All Eyes on the Enron Prize

If the deal holds, Dynegy will walk away with some juicy assets

As Houston-based Enron Corp. (ENE ) imploded amid a dizzying scandal over its finances, few would have blamed Dynegy Inc. CEO Charles L. Watson if he had sat back and gloated. After all, Watson had watched as his bigger, brasher crosstown rival sniffed at Dynegy's (DYN ) more cautious strategy, all the while garnering most of the credit for reshaping the energy-trading business.

Instead, Watson picked up the phone on Oct. 24 and called Enron Chairman, CEO, and longtime acquaintance Kenneth L. Lay to ask how he could help. Lay didn't respond immediately, but as Enron's stock continued to plunge and the company faced a cash squeeze, it became clear what the only realistic answer could be: Bail us out.

So two days later, Lay invited Watson to his River Oaks home near downtown Houston for breakfast to discuss a deal. Over muffins and "a bad cup of coffee" the next day, Watson recalls, they sketched the outlines, and by 10 p.m. that night, the investment bankers were called in. On Nov. 9, Dynegy announced that it would pay about $10 billion, plus the assumption of $13 billion in debt, to buy Enron, which is nearly four times its size. The key to the deal was Dynegy's immediate $1.5 billion infusion of cash to shore up Enron's balance sheet and save its credit rating. The money came from Dynegy's 26% owner, ChevronTexaco Corp.

Without that help, Enron--the seventh-largest U.S. company, based on its $100 billion in sales last year--may well have faced bankruptcy. Watson says that he never would have imagined such an outcome in his wildest dreams. "I don't think anybody foresaw the problems [at Enron]," he says. "It's been incredible to watch."

Watson, 51, has to make good on what may well be his riskiest investment yet. If he can pull it off, the new Dynegy will have revenues of more than $200 billion and $90 billion in assets, including more than 22,000 megawatts of power-generating capacity and 25,000 miles of pipeline. It would control an estimated 20% to 25% of the energy-trading market, up from about 6% now.

That would be sweet vindication for Watson's strategy. Dynegy backs trading operations with hard assets such as power plants, which allows the company to guarantee a supply of electricity to a buyer. In contrast, Enron has worked furiously to shed power plants and oil- and gas-generating fields, believing it could earn higher returns using its trading and technology expertise to tap assets owned by others in markets including steel, pulp, and paper.

IRRESISTIBLE BARGAIN. As Enron's stock slid below $9 from its August, 2000, high of $90, it became a bargain that Watson couldn't pass up. It would have taken years for Dynegy to build up a market-making operation to match Enron's. Its risk-management systems are top-of-the-line. Enron's commercial-services unit, which manages power supplies for corporate customers such as Wendy's International Inc., is three or four years ahead of Dynegy's, says Steve Bergstrom, president of Dynegy. Watson says he still plans to get rid of the $8 billion worth of assets Lay had earmarked for sale, including the Portland (Ore.) General Electric (GE ) plant and oil and gas assets in India. For the $1.5 billion, though, if the deal falls through Dynegy will have the right to Enron's prized Northern Natural Gas pipeline, worth an estimated $2.25 billion. And Dynegy can walk away if Enron's legal liabilities exceed $3.5 billion.

Watson firmly believes that Enron suffered from a crisis of confidence, not a meltdown of its core business. Indeed, Enron's wholesale-trading operation earned $2.3 billion last year. Says Watson: "We know the business. We looked under the hood, and guess what? It's just as strong as we thought it was."

But the trading profits were obscured in recent weeks by Enron's accounting tricks. The biggest danger for Watson is that there are other time bombs ticking away. Already, the company has slashed its reported earnings since 1997 by $591 million, or 20% of its total, to account for controversial partnerships involving Enron officials. The Securities & Exchange Commission is still investigating. "We believe it will take more than just a couple of weeks and a long-term relationship [between Watson and Lay] to do all the necessary due diligence," says analyst Carol Coale of Prudential Securities Inc. Dynegy's Bergstrom counters: "We're pretty certain that most everything of material consideration has been disclosed." If not? The massive earnings boost provides "a high margin of error," he says.

A WANNABE. Of course, regulators may object to the concentration of trading operations. And Watson will have to mesh two very different cultures. Enron is known for its intense, even cutthroat entrepreneurial spirit. Dynegy's operations are more conservative; some compare it to a fraternity. Dynegy's decision to issue new stock options to some Enron employees may soothe battered egos. It should help, too, that Lay decided not to take the $60 million golden parachute he could have received in a buyout. As it is, Lay will not have a management job with the new company.

Dynegy often seemed to be an Enron wannabe, following it into online trading and commercial services. Still, Dynegy's 361% stock gains last year eclipsed Enron's 87% rise, and it rankled some that Lay's execs got more credit. "Chuck Watson may not have been in the spotlight, but he has always been at the forefront of this business," says Bruce M. Withers, who sold his Trident NGL Inc. to Dynegy in 1995. Watson will get more attention next year--he's a 15% owner of the new Houston Texans pro football team. But with his bold takeover of Enron, Watson has ensured that he's off the sidelines for good.

By Stephanie Anderson Forest, with Wendy Zellner in Dallas, and Peter Coy and Emily Thornton in New York

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