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Business & Money

Sticking to the Knitting:
Fortnightly Magazine - March 2005

The other companies either posted large losses that have yet to be fully recovered or barely broke even. Of greater interest, the Skeptics group outperformed companies in the Traditionalist group.

Most of the growth in shareholder value for the Skeptics group came from stock price appreciation, while only about 21 percent of the growth came from dividends. For Traditionalists, a larger proportion of growth (33 percent) came from dividends, though most of the value creation came from stock price appreciation. To better understand the relative performance of the groups, we analyze the performance of each group in more detail.

Recent Converts: True Believers or Biding Time?

Recent Converts were companies whose growth strategies (before 2001) were generally viewed as being in the same market sector as Enron. Around the time of Enron's bankruptcy filing, investors rejected these stocks and sought companies with "safer" strategies. We can differentiate among the strategies pursued by the companies in the Convert group, including:

Wholesale trading or unregulated generation operations. Of course, wholesale trading operations were most closely connected with Enron, and "asset light" wholesale marketers such as Dynegy and Aquila were among those companies that were hit the hardest during the 2001-2002 period.

International investments. As losses from international assets continued to drag down utility earnings, the investment community began to realize that utilities had greatly overspent on many of these assets. The share prices of some companies, such as AES and CMS, fell steeply because of losses related to their businesses in the troubled South American markets. TXU suffered when the U.K. wholesale power markets dried up. Overall, investors sold the stock of just about any utility with a significant international portfolio, regardless of the quality of those assets.

Investments/development of merchant power plants. The glut of gas-fired merchant power plants led to the collapse of wholesale power prices. Merchant portfolios were suddenly worthless. Even companies with large, stable core utility businesses were hurt by their exposure to merchant plants-for example, Duke Energy and Exelon.

In general, companies that underperformed the sector were those that invested most in asset-light strategies, such as wholesale trading. Enron's collapse had less of an impact on companies with asset-heavy trading operations, such as Duke. Companies that focused on international investments were seen as risky-though for reasons somewhat unrelated to problems that investors had with Enron's business model.

In response to the market sell-off in the 2001-2002 period, coupled with increased pressure from rating agencies, most of these companies converted. They announced that they would sell their unregulated businesses and assets, exit international ventures, and shut down energy marketing and trading activities. Going forward, their strategy would go back-to-basics by focusing on regulated utility operations. However, for these Converts, the shift to back-to-basics has delivered mixed results to date ().

Certain companies in the Convert group were winners for a range of reasons. Key elements that determined which Converts were able to restore shareholder value may include the following:

  • The ability to more rapidly restore the balance sheet by selling valued assets (, AEP);
  • The extent to which balance sheets