Lessons From Enron's Meltdown
Who were the prescient few? A handful of short-sellers, people who seek to profit from a stock's decline, and a couple of independent analysts. But investors of all stripes can learn from their willingness to question Wall Street's assumptions.
First off, why would anyone have thought about betting against the likes of Enron and Calpine? Neither company has missed earnings targets recently. In fact, Calpine confirmed Friday that it still expects to post 26% earnings growth next year. Both firms' profits growth has been outstanding for many quarters. Neither sported the stratospheric valuations that were common in the tech sector. Unlike tech, the energy segment of the economy isn't in recession and appears to have solid long-term growth prospects.
What's more, both companies are leaders in their field. Enron is the world's dominant energy trader and Calpine excels at producing electricity from its cutting-edge gas-fired plants. Both are adored on Wall Street. Sell-side analysts have long backed both companies with unabashed enthusiasm -- and continue to do so even as their stocks have fallen over 60% from their 52-week highs.But none of that bothered the doubters -- not one iota. Why?
Checking the Bottom LineOne of the first skeptics on Enron was James Chanos, head of New York-based investment firm Kynikos Associates, which has sold short shares in Enron. Chanos started looking at the giant energy trader toward the end of last year, when it was trading at over $80. What caught his attention was Enron's low return on capital. Sure, the company was posting impressive earnings-per-share growth -- over 30% at the end of 2000.
Enron, Calpine dropping sharply
Horse of a Different Fire DepartmentAs for Calpine? "That's a different animal from Enron," says Chanos. (Kynikos is also short Calpine.) Here, the hedge fund manager saw parallels with the telecom market, where a glut of supply had depressed prices. "Despite what the bulls were saying, there was a surplus of power coming," says Chanos. While that may not be upon us right now, Calpine's sagging stock reflects the fact that demand for the power it sells may not be as strong as once considered. Meade was also cautious on Calpine. The company's plan is to build around 70 gigawatts of power plant capacity. "That's seven New York Cities worth of power," he says. Meade was concerned about the construction risk involved in building that much capacity. True, Calpine hasn't had construction problems. But the company has a lot more capacity to add. "So the jury's still out," says Meade. "And construction costs are rising across the board." Moral of the story? Don't believe the hype.
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