On a cool day in Houston, Texas, early last month, Charles Watson, Dynegy's CEO, announced the boldest deal of his career. In 15 years he had built the
natural-gas producer into a powerhouse, but he chafed in the shadow of Enron, his much bigger hometown rival, and its chairman, Kenneth Lay. Lay's swagger personified the freewheeling energy-trading markets, and Enron had dominated the action, but it was now teetering on the brink of collapse.
So Chuck Watson declared that he would rescue his rival, at a sweet price: just $9 billion in Dynegy stock. Watson was sure that the skeptics were wrong; that with the solving of a few problems Enron would still be a rock-solid money machine. Its revenue grew 57% in the third quarter, to $47 billion--more than one and a half times what Dynegy generated in all of 2000. For a fire-sale price, he said, Dynegy would suddenly expand sixfold into a $200 billion-a-year giant with $90 billion in assets. After operating in obscurity for years, Dynegy suddenly would become the second-largest corporation in America in sales.
Two weeks later Watson's triumph ended in epic failure. He scuttled his dream deal after getting surprised by a string of horrifying financial revelations at Enron. The merger was off, but the recriminations and lawsuits are just beginning. "I was very disappointed," Watson says in characteristic, laconic understatement. He was also furious: Enron had tumbled into turmoil by misleading investors, and now it was misrepresenting its finances yet again--so says Watson--and laying the blame on Dynegy.
In the fallout Enron is struggling to stay alive, and Watson can count his blessings. By retreating he has dodged Enron's $12 billion in debt, the cloud of the investigation now under way by the U.S. Securities & Exchange Commission, the devastated trading floor and a thicket of lawsuits and liabilities. Instead, Watson is setting up the next chapter at Dynegy. He took it over in 1985 with a $600 investment and a 10% stake for himself, building it into a company that, as of
Nov. 30, has a market value of $10 billion. With 5% now, he's worth half a billion.
The death of Enron is a mixed blessing for Watson. Some of its business and its brightest people will wind up at his company; and if he gets his way in court, he will also get its valuable pipeline system, Northern Natural Gas, for the
Even without swallowing Enron, Dynegy is a leading processor of natural gas and one of the top three transporters on every interstate pipeline in North America. Its power plants generate 19,000 megawatts of electricity. In the commodity derivatives markets, where suppliers and utilities lock in future prices, Dynegy is a top trader in natural gas, power, coal, emission credits and weather derivatives. But these volatile trading businesses, which contributed 80% of Enron's earnings, are merely a sideline at Dynegy, contributing only 20% of earnings.
And Watson may yet have a
multibillion-dollar merger in his future. Such big rivals as American Electric Power, Duke Energy and Reliant outmuscle Dynegy in some markets, making them attractive partners. He expresses keen interest in doing more deals; he's made nine acquisitions since 1995, which have kept Dynegy's top line growing a hefty 45% a year. Last year its stock jumped 218%, the second-best performance in the S&P 500. On the day Watson bailed out of buying Enron, he inked a $600 million purchase of BG Storage in the U.K.; it has 30 wells, nine salt caverns and 30 kilometers of pipelines.
Dynegy began life under the unpromising name of the U.S. Natural Gas Clearinghouse, a marketing arm jointly owned by six pipeline companies, Morgan Stanley and Akin Gump, a law firm. Watson began his career as a lowly trainee at Conoco. It was 1984, natural gas was on the verge of revolution, and Watson wanted to be in the vanguard. "A lot of people in this business were scared by deregulation," he recalls. "I was excited by the opportunities." Opportunity arrived in the form of the slapped-together U.S. Natural Gas Clearinghouse.
On Watson's first day on the job, only 6 of the 60 employees borrowed from the parent companies showed up. Later that year he bought out the 10% stakes from the pipelines for $100 each, then got Akin Gump to sell, leaving Morgan as sole shareholder. His vision was clear from day one. Suppliers and buyers would eventually get each other's phone numbers, and one day the fat middleman spreads that Watson's shop relied on would evaporate. Then what?
With the backing of Morgan Stanley and a surfeit of underground salt domes for gas storage, Watson figured that he could buy gas at wellheads and deliver it when and where customers wanted, holding it for them when they didn't need it and serving it up when demand surged. This meant that he would assume the risk of holding gas that might tumble in price.
The startup was barely making its payroll when Watson arrived. He started turning multiple sales a day. By 1989 Morgan Stanley wanted out and sold the company for $16 million. The buyers were three energy companies (British Gas, Nova and Chevron) and employees. Meanwhile Ken Lay at Enron was discovering the same potential in gas trading.
In the mid-1990s electricity joined gas on the deregulatory path. Watson wanted in but needed currency. So in 1995 he bought Trident, a publicly held ethylene producer. The following fall, Watson cut a deal with Chevron to sell the oil giant's entire North American gas output.
Business was booming, but Watson wanted to buy many more gas-processing plants and electric-power plants. The problem was in raising the cash. Dynegy had a public currency, but 88% was now in the hands of employees and three institutions. There wasn't enough of a float to attract institutional shareholders, so in 1997 Nova and British Gas got out. The company's float went to 60% overnight. The next year Watson changed its name to Dynegy. Then he used his stock to make his boldest push yet. Illinova, an Illinois generating company, was nearly insolvent. He bought it for a pittance.
Enron was having a field day with deregulation, too. Instead of buying electricity from a plant and selling it elsewhere for a tiny cut, it began carving output into pieces. As Enron's confidence grew, its trades got more exotic, involving derivatives on pulp, metals, pollution and the weather. Revenues in 2000 doubled, to $101 billion. Reported earnings before interest and taxes hit $2.3 billion.
By then Enron and Dynegy had gone separate ways. Enron sold assets, earning 80% of its profits from trading and 20% from energy. At Dynegy the ratios were reversed. In February Lay handed the top job to Jeffrey Skilling, Enron's president and the chief advocate of the asset-light strategy. Lay became elder statesman. To increase earnings, Skilling set up outside partnerships. They, in turn, issued bonds backed by Enron and used the proceeds to buy power plants, fiber optics and other assets from Enron.
The questions started getting prickly when Enron's stock price fell in the spring. Its business of trading fiber-optic capacity, with revenues of more than $300 million in 2000, lost $137 million in the first half of 2001 as sales plunged. In mid-August Skilling abruptly quit. Then on Oct. 16, Enron set a $1 billion third-quarter charge related to a partnership linked to Andrew Fastow, its CFO, plus a $1.2 billion reduction in shareholder equity because of "accounting errors." On Oct. 25, Stephen Bergstrom, Dynegy's president, was invited to lunch by Stanley Horton, the chief of Enron's pipeline group. Horton told Bergstrom that Enron was in deep trouble and suggested a merger with Dynegy.
Plea in hand, Bergstrom called Watson. "I was intrigued and honored that they had come to us," Watson says. In the end Chevron put $1.5 billion into Dynegy, which used it to buy 100% of the preferred stock in the Enron unit that owns its prized Northern Natural Gas pipeline. That, along with $1 billion more at the merger's close, was expected to give Enron the liquidity it needed.
Watson unveiled his daring rescue plan on Friday, Nov. 9. His hole card: a clause stating that Dynegy's $1.5 billion investment gave it the right to keep the big pipeline even if the deal was aborted. The euphoria faded fast. On Nov. 19, Enron filed quarterly financials that
held two bombshells. Recent credit-downgrades to a notch above junk had put Enron on the hook to repay $690 million to a partnership in just a week--something that Enron had never warned Dynegy about. (Enron has disputed this.) On Nov. 28, three credit agencies downgraded Enron to junk status. That morning Watson called Lay and killed the deal.
Even if Dynegy's biggest deal slipped through Watson's fingers there is a big world of opportunities in energy. Dynegy has a growing presence in Europe and can play the same games it did in the U.S., as the energy industry there deregulates.
Back at home, Watson confronts months of legal wrangling and a long struggle to reclaim legitimacy for the
energy-trading business. The recent chaos in California and the collapse of Enron will make further deregulation--and Dynegy's stock--a tough sale.
Additional reporting by Rob Wherry.