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Tech: What they don't tell you
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October 30, 2001: 12:27 p.m. ET
Enron's fall from grace has been swift and severe. But there is a lesson to be learned.
By David Futrelle
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NEW YORK (CNNmoney) - A year ago, it seemed Enron could do no wrong. Once a dull natural gas pipeline company, Enron transformed itself in the 1990s into the leading trader in a newly deregulated energy market -- and became a Wall Street darling in the process. Its shares gained 60 percent in 1999, and bucked the early stages of the Tech Wreck, nearly doubling in value in 2000 as other tech stocks were beginning their descent.
Now, the party's over. The stock has nosedived more than 50 percent in the past two weeks as questions have mounted about the firm's opaque financials and the credibility of its management. Last week the company sent chief financial officer Andrew Fastow packing amid controversy over millions of dollars in profits he reportedly made off limited partnerships that did big business with Enron.
The company's credibility problems are exacerbated by a simple fact: No one outside of Enron can penetrate the thick fog surrounding the company's financial statements. The Houston-based company, which dominates the energy trading market, engages in myriad financial dealings so complicated, and discloses so little about them, that it is almost impossible to know just how the company makes (or loses) money.
Not the first time
Enron's problem offers merely an exaggerated version of a dilemma that tech investors have confronted repeatedly over the years. Many tech firms are built upon novel business models that make them, quite literally, difficult to account for.
Are the "pro forma" earnings that so many tech firms like to highlight really a reasonable and honest way to evaluate a company's core business? Is the company booking revenues in a reasonable way? In short, where does spin doctoring end and dishonesty (perhaps even outright fraud) begin?
Over the years, many tech firms have been dogged -- sometimes fairly, sometimes unfairly -- by questions about the quality and reliability of their financial disclosures. Wall Street, for example, has taken aim at Amazon's (AMZN: down $0.55 to $6.50, Research, Estimates) reluctance to provide detailed information about revenues and gross margins on the various categories of goods it sells, the sort of information analysts need to determine if the company is indeed on track to deliver the "pro forma" profits it has promised for later this year. In response to these sorts of criticisms, Amazon has actually started providing more information on its earnings calls -- though still not enough to satisfy some critics.
In other cases, the concern isn't with how what numbers are being disclosed but how companies crunch them. Over the years, critics have targeted various questionable accounting tactics popular with Internet firms -- like the once widespread tactic of counting bartered ads as revenue (even though no money changed hands), or the ancient accounting tactic of booking revenues before the money comes in.
The latest accounting controversy surrounds new school telecom firm Qwest Communications (Q: down $0.57 to $16.33, Research, Estimates), which two Morgan Stanley analysts say has used aggressive accounting gimmicks to make its financials smell sweeter. Among other things, the analysts say, Qwest changed its once-conservative accounting of pension plan returns to a more aggressive stance, "quietly" wrote down assets after a big merger and spread out software costs over many years. Company CEO Joe Nacchio angrily denied his company had any "accounting issues and improprieties" and said he resented the "innuendoes."
Neither Amazon nor Qwest is being charged with anything illegal. The question is whether or not they've made a reasonable accounting for themselves. In some cases, though, the reality behind the numbers is worse than even the harshest critics had at first imagined: Bankrupt speech recognition software maker Lernout and Hauspie, for example, essentially conjured millions of dollars in sales out of thin air, booking "revenues" from fraudulent firms largely funded by entities associated with the company itself.
Until Enron comes clean about all its murky dealings, investors won't know whether or not the company is guilty of Amazon-style obfuscation or Lernout & Hauspie style fraud. It's time to fess up -- and quick. 
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