To market, to market

In the summer of 2000, a correspondent on one of the Internet bulletin boards following Enron stock posted a note asking for basic information about what the company does. He had been to the Web site, he wrote, but was still confused. He had not been able to find an Enron FAQ and needed someone to put "Enron in a nutshell" for him.

The replies to his message reveal a lot about the company. A poster with the handle John Quixote put it this way: "Hey! An Enron FAQ! Whatta great idea! Trouble is, this company moves and evolves so quickly that it would be like trying to define a river. It’s just not possible to put this company in a nutshell."

Enron, depending on who’s writing or talking about it, is sometimes described as an energy company or a pipeline company. Its communications subsidiary, Enron Broadband Services, is sometimes called a communications company and lumped together with other communications subsidiaries of energy companies. And Enron does sell energy, wholesale energy, manage pipelines and own and operate a telecom network. Yet Enron Broadband Services also is certified as a competitive local exchange carrier (CLEC) in several states.

But Enron exists to trade, and so do all its parts.

Actually, its spokespeople say that Enron exists to "make a market." But that’s jargon. Sure, Enron wants to make markets. It wants to make markets—and have as much to say as possible about the rules governing those markets—so that it can have places to trade.

Ask Mike Golden if Enron exists to trade. Golden recently joined the company as part of an acquisition.

"I was frankly blown away by how true that is," says Golden, chief technology officer and vice president of network engineering and operations for Enron Broadband Services. "They’re constantly reviewing every asset that they have and whether or not they should keep it or sell it," he said. "The first epiphany was that they exist to trade, and then over time I realized how good they were compared with others in the industry. These guys are just incredible machines for structuring and executing financial deals."

The idea of trading bandwidth is new, of course, and not universally applauded. Enron executives remind us that the very idea of trading natural gas was new once, but its time came. But they concede that, commodity status aside, bandwidth is not gas.

"Take gas molecules," Golden says. "When you put them in the pipeline at a particular point, they push other molecules, and you don’t care which molecules come out at the other end. You very much care with bandwidth because you want your e-mail and not someone else’s to come out." That means, he says, that the technology to control and manage and manipulate that is more complicated than that for electricity and gas. "Bandwidth… is a very dynamic animal," Golden says. "It adds another level to the complexity."

Look at the books

Kevin Hannon, president and chief operating officer of Enron Broadband Services, says his company has completed at least 300 trades since it started trading bandwidth in the fall of 1999. That’s a tiny number when compared with commodity trades in electricity and gas (where that many trades can happen in an hour), but a fairly impressive number when considered in the bandwidth context, where some traders are glad to do one trade a month.

Of course, a company that exists to trade has to expect downs with its ups.

Enron recently announced it would acquire the 33% of Azurix that it doesn’t already own for $326.6 million and then took a charge for that amount against fourth quarter earnings. That reduced Enron’s net by 77%.

Enron, hoping to "make a market" for the international trading of water, created Azurix in 1998 to "pursue opportunities in the global water market by creating innovative solutions and setting new standards for clean water supplies worldwide." Yet it’s a measure—either of investors’ confidence in Enron’s management or of their ignorance of what the company does—that Enron’s stock price actually rose a few points after the announcement on Jan. 22.

This may have something to do with the fact that the company, as a whole, still made money, paying 5¢ a share on $60 million in net income for the quarter, down from 31¢, and $259 million in the fourth quarter of 1999. Without the Azurix charge, its earnings would have been 41¢ a share—6¢ higher than analysts’ target of 35¢.

Enron’s corporate strategy rests on a three-legged stool: its core energy trading business, its energy management and outsourcing business and communications. The core businesses are hugely profitable, although the stool’s legs are uneven.

In the fourth quarter of 2000, Enron’s revenues rose nearly fourfold, from $11 billion in the fourth quarter of 1999 to $40.8 billion. Income before interest, minority interests and taxes was $777 million, almost triple the 1999 figure. The North American natural gas business pushed commodity sales and services went up to $538 million. The energy services business reported $33 million in income before interest and taxes (IBIT) for the fourth quarter and signed contracts worth $4.5 billion, up 73% from the fourth quarter of 1999.

Enron Broadband Services lost $32 million—four times what it lost in the second quarter. Nonetheless, analysts believe that telecom offers Enron’s best chance to "make a market" in the future.

"Communications is the third leg," says Ron Barone, managing director of natural gas research at UBS Warburg and a longtime Enron follower. "It will be a longer time [than it took energy services] before it turns positive, but it will also be longer-term in contribution for their earnings. This could be incredibly significant… in terms of size."

Who else is playing?

Enron is far from alone—or even early—among energy companies entering the telecom industry.

Williams, the Tulsa, Okla.-based pipeline company, formed Williams Communications Group more than two years ago and took it public last year. Williams Communications is now a full-fledged, $2 billion-per-year carriers’ carrier in its own right, using its parent’s pipeline rights of way to get started.

Conectiv, a power company serving Delaware, the eastern shore of Maryland, southern New Jersey and southeastern Pennsylvania, offers local, long-distance and Internet access service to business and residential customers in parts of its territory through its subsidiary Conectiv Communications.

Consolidated Edison offers similar services through a similar subsidiary, Con Edison Communications. The Montana Power Co. has announced it is leaving the energy business altogether and becoming a communications company called Touch America.

Privately held Koch Industries is a major backer of a new telecom carrier, Velocita (formerly PF.Net), a carrier’s carrier that attracted Bob Annunziata as its chairman.

And at least one non-utility leaped into the trading waters with gusto, only to drag itself out of the pool and quietly close its telecom trading subsidiary.

AIG, the huge risk management and insurance company, created AIG Telecom and appointed Eric Raab to run it. Raab went to last fall’s ASCENT

conference to talk about the benefits of bandwidth trading, then began his talk by announcing that the parent firm was getting out of telecom trading and that they were mistaken in doing so. It was his last public utterance, as far as we can tell. He has been unavailable, and AIG, which never announced the folding of AIG Telecom, has not returned phone calls asking about the decision.

But Enron officials say they are different for several reasons. First, they say, they have a network because they’re traders; they aren’t interested in trading because they have a network.

The Enron Intelligent Network consists of about 15,000 route-miles of optical fiber across the U.S. About one-third of that is built and maintained by Enron Broadband Services. The rest has been obtained by leases, swaps and indefeasible rights of use (IRUs). An IRU is a long-term lease in that the owner retains ownership. But the lessee gets to act as if it owned the capacity it has paid for and can carry it as an asset on its books.

"We’ve come to realize that the physical levers are not the biggest resources," Golden says. "We’ve built a relatively light or thin network so we have table stakes."

Second, because its people think of themselves as traders and not as service providers, their strategy is different. Like that of the parent company, Enron Broadband Services’ strategy rests on three legs.

Hot commodity

"We intend to be the world’s largest buyer and seller of bandwidth," says Jim Crowder, Enron Broadband Services’ vice president of strategic alliances and enterprise marketplace services. "We have a second goal, which really supports first, and that is to deploy the most efficient and open network with broad connectivity to that network. The third is in the area of content, really adding value to bits. We want to be the largest provider of premium broadband delivery services. These are the applications that will need bandwidth and drive bandwidth utilization across networks."

That first leg—becoming the largest buyer and seller of bandwidth—stands on Enron Online (www.enrononline.com), a special Web site where registered users can trade in Enron’s commodities.

Buyers and sellers can call Enron Broadband Services on the phone and trade the old-fashioned way, but bandwidth is the newest addition to the site. On EnronOnline, Enron conducts trading between 10 a.m. and 2 p.m. CST. Enron currently offers trades on capacity between its pooling points (it now has 26 of them) at three levels: a TDM DS-3, a TDM OC-3 (Sonet) and a TDM OC-3c (concatenated for IP). The contract lengths are for one month, six months or one year. As recently as six months ago, Enron had two pooling points—one each in New York and Los Angeles. Pooling points are just what the name implies—points, usually housed in data centers inside carrier hotels, where data traffic is pooled.

"We discovered that it’s often much harder to get across a city with bandwidth than it is to get around the world," Golden says. "So we extended our architecture to distributed pooling points, which we’re implementing this year. So the way that works, in each city, as business scales, we’ll put a pair of redundant optical matrix switches in each city. Then smaller pooling point access switches in buildings where bandwidth is already aggregated—co-location spaces, carrier hotels and so on. That creates the potential for rich interconnection between providers and consumers of bandwidth. We want to make it really, really simple to connect to the trading platform."

The network is the second leg. Given the first leg, it should come as no surprise that the network has two functions, and the less important of those functions is to provide communications between Enron pooling points. The more important is to provide trading stock.

Enron, as it does with other commodities, actually takes possession of the bandwidth it trades in. It becomes, in trading jargon, "a party at risk." This distinguishes it from companies that provide what amounts to a bulletin board that introduces buyers to sellers. Enron, in pursuit of its trading goals, is a buyer and a seller. Because it has its own stock, Enron can make up the difference between what a buyer wants and what is available.

For example, a buyer may want an OC-3 from one city to another for a certain length of time but discovers that no one can provide an OC-3 for that length of time. If Enron has capacity of its own between those cities, it can use some of that capacity to make the deal. Or consider this: A company buys capacity, but the seller fails to deliver. If the deal were about orange juice or natural gas, the broker would be expected to make the deal good and so it will be with Enron.

The third leg is content, and this one seems the oddest, at least at first blush. Enron has made several deals in the past year aimed at putting content—all sorts of content—over its network.

For example, Enron has concluded agreements with WebFN.com and Bridge Information Systems. Enron and Media1st.com agreed to provide Media1st.com’s streaming media applications over Enron’s network. More deals like that can be expected in the future, Crowder says, including acquisitions.

The boldest move has been the 20-year deal between Enron Broadband Services and Blockbuster, the video store subsidiary of Viacom. Under that deal, first announced last summer and concluded last month, Blockbuster will make movies available to end users through Enron’s network and those of what its executives refer to as "distribution partners"—carriers and resellers with which Enron has agreements.

"We don’t need to be in control end-to-end," Crowder says. "At the edges, our strategy is based on building broadband distribution partners. In the early going, we reached agreements with companies like RCN, Verio and InterNAP. Then, we’ve made deals with Verizon, SBC, Qwest, Telus and Covad. These are all companies who have agreed to step up to service level agreements."

Hannon says that pumping movies through Enron’s network may not appear to have much to do with trading and making markets, but he invites a closer look.

"At the same time we’re creating the ability to trade and the commodity products, we’re also to a certain extent creating the industry," Hannon says. "We’re priming the pump for bandwidth demand and creating a use for bandwidth and storage that’s being put in place at a fairly rapid pace. While it may look far afield from our traditional businesses, it’s a rational response to a market still growing."

This road leads to…

Among those that may not be happy to see bandwidth traded by the likes of Enron are the people that hold most of it—companies such as AT&T, WorldCom and the RBOCs.

The old-fashioned way of securing bandwidth is to call them and ask for it. They quote you a price, and whether you agree to buy at that price may have a lot to do with how much time you have to make a decision and how much you know about the current bandwidth price. Large holders of bandwidth stand to make more money if their buyers remain ignorant, so why would they turn bandwidth into a commodity?

Enron people say such a question ignores the fact that RBOCs and other large carriers may have a lot of bandwidth, but they don’t have it all, and they don’t always have it where they need it. In other words, they are buyers as well as sellers, and they will come around.

"What we say [to large carriers] is, ‘Look, if you’re interconnected with a pooling point, it doesn’t mean you have to engage the market, but you do have the option to access another source of demand on an instantaneous basis,’" Hannon says.

Some analysts believe that Enron may be on the right track, while conceding that the company, to some extent, is making it up as it goes along.

Counse Broders, senior Internet analyst for Current Analysis, says Enron faces "a real tricky situation right now." Bandwidth trading may make perfect sense in five years, with consumer broadband access more widespread and speed in providing that bandwidth more important to carriers, he says. If Enron turns out to be right, it will be in the corporate catbird seat, he says. But the risk is considerable.

"[Enron] is the one that has the pressure because their brand hangs out there, and they’re the ones that have to get the service turned up," Broders says. "From Enron’s standpoint… it’s just another way to fill the pipe."

If Enron can hang on, Broders says, new vistas await its traders. Demand will increase from new sources—such as corporations interested in distance learning—to fill that pipe.

John Atkin, telecom analyst for Dain Rauscher Wessells, says Enron Broadband Services is in a good position to make this market and make money from it. "They’ve done it before," he says, referring to Enron’s experience in other commodities. Still, the complexity dogs Enron, he says. "Those who are going after trading bandwidth are chasing a moving target," Atkin says.

On the other hand, Atkin concedes that Enron has "some awfully smart people" involved in the chase.

"In talking to some of their corporate development people… they’re interested in knowing everything about content," he says. "I mean, all the way down to layer one, layer zero stuff. They want to be as exposed as they can, partly for strategic reasons and partly for their own business reasons."

Wherever Enron is going with bandwidth trading, it isn’t going alone.

El Paso Energy has been working on a bandwidth trading strategy. In the spring, it sent a half-dozen people, who listened to everything and said nothing, to a bandwidth trading conference in New York. Last July, El Paso Energy formed a telecom subsidiary called El Paso Global Networks. El Paso Energy has not discussed its strategy publicly, but it did purchase optical fiber from Corning in November.

El Paso Global Networks’ president and CEO, Greg G. Jenkins, comes from El Paso Energy’s "merchant energy" operation, which trades energy wholesale. People close to the company say El Paso Energy, which claims to have the largest natural gas pipeline system in the U.S., has committed between $1.5 billion and $2 billion to capital expenditures over the next two years, and much of that is targeted at building up a telecom infrastructure.

In the meantime, Enron Broadband Services has opened its international pooling points in London and Tokyo.

When he dispatched his first employees to London this summer, Crowder was asked if they were energy or telecom people. "They’re traders," he replied.