October 24, 2001=20 Dynegy vs. Enron: A "Tale of Two Companies" =20 By Will McNamara Director, Electric Industry Analysis=20 [IMAGE] Facts: Dynegy Inc. (NYSE: DYN) beat expectations in the third quarter, repo= rting that its earnings rose to $286 million, or 85 cents per diluted share= , from $177 million, or 55 cents per diluted share, for the same period in = 2000. This represented a 22-percent increase from 3Q 2000 and boosted the c= ompany's 2001 earnings estimate. Dynegy has a market capitalization of $14.= 5 billion. Its stock is currently trading at about $43 down from a 52-week = high of $59, although it is important to note that for year-end 2000 the co= mpany's stock was one of the top performers among Standard & Poor's 500 com= panies with a total shareholder return of 218 percent. Dynegy employs 5,778= people. =20 Enron Corp. (NYSE: ENE) reported $638 million in losses for the third quart= er, after taking $1.01 billion in charges associated with several of its no= n-core businesses. The company's 3Q recurring net income (before the write-= offs) increased 35 percent to $393 million, or 43 cents a diluted share, an= d revenue in the quarter rose to $47.6 billion from $30 billion in 3Q 2000.= Enron has a market capitalization of $14.8 billion. Its stock is currently= trading at about $16.0, which represents a six-year low for the company an= d is considerably lower than the peak of $82 hit in August 2000. Enron empl= oys 20,600 people. =20 Analysis: Dynegy closed out a banner year in 2000 and appears to still be o= n a roll in terms of its financial performance. In contrast, Enron faced an= unprecedented year of turmoil, and is presently languishing in a low ebb, = characterized by a strategic crossroads and heightened scrutiny of the comp= any's financial reporting. While the two companies operate in the same mark= et space of power trading and are fierce competitors, Dynegy-ironically the= younger and smaller of the two companies-is an industry success story whil= e Enron's status remains rather uncertain. The questions to be addressed in= this article are: What is Dynegy doing "right"? What is Enron doing "wrong= "? What lessons can other power and natural-gas marketers learn from this "= tale of two companies"?=20 Although they are often referred to as "cross-town rivals," Dynegy and Enro= n are worlds apart in terms of their competitive positions. Their divergent= approaches to the global marketplace illustrate what could be the single-m= ost important element related to their disparate positions at the end of 20= 01. Put more simply, the two companies have vastly different strategies, an= d-hindsight being 20/20-a strong argument can be made that Dynegy's strateg= y is the winner at this juncture. Throughout this article, I will focus on = two key areas in which Dynegy and Enron differ dramatically. Those two key = areas are the ownership of physical generation assets and the extent to whi= ch the companies have expanded (and invested) into non-core sectors.=20 Both companies started out as natural-gas companies and converged into the = power market in the 1990s. However, that is essentially where their similar= ities end, and over the last few years Enron and Dynegy have followed decid= edly different paths. In an attempt to make the complex rather rudimentary,= let me summarize the two paths this way: Enron does not believe it needs t= o own physical assets to be a success in the power and natural-gas trading = sector; Dynegy, on the other hand, not only believes in the ownership of ph= ysical assets, but has set a goal that could ultimately establish the compa= ny as owning one of the largest generation arsenals in the industry. =20 Let's look at the companies separately. We'll discuss Enron first since it = is the older of the two. Enron readily admits that its strategy is difficul= t to define, but a close approximation is that Enron literally creates comm= odity markets so that it can deliver physical commodities to customers. The= participation and success in commodity markets, according to Enron, does n= ot necessitate ownership of physical assets. In fact, the company has routi= nely sold physical assets that are not considered to be strategic to its wh= olesale business. Rather, Enron has concentrated on developing a new philos= ophy of risk management excellence, in which it will merely buy and sell th= e commodities it needs to participate in trading venues. =20 As an example, Enron bought Portland General (which owns 2,000 MW of genera= tion and 41,600 kilometers of electric T?lines) in 1996 as a way to launch = its penetration of the West Coast power markets. When competition fizzled i= n that region, Enron put Portland General back on the sales block (a sale o= f Portland General to Northwest Natural is pending at this writing). Likewi= se in Europe, where it is one of the most prominent trading companies, Enro= n has disposed of generation assets such as Sutton Bridge in England and, u= nlike other U.S. competitors, has refrained from buying additional generati= ng units in opening countries such as Germany and Italy. According to its m= ost recent 10K report filed with the Securities and Exchange Commission, En= ron owns or controls 2,015 MW of generating capacity (including joint owner= ships), which is drastically lower than the average among other companies o= perating in the power trading sector. =20 Dynegy's approach to the market is crystal clear and radically different fr= om Enron's. In the words of CEO Chuck Watson, "Dynegy's long-term strategy = is to focus on marketing and trading around physical assets, which supports= earnings sustainability." Ever since going public in 1995, Dynegy has been= on an acquisition binge, with each purchase significantly increasing its g= eneration capability. Dynegy presently owns or controls about 27,000 MW of = generating capacity in the United States, 26 gas-processing plants and 14,0= 00 miles of pipelines, which are located in geographically competitive area= s. The company's goal is to own or control 70,000 MW, or 10 percent of the = U.S. market, within the next five years. Sometimes, Dynegy has acquired ass= ets through partnerships with other companies such as NRG Energy, but just = as often it has purchased assets independently. Most notably, when Dynegy a= cquired Illinova in early 2000, the purchase doubled Dynegy's generating ca= pacity. Dynegy is now attempting to replicate this approach in Europe, wher= e it is presently planning to purchase natural-gas storage facilities in En= gland. Dynegy executives have argued that natural-gas storage is the best w= ay to back up a natural-gas trading operation. There's no question that the= approach is working. Out of the $286 million that Dynegy reported in the t= hird quarter, $263 million of it came from the company's main wholesale bus= iness. =20 The issue of asset ownership is probably the central defining difference be= tween Enron and Dynegy, and its significance should not be overlooked. It i= s not difficult to make a case that supports Dynegy's approach. Owning phys= ical assets often enables a trading company to gain information in the cour= se of operating power plants that can help the company to gauge markets and= anticipate small changes in price. In other words, by controlling the actu= al output of generation instead of just being involved in buys and sells, a= trader such as Dynegy will theoretically know what the load is going to be= in a particular region, how much power can be produced to meet that load a= nd when shortages might occur. In addition, in markets that are short on in= frastructure, it may be difficult for a trader to participate in the market= unless they actually have ownership of physical assets in the region. By t= he same token, those companies that do control physical assets often have g= reater communication with grid operators, and possible insight to spreads (= the difference between various energy prices). In fact, Dynegy's CEO Watson= fully acknowledges that his company excels at being able to trade around t= he volatility of price, and being capable of resolving balances when shorta= ges exist. This may be more difficult for a company such as Enron to accomp= lish when it has no physical generation of its own to meet discrepancies in= power bids. Dynegy's strategy of acquiring both natural-gas pipelines and = power plants also gives it the flexibility to trade on both commodities.=20 On the other side of this argument, a case could be made that Enron's appro= ach provides more flexibility in reacting to trading volatility. Certainly,= by investing less in power generation facilities, Enron has less capital o= n the line when compared to a company like Dynegy. Under a scenario when ma= rket prices suddenly drop, a company such as Enron that does not have heavy= capital invested in power generation could actually fare better than an as= set-laden company because Enron does not face the pressure to meet the fixe= d payments of a generation facility. Asset-heavy companies also may find th= at their earnings could be impacted by the investment in generation facilit= ies in times of extreme price volatility. As the industry becomes increasin= gly focused on bottom-line results, this could be seen as a potential conce= rn for investors. Further, some would argue that Enron's approach of establ= ishing purchasing contracts with various parties to meet its buy and sell r= equirements is the rough equivalent of owning a generation facility. What E= nron gains by this approach is the presumed flexibility it has by not being= tied down to a specific generation unit and being able to build its own po= rtfolio.=20 Consequently, the issue of asset ownership can perhaps be considered the "g= reat debate" among power traders. However, although Dynegy's overall perfor= mance in the third quarter was better than Enron's, that does not necessari= ly provide a clear endorsement of Dynegy's strategy toward acquiring new ge= neration facilities. Keep in mind that Enron's 3Q losses resulted primarily= from non-recurring charges related to its non-core businesses (broadband a= nd water in particular). Without these charges, Enron's core wholesale trad= ing business continues to perform well. This is a point that CEO Ken Lay ha= s been quick to reiterate to investors. "Our 26-percent increase in recurri= ng earnings per diluted share shows the very strong results of our core who= lesale and retail energy businesses and our natural-gas pipelines," Lay sai= d. "The continued excellent prospects in these businesses and Enron's leadi= ng market position make us very confident in our strong earnings outlook."= =20 Moreover, perhaps even more than ownership of physical assets, the key issu= e that played a role in the current disparity between Dynegy and Enron earn= ings in the third quarter is the companies' approach to developing new line= s of business. Telecom is a perfect example to illustrate the point. Enron= , which prides itself as usually gaining a first-strike advantage, plunged = into the telecom sector well ahead of other energy companies. Under the lea= dership of then-CEO Jeffrey Skilling, Enron sunk large sums of capital into= purchasing broadband capacity on the expectation that the market would qui= ckly become lucrative. Now Lay admits that the company "could have gotten i= nto the broadband business with less capital" and that Enron "spent too muc= h too soon" in this sector. Nevertheless, Enron recorded an $80-million non= -recurring write-down for restructuring its broadband unit in the third qua= rter and is presently attempting to stop the bleeding in this sector by red= ucing future costs in this sector to $40 million a quarter. =20 Dynegy took a much more cautious approach toward expanding into the telecom= sector and made a comparatively small amount of investment when compared t= o Enron. Dynegy has likewise been impacted by the slowdown of the telecom s= ector, but in the third quarter took a $15-million loss in its broadband bu= siness compared to the $80-million loss that Enron reported. However, Dyneg= y clearly specializes in marketing and trading two commodities (electricity= and natural gas) and seems to add other businesses in a very methodical wa= y that merely supplements its core business.=20 It is also important to note that Enron gained the first-strike advantage w= hen it developed EnronOnline, an electronic trading exchange. In fact, Enro= n was the first to create such an exchange in the energy space, well ahead = of its competitors. Dynegy later followed this trend with creating Dynegydi= rect. The two exchanges are different in terms of their trading standards, = but it is important to acknowledge that in this particular case Enron was s= uccessful in launching into the electronic trading space well ahead of its = competitors. The latest available information indicates that EnronOnline ha= s recorded transactions that exceed $590 in notional value. Since its incep= tion in November 2000, Dynegydirect has recorded $33 billion in notional tr= ansactions. =20 At this juncture, Dynegy and Enron are very different with regard to their = approaches toward financial reporting. Enron, which has often been accused = of not providing a balance sheet to investors, is currently struggling from= a serious image problem as the Securities and Exchange Commission pursues = an investigation of possible mishandling of funds by Enron's CFO. To my rec= ollection, no one has ever accused Dynegy of not providing a balance sheet,= and thus the company's status with investors is arguably more solid. As I = don't expect either company to radically alter its competitive strategy any= time soon, my projection is that (at least in the near term), we will cont= inue to see a wide disparity in Wall Street performance between Dynegy and = Enron. That is not to say that anyone should count Enron out of the game. A= s noted, the company's core business of wholesale business remains strong, = but clearly has been tainted by the impact of other non-core businesses. Th= at doesn't mean Enron is down permanently, but it will have to find a way t= o strike a better balance between the businesses that it does best and thos= e businesses that former CEO Jeffrey Skilling believed were advantageous.= =20 In many ways, the comparison between Dynegy and Enron is rather like the to= rtoise and the hare parable. I am sure you can guess which company is the t= ortoise and which is the hare in this analogy. The race between the two is = far from over, although Dynegy is taking the lead at this point, based on i= ts more methodical approach. What will be fascinating to observe is how bot= h companies continue to adapt to changes in the marketplace and possibly mo= dify what up to this point have been adamantly espoused philosophies. =20 Correction statement to 10/23 IssueAlert on European trading:=20 According to a news report from Reuters, the U.S.-owned Entergy-Koch Tradin= g was listed as a publicly traded company. I was informed by my contact at = Entergy that Entergy-Koch Trading is a limited partnership company and not = publicly traded. I apologize for any confusion this error might have caused= .=20 An archive list of previous IssueAlerts is available atwww.scientech.com=20 We encourage our readers to contact us with their comments. We look forwar= d to hearing from you. Nancy Spring Reach thousands of utility analysts = and decision makers every day. Your company can schedule a sponsorship of I= ssueAlert by contacting Jane Pelz . Advertising opportunities are also ava= ilable on our Website. =09 Our staff is comprised of leading energy experts with diverse background= s in utility generation, transmission & distribution, retail markets, new = technologies, I/T, renewable energy, regulatory affairs, community relatio= ns and international issues. Contact consulting@scientech.com or call Nan= cy Spring at 1-505-244-7613. =09 SCIENTECH is pleased to provide you with your free, daily IssueAlert. Let = us know if we can help you with in-depth analyses or any other SCIENTECH i= nformation products. If you would like to refer a colleague to receive our= free, daily IssueAlerts, please reply to this e-mail and include their f= ull name and e-mail address or register directly on our site. If you no = longer wish to receive this daily e-mail, and you are currently a registere= d subscriber to IssueAlert via SCIENTECH's website, please visit http://s= ecure.scientech.com/account/ to unsubscribe. Otherwise, please send an e-= mail to to IssueAlert , with "Delete IA Subscription" in the subject line.= =09 SCIENTECH's IssueAlerts(SM) are compiled based on the independent analysis= of SCIENTECH consultants. The opinions expressed in SCIENTECH's IssueAler= ts are not intended to predict financial performance of companies discusse= d, or to be the basis for investment decisions of any kind. SCIENTECH's so= le purpose in publishing its IssueAlerts is to offer an independent perspe= ctive regarding the key events occurring in the energy industry, based on = its long-standing reputation as an expert on energy issues. Copyright = 2001. SCIENTECH, Inc. All rights reserved.=09
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