Subject: Enron

Shares of Enron Corp. (NYSE: ENE - Quotes, News, Boards) were smacked around  again yesterday, following close on the heels of seven-session decline that  sent the stock down more than 13 points, or 16%, from its recent high of  $84.63 (December 28), all amid uncertainty and considerable volatility.
The pullback doesn't appear to be company-specific exactly, although the  rumblings in a certain geographic region, namely California, are triggering  aftershocks  throughout the U.S. energy community.
As we outlined in a report on January 4, the energy situation in California  has rapidly reached crisis proportions.
Strict environmental legislation and  the uncertain  profit potential post-deregulation has kept utilities from installing  sufficient generating capacity in the state over the last 10 years.
The state's two major utilities, PG&E Corp. (NYSE: PCG - Quotes, News,  Boards) and Edison International (NYSE: EIX - Quotes, News, Boards) , are  facing the  prospect of eventual insolvency due to the spiraling costs of electricity  purchased on the open market.
However, the rates the utilities can charge  their customers  for power represent a fraction of the costs that prevailed during the  gradual rollout of full-scale deregulation.
The risks to Enron are two-fold.
For one, the crisis in California may result in a default of payments to the  state's major wholesale energy providers, including Enron.
Although the  company does  operate in California, the bottom-line impact would likely be shielded to a  considerable degree because of Enron's size, strength, and diversified global  revenue  streams.
In addition, Enron would likely be high on the list of default  payees given its importance to future wholesale energy supplies in the  region.
More significantly, investors are concerned that California legislators may  pull the plug on deregulation entirely, or at least until the current crisis  abates.
Some also  fear this mess might derail utility deregulation in other states as  regulators and politicians alike become fearful of adverse and unintended  economic consequences.
Neither scenario is probable.
For one thing, the airline industry was  deregulated in fits and starts, with plenty of mistakes and recrimination  along the way.
And a  strong argument can be made that the shortage of electric power would have  pressured rates sharply higher even in a fully regulated environment.
The California Public Utility Commission will attempt to decide the best  course of action this week.
It appears inevitable that, regardless of PG&E  and Edison's  ultimate fate, the state's energy consumers will likely absorb much of the  burden through an increase in the prevailing rate cap.
Enron has also fallen victim to the rotation out of strong defensive stocks  on the heels of the Federal Reserve's unexpected interest-rate cuts last  week.
The initial  euphoria has waned, however, upon the realization that the sharp rate cuts  will serve to offset what appears to be a rapid rate of erosion in domestic  economic  growth, rather than generating a rebound in economic activity.
As a result,  we expect investors once again to seek the shelter of well-capitalized  defensive plays  like Enron.
We would emphasize that several factors that weigh in Enron's favor have been  overlooked amid the California crisis.
The November-December period was  18% colder than normal and the second-coldest start to the winter months in  the past 50 years.
Coupled with an uncertain supply situation, particularly  in natural  gas, Enron stands to profit handsomely from energy volatility and pricing, an  environment that is likely to exist for at least the next 12 months.
In addition, Enron's diversification into still more new avenues of growth  help to insulate the company from additional challenges of this sort in the  future.
The  markets for EnronOnline, a real-time commodities exchange vehicle, and  Enron's broadband services unit are expected to at least triple over the next  year.
An eventual inflection point in the groups' profitability would serve to send  profits measurably higher in the long term.
Despite the recent turmoil, Enron's consensus earnings estimate for 2001,  according to First Call, has come down a mere penny, to $1.65 a share.
Although the  stock's rich price/earnings multiple of 43 times may aggravate its near-term  volatility, the absence of a complete collapse of the stock indicates the  market  approves of Enron's maneuvers so far and is confident in its prospects going  forward