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Where Wall Street went wrong
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November 29, 2001: 3:06 p.m. ET
Enron was in bad shape for a long time, but analysts kept beating the drum.
By Paul R. La Monica
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NEW YORK (CNN/Money) - The writing was on the wall for Enron way before Wednesday's meltdown.
CEO Jeff Skilling shocked investors in August by resigning. Then in October the company reported a mammoth third-quarter loss and the Securities and Exchange Commission launched an investigation into some suspect partnerships, a move that led to the firing of Enron's chief financial officer. As if that wasn't enough, Enron announced on Nov. 8 that it was restating earnings dating back to 1997.
Analysts certainly shouldn't have had a problem reading the writing -- it stood out like graffiti. Yet as recently as last week, more than half of the 15 analysts following the company rated the stock at least a buy: Six had Enron (ENE: down $0.25 to $0.36, Research, Estimates) a strong buy and two a buy, according to First Call. Yeah, and the Titanic was supposed to be unsinkable. Two brokerage firms - RBC Capital Markets and UBS Warburg -- just downgraded Enron from a Strong Buy on Wednesday, after the stock already had fallen from a 52-week high of $84.87 to $4.14. Thanks for nothing.
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CNNfn's Amanda Lang looks at why it took Wall Street so long to recognize Enron's troubles.
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Enron's stock closed at a meager 61 cents a share Wednesday and adding insult to injury, it will be removed from the S&P 500 after the close of trading Thursday. So you'd think that everybody would have gotten around to downgrading the stock by now, right? Wrong. According to First Call, four analysts still rate the stock a buy, with two of the four rating Enron a strong buy. Unbelievable. What are they waiting for?
Granted, the stock did move up earlier this month when Dynegy agreed to purchase Enron. But one market observer said this short-lived rally wasn't enough cause for Wall Street to ignore Enron's myriad problems. Dynegy terminated the merger on Wednesday. "It's kind of shocking to read some of the comments of the analysts who were bullish on Enron basically up to the end, saying that what justified their bullish signal was the fact that the price went up," says Jay Diamond of newsletter Grant's Interest Rate Observer said on CNNfn's The Money Gang.
Shouldn't Have Believed the Hype
Enron was one of the most widely hyped stocks of 2000, climbing 88.6 percent in an otherwise brutal market. Goldman Sachs market guru Abby Joseph Cohen sang the stock's praises. The stock was widely held in mutual funds of prominent money management firms like Janus, Alliance and AIM. Even as the stock of the energy trading firm started to trade more like a technology stock than a stodgy utility company, few questioned the valuation.
It helped that Enron, which trumpeted its nascent broadband trading business at every turn, was able to convince analysts who for the most part specialized in energy stocks, that it would have no problem trading broadband capacity the way it did electrical power despite the myriad differences between the energy and telecommunications businesses. "What's the difference between measuring the gas pumped through a pipeline or the data transmitted through a voice line?" Merrill Lynch analyst Donato Eassey said in a BusinessWeek online article in December 2000.
Turns out it wasn't that easy after all. Although it may have made intuitive sense for Enron, which already traded commodities like gas and electricity, to also trade Internet bandwidth capacity, it appears that Enron overextended itself. Enron's broadband business, including a ballyhooed partnership with Blockbuster to deliver movies on demand that dissolved shortly after it was formed, bled red ink. This contributed to Enron's capital crunch, as it required a huge investment that never yielded positive returns. It also didn't help that Enron bulked up its broadband initiatives precisely when many Internet companies began to go out of business in spades.
One analyst even defended his recommendation of Enron by comparing the company to one of the greatest athletes in modern history. "Enron is no black box," Goldman Sachs' David Fleischer said in a Business 2.0 article last March, pooh-poohing the notion that Enron's financial statements were difficult to understand and that an investment in the company required a huge leap of faith. (Business 2.0 is published by AOL Time Warner, owner of this Web site.) "That's like calling Michael Jordan a black box just because you don't know what he's going to score every quarter." Unfortunately for Fleischer, who finally removed Enron from Goldman's coveted Recommended List on Nov. 21, a more apt sports analogy would probably be Ben Johnson, the Canadian sprinter who had to turn in his Olympic gold medal in 1988 due to steroid use.
This, of course, is not the first time that analysts have been horribly wrong about a stock. Back in April of 1998, franchising conglomerate Cendant was one of Wall Street's favorite stocks. Nearly every analyst had Cendant rated a buy...until the company reported that there were accounting irregularities that caused earnings to be inflated. Analysts downgraded the stock in droves shortly thereafter and now, more than three years later, Cendant has yet to get back to the lofty heights it traded at when it was a Wall Street darling.
And last year, data mining software firm Microstrategy was a top pick of many analysts, even when it was trading at $333 a share, until the company announced in March 2000 that it would restate earnings due to new accounting methods. Microstrategy now trades at around $3.40.
Ignoring the warning signs
But Wall Street's refusal to recognize the writing on the wall was especially galling since Enron has been in turmoil for months. It's not as if analysts were blindsided. It brings to mind a quote from legendary baseball manager Casey Stengel: "Can't anybody here play this game?"
While many equity analysts stubbornly defended Enron, credit rating agencies were slashing the ratings of Enron's debt for months, culminating with Standard & Poor's downgrade of Enron's bonds to junk status on Wednesday. Two other rating agencies, Moody's and Fitch, also cut Enron's debt to junk on Wednesday. Now the most prominent B word being used on Wall Street to describe Enron is bankrupt, not buy.
It just goes to show that even when the proverbial excrement is hitting the fan, many Wall Street analysts still have no problem finding the bright side in a situation. After all, it's hard to gain new investment banking clients when you trash a stock. That's all the more reason for investors to keep in mind that bad news is bad news, even if an analyst's rating indicates otherwise. Anyone still holding on to Enron sadly learned that the hard way. 
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