Personal Finance > Investing
The Enron witch hunt
graphic February 11, 2002: 6:56 p.m. ET

The take-no-prisoners search for accounting tricks could leave some bargains.
By Adam Lashinsky
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SAN FRANCISCO (CNN/Money) - The "cockroach theory" is so well tested that it has become gospel to veteran investors: Where there's one problem, there's likely to be another. To wit, a company rarely reports only one bad quarter, infrequently has just one senior executive quit suddenly, and almost never discloses an isolated instance of misunderstood accounting practices.

This is why prudent investors don't stick around to see a room full of "cockroaches." At the first whiff of trouble, they sell. It's also referred to as shooting first and asking questions later. And it can be a mistake.

Witness the plight of Hanover Compressor (HC: up $0.42 to $12.40, Research, Estimates), a Houston-based maker of oilfield and natural-gas equipment. Hanover had numerous, though not particularly large, dealings with Enron, easily the most vilified U.S. corporation of the 21st century. (It feels so good to make sweeping statements that are completely accurate!)

Hanover also employs off-balance-sheet financing, an equally vilified financial technique that happens to be a completely legitimate practice. In Hanover's case, it sells equipment to a trust, managed by a bank syndicate, and then leases back the equipment for a certain period of time. Hanover's oil-patch customers then pay Hanover a fee to operate and maintain the equipment. The bank syndicate keeps the equipment on its balance sheet for a fee.

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    The key here is that the revenues that flow to Hanover as a result of the "sale" of the equipment aren't made up, and the expenses associated with them aren't hidden. They're fully disclosed in securities filings, and the analysts who follow Hanover know all about them.

    But woe to the company that uses off-balance-sheet financing and, worse, does business with Enron. Since Hanover's shares started falling on the penultimate trading day of 2001, they've plunged from $26 to Monday's close of $12.40. And yet the company is solidly profitable.

    It does have one small accounting issue, however. Hanover may have incorrectly accounted for revenue associated with a joint venture it has with Royal/Dutch Shell in Nigeria. But at worst, Wachovia Securities analyst Yves Siegel estimates that Hanover accounted for the revenue too quickly and that six cents of earnings (out of $1.32 per share for all of 2001) could be in question.

    "They could be criticized for booking revenues from the joint venture too early," says Siegel, whose firm helped underwrite a Hanover securities offering last year. "But calling this Enron-like activity is unfair." Before the plunge, Siegel had a $39 target on Hanover's stock. He acknowledges it will take time for confidence to come back to company's management. "But to say the stock is a double from here is not being overly aggressive."

    Will there be more accounting shenanigans at Hanover Compressor? If so, the stock -- which fell as low as low as $10.50 -- likely will plummet again. But is it possible the market will decide that Hanover's off-balance-sheet financings are more like General Electric's and less like Enron's? If that's the case, this downtrodden stock is an easy winner.

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