The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (47 page)

With Azurix clearly in trouble, its directors were meeting more frequently. By November, there were monthly meetings, and they were in crisis mode. These were not polite, Enron-like affairs. Skilling used the meetings to lash out at Mark, arguing that Azurix had to stop spending money and instead follow an asset-light model, the strategy that was working so well for him with EES and Broadband. But neither did Skilling want Azurix to simply hunker down; he demanded growth. “You could just feel the tension between him and Rebecca,” says one former Azurix employee. “Jeff would just attack, attack, attack. And Rebecca was just dancing.” Skilling would ask Mark, “What’s your competitive advantage?” Mark had no good answer. “We’re here to make things happen,” was the best she could do.

In early February, Mark announced that the company had a new strategy: Azurix would now become an Internet company. Taking a cue from Skilling’s broadband strategy, she announced plans to sell water equipment and trade water contracts and water-related products online.

Although the first part made sense—indeed, USFilter is doing it today—the idea of trading water was doomed. Water couldn’t be easily moved from one place to another like natural gas or electricity. Even in the American West, where water is of critical importance, the system for getting water from one place to another is discrete; one can’t suddenly decide to reroute water the way one can reroute gas or electricity. And unlike BTUs or megawatts, water droplets are not created equal; they differ in salinity and taste, for starters. These were fundamental facts, well known to anyone who had spent any time in the water business. Yet Mark didn’t hesitate to predict that her way would work. She told the
Economist
that Azurix had “created something completely different, unlike the French who have piddled around with this industry for the past 150 years.”

Given how poorly the company had performed in its short time as a public entity, here’s the unbelievable thing: Azurix actually managed to get more money out of Wall Street. True, the money came in the form of junk bonds and bore an interest rate of over 10 percent. But still, it was $600 million, which was, amazingly, $100 million more than Mark had set out to raise. Once again, though, the deal didn’t buy Azurix much time. It had to use all but $18 million of the proceeds to pay down existing debt, including a credit line it maintained with Enron.

That March, with the stock trading at between $7 and $8 a share, the Azurix management team pushed Mark to bring in some consultants from McKinsey. The consultants’ mandate was to evaluate the company’s worth and help it figure out a strategic direction. The McKinsey analysis was stark: Azurix, the consultants reported, was worth as little as $4 to $5 a share. And its only hope was to begin dramatically slashing costs.

In the wake of the report, Mark held a two-day meeting at a swank hotel called the Houstonian to discuss how to rebuild Azurix’s value. During the second day, employees were divided into teams and given problems to tackle. One was: how do we get the stock to triple? This group, led by Chris Wasden, was the last one to present, and as the team members waited their turn, one bored employee began to doodle on a transparency. He drew a picture of a pig in the sky, complete with clouds and wings. When Wasden took his turn, the employee who drew the doodle came up to the podium with him and put the transparency up for all to see. “Chris is scared to tell you this,” he said, “but the stock will only triple when pigs can fly.”

When Wasden had finished, Mark took to the podium. “I grew up in Missouri on a pig farm, and I know a lot about pigs,” she said defiantly. “And I’m here to tell you, sometimes pigs
do
fly.”

That was the thing about Rebecca Mark. She would not—
could not
—admit defeat. Many of Azurix’s problems she had brought on herself. Yet even knowing that, some Azurix employees found something both sad and admirable about her refusal to give up.

“She came into the office every day,” says a former Azurix executive, “never acting like anything other than the fearless leader who would lead you out of the darkness.” Mark once told this person: “You never ever wake up in the morning without saying, ‘I will win today.’ ” That quality of unyielding optimism was her greatest strength. And it was also her greatest weakness.

 • • • 

The last straw came on April 2000, and there is rough justice in the fact that it emerged from that same Buenos Aires contract that had hobbled Azurix from the start. One day, the residents of the Argentine city of Bahía Blanca, which was part of Azurix’s Buenos Aires territory, complained that their water was brown
and stinky. “It smells and tastes like a pesticide,” said a city spokesman. An investigation revealed that the water contained higher amounts of algae than was normal. Azurix blamed the problems on the government’s failure to treat a reservoir it operated; the government blamed Azurix. The city’s public health chief told reporters, “I’ve worked here for 25 years, and this is the worst water crisis I’ve ever seen.” Azurix had to supply bottled water in trucks and agree not to bill customers for 50 days. The army was called out to deliver water to the elderly and schoolchildren. By the end of the year, prominent government officials were saying that Azurix should be removed as the operator of the concession.

On a Sunday in July, Mark planned a dinner for Azurix’s top executives and its board at an exclusive Houston restaurant. Two prospective new board members were in attendance, and Mark had the Azurix team set to deliver its latest business strategy.

Almost before anyone could get a word out, Skilling went on the attack, firing off detailed questions about the numbers and the financing plans. It turned into a bloodbath, with Azurix executives unable to defend their business plan. One remembers Lay, ever the smiling glad-hander, telling the two prospec-
tive board members that they might want to reconsider. The Azurix team was mortified.

On Tuesday, August 8, 2000, Azurix warned yet again that it would not meet its earnings expectations. On the news, Azurix’s stock fell another 20 percent, to $6.69 per share. Two weeks later, Azurix sent out a terse press release announcing that Rebecca Mark had resigned.

By the end of 2000, Azurix, which had begun its life some two years earlier with $232 million in operating profit, thanks to Wessex, was down to less than $100 million in operating profit, which didn’t include a $402 million write-off for Buenos Aires. Its debt load had more than quadrupled, to almost $2 billion. Azurix’s stock slid to as low as $3.50 before Enron announced, in late 2000, that it would repurchase the publicly held shares. Enron wound up paying $8.375 a share, a total of $330 million, less than half the price the public had paid less than two years earlier.

At most companies, the failure of a highly touted offshoot would be a cause for dismay and sadness. Not at Enron. The
Wall Steet
Journal
writers cast Mark’s demise as validation that Skilling’s way of doing business was superior. Skilling’s trading activities, wrote the paper, “generate a much bigger rate of return while tying up less capital than do the kind of traditional infrastructure projects pursued by Ms. Mark.” Ken Lay told the
Journal:
“A lot of capital has been chewed up. I think it’s best for Rebecca to start afresh.”

What no one seemed to appreciate was that Azurix’s failure was not some distant event that Enron could dismiss with impunity. It had looming consequences. There was, for instance, the Marlin debt of $1 billion. Enron was now clearly on the hook for that debt, which was due in early 2002. What’s more, the Marlin debt was a matter of public record—it was spelled out in financial-offering documents that any big investor could obtain.

And some did just that. As often happens when a stock makes a meteoric rise, Enron had caught the attention of several short sellers. Short sellers are investors who make money by betting that a stock will go down, not up. They do this by selling stock that they don’t actually own—betting that they will later be able to buy it at a lower price and pocket the difference.

Short sellers tend to be a suspicious lot, and as they looked closer they began to wonder about Marlin and about how Enron was going to pay back that debt. They also started to wonder what the existence of that strange Marlin structure and the flameout of Azurix suggested about the rest of Enron.

 • • • 

The Azurix saga represented the public part of Mark’s downfall. There was a back story as well, one that played out in typical Enron fashion, with only the insiders aware that it was unfolding. The story came from the final chapters of the Enron International saga, and it had just as much to do with Mark’s departure as the Azurix debacle.

Enron’s international development efforts hadn’t ended when Mark went to Azurix. Enron developers struck deals to build plants in war-torn regions that included Croatia and the Gaza Strip and went on buying sprees, snapping up, among other things, part of a gas-distribution business in South Korea for almost $300 million. Nowhere did Enron buy more than in Brazil, which began privatizing its energy sector in the 1990s. The privatization news had sparked a competitive frenzy, with energy companies racing into the country to land deals. In mid-1998, about the time Enron was buying Wessex to get Azurix up and running, the company announced that it had bagged a big prize: a controlling interest in Elektro Eletricidade, Brazil’s sixth-largest electricity distributor. The cost was $1.3 billion.

As ever, the analysts gushed. “A lot of times what might seem surprising or illogical turns out to be right when Enron does it,” wrote Schroder & Company’s Ray Niles. But the acquisition was an almost immediate disaster. Just about six months after the deal was announced, Brazil devalued its currency. The move instantly sliced Elektro’s value. But in March 1999, Enron increased its ownership of Elektro from 47 percent to 100 percent at an undisclosed cost, perhaps because if a third party had bought the stake, Enron might have had to write down its existing stake. Elektro’s value continued to plummet as Brazil’s economic problems worsened. (The Elektro purchase was funded partly by an SPE. Enron later repaid the banks that funded the SPE by selling 25 percent of Elektro to Whitewing for $461.5 million. A year later, Enron estimated the value of that stake at $245 million.) Enron’s other South American assets—the same assets Skilling had been touting ever since he’d toured the region with Mark several years before—also sank in value.

Mark, of course, was running Azurix by then. No matter: Skilling needed someone to blame, and he blamed her. Never mind that both he and Lay had signed off on the Elektro deal, and Mark’s signature was nowhere to be found. Never mind that Lay had been enthusiastic about the purchase. The executives running the South American division were Mark’s acolytes; they wouldn’t so much as lift a finger without her approval.

For most of the 1990s, Mark’s business had been a story about the future. Although Enron earned development and construction fees, which it was able to book as earnings, the serious profit was supposed to come after its projects were up and running. And by the end of the decade, that future was supposed to have arrived. Wall Street analysts had been predicting for years—based on the guidance they’d received from Enron—that International would be producing upward of $350 million in earnings by 2000. In early 1999, Goldman’s Fleischer predicted that EI would grow its earnings at a 25 percent clip for the forseeable future.

But with 2000 fast approaching, it was becoming obvious inside Enron that these figures were astronomically off base. Like most Wall Street frenzies, the international development craze was wildly overhyped. In the wake of the Asian crisis of 1998 and the resulting economic meltdown in emerging markets, the values of virtually all energy assets collapsed—it didn’t matter who owned them. Even so, some of Enron International’s assets were almost comically awful, and others were fields of dreams. A power plant it built in China was never commercially operated. The Dominican Republic plant was padlocked for a time. The plant in Cuiabá, Brazil, was hundreds of millions of dollars over budget. In Poland, there were difficulties getting the government to pay Enron for a plant it had built. A planned pipeline in Mozambique never happened, nor did a $500 million plant in Indonesia or a $200 million plant in Croatia. And that doesn’t even include the greatest debacle of them all—Dabhol, the $3 billion project that remains shuttered to this day.

Skilling would rage at International’s problems and at the woman he held responsible for them. As was always the case with Skilling, he deeply resented having to deal with “her mess.” “It was not my vision,” he told friends. “I built a business. Now, I’m spending all my time cleaning up messes. It’s the last thing I want to be doing.”

It was at a budget-planning session for the year 2000 that Skilling discovered just how bad things really were. He was expecting the international executives to present plans to bring in $500 million in operating profit; instead, they projected less than $100 million. He thought at first they were lowballing him, giving him a number they knew they could beat. He soon discovered that just the opposite was true: the $100 million was a stretch. “We invested $5 billion in equity to earn $90 million?” he asked in disbelief.

Amanda Martin remembers seeing Skilling around this time. He seemed more distraught than she had ever seen him. Although he had asked her to come by to discuss Azurix, he didn’t want to talk about the water business. It was International’s problems that were on his mind. “Just fix it,” Skilling said about Azurix. “You’re my friend. We can’t take any more hits.”

Not long afterward, a near miracle took place: an investor group from the United Arab Emirates expressed interest in purchasing 80 percent of Enron’s international assets. It represented a potentially astounding escape: the ini-
tial offer valued all of EI at more than $7 billion. Enron called the deal Project Summer.

Cliff Baxter’s handwritten notes show that the potential buyers were valuing Enron’s Dabhol stake at $950 million at a time when it was on Enron’s books for $714 million. And they put a value of $4.3 billion on the South American assets, compared with Enron’s book value of $3.4 billion. Once Skilling concluded that the buyers were real, he got so excited that he assigned a team to help Enron figure out what it should do with the massive inflow of cash it would soon be getting from the Middle Eastern investors.