Dynegy and Enron Announce Merger

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[IMAGE] [IMAGE] [IMAGE] November 12, 2001 Dynegy and Enron Announce Mer=
ger By Will McNamara Director, Electric Industry Analysis [News item fro=
m Reuters] Dynegy Inc. (NYSE: DYN) agreed on Nov. 9 to acquire rival Enron=
Corp. (NYSE: ENE) for some $9 billion in stock, underlining the dramatic r=
eversal of fortunes for the Houston-based energy trading giant that was val=
ued last year at nearly $80 billion. Enron's stock fell sharply in the past=
month due to investors' concerns about murky transactions that sparked an =
investigation by U.S. regulators and damaging downgrades by credit rating a=
gencies. The merged company will retain the Dynegy name. It will have annua=
l revenues of more than $200 billion and assets worth $90 billion, includin=
g more than 22,000 megawatts of electricity generating capacity and 25,000 =
miles of natural-gas pipelines. It will be North America's biggest marketer=
and trader of natural gas and electricity, positions previously held by En=
ron. Analysis: Well, it's now official. The announcement of what presumabl=
y will be the final chapter in the Enron saga came with much fanfare at the=
end of last week. It is indeed a dramatic end. Enron, the maverick and inn=
ovative company that has often been credited for literally creating deregul=
ated markets in the energy industry, will no longer exist after what has be=
en a very quick and unbelievable fall from grace over the last several mont=
hs. Dynegy, the slow and methodical company that took a more traditional ap=
proach toward success, is making a stunning acquisition of its formal rival=
and locking in much of the industry market share of Enron. Can there be an=
y doubt that this is the energy industry's manifestation of the tortoise an=
d the hare parable? Enron has clearly lost the race to Dynegy, but is makin=
g a smart choice to be bought, considering its desperate circumstances and =
the unlikelihood of its regaining financial strength on its own. For Dynegy=
, this acquisition is a major win, as the combination will create the bigg=
est and strongest energy merchant in the world. There are so many interes=
ting dimensions to this mammoth deal. Before addressing some issues related=
to the approval of the deal, let's establish some of the key points of the=
merger agreement. There have been some mixed reports, but it is generally =
believed that Dynegy is buying Enron for about $10 a share, quite a steal c=
onsidering that just over a year ago Enron was trading at close to $90 a sh=
are and had a market value of nearly $70 billion. Under terms of the agreem=
ent, Enron shareholders will receive 0.2685 Dynegy shares per share of Enro=
n common stock. Dynegy's current stockholders (including ChevronTexaco Corp=
., which currently owns 27 percent of Dynegy) will own approximately 64 per=
cent of the combined company, while Enron's stockholders will own approxima=
tely 36 percent of the combined company's stock at closing. In addition, =
Dynegy will provide an immediate $1.5-billion asset-backed equity infusion =
into Enron to help the company with its current financial woes, followed by=
an additional infusion of $2.5 billion into the combined company by Chevro=
nTexaco. Chuck Watson, chairman and CEO of Dynegy, will retain his position=
at the new company. Steve Bergstrom, president of Dynegy, and Rob Doty, ch=
ief financial officer, will retain their positions at the new company. It i=
s not presently known what role, if any, Ken Lay, current CEO of Enron, wil=
l hold at the new company. Of course, this acquisition could not have tak=
en place if Enron had not fallen into a very vulnerable spot this year. Qui=
te literally, Enron was pushed into this deal because it was running out of=
cash, its stock had tanked and its credit ratings were slashed to near jun=
k levels, all within the last several weeks. Enron's decline over the cours=
e of 2001 has been the result of losses in its telecom sector, losses from =
its involvement in India, the departure of its former CEO Jeffrey Skilling,=
a Securities and Exchange Commission (SEC) investigation into some of its =
business practices, and lack of investor confidence about Enron's honesty i=
n its financial reporting. This last point gained validity last week when E=
nron announced that it had overstated earnings by 20 percent over the last =
four years and investors should disregard the company's financial statement=
s from 1997 through the first half of 2001. The restating of its earnings f=
or the last five years sliced $591 million from Enron's reported profits. I=
n addition, Enron revised its debt upward in each year from 1997 to 2000. A=
t the end of 2000, Enron's debt was $10.86 billion, $628 million more than =
it had previously reported. By not reporting this debt earlier, Enron presu=
mably was able to maintain a stronger credit rating than it would have had =
the accurate records been disclosed. The key value for Dynegy in this acq=
uisition is Enron's successful energy trading business. In addition, Dynegy=
could also find synergies in Enron's retail unit, Enron Energy Services an=
d EnronOnline, the company's electronic trading unit. Dynegy has a similar =
trading site known as Dynegydirect, which was launched after Enron gained t=
he first-strike advantage in this market space. Details are still emerging,=
but it would make sense if Dynegy opted to not purchase other units under =
Enron's business structure, such as the company's water and telecom busines=
ses, which are losing money. Dynegy has its own telecom unit, which has als=
o lost money this year, so it may not want to expand in this slow-growing s=
ector at this time. Vivendi Environnement, a French company that has expand=
ed into various lines of business, has reportedly expressed interest in the=
remaining subsidiaries of Azurix, Enron's struggling water subsidiary. Not=
e that Enron sold Azurix North America to American Water Works. The deal =
is subject to regulatory reviews and shareholder approval from Dynegy and E=
nron shareholders. Dynegy shareholder approval may be contingent upon any p=
ossible downgrades on its long-term debt that Dynegy could encounter with t=
he purchase of Enron. At this juncture, it does not appear that Dynegy will=
be downgraded, but this is a fast-changing story and conditions could chan=
ge abruptly. Financing the deal may also be an issue, even with the infusio=
n of capital from ChevronTexaco. Dynegy reportedly has $3 billion worth of =
debt and has a market capitalization of $11.7 billion. Thus, Enron's own mo=
re substantial debt may be too significant for Dynegy to absorb, a concern =
that may cause Dynegy shareholders to veto the deal. This issue could be he=
lped if Dynegy only elects to purchase some of Enron's assets and if there =
is some repair work done on Enron's balance sheets. The issue of regulato=
ry approval could be difficult, as the combination of the two huge companie=
s may cause regulators to be concerned about market power and antitrust iss=
ues. The review of this merger will be unprecedented, considering that the =
wholesale natural-gas and electricity trading market is still fairly young.=
Certainly, a deal of this magnitude has not previously occurred in the der=
egulating energy industry. It is not presently clear which regulatory agenc=
y will be involved in the review, although the Federal Energy Regulatory Co=
mmission (FERC), the Federal Trade Commission and the Justice Department co=
uld all be involved. FERC would most likely become involved only if the acq=
uisition includes the transfer of a physical asset, such as a pipeline. FER=
C may not become involved if the deal is structured solely as an exchange o=
f stock. Not involving FERC would be more advantageous for Dynegy and Enron=
as the timeline for approval would be significantly shorter. An issue th=
at most likely will be at the top of the list of review items for regulator=
s would be the extent to which the combination of Enron and Dynegy would ho=
ld market power in the natural-gas trading space, which could pre-empt mark=
et entry by other competitors. The combined company would be considerably l=
arger than its nearest competitors. Scope and scale are considered the top =
competitive assets in the trading sector, and the combination of Dynegy and=
Enron will certainly have those assets in abundance. It will fall on regul=
ators to determine if the combined company is so large that it precludes ot=
her competitors from emerging into the same space. To say that this deal =
is a sweet victory for Chuck Watson is an understatement. The two rival com=
panies followed very different paths to success. Enron, under the leadershi=
p of Jeffrey Skilling in particular, espoused an unorthodox belief that the=
company did not need to own physical assets in order to achieve success in=
the energy-trading space. Dynegy, on the other hand, approached the market=
from the opposite perspective, and diligently acquired diverse generation =
assets across the United States and internationally to support its trading =
operation. Up until the start of 2001, it appeared that Enron's strategy wa=
s the more successful of the two. Enron, with $100 billion in revenues and =
$1 billion in profits in 2000, ranked fifth on Fortune 500's list of larges=
t U.S. companies. In contrast, Dynegy ranked 54 on the same list and had $2=
9 billion in revenues and $500 million in earnings. However, 2000 turned ou=
t to be Dynegy's year and the success continued into 2001, the very year th=
at would bring Enron's downfall. Enron's problems culminated in $638 millio=
n in losses in the third quarter, after taking $1.01 billion in charges ass=
ociated with several of its non-core businesses. Taken with the other facto=
rs plaguing the company, Enron became exceptionally vulnerable and prone to=
a takeover, which has now provided Dynegy with a strong gain. The purcha=
se of Enron will literally quadruple Dynegy's size and should immediately p=
rovide an accretive earnings contribution. Further, Dynegy claims that it e=
xpects a 15- to 20-percent annual earnings growth over the next three years=
following its planned acquisition of Enron. If it gains all of the necessa=
ry regulatory approvals, Dynegy will become the undisputed market leader in=
the energy industry, with annual revenues of $200 billion and $90 billion =
in assets. The company will have 22,000 MW of generating capacity, which mo=
ves its closer to the previously established goal of accumulating 70,000 MW=
by 2005. In other words, the combined company will dwarf any other competi=
tion in the trading sector and be considerably ahead of its nearest competi=
tors such as Mirant or Duke Energy in terms of size, resources and assets. =
Word of the acquisition caused Enron's shares to increase some, one of th=
e few upward bumps that the company had experienced in the last few months.=
Shares of Enron rose 44 cents, or 5.2 percent, to $8.85 in mid-day trade o=
n the New York Stock Exchange on Nov. 9. As of early morning trade on Nov. =
12, Enron shares were priced at $9.40. Shares of Dynegy gained $2.24, or 5.=
8 percent, to $41 in early trade on the New York Stock Exchange. An archi=
ve list of previous IssueAlert articles is available at www.scientech.com =
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