Author Topic: What was wrong with Enron's financials?  (Read 4870 times)

Cigarbutt

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Re: What was wrong with Enron's financials?
« Reply #10 on: June 16, 2019, 07:59:13 PM »
I had heard of Enron during the energy deregulation era and then it was surrounded by a halo of success.
I looked into it when Fairfax (through ORH) reported Enron-related losses (?bond losses) and when, for a while, some suggested that FFH was the next Enron.

When looking retrospectively and using accounting prisms elaborated after the fact, red flags are pretty obvious (revenue recognition, cashflow vs income, SPEs etc) but IMO only a few individuals could have spotted the extent of the fraud and have the courage to publicly voice concerns. There were some relevant and investigative-type questions asked by analysts but it's very hard to unsettle a stock market darling that reports audited results and obtains adequate credit ratings.

It's probably best to walk away from these potential situations using basic sniff (accounting or management trust) tests.
Financial Shenanigans by Mr. Schilit is a good book. Edit: I agree with Grafter.
The whole story about Enron though is fascinating (human nature etc).

For the opening poster, Nomad, I have a few pages from the CFA level I and II program that deal specifically with the Enron post-mortem accounting analysis and something can be done privately.
« Last Edit: June 16, 2019, 08:01:21 PM by Cigarbutt »


writser

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Re: What was wrong with Enron's financials?
« Reply #11 on: June 17, 2019, 12:04:14 AM »
Quote
Financial Shenanigans by Mr. Schilit is a good book.

Yes, recommended.
I'm sorry if I have offended you. Please contact this forum's safe space coordinator to work thing out.

@thewritser

cherzeca

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Re: What was wrong with Enron's financials?
« Reply #12 on: June 17, 2019, 08:37:33 AM »
this is a worthwhile pursuit, ex post analysis, but I think it is very hard to develop an expertise in detecting ex ante accounting BS.  while detecting disconnects between profits and cash flow is the linchpin, there is just a lot of dead ends that you may end up in when companies use VIEs and unique arrangements (why did the cfo set up all of these subs that he was in charge of...?).

the difference between then and now that interests me is social media.  while financial twitter is generally a mess, I think there can be some interesting tidbits.  the whole $tslaq thread has some interesting vehicle delivery tweets that can be measured against musk's bravado...at least when he was still tweeting.  you never know when you will find gold in your pan, and I think following some of the twitter noise may lead you to some interesting signals.

and of course, just following the 13Fs of guys like Einhorn is another way to sniff stuff out.  Einhorn and the short community like to talk to each other

Schwab711

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Re: What was wrong with Enron's financials?
« Reply #13 on: June 17, 2019, 12:19:15 PM »
I think the whole point of Enron is there wasn't enough information to know there were issues. That's at least some of the reason for expanded disclosure in Sarbanes-Oxley and the dissolution of Arthur Anderson. My understanding is Enron didn't look to be generating operating profits and no one could describe how they earned their trading profits (Chanos/McLean thesis). The related party transactions were complex and potentially pointed to accounting issues (Chanos). In reality, they hinted at what was later known as the Raptor transactions (the empty shells hiding debt).

I believe both Bethany McLean and Jim Chanos, famous for calling out Enron before the fall, both believed Enron was overvalued because of unsustainable profit origin and potentially untrustworthy numbers, but not necessarily fraud. Without the whistleblower, I'm not sure the Enron story is the same (though they would have failed eventually from their own losses).

In hindsight, you can definitely see that trading IBIT exceeds the group's IBIT, which points to what Chanos/McLean saw. At the peak, Enron was valued at something like 7x P/B and 55x IBIT (which was more than 100% trading profits). Further, p.39 (slide 41/60) shows the assets quality of the price risk management assets. Enron had 4x the PRM assets with a 25% increase in reserves. Roughly 25% of their $21.5b of PRM was non-IG. This was another hint that the trading profits were probably not sustainable.

Even if the numbers were real, the argument at the time was that the valuation didn't match the underlying company.

McLean's famous article:
http://archive.fortune.com/magazines/fortune/fortune_archive/2001/03/05/297833/index.htm

Whistleblower:
https://www.theguardian.com/business/2003/jun/21/corporatefraud.enron

« Last Edit: June 17, 2019, 12:33:52 PM by Schwab711 »

SharperDingaan

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Re: What was wrong with Enron's financials?
« Reply #14 on: June 17, 2019, 04:23:25 PM »
Almost always these things are the result of an ill-conceived change in an accounting standard; in this case, the standards around securitization. At the time the entire profit on a 20 year securitization deal, could be booked as profit on day-1; today you can only book profit as you earn it.

Of course an accountant has to find the anomoly, an analyst has to call it, and it is in neither parties interest; until there is more to be made on the way down, versus the way up. Hence it is a rigged game; and it is to you (the investor) to both realize that, and realize that it cannot be pumped without promotion. These companies are 'market darlings' for a reason.

Point is, that unless you are a forensic accountant, you are not going to detect them.

SD
 

cherzeca

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Re: What was wrong with Enron's financials?
« Reply #15 on: June 17, 2019, 05:23:44 PM »
@sd

except Enron was booking profit for handshake joint ventures some of which were never documented much less actually put begin operations.  you can't find this kind of fraud looking at financial reports

coc

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Re: What was wrong with Enron's financials?
« Reply #16 on: June 17, 2019, 06:38:42 PM »
Important to note: understanding the public filings will probably not let you conclude fraud in and of itself. Itís only part of a puzzle. But unless the fraud is extremely clever, and Enron wasnít, they should give you strong hints that all was not well. Itís not necessary to have a full picture of the fraud to know what to avoid. Chesapeake Energy is a good recent example - perhaps not fraud, but very problematic in some ways familiar to the Enron story. (Hiding debt, hiding payments etc)

Itís also worth looking at Azurix, which Enron IPOed and then had to buy back.
Another total sh*tshow.

https://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0001080205&type=10-k&dateb=&owner=exclude&count=40


SharperDingaan

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Re: What was wrong with Enron's financials?
« Reply #17 on: June 18, 2019, 06:16:58 AM »
The reality is that looking at financials is only going to catch the bad or incompetent, the visible part of the iceberg.
Think about how business is actually done in most places in the world; where's the line on the P&L entitled 'bribes'? And have you ever seen an account entitled 'bribes', in a general ledger? We simply call bribes something else - making 'covering up' an every-day part of business. The deciding factor is a judgement call, subject to incentivization.

SD

coc

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Re: What was wrong with Enron's financials?
« Reply #18 on: June 19, 2019, 07:16:10 AM »
I forgot to include this report in my prior posts - written by a great analyst / short seller named Mark Roberts in 2001 before Enron collapsed. He pretty well outlines everything you should/would have found in the filings ó which again, were the tip of the iceberg, but as his report shows, more than enough.

https://www.offwallstreet.com/userfiles/files/ideas/NEW_ENE_5_6_01.pdf

cherzeca

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Re: What was wrong with Enron's financials?
« Reply #19 on: June 19, 2019, 07:29:28 AM »
I forgot to include this report in my prior posts - written by a great analyst / short seller named Mark Roberts in 2001 before Enron collapsed. He pretty well outlines everything you should/would have found in the filings ó which again, were the tip of the iceberg, but as his report shows, more than enough.

https://www.offwallstreet.com/userfiles/files/ideas/NEW_ENE_5_6_01.pdf

outstanding work