Conspiracy of Fools (47 page)

The camera cut to a brunet woman. “Hi, Kitty,” Schaffler began. “Once again, a broad-based rally.”

But not all the news was good. “Azurix is down sharply,” Schaffler said. “It reported earnings in line with what the Street was looking for, but warned its fourth quarter and year 2000 results would be below expectations. Merrill Lynch downgraded the stock today.”

A stock that went public at $19 a share was now floundering at $7.75. In just 105 trading days, more than 60 percent of Azurix’s value had been wiped out. The traders roared. Azurix—“the chick company,” as they called it—was a miserable failure. It was fun to watch.

None of them worried what that meant for
their
jobs. After all, Azurix had a different management team. Whatever their incompetence, they had nothing to do with Enron.

About an hour later in Antioch Park, across the street from the Enron building, members of the Houston Astros baseball team walked down an outdoor runway, modeling new uniforms for their top corporate sponsor.

Thousands of Enron employees cheered while eating a lunch served in what the company called the Big E Café. On a dais, Lay and Skilling watched as players appeared wearing multiple versions of the uniforms, including a pinstripe ensemble—an homage, the club’s owner said, to the business community surrounding Enron Field.

By two the event had broken up. Lay and Skilling made their way across the street. Around them, employees jabbered excitedly. There was enthusiasm for the uniforms, but it was more than that. There was exhilaration about their place in the city. The Astros had become
their
team, with Enron emerging as part of the very fabric of Houston.

Skilling headed to the top floor, then changed elevators for the mezzanine level. He was scheduled to meet with Joe Sutton and part of the international group to review next year’s budgets for projects in Asia, the Pacific, Africa, and China.

Even with Azurix’s chaos in the marketplace, the baseball lunch had been a refreshing break and Skilling was in a good mood. He arrived at conference room 50M, then took a moment to chat with Sutton, who a few months earlier had been named vice chairman, taking Rebecca Mark’s place.

“Okay,” Skilling said, pulling in his chair. “Asia and Africa. Joe, want to kick it off?”

Sutton stayed in his seat. “All right. We have the regional team here. But we’d like to start with a review of the entire division, to show where this fits in.”

An accountant with international rattled off the numbers. Skilling listened with growing alarm. He and Causey had sized up international recently, figuring it would chip in about $500 million in profits next year. But the more
the accountant spoke, the smaller the numbers seemed. A slide went up, showing a region-by-region breakdown. Skilling’s eyes drifted to the bottom line.

About $100 million
. “Whoa, wait a minute,” Skilling interrupted. “Is this for all of international?” Sutton nodded. “Yeah.” Skilling looked at the faces around the table.

“Guys, we’ve got seven billion dollars invested in this business.
Seven. Billion. Dollars
. And you’re telling me we’re going to make $100 million next year? I came in here expecting a $500 million number.”

Skilling had been around the block enough to recognize what was going on.
A sandbag
. Sutton was coming in with ridiculous projections so that next year, when he blew through those levels, his performance would look great.

“Joe, should we just stop meeting now, and you guys go out and come back with a different set of numbers?” he asked sharply. “Maybe something a little more realistic?”

“Jeff, those are the numbers.”

“Oh, come on!” Skilling snapped.

Sutton stared back at him.

“Fine,” Skilling said. “Let’s go through it.”

Region by region, the executives reviewed the performance. Asia. Africa. The Caribbean. South America. India—profits in India were
going down!
There were asset sales built into the numbers, so some of the results weren’t even from operations.

Skilling worked his jaw.
Seven billion dollars
. Seven billion dollars invested to earn $100 million in profits. Hell, if they had stuck the money in a bank account earning 3 percent, the earnings would have been higher!

Numbers whirred through his mind. Two billion dollars in Azurix, flushed away in the morning. Seven billion in international, flushed away in the afternoon.

He held up his hands. “We’ve got seven billion of book value on this stuff. What’s it worth if we sell it?”

The question hit the room like a percussive explosion. “Oh, it’s worth a lot more than that,” Sutton said.

Skilling slapped the table. “Fine,” he snapped. “Then that’s what we’ll do.”

He looked around the room.

“I want this stuff fucking sold!” he snapped.

Skilling was panicked. The shortfall in international was huge; it would be Azurix II, only this time
Enron
would be the laughingstock. He scurried to
find Baxter. International needed to be sold, he said, and he wanted Baxter to handle the deal. Baxter was enthralled; a multibillion-dollar sale was just the thing to get his juices going.

The next afternoon, executives from Enron North America, the most recent name for wholesale, came in for the same budget exercise. Greg Whalley, newly appointed to run the trading desk, laid out his projections. Skilling could smell a sandbag. They could do a lot better.

“Listen,” he interrupted. “Stop. I need another $400 million, pretax.”

Whalley thought about it. “Okay,” he said. “We’ll get you another $400 million.”

McMahon saw Fastow in the hallway. Weeks had passed since they spoke about LJM2 and the banks, but McMahon had never heard which banks Fastow was visiting and which had invested. McMahon flagged him down. “You still haven’t gotten me that investor list.”

Fastow nodded solemnly. “Yeah, you’re right,” he said. “I’ve got to get that for you.”

Then he continued on his way.

Lay and Skilling could not stop ruminating about the week’s events. How could it have happened? How could so many billions of dollars have been invested so badly?

Skilling blamed Rebecca Mark, viciously attacking her to Lay as incompetent. But Lay wouldn’t buy it. She almost single-handedly pulled together Dabhol—well, yes, that was having troubles. But it was a challenging project. Things could still turn out well. Lay believed in her.

The two decided to speak with Mark, to stress how Azurix’s strategy needed to be rethought. Mark and her people were already talking about new bids, showing estimates of returns of less than ten percent. That just wouldn’t work; when the cost of the capital needed for the acquisition was factored in, Azurix would
lose
money on the deal. The three set up a meeting to thrash things out.

Once they all got together, Lay was the first to speak.

“Rebecca,” he said, “obviously, things aren’t as much on track as we thought, so you’re going to have to impose some more discipline on your investments and costs.”

Like this new deal she was talking about, Skilling said. Azurix had to pay more than ten percent interest on its debt. So the company would be borrowing cash at, say, eleven percent for returns of nine percent. It was a money loser.

“That’s not the point,” Mark replied. “We need to keep investing to grow as fast as possible. Merrill Lynch says our valuation is all about EBITDA, not earnings.”

EBITDA. A
fancy Wall Street term for profits, with all of the financial expenses removed. It stood for “earnings before interest, taxes, depreciation, and amortization.” Steady growth in EBITDA could be a sign of future strong profits, but not if it was being accomplished by manufacturing full, after-tax losses.

Lay couldn’t believe what he was hearing. Was Mark really arguing that the deeper into a hole she got, the better off her company would be?

“Rebecca, that doesn’t make any sense,” he said. “Surely you understand that if you put capital into projects with returns that are below the cost of that capital, ultimately you’re going to go bankrupt.”

“This is what Merrill tells me is the way things are around this industry,” Mark replied. “We have to grow EBITDA. That’s all that matters.”

This is ludicrous!
“So the more money you lose, the more valuable you are?” Skilling said. “That’s nuts!”

Mark stuck to her guns. Investors wanted EBITDA growth, she insisted. That would make the stock price go up. Azurix needed to keep buying water assets so that it could grow EBITDA.

Skilling wanted to pull out his hair. “Rebecca, Merrill doesn’t mean grow EBITDA by creating losses! They assume nobody would do that! I mean, why not sell junk debt at 12 percent and use the cash to buy government bonds? You’ll get plenty of EBITDA, but you’ll lose big money for every dollar of EBITDA you get!”

Mark didn’t give an inch. “Our bankers tell us we have to grow EBITDA. That’s what investors are looking for.”

Lay almost staggered out of the room. His faith was shaken, but not gone. He still believed Mark was smart. But suddenly he knew that he had entrusted billions of Enron’s dollars to someone who could get locked into an illogical position. And he only realized it now. Years too late.

He and Skilling climbed onto the elevator. The doors closed, and Skilling seized the moment. He faced his boss.

“Do you understand, Ken?” he asked plaintively. “Do you see what I’ve been trying to tell you?”

Lay watched the numbers move over the door.

“Yes,” he said, “I do.”

———

Another week had passed, and still McMahon had received nothing from Fastow about LJM2 and the banks. At the end of the next meeting they both attended, he stopped Fastow as they headed out the door.

“Andy, I still need that investor information about the banks,” McMahon said.

Fastow made a face. “Oh yeah, you’re right,” he said. “I’ll make sure to get right on that.”

Fastow headed down the hall. As McMahon watched him, realization settled in. That list was never coming.

This was no time for a breather. Enron couldn’t slow down. Not if it was going to propel its stock price to the next level. Of that, Lay and Skilling were sure.

The growing tower of miscalculations—international, Azurix, a lot of merchant investments—none of that called for a reassessment of strategy. Lay and Skilling didn’t even view all of them as mistakes. And they felt sure management would work through it—with asset sales, restructurings, whatever. The billions of dollars in debts associated with those deals were mostly off balance sheet. That was the past. Enron had to move to the future.

And they had a plan. Ramp up Enron Communications. The Internet was hot, the new economy was everything. Push hard, hire employees, invest plenty. That would catapult Enron ahead. But they needed somebody to take charge, to lead the troops onto the next battlefield.

They knew exactly who it should be.

At three on November 18, Enron’s directors gathered for a special meeting. Their mood was sharp with anticipation. Enron, they knew, was about to propel itself in a new direction.

Lay called everyone to order. “The purpose of this meeting is to discuss opportunities the company is seeing for Enron Communications,” he began. “We are more optimistic about the growth potential at ECI than any other division.”

There had been a two-day session in Scottsdale, Lay said, where Skilling and the ECI team had reviewed everything. Now they were ready to put a plan in action.

“We’re concerned whether the team is focused enough,” Lay said. “And so this is our idea.”

He looked around the table. “We want to have Jeff Skilling spend more time with the team,” he said. “That would take him away from his corporate duties, so Joe Sutton and I would pick up the slack.”

Skilling took the floor. This was a great opportunity to affect the future stock price, he said. Enron was now trading at forty dollars. With business as usual, it should end the year at fifty-one dollars. But pushing hard into broadband could be worth an additional ten to fifteen dollars a share, he said.

“I would like to have a significant role in this business,” he said. “I’d like to continue my role at Enron but spend significant time at ECI as we ramp up.”

The best outcome, Lay said, would be if Skilling remained chief operating officer at Enron but was also formally appointed chairman of Enron Communications.

John Duncan spoke. “I’m not sure. There is a chance of misinterpretation by the investment community.”

Others differed. “What makes Enron great is
management flexibility,”
Norm Blake said. “I applaud the decision.”

The directors asked for the chance to discuss the decision alone, and Skilling left the room. Once the door closed, Lay spoke.

“This is the right decision,” he said. “Jeff has the skills needed here. But doing this is riskier than just staying COO. We need a safety net for him.”

Lay had thought it all through. He was ready to truly anoint a successor. The moment had finally arrived.

“We need to extend Jeff’s contract through 2003,” Lay said. “And we should make it official that he can consider himself constructively terminated by the end of next year if he is not offered the position as CEO of Enron.”

Several directors were stunned. That meant if Skilling wasn’t named CEO by December 2000, he could collect an entire three-year contract and go home. What about Lay?

“I will step down as CEO at year-end 2000, with the option to extend that if either ECI or Jeff isn’t ready,” he said. “I would also stay one year as chairman.”

There was a pause. “Do I have a motion?” Lay asked.

Robert Jaedicke raised a hand, putting the proposal to the board. It passed unanimously. “Thank you,” Lay said, smiling.

It was done. Enron had launched its last huge investment in a business that, again, no one in the room fully understood. But this time it would be led by the executive designated as the man to take Enron into the twenty-first century.

EARLY ON A THURSDAY
afternoon, Ken Lay escorted a man through crowds of Enron executives who were milling about the main floor at the Hyatt Regency Hill Country Resort. Several gaped as the two passed by, recognizing Lay’s guest. The ill-fitting toupee was gone, and the years had softened his sharp, angular features. Even so, no executive was likely to forget Michael Milken, the former junk-bond king who had once been at the epicenter of Wall Street’s crime wave in the 1980s.