Fool.com: A Foolish Look at Enron [Drip] February 7, 2000

DRIP PORTFOLIO
A Foolish Look at Enron

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By George Runkle (TMF Runkle)
February 7, 2000

This week I wanted to write about a very interesting company that has come up in the news recently. The company is Enron (NYSE: ENE), and traditionally it has been an energy company. It provides a wide range of energy-related services, such as facilities management, gas transmission, energy sales, and risk management.

Enron's facilities management services caught my eye, since the company provides consulting and construction management services to facilities to help them lower their energy use. Having been a facilities engineer, I know how much purchasing gas and electricity can suck out of your budget. Every dollar saved in energy expenses can be used for employee salaries, maintenance, repairs, or even profits. However, how do you decide what changes to make to lower energy costs? Beyond lowering thermostats, a significant amount of analyses and expertise is required to make cost-effective changes.

OK, enough of that, we only have about a page here, so I have to get to the ideas quickly. Enron has gas transmission pipelines, which is a concept that is pretty easy to understand. Managing pipelines requires ownership of significant right of ways (which get more expensive to purchase every year), taking care of compressors, the pipe itself, and scheduling the deliveries. It's not that complex, but it leads to another industry, which I'm getting to.

Now, another area that they are involved in can be loosely called "risk management." Enron uses some investment vehicles that aren't really Foolish for us as investors, but make a lot of sense for the end users and producers. The vehicle: futures. Let's use an example. A power company needs to purchase a certain amount of gas every month. It can continue doing so as it needs the gas, and try to budget for the fluctuations in prices. The producer can do the same, and run into the same difficulty from wild price swings. Or, the producer can sell gas that would have been sold in the future on the open market today, which the utility company can purchase. Both now know what their costs and revenues will be, and lowered their risk. While getting between these points is very risky for a trader, they provide a needed product to both ends.

How does providing energy trading and energy services make this company a "Pathfinder"? Well, it doesn't -- except Enron has applied these ideas to telecommunications. What is a fiber optic cable? It's a pipeline for data and voice communications. It requires a right of way, the fiber (pipeline); the signal must be boosted periodically (just as gas must be boosted in compressor stations during its transmission), and the signals must be delivered to the customers. While the process is much more involved on a technical level, the principles are the same.

To accomplish all of this, Enron is building a nationwide fiber network through alliances with Cisco Systems (Nasdaq: CSCO), Ciena (Nasdaq: CIEN), and Sun Microsystems (Nasdaq: SUNW). Enron's website touts that this will be a "pure IP" (Internet Protocol) network, with no ATM, Frame Relay, or SONET. This is a complex idea that, when boiled down to a few sentences, means that data is transmitted over the network very efficiently. An IP network interleaves data between different customers, providing for more efficient transmission. It allows more data to be transmitted over the same amount of fiber. In very simplified terms, data in an IP network is broken down into small packets that can be routed over wherever space in the network appears. Packets from one source can be mixed in with ones from other sources, so the network isn't tied up with pauses in the data transmission.

Let's go on to the next area of interest to us -- bandwidth trading. Excess capacity in fiber optic lines is leased to different companies. For example, many long distance providers don't actually own the network they transmit over -- they lease capacity from AT&T (NYSE: T), Sprint (NYSE: FON), etc. Also, private companies and the government do the same thing (such as the U.S. military's DSN network).

Currently the system is rather cumbersome, but Enron proposes to streamline the process. They are working on a system to make bandwidth trading the same as buying pork bellies, frozen orange juice, heating oil, or coffee. Again, while it will be yet another risky strategy for traders to be involved in, it will be of great benefit to the owners of the networks and the end users. Enron is pushing to develop this system because they will operate as a market maker, bringing buyers and sellers together.

Of course, while all of these businesses are interesting, how profitable are they? Next week we'll take a look at Enron's financials and see. We'll also examine the SEC forms 10-K and 10-Q to see what we find there. I'm leaving for Korea next Saturday, so when that column appears, I should be just starting to really hurt from the jet lag. I'll be doing my Fool work from over there, too -- as I said when this whole Pathfinder series started, our location in the world is no longer that important.

Drip Portfolio

2/7/00 Closing Numbers
Ticker Company Dly Pr Chg Price
CPBCAMPBELL SOUP-3/8$27.81
INTCINTEL CORP3/16$107.94
JNJJOHNSON & JOHNSON-11/16$81.44
MELMELLON FINANCIAL CORP3/16$32.94

  Day Week Month Year
To Date
Since
7/28/97
Annualized
Drip 1.42% 1.42% 1.78% 7.43% 39.58% 14.07%
S&P 500 -.10% -.10% 2.05% -3.15% 51.58% 17.85%
S&P 500(DA) -.10% -.10% 2.05% -3.15% 54.20% 18.65%
S&P 500(DCA) n/a n/a n/a n/a 26.10% 9.59%
NASDAQ 1.83% 1.83% 9.68% 6.20% 175.35% 49.17%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
9/8/9722.9799INTC45.635$107.94136.52%
11/14/9711.811JNJ80.721$81.440.89%
11/5/9831.3788MEL34.307$32.94-3.99%
4/13/988.174CPB54.586$27.81-49.05%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
9/8/9722.9799INTC$1,048.68$2,480.39$1,431.71
11/14/9711.811JNJ$953.39$961.86$8.46
11/5/9831.3788MEL$1,076.51$1,033.54($42.97)
4/13/988.174CPB$446.18$227.34($218.84)
  Cash: $24.38  
  Total: $4,727.51  


Key
• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Note
Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.