Investor Letter: Enron – ask why.

Published April 27, 2016

This week’s letter takes a slightly different approach compared to our others. Instead of focusing on a company that is thriving or at a crucial time in its lifecycle. We are looking at one of the largest corporate scandals and bankruptcies of our lifetime, Enron. At the time of the letter, winter 2001, Enron was thriving and on the verge of their demise. Littered with lies and deceptions, we found ourselves asking ‘why and how’ as we dove into the details of the scandal.

enron ask why

A difficult subject to summarize; forensic accountants, Bala Gharan and William Bufkins, draws parallels from the Titanic to Enron. An “unsinkable” ship and a “sure fire” stock, a reckless decision to race through iceberg infested waters and a series of reckless investment decisions, and ultimately the following:

“Like the Titanic, the human tragedy from Enron is all too well known–a devastating loss for Enron employees and shareholders as Enron’s stock plunged to less than a dollar, with collateral damage extending to virtually every other energy merchant company including Dynegy, Reliant Energy, El Paso, and Williams, all of whom modeled themselves in various degrees after Enron. Enron’s fall also directly led to the indictment, subsequent conviction, and collapse of Arthur Andersen, one of the world’s preeminent accounting firms.”

We have pulled out the sections we found most interesting and added our thoughts below. All of the charts, images, quotes, and emphasis below were added by us.

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The 2000 Enron Investor Letter

To Our Shareholders,

Enron has built unique and strong businesses that have tremendous opportunities for growth. These businesses — wholesale services, retail energy services, broadband services and transportation services — can be significantly expanded within their very large existing markets and extended to new markets with enormous growth potential. At a minimum, we see our market opportunities company-wide tripling over the next five years.

Enron is laser-focused on earnings per share, and we expect to continue strong earnings performance. We will leverage our extensive business networks, market knowledge and logistical expertise to produce high-value bundled products for an increasing number of global customers.

Competitive Advantages

Our targeted markets are very large and are undergoing fundamental changes. Energy deregulation and liberalization continue, and customers are driving demand for reliable delivery of energy at predictable prices. Many markets are experiencing tighter supply, higher prices and increased volatility, and there is increasing interdependence within regions and across commodities. Similarly, the broadband industry faces issues of overcapacity and capital constraint even as demand increases for faster, flexible and more reliable connectivity. Enron is in a unique position to provide the products and services needed in these environments. Our size, experience and skills give us enormous competitive advantages. We have:

  • Robust networks of strategic assets that we own or have contractual access to, which give us greater flexibility and speed to reliably deliver widespread logistical solutions.
  • Unparalleled liquidity and market-making abilities that result in price and service advantages.
  • Risk management skills that enable us to offer reliable prices as well as reliable delivery.
  • Innovative technology such as EnronOnline to deliver products and services easily at the lowest possible cost.

These capabilities enable us to provide high value products and services other wholesale service providers cannot. We can take the physical components and repackage them to suit the specific needs of customers. We treat term, price and delivery as variables that are blended into a single, comprehensive solution. Our technology and fulfillment systems ensure execution. In current market environments, these abilities make Enron the right company with the right model at the right time

In addition to the advantages listed above there are 2 others “advantages” they are hiding from their shareholders:

  • Mark-to-Market Accounting: The accounting act of recording the price or value of a security, portfolio or account to reflect its current market value rather than its book value (Investopedia)
  • Merchant Model: Allows firms to report the entire value of each trade they are a counter party as its revenue, rather than reporting only revenues from trading /brokerage fees. (Bala Dharan)

In addition to other aggressive and illegal accounting/financial practices many financial researchers trace the Enron Scandal back to both the Mark-to-Market and Merchant Models of accounting. Both models were used to inflate profits and hide losses for Enron. When Jeffrey Skilling was hired by Enron in 1991 his first major task was to get acceptance from the SEC to practice Mark-to-Market accounting. Just 9 months later Enron was the first company outside of a financial institution to use the model.

We just scratched the surface on Enron and are aware there are numbers of other financial deceptions that were used. We will primarily focus on the 2 accounting practices mentioned.


In their 2000 shareholder update, Enron reported their revenues to be just north of $100B and approximately $41B in 1999. In a forensic breakdown of their financial records it is estimated that the actual revenue would have been just $6.3B in 2000 and $5.35B in 1999; about 15% of the revenues they were actually reporting.

The Astonishing Success of EnronOnline

In late 1999 we extended our successful business model to a web-based system, EnronOnline. EnronOnline has broadened our market reach, accelerated our business activity and enabled us to scale our business beyond our own expectations. By the end of 2000, EnronOnline had executed 548,000 transactions with a notional value of $336 billion, and it is now the world’s largest web-based eCommerce system. With EnronOnline, we are reaching a greater number of customers more quickly and at a lower cost than ever. It’s a great new business generator, attracting users who are drawn by the site’s ease of use, transparent, firm prices and the fact that they are transacting directly with Enron. In 2000 our total physical volumes increased significantly as a direct result of EnronOnline.

While Enron was busy implementing EnronOnline they were just as busy implementing aggressive accounting practices. Most notably, EnronOnline accounted using the “Merchant Model”. Basically, they could account for all revenues from a trade in which they were a party; in reality they were only taking in a small percentage from brokerage/trading fees.

EnronOnline has enabled us to scale quickly, soundly and economically. Since its introduction, EnronOnline has expanded to include more than 1,200 of our products. It also has streamlined our back-office processes, making our entire operation more efficient. It has reduced our overall transaction costs by 75 percent and increased the productivity of our commercial team by five-fold on average. We are not sitting still with this important new business tool — in September 2000 we released EnronOnline 2.0, which added even more customer functionality and customization features and attracted more customers.

Enron Energy Services

Our retail unit is a tremendous business that experienced a break-out year in 2000. We signed contracts with a total value of $16.1 billion of customers’ future energy expenditures, almost double the $8.5 billion signed in 1999. We recorded increasing positive earnings in all four quarters in 2000, and the business generated $103 million of recurring IBIT. Energy and facilities management outsourcing is now a proven concept, and we’ve established a profitable deal flow, which includes extensions of contracts by many existing customers. Price volatility in energy markets has drawn fresh attention to our capabilities, increasing demand for our services. No other provider has the skill, experience, depth and versatility to offer both energy commodity and price risk management services, as well as energy asset management and capital solutions.

Using Mark-to-Market accounting it largely inflated the value of the mentioned contracts. For example, if one of the contracts was for $50M over 10 years it allowed Enron to account for the full $50M in the current period. Additionally, in a volatile market it allowed Enron to use their own methods to estimate the future price of the respective product so they could easily overestimate the unrealized profits to hide losses and continue to drive their profits.


Enron Broadband Services

We have created a new market for bandwidth intermediation with Enron Broadband Services. In 2000 we completed 321 transactions with 45 counter parties. We are expanding our broadband intermediation capabilities to include a broad range of network services, such as dark fiber, circuits, Internet Protocol service and data storage… Content providers want to extend their established businesses and offer viewers at home an additional convenient way to choose and receive entertainment. Enron provides the wholesale logistical services that bridge the gap between content providers and last-mile distributors. Full-length movies-on-demand service has been successfully tested in four U.S. metropolitan markets.

“Full-length movies-on-demand service” – AKA a $110M deal with BlockBuster to offer consumers on-demand movies which BlockBuster would back out of just months later due to failure of the pilot program. However, Enron would continue to account for the revenue using the “mark-to-market” accounting system. Although $110M might be minuscule in the grand scheme of things it offers an interesting look at how they leveraged their financials to drive their revenues, in turn driving the stock price up. 

Strong Returns

Enron is increasing earnings per share and continuing our strong returns to shareholders. Recurring earnings per share have increased steadily since 1997 and were up 25 percent in 2000. The company’s total return to shareholders was 89 percent in 2000, compared with a negative 9 percent returned by the S&P 500. The 10-year return to Enron shareholders was 1,415 percent compared with 383 percent for the S&P 500.


Just 12 months after this letter was published the price on Enron stock plummeted to less than $1 a share. Little did Enron shareholders know the executives were busy trading Enron stock well aware of the scandalous accounting practices that would eventually lead to the demise of Enron. Between 1998 and 2001 a total of 29 Enron executives and board members totaled $1.1B in proceeds from selling Enron stock

Enron hardly resembles the company we were in the early days. During our 15-year history, we have stretched ourselves beyond our own expectations.

We have metamorphosed from an asset-based pipeline and power generating company to a marketing and logistics company whose biggest assets are its well-established business approach and its innovative people

Our performance and capabilities cannot be compared to a traditional energy peer group. Our results put us in the top tier of the world’s corporations. We have a proven business concept that is eminently scalable in our existing businesses and adaptable enough to extend to new markets.

Our talented people, global presence, financial strength and massive market knowledge have created our sustainable and unique businesses.

EnronOnline will accelerate their growth. We plan to leverage all of these competitive advantages to create significant value for our shareholders.


 Kenneth L. Lay                                                                                                  Chairman

 Jeffrey K. Skilling                                                                                              President and Chief Executive Officer

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