Shock therapy for Janus
Janus chalked up big losses in the Enron debacle. Could they have prevented it?
NEW YORK (CNN/Money) - The timing could not have been more embarrassing for Janus Funds. Its annual conference with financial journalists in New York City in December happened to come just four days after one of its highest-profile holdings of the year, energy trader Enron, filed for bankruptcy. Yep: Janus had been one of Enron's largest shareholders -- its funds held 41 million shares as recently as Sept. 30 -- as well as one of its biggest boosters.
The conference room at the studiously hip W hotel on 49th Street -- where the doormen dress in artsy black -- was filled with reporters eager to grill Janus on the hottest business story of the moment. If you guys are so darn smart, they wanted to know, how come you didn't see this coming?
Janus' top fund managers didn't miss a beat. Clearly aware that owning the biggest investing disaster in recent memory wasn't good for their image, they came prepared to spin. Janus Mercury's Warren Lammert, who's also a member of the firm's executive investment committee, took the first whirl.
Yes, Enron was a disappointment, he explained, but nothing to get excited about. In fact, he continued, it turns out Janus hadn't really lost all that much money on Enron: Managers began buying well before the stock's dazzling run-up in 2000 and sold huge chunks at the highs. The fund firm basically broke even, injected Janus Twenty manager Scott Schoelzel, in the end losing 0.12 percent of its investment -- "a rounding error," he sniffed.
Actually, it's more complicated than that. After the presentation, I buttonholed several Janus managers for details and was surprised to learn that throughout Enron's long and awful fall -- from an all-time high of $90.75 a share in August 2000 to an incredible 66 [cents] a share the day of the conference -- there were real divisions within Janus' ranks about the stock. Ironically, while other investing pros blame Enron executives for withholding key information about the business, Janus had the deepest information and best access to Enron -- yet stayed invested anyway.
Janus has long prided itself on its exhaustive research. But some insiders are now asking themselves whether they got too close to the company they followed. Indeed, some are even turning their research instincts inward, retracing their steps to find the source of their Enron mistakes, searching for
lessons that might help avoid trouble the next time. Did Janus fail to heed warning signs? Or is Enron a harsh reminder that all the research in the world can't make investing a sure thing?
All the right moves
Janus often boasts of the lengths it goes to understand a company -- analysts stocking shelves at Walgreen's, for example, or venturing into operating rooms to watch surgeons implant Guidant's stents. Enron was no different. First attracted by the Houston pipeline company's transformation from staid utility to high-tech energy trader, Janus immersed itself in data, crunching numbers, attending industry conferences and meeting frequently with top executives. Blaine Rollins, who runs the flagship Janus fund, visited Enron's trading rooms in London in late 1999 to get a firsthand look at the business.
The homework helped Janus take advantage of Enron's foray into telecom well ahead of the Wall Street pack. By the time Enron held an investor conference in early 2000 to detail plans to trade telecom bandwidth, Janus already owned 59 million shares. After that jam-packed session (among the attendees were Janus' energy analyst, telecom analyst and five portfolio managers), it came away even more enthralled by Enron's supercharged growth projections and visions of trading platforms for New Economy commodities.
As Karen Reidy of Janus' Balanced and Core Equity funds told Barron's in early 2000: "I couldn't believe how deep Enron's management is. I followed General Electric for a number of years and thought, 'Wow! This is GE-type management!' It added several layers to the depth of our confidence."
Still, when the stock hit all-time highs in the summer of 2000, managers grew skittish about Enron's valuation -- a steep 69 times the previous 12 months of earnings. Janus' stake in Enron was worth about $4 billion. "It was very pricey," Rollins recalls, "and I took chips off the table to be prudent."
In fact, Rollins sold 27 percent of his Enron shares between April and October 2000. Reidy dumped 67 percent of Equity Income's shares. Mercury, Global Technology and Worldwide also were big sellers. By the end of 2000, Janus as a firm had cut its total position in Enron by 39 percent to 40.9 million shares, reaping huge profits. The selling continued into 2001, as Helen Young Hayes of Worldwide eliminated her last 1.4 million shares and Global Technology unloaded another third of its stake.
While Janus managers wondered about the stock's valuation, they seemed less concerned about the area that would ultimately take down Enron -- the now-notorious limited partnerships, which Enron used to keep debt from new
acquisitions off its balance sheet. Other investors in Enron have claimed ignorance about the outside partnerships, but Janus was well aware of them.
In fact, Janus managers discussed the partnerships -- and Enron CFO Andrew Fastow's below-the-radar involvement in them -- with Enron brass several times. "We indicated discomfort with it," Lammert says. "We also thought it wasn't totally irrational. These were very complicated transactions, and they indicated that putting some skin in the game with their CFO helped them with their cost of capital." The fact that the partnership transactions required the approval of Enron's board, and that firms like Goldman Sachs and First Boston were involved in the partnerships, helped ease his mind, Lammert adds.
It wasn't just the partnerships that sparked questions in Denver. "There was always lots of debate on cash flow," says David Corkins of Growth & Income. "Some people were more optimistic." John Schreiber, who runs Janus 2, remembers a disconnect between Enron's high earnings growth and its poor scores on efficiency measures like return on invested capital: "It seemed a little strange."
But these concerns never shook the fundamental belief in Enron's core trading business, which appeared to be growing 30 percent annually. Despite that little voice in Schreiber's head about invested capital, he made Enron his fourth-largest holding in early 2001, his first quarter as manager of Janus 2. (Janus Twenty also took a big position for the first time early last year; its 8.9-million-share purchase made Enron the fund's eighth-largest holding.)
Why the decision to buy? Schreiber says he trusted Enron's top people: "You had to go on track record -- management's historical ability to deliver on expectations." In other words, Janus gave Enron the benefit of the doubt.
The inflection point came in August, with the surprise resignation of Enron CEO Jeffrey Skilling for "personal reasons" a mere six months after he had moved into the post. "It raised a red flag, and I sold," Schreiber says simply. Adds Schoelzel of Janus Twenty: "You don't want to see that twice, I don't care what's in the freakin' model." The two funds did an immediate 180 and began unloading shares.
Rollins and Lammert had a different reaction: After Skilling's resignation sparked a 15 percent drop in the stock, to about $37, they bought more shares. Rollins told MONEY three days after Skilling quit that he was excited by Enron's opportunities and its low valuation of 16 times estimated 2002 earnings. "People should not be worried about Jeff taking some time off," Rollins said at the time. "This is not just Jeff Skilling's company."
Why the optimism? Lammert today points to a meeting he and Rollins had with Enron execs after Skilling left in August: "They told us that they were going to improve investor disclosure significantly and get rid of the partnerships. They were headed in the right direction." That faith in Enron helps explain why Janus as a whole still held 41.3 million shares as late as Sept. 30. A month later -- after the stock was already down 83 percent for the year to $14, after Enron took a $1.2 billion charge against shareholder equity, after CFO Fastow resigned amid controversy -- Janus was still stuck with nearly 19 million shares. By Nov. 30, Janus had finally rid itself of Enron stock. But that hasn't ended the soul-searching by fund managers.
Maybe there's little Janus could have done differently. Sometimes, bad stocks happen to good managers. In Enron's case, the final crash was so swift and steep -- down 98 percent in just 21 trading days -- it has been likened to a Depression-era bank run. "You can only learn so much," says Corkins of Growth & Income. "Actually, I think the process worked: Enron raised some questions, and different portfolio managers interpreted them different ways."
Lammert isn't leaving it at that. He's working with Janus' energy analyst to reconstruct their financial models; he may even hire an accounting professor familiar with Enron to help Janus managers hunt for errors in their interpretations of the company's complex accounting. "We're going through that process of examination," Lammert says. "Our research process is not infallible. Sometimes we get it wrong."
It's true that even the best managers make mistakes, and the fact that the biggest name in growth investing seems interested in learning from this particular whopper is to its credit. But for Janus shareholders who've watched their stock funds lag most competitors -- only three of 17 funds rank in the top half of their Morningstar categories -- that's got to be cold comfort.
What a tidy ending if the key mistake here were as simple as faulty financial data or accounting naivete. But the real issue is likely bigger than that: Some managers seemed to allow their enthusiasm for a great "find" -- an investment that had delivered spectacular riches -- to blind them to signs of trouble.
"If there is a soft spot in the process," Schoelzel says of Janus' stock-picking strategies in general, "it's that sometimes because we feel so good about the company and so good about the people running the company, we may not be as quick to sell some positions that we otherwise should." It's a danger that every fund manager -- and every fund investor -- must strive to guard against.