Why John Olson Wasn’t Bullish on Enron

Hindsight is always 20/20. Now that Enron has fallen, post-mortem analyses of the energy company’s demise abound. Financial gurus and journalists are scrambling for front-row seats at the autopsy, eager to uncover the early warning signs that no one saw. As the company’s shares languish in penny-stock territory, everyone will tell you that Enron was doomed from the start – though most people would have been hard-pressed to find anyone saying that during the company’s go-go glory days.

After all, when Enron said, “Jump,” most analysts asked, “How high?”

Most analysts, that is, but not John Olson. The senior vice president and director of research at Houston-based securities firm Sanders Morris Harris was always skeptical of Enron’s excesses. At the risk of being the laughingstock of Texas society, Olson refused to join the herd in touting a company whose business grew ever more opaque and incomprehensible even as its share price soared. And while almost every other analyst had “buy” recommendations on Enron stock, Olson steadily maintained that the company was “not very forthcoming” about how it made money and that “no analyst worth his salt can seriously analyze Enron.”

Seasoned Researcher

Olson, who received his MBA from Wharton in 1966, has been in the securities research business for 35 years, with stints at Merrill Lynch and First Boston, among others. Always focused on the energy and utilities industries, he followed Enron from its inception, when it was formed by the merger of Houston Natural Gas and InterNorth in 1985.

Olson watched as Enron and its competitors struggled in the initial years to come up with a viable strategy in the face of a changing business landscape. The energy industry was deregulated by the government in the 1990s, and deregulation brought with it the need for market makers and brokers to promote efficient transactions and stabilize costs.

Enron, says Olson, pursued a global plants-and-pipelines strategy but bit off more than it could chew. “The company’s ambitions outdistanced its ability to conquer all these markets at the same time,” he notes. “The mandate at Enron was to produce something like 15% annual growth in earnings per share. But realistically, demand for these commodities grows maybe 1% or 2% a year. To make up for it, Enron focused on the trading business – and it saw phenomenal rates of growth.”

Trading and making markets seemed to be Enron’s killer app, and the company’s earnings skyrocketed. With the rollout of Enron Online, the firm seemed to be positioned to take advantage of technology and set the standard for the new generation of Internet-based trading. “Enron dominated the marketplace and seemed to be a total success,” Olson says. “Setting up the electronic trading platform became the equivalent of owning a New York Stock Exchange trading firm and all the specialist units. Enron stood ready to buy or sell in about 1,800 contracts.”

But, says Olson, the company was still greedy. “It got involved in a water business that collapsed nearly right out of the starting gate. Then it got into broadband services, which was the most egregious investment mistake of all,” overbuilding fiber optic line capacity without commensurate demand. “For many years, the trading business allowed Enron to bury the bodies. But when the company tried to do this broadband strategy, it found it couldn’t hide the bodies any more. Suddenly Enron was left with $14 billion in debt assets – roughly a third of the company’s total assets.”

Warning Signs

Olson saw Enron’s hyperactive growth numbers, kept his ear to the ground, and remained skittish about the stock. The firm thrived on playing hardball with auditors and with Wall Street, he says. “The CFO never came to analyst conferences; he’d always be buried somewhere with his financiers. Analysts were duped. They were never able to see the off-balance-sheet partnerships; they never saw how earnings were being puffed up by mark-to-market accounting.”

Of course, every company bets on the future when it makes investments and takes on debt — but Enron seemed to be a candidate for Gamblers Anonymous. Olson knew something wasn’t quite right. “I live in Houston. It’s a small town in a certain sense; it’s the energy capital,” he says. “All the vibes from ex-Enron employees and former auditors were that these people were riding the edge with everything.”

Naturally, top brass at Enron didn’t take kindly to his attitude. Company executives tried to convince Olson that he was wrong, but he didn’t budge. “When [Enron chairman] Kenneth Lay brought in Jeffrey Skilling as CEO, they spent a good deal of time getting rid of others; no collective wisdom was brought to bear on the situation. Skilling talked as if Enron were the New Economy, and told me I didn’t get it. And he was right: I didn’t get it.”

An account published recently in the New York Times reported that Lay also tried to silence Olson by complaining to his boss. After U.S. News and World Report published Olson’s critical comments about Enron last year, Lay reportedly sent Olson’s boss a handwritten note that said, “John Olson has been wrong about Enron for over 10 years and is still wrong. But he is consistant (sic).” According to the Times, when his boss showed him the note, Olson retorted, “You know that I’m old and I’m worthless, but at least I can spell “consistent.’”

Enron had an excellent investor relations campaign to explain and lend support to the rising stock price, says Olson. “But,” he notes, “if you kicked enough tires and talked to enough people, you knew that you didn’t really know what the company was up to.”

Olson did think he understood the firm at one point, when its share price had dipped to the mid-$20s amidst the initial revelations of inflated accounting last September. In retrospect, of course, it was no bargain at all, as the company proceeded to implode in a crisis of confidence.

Why didn’t Wall Street see through Enron? Olson claims that the firm had a heavy-handed policy when it came to investment banks. “Enron did business with you only if your analyst gave them a strong buy rating. Why else did well-known analysts stand by their ratings when the stock price plummeted to $60? $50? $40?” Olson himself did not feel pressured, he says, since he works for a small firm that doesn’t do investment banking with big clients like Enron.

Spotting Future Enrons

To the average investor, Olson offers advice that seems to come straight out of a Warren Buffett stockpicking guide: “Always invest in only those things you understand. Invest only in companies that are making money.”

A guiding rule of securities analysis, says Olson, is to ask, “What kind of investing credentials does this price-to-earnings ratio buy me? What kind of growth rate and profitability, return on equity, etc. does it get me? You don’t really need anything else to understand the business.”

Needless to say, numbers are only useful if the company doesn’t engage in shady accounting practices. But Olson isn’t a cynic, and emphasizes that rogue shenanigans like Enron’s are the exception, not the rule. “Most companies don’t engage in this kind of gamesmanship,” he notes.

Olson is also optimistic about the energy sector as a whole, and speaks quite bullishly about other firms. “Enron had a trading mentality, an adrenalin-rush atmosphere. Skilling looked down upon hard assets; he wanted to do everything synthetically. But others, such as Dynegy, Duke Energy, El Paso, Reliant – have different cultures. Certainly the ratings agencies have raised the bar on trading companies, but I think the energy trading industry will be strong once again in six to 12 months.”

Will Olson be proved right once again? Wait and see.

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