Enron 101
How a group of students sold Enron a year before the collapse
Wall Street lore says that no one saw the collapse of Enron coming. Chairman Kenneth Lay, CFO Andrew Fastow, COO Jeffrey Skilling, and their band of brigands had done such a good job of fooling accountants, auditors, investors and regulators that the implosion was a shock to all. Like much conventional wisdom on Wall Street, this is not entirely true.
In May 1998 a team of students at the Johnson School selected Enron as the subject of their term project for Professor Charles M. C. Lee’s course in financial statement analysis. At the time, ENE was trading around $40/share and was widely touted by analysts as being the company best placed to take advantage of accelerating deregulation in energy markets.
How did teams of B-school students see plainly what professional analysts, asset managers, and regulators missed? They did the math.
To their own surprise, the team returned a “sell” recommendation
based on the strict application of the fundamental tools
Professor Lee had taught them. Although the team did note that the
eight-variable Beneish model indicated possible earnings manipulation,
their sell recommendation was based primarily on an intrinsic
value of about $35/share versus the then-current price of $48/share
in a 52-week range of $35 to $51.50/share.
Later that year, the Johnson School started the Cayuga Fund,
a live-money investment opened with $650,000. The sell call on
ENE had proved prescient, and the fund took a modest position in
ENE in December 1998 at around $27/share. A separate purchase
in October 1999 at $40/share gave the fund a holding of 720 shares
(including splits) at an average purchase price of $29.40.
The very next year the sell call was taken up again, this time in
greater urgency. A role in managing the Cayuga Fund is part of the
required curriculum for select second-year students. Two of them,
Feidhlim Boyle and Tyger Park, both MBA ’01, were assigned the
energy, mining and manufacturing sectors, including Enron. As Boyle
and Park settled back into the class routine that fall of 2000, nothing
was hotter than ENE, which was trading higher than $90/share.
Boyle and Park were in Professor Lee’s analysis course and were
familiar with the 1998 evaluation. Again the recommendation was sell on ENE, but this time it involved real money. Boyle and Park
stood in front of their class and made a case to sell one of the highest
fliers on Wall Street.
The class accepted their argument, as did the faculty and staff
supervisors.
The Cayuga Fund sold its entire position in ENE at $67.38 on December
1, 2000, booking a return of 129 percent. To be sure, neither
the 1998 team nor Boyle and Park saw at the time the enormity of the
Enron fabrication. But their recommendations were hardly a lucky
call. They didn’t believe the hype, but they did do the math.
Exactly one year and one day later, December 2, 2001, Enron
filed for bankruptcy.
Theory In Practice
Joe Thomas became dean of the Johnson School in 2007, but has
served on the faculty for more than 30 years. While exceedingly
proud of the fundamental analysis done by the students, he is quick
to note that there was no sense of clairvoyance at the time. “It was
mostly a non-event,” Thomas recalls. “There was some feeling that
Enron was too good to be true, but no one was prescient enough to
foresee what actually happened. Our students simply did careful
analysis that showed that what was going on with ENE was not
sustainable. No one knew the level of fraud.”
Doubling its money on Enron stock is certainly a point of
pride, but it is just one of many good picks made at the Johnson
School and at several of the other top B-schools in the country.
Thomas says he and his fellow deans have explored the idea of
monetizing the analysis that students, faculty and alumni do. “We’ve discussed it, and we’ve realized that it would take resources
that we don’t have.”
Occasional interest has also come toward B-schools from Wall
Street firms. Thomas says he cannot comment on any such feelers, but
it is known that at least one financial firm has approached the Johnson
School, and sources in the financial sector and in academia suggest
there have been several such contacts at other schools as well.
The attraction is clear: pure, fundamental analysis that is essentially
free from bias. But the devil is the details, most importantly how
to insulate the schools from liability and maintain that objectivity,
and secondly how to make reporting regular and consistent.
“We can do the analysis,” says Thomas, “and we have discussed
selling the output. But it would have to be at arm’s length. There
would have to be legal protection.” He adds that there is nothing
along those lines underway at present.
For the time being the only real money at stake is in the Cayuga
Fund. Thomas stresses that the Cayuga Fund “is not just play
money. We do seriously want to make money, and we are very proud
of the return, especially as this is an educational fund and we don’t
use any leverage.”
As of May 2009, the fund had assets under management of $11.6
million, according to Lakshmi Bhojraj ’95, MBA ’01, director of the
Parker Center for Investment Research at the Johnson School. She
is also a classmate of Boyle and Park. The center was established in
1998 concurrently with the creation of the Cayuga Fund and the
school’s move from a Modernist box on the edge of campus (Malott
Hall) to Sage Hall, a lovingly restored Queen Anne complex in the
very center of the university.
Bhojraj says that the Parker Center is a state-of-the-art facility,
comparable in capability, if not size, to any trading floor on Wall
Street. “We have cool data walls with live feeds. The software and
analytical tools alone would cost $1.8 million just for fees at a commercial
operation. Some is donated, most comes at a discount, and
in return we help the vendors with their beta testing,” she adds.
According to a recent survey by Brian Bruce, director of the
Alternative Asset Management Center of the Cox School of Business
at Southern Methodist University in Dallas, there are at least 275
schools that have student-managed live-money investments. Total
assets under management were about $340 million, but that was
pre-recession. “It may be as low as $250 million now,” says Bruce.
“That is why we are renewing our survey and hope to have results
later this year.”
Most B-school funds are quite small, with average assets under
management of $1.4 million and the median holding of just
$400,000. Ohio State and the University of Minnesota had more
than $20 million in the last survey, the latter split evenly between a
growth and an income fund. Cornell and the University of Texas are
the only other schools with more than $10 million.
Bhojraj notes that Cornell is one of the few institutions to
combine a full-scale trading floor and a live-money fund at a
research university. “The University of Michigan is probably most
comparable to us, but that is because it was modeled after us,” she
says. “The University of Texas at Austin also has a trading room
and a fund.”
She further differentiates among the educational funds. “I believe
that many of the larger funds hold a lot of Treasuries and are managed more passively. We are among the largest actively managed.”
Bhojraj also notes that many educational funds handle mostly
endowment money. “We have real investors. The endowment is one
of them, but it is not a significant investor.”
The Cayuga Fund uses both a quantitative and a fundamental
approach, and a proprietary model to screen stocks. Screened stocks
are passed to student sector managers for fundamental analysis. The
faculty director and Parker Center director supervise and manage
the risk of the portfolio all year. This includes taking positions as
hedges and supplementing student recommendations with quant
picks. They actively rebalance and manage the portfolio when the
students are not in session. The fund also has its own board of
directors, while the dean and the faculty director are the designated
managers (equivalent to general partners) of the fund.
The Johnson School is also host to the annual intercollegiate
MBA Stock Pitch competition held the first week of November
every year since 2003. Cornell placed highly in the first few years,
but has not fared as well recently. “The winners are based on how
convincing their pitches are, not on how their picks perform,” says
Bhojraj. “Our picks have done well on a performance basis, so starting
this year we are going to track performance, and also back-test
our picks for the last couple of years.”
Bruce adds that intercollegiate stock picking and pitching competitions
are growing. He notes the Texas Investment Portfolio Symposium is held every March, with the winners going on to the CFA Institute
regional and global challenges. Doug Vieland, executive director of
the Association of Collegiate Business Schools and Programs, says his
organization is looking into several different ways to raise the profile of
the research conducted by students at member institutions. Those could
include tracking and communicating the number and performance of
student-managed funds as well as the various competitions.
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