Enron's swap with Qwest raises more accounting questions

The two companies struck a deal last fall to swap fiber optic network capacity and services at inflated prices in an effort to improve each company's financial picture

NY TIMES NEWS SERVICE , NEW YORK

Sat, Mar 30, 2002 - Page 19

Enron and the telecommunications giant Qwest Communications struck a deal last fall to swap fiber optic network capacity and services at exaggerated prices in an effort to improve each company's financial picture, executives close to the deal said this week.

Details of the deal, which were not announced at the time but have been disclosed in recent filings in Enron's bankruptcy case, indicate that the two companies raced to complete the transaction as the third quarter was ending in September. Enron and Qwest valued the transaction at more than US$500 million, but analysts said the timing and the valuation would be hard to justify because by last fall a glut of fiber optic capacity had sent network prices plummeting.

Similar deals by other companies in the last few years have become the focus of inquiries by federal prosecutors, the Securities and Exchange Commission and Congress, as investigators try to determine whether the network swaps were legitimate transactions or sham deals meant to lift revenues artificially. So far, in describing its responses to SEC questions, Qwest, the dominant telephone company in 14 Western states, has said publicly that its swaps are based solely on the needs of its network operations.

But executives close to the Qwest-Enron deal, one of the largest recorded, said the swap had other objectives. It helped Qwest soften a deteriorating situation in profit and revenue at the end of last year's third quarter, the executives said. The deal also allowed Enron, which was tumbling toward a bankruptcy court filing, to avoid recording a huge loss by selling an asset whose value had plummeted on the open market, they said.

"Qwest said: we will overpay for the assets, and you will overpay me on the contract," one former Enron executive said. "They had a pinch in the third quarter and needed a deal."

A financial analyst looking at the deal's details for the first time this week, questioned the need for a swap. "It's totally irrational to buy capacity from Enron," said Patrick Comack, a telecommunications analyst at the investment house of Guzman & Co in Miami. "This is clearly a swap for accounting purposes."

Arthur Andersen, which was indicted earlier this month by the Justice Department on obstruction of justice charges tied to Enron's collapse, signed off on the way Qwest and Enron accounted for the deal. An Andersen spokeswoman, Kim Boyland, said the firm had relied on its clients' assessment of the deal's worth. "The auditor is not the business adviser," Boyland said, "and would not advise the company as to the valuation."

A Qwest spokesman, Tyler Gronbach, said Thursday that the company had bought more than network capacity from Enron, including the right to place its equipment at Enron sites and the purchase of power supplies and spare network conduits. Qwest could use the conduits to install fiber or sell space in them to other companies, he said.

"We paid what we believe was fair market value for the package we bought," Gronbach said. He declined to discuss how Qwest valued each element of the deal.

Enron executives declined to discuss the specifics of the deal. "Many of the matters that occurred, while they may have been perfectly appropriate, are being looked at by several different government authorities, so we'll have no further comment," Mark Palmer, an Enron spokesman, said.

Qwest began encountering criticism last year from analysts and investors over a series of swaps in early 2001. The SEC started asking questions earlier this year, sending Qwest a letter requesting information about its network capacity swaps in 2000 and 2001. One deal involved Global Crossing, which is operating under bankruptcy protection and is also the focus of government investigations.

For Enron's part, the company had been known to be a sometime player in the network swap market. In the second quarter of last year, Enron had negotiated to swap much of its unused fiber with Global Crossing, the former Enron executives said, but that deal fell apart because of Global Crossing's credit problems. But the disclosure of the September deal places Enron as a central participant in the market even as the company was hurtling toward a bankruptcy protection filing.

In the second quarter of 2001, Qwest and Enron had tried to negotiate an even larger deal, involving most of Enron's fiber optic cable and access to Qwest's network, according to people close to both executives. The discussions involved Joseph P. Nacchio, the chief executive of Qwest, and Jeffrey K. Skilling, Enron's chief, but the talks broke down in June.

People close to the September deal said that executives at Enron and Qwest held discussions that lasted into the final days of the third quarter, pondering how to account for the deal so that each would gain accounting benefits and improve its quarterly earnings reports.

The deal came shortly after Qwest said that it would reduce its work force by 4,000 amid a sharp downturn. On Sept. 10, the company also trimmed its revenue and profit forecasts for 2001 by about US$1 billion and US$500 million, suggesting a sharp slowdown in the second half of the year.

Then, on Sept. 30, a Sunday and the final day of the third quarter, Qwest signed a deal to pay Enron US$308 million for assets that included so-called dark fiber along a route from Salt Lake City to New Orleans. Dark fiber refers to idle network strands that require additional investments in electronic equipment before they can be put into service. In exchange, Enron agreed to pay Qwest US$195.5 million for "lit wavelength," or active fiber optic cable services, over a 25-year period; each company exchanged checks for about US$112 million around the close of the deal.

To Comack, the Guzman & Co analyst, Qwest may be paying for assets for which it has little use. "I can't conceive of any reason they would need more dark fiber in the US," he said.

The deal enabled Enron to book a sale and avoid recording a loss on the dark fiber assets, whose value in the open market had dropped far below the price on Enron's books.

Qwest did not announce the Enron deal after it was made, although the company had regularly issued news releases for smaller deals, including a US$20 million contract with Perot Systems Inc on Sept. 27.

When Qwest announced third-quarter results on Oct. 31, however, it boasted about the expansion of its fiber optic network, without naming Enron: "In a transaction with a significant business customer, Qwest purchased approximately US$300 million of assets -- including the 5,500 miles of domestic fiber routes, co-location space and power -- to diversify and extend its network and to provide backup facilities."

The news release continued: "This customer has also agreed to purchase high-speed optical network capacity from Qwest, with approximately US$86 million or revenue recognized in the third quarter and additional future contracted revenue."

Even so, Qwest's third-quarter results were disappointing, a loss of 9 cents a share, though better than the 14-cent-a-share loss a year earlier. Revenue, considered an important barometer of how the telecommunications companies were growing, was equal to a year earlier, at about US$4.8 billion.

While the deal provided an US$86 million increase to Qwest's reported revenues in the third quarter, it reduced reported earnings by an undisclosed amount, Gronbach, the Qwest spokesman, said. He declined to reveal how much profit Qwest booked from the deal in the quarter, but said it was more than offset by the US$112 million that Qwest paid to Enron in the quarter. The deal provides for Qwest to pay Enron another US$83.5 million in two payments this year.

Tim McDonald, a telecommunications analyst at the Bank of New York, said: "Qwest has been among the most aggressive in the industry in the use of swaps. In 2001, about US$660 million of its roughly US$1 billion in network capacity sales were in the form of swaps."