The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

by Bethany McLean

  And there was a big one out there for the getting. The political leaders of Buenos Aires province in Argentina decided to allow private water companies, including Azurix, to bid for the right to manage the water and wastewater needs in part of the province. The contract would run for 30 years. Even as Mark was busy preparing for the IPO, a team from Azurix was in Argentina, trying to gauge how much it should bid. (Mark herself didn’t have the time to visit.) In mid-May, an Azurix board meeting was called to discuss the company’s final bid. The mood was tense, with Azurix’s officials worried that they might lose out to one of the French water giants, which were also bidding for the business. The numbers were already big, but one person present remembers Ken Lay asking if Azurix could support upping the bid another $30 million. The Azurix team said yes, and no one present said no. Azurix bid $439 million.

  Days later, on May 18, 1999, Azurix was notified that it had won the rights to the Buenos Aires concession. Though Azurix bid for the right to manage two regions—2.1 million people—while most competitors bid for smaller pieces, the company’s offer was more than three times higher than the next contender. “There was so much money on the table, the rest of the industry was laughing at us,” says a former Azurix executive. But the deal was done—Azurix had shown it could do what it promised—and the prospective investors were none the wiser.

  Three weeks later, on June 9, Azurix went public. Mark and CFO Rod Gray each bought $1 million worth of stock to show their faith. Azurix’s shares opened at $19 per share; the sale raised just under $700 million. Once again, however, the big winner was not Azurix but Enron. Over half the shares—20.5 million—were sold by Atlantic Water Trust. Enron took $185 million of those proceeds; most of the rest of it went to pay down some of the Marlin debt. And Azurix? It wound up with $300 million. Most of that cash was quickly consumed by repaying an advance from Enron and funding the Buenos Aires deal.

  Still, it seemed a triumphant moment. Over the next month, the stock rose to $23.88. Merrill Lynch earned some $25 million in fees on the deal; its analyst dutifully predicted that Azurix would achieve average annual growth of 30 percent over the next decade. As for Mark herself, the IPO made her controversial in England, where business writers pounded her for taking two million Azurix stock options.

  But to most other observers, Mark seemed at the pinnacle, both personally and professionally. In July, she joined Enron’s board, rekindling the old speculation that she might be in line to run the company one day. (She told friends that she joined the board mainly to protect Azurix’s interests.) During an early September interview with Fox’s Neil Cavuto, he pointedly asked her to address the rumors that she would be Enron’s next chairman. She refused to comment but did say about Azurix, “This is a company that I think will grow exponentially over the next three to five years.” Later that fall, Mark was ranked 29th in Fortune’s annual list of the 50 Most Powerful Women in Business. (The year before, she was ranked fourteenth. “Fierce and fearless,” wrote the magazine that year, “Mark is like a character in an Ayn Rand novel.”) Fortune also noted that she was “beginning a new five-year project: to consolidate the $300 billion global water market.” And she became engaged to a Bolivian-born businessman named Michael Jusbasche, whom she married in October. On the surface, life appeared sweet for Rebecca Mark.

  • • •

  Just weeks after the IPO, Amanda Martin walked into Mark’s office and said, “We’ve got a mess on our hands.” The mess was Buenos Aires.

  It was almost immediately apparent that the Buenos Aires deal would have been horrendous at any price. The Azurix team sent to Argentina to scout out the deal missed some important details, starting with the fact that the water system’s headquarters wasn’t included in the bid. Azurix employees had to scramble to find office space and hang a shingle on a storefront so people could pay their bills. So many records were missing that Azurix could bill only 60 percent of its customers. Many water users didn’t pay at all, because they were friendly with the government, which protected them. The Azurix team hadn’t even realized that basic maintenance work had been ignored for years; Azurix engineers later estimated that the company needed to spend $350 million on infrastructure over the next five years. Wasden remembers coming to a stomach-wrenching realization: “We’re not ever going to make any money on this thing.” He was right: over the next six months, Buenos Aires produced just $39.5 million in revenues and a pathetic $400,000 in operating profits; in 2000, the Buenos Aires operation had an operating loss of $11.6 million.

  On August 5, Azurix had to report its quarterly earnings for the first time. Mark announced that the company had hit its profit target, with $20 million in earnings for the quarter. But that figure was entirely due to Wessex, and during the ensuing conference call with analysts, she conceded that the deals were coming a little slower than she had expected.

  In June, Azurix had bid on a big contract to manage Berlin’s water supply but lost out to Vivendi. Still, Azurix was attempting to put together projects in Bucharest, Tangier, and Peru, among other places, and she expressed confi-

  dence that all would be well. One by one, though, each of those deals was pushed back, and the stock began to slide. What deals the company did complete were small and scattered. They included a concession in Cancún, a Canadian water-service company, and a German construction company. None was a show-

  stopper and several were dogs. Within four months of the IPO, Azurix stock stood at $17 a share, two dollars below the original offering price.

  It didn’t help that Azurix seemed to sink into one political pothole after another. On September 21, 1999, Mark and several members of her team met with Florida’s governor, Jeb Bush, to discuss the possibility of Azurix selling water from the Everglades in exchange for helping to fund a $7.8 billion restoration project. The project was supposed to capture storm runoff; some of it would stay in the Everglades and some of it would be sold. When Azurix’s plan was leaked to the press, it caused an uproar, with the chairman of the Florida legislature’s Everglades committee calling the idea “the most sinister business proposition the state has ever had.” The proposal went nowhere.

  A few weeks later, Azurix spent $31.5 million to buy 13,600 acres in Madera County, California, from a developer who, according to Public Citizen, had paid just $8 million for the land eight years earlier. Mark wanted to use the land to build an underground water-storage bank so that Azurix could collect water in wet years and sell it in dry years. Once again, Azurix executives underestimated the politics of water. Upon learning why Azurix had bought the land, the Madera County government immediately began drafting a set of rules that would require the company to obtain elaborate approvals before it could make a move. Organizations including the Sierra Club and a local farmers group berated Azurix, with the farmers calling the plan a “crime in progress” and a “theft of our water.” That plan also stalled.

  Even Wessex, Azurix’s one solid asset, was sinking. An upsurge in the value of the dollar against the British pound hurt Wessex’s reported earnings, which were calculated in dollars. In late 1999, the company was told by British regulators that it had to cut its rates by 12 percent starting in April 2000. The real killer was that like so many other older water utilities, Wessex needed to upgrade its own facilities—at a cost estimated to be upward of a billion dollars. “Within a year,” says a former Azurix official, “you could make a good case that Wessex was worth about $1 billion less than we paid.” By late October 1999, Azurix’s stock had fallen to $13 a share.

  The first real day of reckoning was November 4. Just five months after the company had gone public, Mark was forced to announce that Azurix’s earnings would be dramatically lower than investors were expecting. She had wanted to make a more upbeat announcement—she was sure things were going to turn around—but the company’s lawyers wouldn’t let her. The tone on the resulting conference call was extremely negative. The stock promptly plunged 40 percent, to $7.75 a share.

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sp; In an effort to cut Azurix’s costs, Mark began to let go of some of her high-priced talent. But because of the guaranteed contracts she signed in the company’s heady early days, even the layoffs cost money. Though he’d worked at the company for only a short time, CFO Rod Gray’s severance called for him to receive $3.5 million over four years. Azurix’s strategist, Ed Robinson, also walked off with a $2.1 million payout when he left. Meanwhile, there were rumors that Azurix couldn’t make its payroll. During the fourth quarter, Azurix announced a restructuring and took a $34 million charge.

  Inside Enron, Azurix became a whipping boy. Some of the traders called it the “chick company.” Although it had been in existence for only a year and a half, Enron executives were already writing it off. After an employee made a joke about Azurix’s performance in a December 1999 all-employee meeting, Lay said: “What happened there is, in fact, too bad. It maybe in part couldn’t have been prevented; maybe part of it could have been prevented. . . . Enron doesn’t like to be associated with any company that’s not successful. We’re sorry that Azurix has not been totally successful. . . .”

  With Azurix clearly in trouble, its directors were meeting more frequently. By November, there were monthly meetings, and they were in crisis mode. These were not polite, Enron-like affairs. Skilling used the meetings to lash out at Mark, arguing that Azurix had to stop spending money and instead follow an asset-light model, the strategy that was working so well for him with EES and Broadband. But neither did Skilling want Azurix to simply hunker down; he demanded growth. “You could just feel the tension between him and Rebecca,” says one former Azurix employee. “Jeff would just attack, attack, attack. And Rebecca was just dancing.” Skilling would ask Mark, “What’s your competitive advantage?” Mark had no good answer. “We’re here to make things happen,” was the best she could do.

  In early February, Mark announced that the company had a new strategy: Azurix would now become an Internet company. Taking a cue from Skilling’s broadband strategy, she announced plans to sell water equipment and trade water contracts and water-related products online.

  Although the first part made sense—indeed, USFilter is doing it today—the idea of trading water was doomed. Water couldn’t be easily moved from one place to another like natural gas or electricity. Even in the American West, where water is of critical importance, the system for getting water from one place to another is discrete; one can’t suddenly decide to reroute water the way one can reroute gas or electricity. And unlike BTUs or megawatts, water droplets are not created equal; they differ in salinity and taste, for starters. These were fundamental facts, well known to anyone who had spent any time in the water business. Yet Mark didn’t hesitate to predict that her way would work. She told the Economist that Azurix had “created something completely different, unlike the French who have piddled around with this industry for the past 150 years.”

  Given how poorly the company had performed in its short time as a public entity, here’s the unbelievable thing: Azurix actually managed to get more money out of Wall Street. True, the money came in the form of junk bonds and bore an interest rate of over 10 percent. But still, it was $600 million, which was, amazingly, $100 million more than Mark had set out to raise. Once again, though, the deal didn’t buy Azurix much time. It had to use all but $18 million of the proceeds to pay down existing debt, including a credit line it maintained with Enron.

  That March, with the stock trading at between $7 and $8 a share, the Azurix management team pushed Mark to bring in some consultants from McKinsey. The consultants’ mandate was to evaluate the company’s worth and help it figure out a strategic direction. The McKinsey analysis was stark: Azurix, the consultants reported, was worth as little as $4 to $5 a share. And its only hope was to begin dramatically slashing costs.

  In the wake of the report, Mark held a two-day meeting at a swank hotel called the Houstonian to discuss how to rebuild Azurix’s value. During the second day, employees were divided into teams and given problems to tackle. One was: how do we get the stock to triple? This group, led by Chris Wasden, was the last one to present, and as the team members waited their turn, one bored employee began to doodle on a transparency. He drew a picture of a pig in the sky, complete with clouds and wings. When Wasden took his turn, the employee who drew the doodle came up to the podium with him and put the transparency up for all to see. “Chris is scared to tell you this,” he said, “but the stock will only triple when pigs can fly.”

  When Wasden had finished, Mark took to the podium. “I grew up in Missouri on a pig farm, and I know a lot about pigs,” she said defiantly. “And I’m here to tell you, sometimes pigs do fly.”

  That was the thing about Rebecca Mark. She would not—could not—admit defeat. Many of Azurix’s problems she had brought on herself. Yet even knowing that, some Azurix employees found something both sad and admirable about her refusal to give up.

  “She came into the office every day,” says a former Azurix executive, “never acting like anything other than the fearless leader who would lead you out of the darkness.” Mark once told this person: “You never ever wake up in the morning without saying, ‘I will win today.’ ” That quality of unyielding optimism was her greatest strength. And it was also her greatest weakness.

  • • •

  The last straw came on April 2000, and there is rough justice in the fact that it emerged from that same Buenos Aires contract that had hobbled Azurix from the start. One day, the residents of the Argentine city of Bahía Blanca, which was part of Azurix’s Buenos Aires territory, complained that their water was brown

  and stinky. “It smells and tastes like a pesticide,” said a city spokesman. An investigation revealed that the water contained higher amounts of algae than was normal. Azurix blamed the problems on the government’s failure to treat a reservoir it operated; the government blamed Azurix. The city’s public health chief told reporters, “I’ve worked here for 25 years, and this is the worst water crisis I’ve ever seen.” Azurix had to supply bottled water in trucks and agree not to bill customers for 50 days. The army was called out to deliver water to the elderly and schoolchildren. By the end of the year, prominent government officials were saying that Azurix should be removed as the operator of the concession.

  On a Sunday in July, Mark planned a dinner for Azurix’s top executives and its board at an exclusive Houston restaurant. Two prospective new board members were in attendance, and Mark had the Azurix team set to deliver its latest business strategy.

  Almost before anyone could get a word out, Skilling went on the attack, firing off detailed questions about the numbers and the financing plans. It turned into a bloodbath, with Azurix executives unable to defend their business plan. One remembers Lay, ever the smiling glad-hander, telling the two prospec-

  tive board members that they might want to reconsider. The Azurix team was mortified.

  On Tuesday, August 8, 2000, Azurix warned yet again that it would not meet its earnings expectations. On the news, Azurix’s stock fell another 20 percent, to $6.69 per share. Two weeks later, Azurix sent out a terse press release announcing that Rebecca Mark had resigned.

  By the end of 2000, Azurix, which had begun its life some two years earlier with $232 million in operating profit, thanks to Wessex, was down to less than $100 million in operating profit, which didn’t include a $402 million write-off for Buenos Aires. Its debt load had more than quadrupled, to almost $2 billion. Azurix’s stock slid to as low as $3.50 before Enron announced, in late 2000, that it would repurchase the publicly held shares. Enron wound up paying $8.375 a share, a total of $330 million, less than half the price the public had paid less than two years earlier.

  At most companies, the failure of a highly touted offshoot would be a cause for dismay and sadness. Not at Enron. The Wall Steet Journal writers cast Mark’s demise as validation that Skilling’s way of doing business was superior. Skilling’s trading activities, wrote the paper, “generate a much bigger rate of retur
n while tying up less capital than do the kind of traditional infrastructure projects pursued by Ms. Mark.” Ken Lay told the Journal: “A lot of capital has been chewed up. I think it’s best for Rebecca to start afresh.”

  What no one seemed to appreciate was that Azurix’s failure was not some distant event that Enron could dismiss with impunity. It had looming consequences. There was, for instance, the Marlin debt of $1 billion. Enron was now clearly on the hook for that debt, which was due in early 2002. What’s more, the Marlin debt was a matter of public record—it was spelled out in financial-offering documents that any big investor could obtain.

  And some did just that. As often happens when a stock makes a meteoric rise, Enron had caught the attention of several short sellers. Short sellers are investors who make money by betting that a stock will go down, not up. They do this by selling stock that they don’t actually own—betting that they will later be able to buy it at a lower price and pocket the difference.

  Short sellers tend to be a suspicious lot, and as they looked closer they began to wonder about Marlin and about how Enron was going to pay back that debt. They also started to wonder what the existence of that strange Marlin structure and the flameout of Azurix suggested about the rest of Enron.

  • • •

  The Azurix saga represented the public part of Mark’s downfall. There was a back story as well, one that played out in typical Enron fashion, with only the insiders aware that it was unfolding. The story came from the final chapters of the Enron International saga, and it had just as much to do with Mark’s departure as the Azurix debacle.

  Enron’s international development efforts hadn’t ended when Mark went to Azurix. Enron developers struck deals to build plants in war-torn regions that included Croatia and the Gaza Strip and went on buying sprees, snapping up, among other things, part of a gas-distribution business in South Korea for almost $300 million. Nowhere did Enron buy more than in Brazil, which began privatizing its energy sector in the 1990s. The privatization news had sparked a competitive frenzy, with energy companies racing into the country to land deals. In mid-1998, about the time Enron was buying Wessex to get Azurix up and running, the company announced that it had bagged a big prize: a controlling interest in Elektro Eletricidade, Brazil’s sixth-largest electricity distributor. The cost was $1.3 billion.