Stephanie McGinnis [Stephanie McGinnis/HOUIECT@lt-Comp] Thursday, August 31, 2000 7:04 AM Mary Kay Moore Rick L Carson Lessons Learned Rick Buy was very pleased with what you were able to do with our Lessons Learned presentations. We greatly appreciate your help in making this presentation a success!!!!! Below are the final versions which were given to Rick Buy (and the printed version to Jeff Skilling today). I~j I~i~ Lessons Learned Lessons Learned Animated MKM.p... Handouts SKM.p... Thanks again! Stephanie I GOVERNMENT EXHIBIT 24598 Cnm No H 04-0025 1 Unknown From: ent: Cc: Subject: Investment Portfolio Lessons Learned September 2000 0 Investment Performance Summary Statistics - Worldwide Equity Portfolio Cost Basis $6.2 Bn Troubled- $241 MM 4% Carrying Value $6.9 Bn Troubled $232 MM 3% CONCLUSIONS * 61 % of originally expended capital is not meeting expectations. * Enron has $3.8 Bn of earnings exposure on assets performing below expectations. * 78 out of 154 equity transactions are underperforming! a Below Expectations $3,540 MM 51% Investment Performance Summary Statistics - Worldwide Debt Portfolio Cost Basis $1.3Bn Carrying Value $1.3 Bn CONCLUSIONS * 45% of originally expended debt capital is not performing or has issues. * Enron has $547 MM of earnings exposure on debt that is non-performing or has issues. * 31 out of 65 debt transactions are non-performing or have issues! 0 0 Why are 109 deals comprising 50% of our investment portfolio not performing according to expectations? Underperforming Deals Major Factors Underperforming Deals Major Factors In tense pressure to close deals driven by earnings considerations has motivated Enron to assume extraordinary investment risks or risks which have not been appropriately priced. RAC shares the responsibility for not adequately assessing and modeling transaction risks or increasing the capital price to reflect these risks. Oil and gas drilling partnerships are examples of extremely high risk investments. Despite this, Enron has invested over $380 million in 23 partnerships since 1994. Twelve of these partnerships have been complete failures with over $75 million written off. Of the remaining eleven partnerships, seven are currently on the "Watch or Troubled Deal List." Underperforming Deals Major Factors Investment assumptions have not been sufficiently validated by third party participation or use of current market input providing the ability to syndicate or, in the the absence of syndication, that investment terms are comparable to those of similar transactions. A study of a number of "troubled" investments where Enron did not have third party participation indicates that a major area where we may have differed from current market is in growth assumptions. Often our mezzanine debt was priced below market because we had received warrants, which were highly valued internally because of our aggressive growth assumptions. If third party participation had been applicable, it is likely that growth assumptions would have been more conservative. 0 Underperforming Deals Major Factors Immediate recognition of MTM earnings, assuming flawless execution, has not incentivized commercial personnel to aggressively manage deal execution through exit for value. Incentives to assure that actual performance meets projections have been inadequate. The chart below shows the combined historical fair value marks through time of 30 transactions which have appeared as "Troubled" or "Loss" on the bi-weekly Watch List Report since its inception in January 1999. The fact that as much as $113 million in MTM income was credited to these failed projects causes concerns that proper incentives for long term execution are absent from our current structure. 0 Underperrorming Deals Major Factors We have a dismal record of investment performance in start-up entities involving technology and construction risks due primarily to the significant inherent risks of start-up businesses, our counterparties' lack of management expertise, as well as passive execution oversight by Enron. These risks have been exacerbated by investments in industries where Enron had limited expertise, so pitfalls obvious to experienced investors were not avoided. Construction of start-up steel mills and processing facilities is an area where Enron has invested over $121 million despite our lack of expertise in the area. To date, $80 million has been lost and the remaining $41 million is in serious jeopardy. Underperforming Deals Major Factors 0 0 Investees have been undercapitalized and have experienced liquidity crises in some instances due to our failure to insist on both third party financing and a source of "rainy day" liquidity before making our investment. 0 Enron acquired a majority equity interest in a landfill gas company in 1999. It was recognized prior to deal closing that substantial external project financing was necessary for the Company to be viable. The acquisition was closed with the representation that a financing commitment was in place with a recognized financial institution. Apparently the financing "commitment" was much more tentative than originally represented and fell through soon after closing. Enron now having to provide "life support" working capital because we failed to ensure before making our investment that appropriate third party financing was in place! Underperlorming Deals Major Factors for the Beca use of Enron 's aggressive investment policies, "troubled deals" should be expected; we have inadequately planned for "troubled deals" in terms of our legal documentation, our monitoring procedures and ability to react to these transactions with a "quick response" team. 0 * for the A study of a number of deals that have become "troubled" indicates that legal documentation providing Enron rights in a distress situation were never included or were negotiated away by dealmakers. In one preferred stock investment, Enron reserved additional rights if the company failed a cash flow test. Unfortunately, "cash flow" was not adequately defined and the company was able to avoid our assertion of additional rights. 0 How do we improve our investment performance? S 0 Recommendations Investment Performance Improvement Recommendations #5-Investments in start-up entities will not be ap roved without the following: #1- o Jdmeetw at i inators rms - ndere timid ba ed pn o r "Ie~sons xp or o - ons uQtIojl, ~tart- risks. Idasing. above * Deal "milestones" and established due dates to monitor the Summary If Enron is to be successful in its investing activities it must: 1~. U, a) U, 'sm~ U, a) oc~ lining in~i 0 w Ki U * - C', * - a) a) 0 E U, U, a) U 0. *0 U, U, a) U, U, a) *0 0 4-pa cn0 =a) ox U~a) a) L.V 00) * - U 00 vi-. a)0 oE a) 0 0 0 0 Investment Portfolio Lessons Learned September 2000 Investment Performance Summary Statistics - Worldwide Equity Portfolio Cost Basis Troubled $241 MM 4% $6.2 Bn Carrying Value $6.9 Bn Troubled $232 MM 3% CONCLUSIONS * 61 % of originally expended capital is not meeting expectations. * Enron has $3.8 Bn of earnings exposure on assets performing below expectations. * 78 out of 154 equity transactions are underperforming! Investment Performance Summary Statistics - Worldwide Debt Portfolio Cost Basis $1.3Bn Carrying Value $1.3 Bn CONCLUSIONS * 45% of originally expended debt capital is not performing or has issues. * Enron has $547 MM of earnings exposure on non-performing or has issues. debt that is * 31 out of 65 debt transactions are non-performing or have issues! Why are 109 deals comprising 50% of our investment portfolio not performing according to expectations? Underperforming Deals Major Factors I In tense pressure to close deals driven by earnings considerations has motivated Enron to assume extraordinary investment risks or risks which have not been appropriately priced. RA C shares the responsibility for not adequately assessing and modeling transaction risks or increasing the capital price to reflect these risks. Oil and gas drilling partnerships are examples of extremely high risk investments. Despite this, Enron has invested over $380 million in 23 partnerships since 1994. Twelve of these partnerships have been complete failures with over $75 million written off. Of the remaining eleven partnerships, seven are currently on the "Watch or Troubled Deal List." Investment assumptions have not been sufficiently validated by third party participation or use of current market input providing the ability to syndicate or, in the the absence of syndication, that investment terms are comparable to those of similar transactions. ~'*' A study of a number of "troubled~~ investments where Enron did not have third party participation indicates that a major area where we may have differed from current market is in growth assumptions. Often our mezzanine debt was priced below market because we had received warrants, which were highly valued internally because of our aggressive growth assumptions. If third party participation had been applicable, it is likely that growth assumptions would have been more conservative. 4' Immediate recognition of MTM earnings, assuming flawless execution, has not incentivized commercial personnel to aggressively manage deal execution through exit for value. Incentives to assure that actual performance meets projections have been inadequate. 0 The chart below shows the combined historical fair value marks through time of 30 transactions which have appeared as "Troubled" or "Loss" on the bi-weekly Watch List Report since its inception in January 1999. The fact that as much as $113 million in MTM income was credited to these failed projects causes concerns that proper incentives for long term execution are absent from our current structure. 0 We have a dismal record of investment performance in start-up entities involving technology and construction risks due primarily to the significant inherent risks of start-up businesses, our counterparties' lack of management expertise, as well as passive execution oversight by Enron. These risks have been exacerbated by investments in industries where Enron had limited expertise, so pitfalls obvious to experienced investors were not avoided. Construction of start-up steel mills and processing facilities is an area where Enron has invested over $121 million despite our lack of expertise in the area. To date, $80 million has been lost and the remaining $41 million is in serious jeopardy. Investees have been undercapitalized and have experienced liquidity crises in some instances due to our failure to insist on both third party financing and a source of "rainy day" liquidity before making our investment. Enron acquired a majority equity interest in a landfill gas company in 1999. It was recognized prior to deal closing that substantial external project financing was necessary for the Company to be viable. The acquisition was closed with the representation that a financing commitment was in place with a recognized financial institution. Apparently the financing "commitment" was much more tentative than originally represented and fell through soon after closing. Enron now having to provide "life support" working capital because we failed to ensure before making our investment that appropriate third party financing was in place! L for the "Wo Because of Enron 's aggressive investment policies, "troubled deals" should be expected; we have inadequately planned for "troubled deals" in terms of our legal documentation, our monitoring procedures and ability to react to these transactions with a "quick response" team. for the A study of a number of deals that have become "troubled" indicates that legal documentation providing Enron rights in a distress situation were never included or were negotiated away by dealmakers. In one preferred stock investment, Enron reserved additional rights if the company failed a cash flow test. Unfortunately, "cash flow" was not adequately defined and the company was able to avoid our assertion of additional rights. How do we improve our performance? investment 0 Recommendations 0 0 Investment Performance Improvement Recommendations #1 - RAC Underwriting should meet with deal originators and portfolio managers to reach agreement on risks previously underestimated based on our "lessons learned" such as drilling, exploratory, construction, start- up, counterparty management and other execution risks. * Investment Performance Improvement Recommendations #2- Segregate commercial responsibilities into two groups. One should be responsible for transaction origination and the other for transaction execution and asset management. There should be a definitive transfer of the asset to the Execution group at closing. 0 0 Investment Performance Improvement Recommendations #3- Compensation based on MTM earnings on transactions should be shared between Origination and Execution functions with Execution personnel not earning their compensation until the transaction is successfully performing. ¾~ * * Investment Performance Improvement Recommendations #4- Deals must be developed using current market terms or third party participation to corroborate pricing and provide the ability to syndicate or maximize the probability of a successful exit. * Investment Performance Improvement Recommendations #5-Investments in start-up entities will not be approved without the following: * Independent consultant / engineering reports prepared for Enron, not another entity, if Enron lacks internal expertise * Detailed plans for design, construction, and commissioning of new asset * Assessment of the capabilities of management and staff with a plan to correct deficiencies * Detailed cash flow budget and liquidity plan in the event of project delay or cost overruns * Deal "milestones" and established due dates to monitor the above Investment Performance Improvement Recommendations #6-Initiation of an independent legal review of transaction documents (in addition to the deal attorney) to ensure that Enron is not assuming undue legal risks and has maximized its rights in the event of a distress situation. S Summary If Enron is to be successful in its investing activities it must: * Assess and price risks more realistically * Devote additional resources to deal monitoring and execution 0