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It is no accident that Ken Lay’s career in the energy business began—and, most likely, ended—in the city of Houston, Texas.
Houston was the epicenter of that world, home to giants like Exxon, Conoco, and Pennzoil. Spindletop, the legendary field that triggered the first Texas oil boom, back in 1901, is just up the road. To the south and east, sprawled over thousands of acres, lie refineries, petrochemical plants, gas-processing facilities, and tank farms—the grimy monstrosities that feed the nation’s hunger for plastics, fertilizer, heat, electricity, and gasoline.
For most of the twentieth century, Houston’s economy rose and fell with the price of crude. In the 1970s, when an Arab oil embargo was strangling the rest of America, Houston boomed. By 1987, when lower energy prices were pumping fresh life into the country, the city was flat on its back.
Houston also perfectly reflected the culture of the energy business. It was sprawling and rough, lusty and bold, wide open to opportunity and worshipful of new money. A city built on a swamp, Houston was a place where a man with a wildcatting spirit could transform himself virtually overnight; a like-minded company could remake itself, too.
The romance and myth in the energy business, of course, had always been about oil. It was crude that built empires, inspired legends, and launched wars. It was oil that the Mideast sheiks used to hold America hostage. It was oil that created the towering fortunes of Rockefellers and Hunts.
But Ken Lay’s destiny lay in a humbler hydrocarbon: natural gas. Transparent, odorless, lighter than air, natural gas, composed mostly of methane, lies trapped in underground pockets, often beside oil deposits. America has long had vast reserves of gas, and it burns far more cleanly than either coal or oil. Yet for the first half of the last century, America had little use for the stuff. It was a mere by-product in the quest for oil, priced so cheaply it wasn’t worth laying new pipelines to move it across the country. Instead, natural gas was usually just burned off as waste or was pumped back into the ground to maintain pressure to extract more oil.
By the 1950s, however, the perception of natural gas had begun to change. Gas was never going to attain the mythic status of oil—not even after Enron arrived on the scene—but it gradually became useful and even important. A flurry of pipeline construction had linked gas supplies in Texas and Louisiana with the rest of the country. Dozens of new petrochemical plants—many along the gulf coast of Texas—relied on natural gas as their basic fuel. By the time Richard Nixon took office in 1969, gas heated a large percentage of the nation’s homes and powered thousands of industrial sites year-round. Still, except for the occasional pipeline explosion, natural gas remained largely an afterthought, literally beneath notice, crawling silently about the country at ten miles per hour through a network of buried steel.
Back in those less complicated times, there were lots of industries that operated more or less by rote: the old banker’s motto, for instance, was “3-6-3”: take money in at 3 percent, lend it out at 6 percent, and be on the golf course by 3 P.M. But few industries were as downright sleepy as the gas-pipeline business. Yes, there was the occasional pipeline company that explored for gas, too; exploration has always been the most romantic part of the energy business. But mostly the pipeliners bought gas from oil giants and smaller independent exploration companies, then moved it across the country through their networks of underground pipes. Most of the gas went directly to industrial customers, while the rest was sold to regional gas utilities, which piped it to smaller businesses and consumers.
It was all very simple and straightforward—especially since every step of the process was under government control. The federal government regulated interstate pipelines, dictating the price they paid for gas and what they could charge their customers. (State agencies regulated intrastate pipelines in much the same fashion.) However much executives spent on operations, whether for moving gas or redecorating their offices, Washington let them recover their costs and tack on a tidy profit. “In the pipeline business, you’d have to make one or two decisions a year,” says one former Enron executive. “Everyone who operated in it was pretty much brain dead.”
It wasn’t until the 1970s that things began to change—or at least to change enough to attract the interest of a bright, shrewd, and intensely ambitious young man like Ken Lay. Far from being afraid of the coming changes, Lay wanted to push things along, to accelerate the pace of change. In later years, colleagues joked about his penchant for taking rapid action— any action—describing Lay’s management style as “Ready, fire, aim.”
A Baptist preacher’s son, Lay believed powerfully in the dogma of deregulation. He sermonized about the virtues of unshackling the gas industry, propelling it into a new, deregulated world, where the free market set prices. In this new world, surely, there would be winners and losers: those who had the skills to thrive in a deregulated universe and those who didn’t. From the start, he saw himself as one of the winners. He could envision taking control of a lowly pipeline company and transforming it into the first “gas major,” a company with the power, brains, resources, and global reach of the oil giants.
Lay usually expressed his preference for deregulation in ideological terms; his training as an economist had taught him that free markets simply worked better than markets controlled by the government, he liked to say. But he also believed that deregulation would create opportunities to make money—lots of money. And making money was terribly important to Ken Lay.
In later years, when Enron was at the peak of its powers, Lay was viewed as he’d always wanted the world to see him—as a Great Man. He was acclaimed as a business sage, a man of transcendent ideas who had harnessed change in an industry instinctively opposed to it. In the public face he presented, Lay seemed to care deeply about bettering the world. He spent much of his time on philanthropy: in Houston, he was the go-to man for charitable works, raising and giving away millions. He spoke often about corporate values. And he was openly religious. “Everyone knows that I personally have a very strict code of personal conduct that I live by,” he once told an interviewer for a religious magazine called The Door . “This code is based on Christian values.”
Lay was a hard man not to like. His deliberately modest midwestern manner—Lay made a point of personally serving drinks to subordinates along for the ride on Enron’s flagship jet—built a deep reservoir of goodwill among those who worked for him. A short, balding man with an endearing resemblance to Elmer Fudd, he remembered names, listened earnestly, and seemed to care about what you thought. He had a gift for calming tempers and defusing conflict.
But this style, soothing though it may have been, was not necessarily well suited to running a big corporation. Lay had the traits of a politician: he cared deeply about appearances, he wanted people to like him, and he avoided the sort of tough decisions that were certain to make others mad. His top executives—people like Jeff Skilling—understood this about him and viewed him with something akin to contempt. They knew that as long as they steered clear of a few sacred cows, they could do whatever they wanted and Lay would never say no. On the rare occasion when circumstances forced his hand, he’d let someone else take the heat or would throw money at a problem. For years, Lay seemed to float, statesmanlike, above the fray, removed from the tough day-to-day business of cracking heads in corporate America. Somehow, until Enron fell, Ken Lay never seemed to get his hands dirty.
A man of humble origins, Lay also became addicted to the trappings of corporate royalty. For years, he spent most of his time playing power broker. He traded personal notes with presidents, pulled strings in Washington, and hobnobbed with world leaders. Back in Houston, he was known as someone whose ring any aspiring politician needed to kiss. Indeed, there was talk he would someday run for mayor—if he didn’t accept a president’s call to serve in the cabinet instead. Some of that, unquestionably, came with the territory; some of it even benefited Enron. But it came at a big cost: over time, he lost touch with his company’s business.
Though few people complained about it before Enron fell, Lay’s behavior also betrayed a powerful sense of personal entitlement. Long after his annual compensation at Enron had climbed into the millions, Lay arranged to take out large personal loans from the company. He gave Enron jobs and contracts to his relatives. And Lay and his family used Enron’s fleet of corporate jets as if they owned them. On one occasion, a secretary sought to arrange a flight for an executive on Enron business only to be told that members of the Lay family had reserved three of the company’s planes.
At lunchtime, top Enron executives, who worked on the richly paneled fiftieth floor of the company’s headquarters tower in downtown Houston, routinely dispatched their assistants to fetch lunch so they could eat at their desks. Most ate their sandwiches on deli paper. Not Ken Lay. When his meal arrived, his staff carefully unwrapped it, placed the food on fine china, and served him lunch on a covered silver platter.
There was no fine china in Kenneth Lee Lay’s early life. He grew up dirt-poor. Indeed, the Enron chairman’s history is a classic Horatio Alger story. He was born in 1942 in Tyrone, Missouri, an agricultural dot on the map in the Ozarks. Before Lay became a business celebrity, the region’s most famous former resident was Emmett Kelly, the circus clown known as Weary Willie.
Lay portrays his childhood, spent largely in tiny farm towns with outhouses and dirt roads, in Norman Rockwellesque terms. But the Lays were always struggling—until he was 11 years old, Ken Lay had never lived in a house with indoor plumbing—and at a young age, he set his mind on finding his fortune.
His parents, Omer and Ruth Lay, had three children; he was the middle child, after Bonnie and before Sharon. For a time, the Lays owned a feed store. Then disaster wiped them out: the Lays’ deliveryman crashed a truck, slaughtering a load of chickens. Omer had to take to the road as a traveling stove salesman; the family followed from town to town, until they were finally forced to move in with in-laws on a farm in central Missouri. Omer, a Baptist lay preacher who held a succession of day jobs to feed the family, started selling farm equipment. Acutely conscious of the family circumstances, young Ken always worked: running paper routes, raising chickens, baling hay. “It’s hard for me not to think Ken was an adult when he was a child,” his sister Sharon said years later. The hardship honed Lay’s ambition. He later spoke of spending hours on a tractor, daydreaming about the world of commerce, “so different from the world in which I was living.”
Lay’s parents never made it past high school, but college transformed his life. The family eventually resettled in Columbia, Missouri, where all three children attended the University of Missouri. Omer worked as parts manager in a Buick dealership then as a security guard at the university library while preaching at a small Baptist church. Ken painted houses, earned scholarships, and took out loans to pay his way through school.
Lay was a devoted and stellar student, serious beyond his years, with a natural intellectual bent. He’d entered college planning to become a lawyer but became enraptured by the study of economics during an introductory class taught by a popular professor named Pinkney Walker. He discovered that theory and fresh ideas fascinated him. But his passion always had a pragmatic side. He cared about politics and public policy, how government could shape markets. “Ken was one of these 4.0 guys who had some street sense,” says Phil Prather, a Missouri classmate and lifelong friend. “Most 4.0 guys I know are a bunch of savants.”
Although Lay stood out for his brains, he was never the stereotypical egghead who spent every waking moment in the library. Though slight, low-key, and quiet—he struggled for years to overcome a mild stammer—he was popular as well. At Missouri he won election as president of Beta Theta Pi, the university’s largest and most successful fraternity. (Among Lay’s predecessors in the Missouri frat house: Wal-Mart founder Sam Walton.) Lay became an inveterate collector of relationships. At each major stop in his early life, he forged bonds that lasted for decades. These weren’t only personal acquaintances. Time and again, he would tap his growing network: for a job, for a favor, or to surround himself with those he trusted. This skill propelled his climb.
The first key relationship, in fact, was with Pinkney Walker. Walker was drawn by Lay’s brains and ambition and quickly became his mentor. “We just hit it off with each other from the first,” remembers Walker. “It was always inevitable that he would be a man of wealth.” After a lifetime of pinching pennies, Lay was eager to start making money. But after graduating Phi Beta Kappa in economics, he remained in school to get his master’s degree after Walker convinced him that he would be better off in the long run with a master’s on his résumé. Lay finished school in 1965.
For the next six years, Lay paid his dues: first in Houston, at Humble Oil (a forerunner to Exxon), where he worked as an economist and speechwriter while taking night classes toward his Ph.D., then in the navy, in which he enlisted in 1968, ahead of the Vietnam draft. Originally intended to become a shipboard supply officer, perhaps in the South China Sea, Lay was abruptly reassigned to the Pentagon. This assignment introduced him to Washington. Lay later attributed such critical turns in his life to divine intervention, but in this instance, there was no miracle involved: Pinkney Walker had pulled some strings for his protégé. Instead of putting in his tour of duty at sea, Lay spent it conducting studies on the military-procurement process. The work provided the basis for his doctoral thesis on how defense spending affects the economy. At night he taught graduate students in economics at George Washington University.
At each of these early stops, Lay received a taste of life at the top. At Humble, he wrote speeches for CEO Mike Wright; at the Pentagon, he recruited a high-level officer to provide support for his work as a lowly ensign.
By then Lay was a father of two. He was married to his college sweetheart, Judith Diane Ayers, the daughter of an FBI agent from Jefferson City, Missouri. They met in French class, and like so many others, Judie recalls being drawn by Ken’s “maturity and dependability.” Ken and Judie wed in the summer of 1966, after she completed her journalism degree. Ken was 24, Judie 22. Their children, Mark and Elizabeth, arrived in 1968 and 1971.
Before joining the navy, Lay had promised Exxon (the name had been changed from Humble) that he would return to the company. But once again, Pinkney Walker had other ideas. President Richard Nixon had just named Walker to the Federal Power Commission—then the agency regulating the energy business—and Walker wanted Lay as his top aide. The new commissioner placed a call to Exxon’s CEO, urging him to let Lay off the hook. “I made it clear to him he was making a friend,” says Walker.
Though Walker wound up staying only 18 months in Washington, it was long enough for his young deputy to make an impression. In October 1972, the Nixon White House tapped Lay for a new post as deputy undersecretary of energy in the Interior Department. He became one of the administration’s point men on energy policy. Lay’s new government position paid him a higher salary than was typical for such rank, thus requiring a special exemption from the U.S. Civil Service Commission. Interior Secretary Rogers Morton made the request. “The potential of an energy crisis is of immense proportion,” wrote Morton. Without the exemption, “the Department of the Interior cannot hope to attract a man of Dr. Lay’s stature and unique talents.” Lay was 30 years old.
What a time it was to be making energy policy for the United States! Or rather, what a time it should have been. In early 1973, shortly after Lay began his new job, the country suffered electrical brownouts and natural-gas shortages. Then came the Arab oil embargo. Pump prices soared, and people had to line up for blocks to get gasoline for their cars. Government officials warned Americans to curtail long vacation trips. After decades of consuming ever more energy, the country was in the midst of a full-fledged energy crisis. The president capped the year by announcing that because of the crisis, he wouldn’t light the national Christmas tree.
But the Interior Department’s new deputy undersecretary of energy wasn’t around long enough to effect policy. Concluding that the energy crisis was bound to mean big changes for the staid old pipeline industry, Lay decided the time was ripe to exit the government and head into the world of business. In September 1973, less than a year after he arrived at the Interior Department, Lay put out a feeler to W. J. (Jack) Bowen, CEO of a midsize pipeline company called Florida Gas, whom he’d met at a public hearing in his capacity as deputy undersecretary. “As you know, I have been involved in energy policy making in Washington for the past two and one-half years,” Lay wrote, using Interior Department stationery. “I feel it is now time I begin thinking about returning to the private sector and resuming my career in business. I would be most interested in being considered for possible job opportunities with Florida Gas Company. The natural gas industry, obviously, faces some very difficult challenges in the months and years ahead, and I would like to be in a position in industry to help meet these challenges.”
Bowen, a West Point graduate, met with Lay in Washington then brought him and Judie down for a visit to the company’s headquarters in the Orlando suburb of Winter Park. Bowen also personally called his references: Lay’s old boss at Exxon, a rear admiral in the Pentagon, and, of course, Pinkney Walker. Bowen took notes on their comments. “Never had a better man technically. Would like to have—tops!” declared the admiral. “Head’s screwed on straight,” said Walker. “Think a great deal of him. . . . Good worker. Very smart,” added the Exxon man, who went on to offer the only cautionary note: “Maybe too ambitious.” By year’s end, Lay was in Winter Park as vice president for corporate planning, with a starting salary of $38,000 a year plus 2,500 stock options.
Bowen left the next year for Transco Energy, a much bigger pipeline company in Houston. That only accelerated Lay’s rapid ascent. By 1976 he was president of the pipeline division at Florida Gas; by 1979, president of the entire company. For the first time in his life, Ken Lay was flush. He owned a $300,000 house, joined the Winter Park Racquet Club, and bought a beach condo on the Florida coast and a ski condo in Utah. In 1980 Lay made $268,000.
His marriage, however, was falling apart. The preacher’s son was carrying on an affair with his secretary, a divorced mother of three named Linda Phillips Herrold, who would become his second wife. Newspaper profiles later described Lay’s divorce as “amicable.” And indeed, in the years after his split, Lay established a remarkably cordial relationship with his first wife. Over the years, Lay even paid for Judie and their two kids to accompany him, Linda, and Linda’s children on family ski trips and cruises. When friends showed up for the Lays’ Christmas parties in Aspen, they were startled to discover both of his wives there, mixing amiably. Says one friend: “I was expecting to see Judie in Ken’s Christmas card.”
But if the aftermath was friendly—a testament to Lay’s ability to smooth over any conflict—the split itself was anything but. Lay began talking to Judie about separating in late 1980. About that time he called up his old boss, Transco chairman Jack Bowen, told him he had “domestic problems,” and asked if Bowen had a job for him in Houston. Once again, a key relationship Lay had forged paid off. Bowen, then 57, hired the 39-year-old Lay as Transco’s president—and his heir apparent. In late April 1981 Lay filed for divorce, requesting custody of his two children, just days before officially beginning his new job in Houston. About this time, Linda Herrold was also transferred to Florida Gas’s Houston office.
Judie responded in court papers that Ken was unfit to have custody. A few weeks later, Judie suffered what doctors later called a “psychotic episode” resulting from “manic-depressive illness.” She spent several months undergoing treatment at hospitals in Houston and North Carolina. At one point, at her doctors’ urging, Ken had signed legal papers to have his estranged wife involuntarily committed. The psychiatrists treating Judie concluded that the episode was triggered by the couple’s impending divorce. As one psychiatrist later testified in deposition: “The divorce or the thought of a divorce hit her very hard. ‘It was like dying,’ as she put it.”
By the end of 1981, Judie had recovered, and the year-long courtroom sparring resumed. As a court date loomed, her lawyers deposed Lay, Jack Bowen, and Bill Morgan, a University of Missouri frat brother Lay hired to work for him as an attorney at Florida Gas. The two sides finally signed settlement papers in June 1982, with the trial just a week away. Under the agreement, Judie would get primary custody of the children. Lay would make a lump-sum payment of $30,000 plus $500 a month in child support, alimony of $72,000 a year for four years, and $36,000 a year thereafter. (Lay later voluntarily increased his payments to Judie on five occasions—most recently in 1999, to $120,000 a year.)
A Florida Gas executive named John Wing—who later played a big role at Enron—served as the legal witness for Lay at the three-minute hearing in which the divorce was finalized. When it was over, Lay headed straight to the Orlando airport, where a Transco jet was waiting to fly him to Texas. Lay and Linda Herrold were married one month later in Houston.
Judie Lay, who still lives in Winter Park, credits her ex-husband for extending an olive branch. About three years after the divorce, she says, their children told her that Ken and Linda had invited them all to go skiing together for Christmas—and that he would pay for her hotel room. “We didn’t all sit down under the Christmas tree the first year,” she says. “It kind of gradually became more togetherness. The bad times sort of flowed away. We’re all good friends now. He’s treated me very nicely.”
It was at Transco that Ken Lay came to be widely regarded as a rising star. Unlike Florida Gas, Transco was a big-time company. It controlled a 10,000-mile pipeline system that provided almost all of New York City’s natural gas and served large portions of New Jersey and much of the Southeast. But it wasn’t just the size of the company that allowed Lay to shine; it was the condition of the pipeline industry. The business was in terrible shape.
One part of the nation’s energy crisis was a persistent shortage of natural gas; in some regions, schools and factories had been forced to close because the gas needed to heat them was in such short supply. Gas producers, not surprisingly, argued that the problem was that the government-mandated price was simply too low to encourage new exploration efforts. So in 1978 Congress hiked the regulated price that would be paid to producers (as exploration companies are called) for some types of natural gas. At the same time, though, Congress passed legislation barring the use of natural gas for any new industrial boilers. Thus the first law was intended to increase supply, while the second was intended to depress demand. Although this was hardly full-scale deregulation, it was the government’s first tentative step in that direction.
Unfortunately for the pipeline industry—and here was the great irony of the situation—the new rules worked far too well. Sure enough, the higher prices jump-started gas exploration and increased the nation’s supply of natural gas. But at the same time, demand for gas began dropping precipitously, not only because of government action but because as natural gas prices rose, many industrial customers switched to coal or fuel oil, which were suddenly cheaper. Over time, this put the pipeline companies in an impossible position.
Why? Because the pipelines, eager to protect themselves against future shortages, had started cutting long-term deals with individual producers to take virtually all the gas they could provide at the very moment when demand was dropping. The contracts they’d signed were called “take or pay,” meaning they were obliged to pay for the gas at the new higher rates even if they didn’t need it . Then, in the mid-1980s, the government made a bad situation even worse when it took its next small step toward deregulation: it freed utilities and industrial customers from their contracts to buy from the pipelines, allowing them to shop for better prices on the open market or turn to cheaper fuels.
But the government refused to let the pipelines out of their expensive take-or-pay commitments. This put pipeline companies between a rock and a hard place: stuck with huge volumes of gas at prices they could no longer pass on to customers. As a result, many of the companies became technically insolvent, and a few went bankrupt. Some form of relief was obviously needed—from Washington, the gas producers, or the courts. Over time, the companies pursued all three avenues: lobbying, negotiating, and litigating. Orchestrating it all took years and proved expensive. It wasn’t until the late 1980s and early 1990s that the crisis finally ended and the natural-gas business, including the pipeline industry, was largely deregulated.
But though the beginning of this crisis was bad for the industry, it was certainly good for Ken Lay. With his Ph.D. in economics, his Washington experience, and his long advocacy of deregulation, Lay seemed like just the right man for the new age. With the industry in paralysis, he began helping Transco work through its take-or-pay problem by setting up a fledgling spot market for natural gas, where producers who let Transco out of its take-or-pay obligation could sell directly to their customers, paying Transco just to move the gas. Thoughtful and articulate, Lay was in demand at industry conferences and Capitol Hill hearings. “Ken isn’t bound by tradition,” declared John Sawhill, head of the global energy practice for the consulting firm, McKinsey & Company. Even Wall Street viewed him as a major asset. The Houston Chronicle wrote in 1983, “Some analysts attribute the strength of Transco’s stock price to Lay’s credibility and his bold and unique accomplishments.”
If Lay had stayed at Transco, he probably would have become CEO in 1989, when Bowen planned to retire. But as it turned out, he didn’t have to wait nearly that long to become a chief executive. In the summer of 1984, opportunity came knocking, and he eagerly answered the call. It came in the form of a meeting with a man named John Duncan, who had helped put together the old conglomerate Gulf & Western, and was a key board member of a midsize pipeline company called Houston Natural Gas (HNG).
Lay and Duncan had gotten to know each other a few months earlier, when HNG had been trying to repel a takeover attempt by a corporate raider and Transco had offered to act as a white knight—a friendly alternative acquirer. Ultimately, Transco’s help wasn’t needed, but Lay had clearly made an impression. In their meeting, which took place over breakfast on a Saturday morning, Duncan popped the question: would Lay consider becoming CEO of HNG? He didn’t require a lot of convincing. “By Sunday morning,” Lay later recalled, “it was sounding kind of interesting.”
Houston Natural Gas had a special place in the city. Though smaller than many local rivals—annual revenues were $3 billion—it had for years assumed the role of the “hometown oil company.” Part of that was its heritage: the company dated back to 1926, and it had long been the prime gas supplier to the huge industrial plants on the Texas coast. Part of it was due to Robert Herring, its longtime chairman, who was active in every important civic project and charitable event in town. Herring’s wife, Joanne, was an international socialite, and the couple’s home in exclusive River Oaks—one of America’s wealthiest neighborhoods—became Houston’s preeminent salon, a place where oilmen mixed with international royalty. Herring had died of cancer in October 1981; HNG, though still profitable, hadn’t been quite the same since. His successor, 60-year-old M. D. Matthews, was a nondescript caretaker type. Even after the takeover attempt was repulsed, HNG’s modest debt made it a juicy target for corporate raiders. And the takeover battle had left the HNG board convinced that it needed stronger leadership.
On Monday, Lay won Jack Bowen’s blessing for his departure, and in June 1984, at the age of 42, Ken Lay became chairman and chief executive officer of Houston Natural Gas. After her husband assumed his big new job, Linda Lay exulted to a friend: “It’s fun to be the king.” HNG would serve as the foundation for building Enron.
From the moment he walked in the door, Lay operated on one theory: get big fast. His core belief, as ever, was that deregulation— real deregulation—was coming soon. And when it did, he believed, the price of the commodity would reflect true market demand and the companies with the best pipeline networks would be the ones calling the shots. In just his first six months, Lay spent $1.2 billion on two pricey acquisitions that dramatically extended HNG’s pipeline system into the growth markets of California and Florida. (The Florida pipeline had been owned by Lay’s old company, Florida Gas.) He even talked to his old friend, Jack Bowen, about a deal with Transco. At the same time he unloaded $625 million in holdings outside the core pipeline business, including coal-mining properties and a fleet of barges.
Then came a bit of luck. In April 1985 Lay got a call out of the blue from a man named Sam Segnar, the CEO of InterNorth, a big Omaha pipeline company. Because Lay was in Europe at the time courting investors, John Wing, his old deputy from Florida Gas—who had just hired on as HNG’s chief strategy officer—handled the call. Segnar wanted to pitch the idea of InterNorth’s buying HNG. But it quickly became apparent that Segnar was too eager for his own good.
InterNorth, three times the size of HNG, had long been one of the most respected operators in the pipeline business. Among its 20,000 miles of pipeline was a genuine prize: Northern Natural, the major north-south line feeding gas from Texas into Iowa, Minnesota, and much of the rest of the Midwest. For decades, InterNorth had assumed a role in Omaha much like that of HNG in Houston. It was the caretaker of civic causes—the number one corporate citizen. Like HNG it had been run for years by a beloved figure, Bill Strauss. Under Strauss, InterNorth was a quiet, steady company with low debt and terrific cash flow that paid executives modest salaries and carefully watched expenses.
But in 1981 Strauss had turned the company over to Segnar, a charmless personality who upset many in frugal Omaha with a series of ham-handed moves. He purchased a company jet, bought a corporate ranch in Colorado, and closed the fifteenth-floor corporate dining room to all but a few top executives, who were served by white-gloved waiters. Worst of all, Segnar made a string of bad diversification investments. InterNorth was also powerfully motivated by the fact that Irwin Jacobs, a corporate raider, was buying up its shares. Jacobs’s looming presence sent Segnar into a panic. He persuaded the board that the only way to make InterNorth “sharkproof” was to make the company bigger and dramatically increase its debt. Buying HNG would accomplish both goals.
Lay and Segnar turned over negotiations to Wing and Rocco LoChiano, Segnar’s top deputy. They met at the St. Regis Hotel in Houston and quickly started talking price. At the time, HNG was trading at about $45 per share. LoChiano figured HNG was worth perhaps $60, $65 tops. But Wing, a canny negotiator, took advantage of InterNorth’s desperation to strike a deal, and quickly brought the price up to $70 a share. And that wasn’t all. Wing demanded that the smaller company’s younger management team ultimately end up in charge. Amazingly, LoChiano and Segnar agreed: Lay would replace Segnar, then 57, as CEO and chairman of the combined company after just 18 months. “I think I get this,” LoChiano told Wing over a cup of coffee. “We’re the rich old ugly guy with all the money, and you’re the good-looking blonde.” Wing laughed. “Yeah, that’s right,” he replied.
Just 11 days after the first phone call, the two CEOs won approval for the $2.3-billion deal from their respective boards. From a business standpoint, HNG InterNorth, as it was called, seemed an elegant combination: with 37,500 miles of pipeline, the new $12 billion company would have the largest gas-distribution system in the country, running from border to border, coast to coast. It would have access to the three fastest growing gas markets: California, Texas, and Florida. And it had some $5 billion in debt, surely more than enough to put it safely beyond the reach of raiders like Irwin Jacobs. As for Ken Lay, he wound up with a personal windfall: a $3 million profit from converting his stock and options in the wake of the merger.
Mergers that sound good on paper often wind up facing a far harsher reality. Such was the case with HNG InterNorth. There were two fundamental issues. The first was that almost immediately after the transaction closed, the InterNorth directors came down with a bad case of buyer’s remorse. As the implications of the deal sunk in, they began to realize that even though their company was the acquirer, they had pretty much given away the store to the Texans. Why, they now wondered, did HNG come before InterNorth in the new name when InterNorth had been the acquirer? Why was Segnar so quick to agree to give the CEO job to Lay in 18 months? Did it have anything to do with promises of a fat severance package? (Segnar ended up walking away with $2 million.) Why did HNG have almost as many seats (8) on the new board as InterNorth (12)? The more they thought about how they’d been snookered, the madder they got, but they were far angrier at their man, Segnar, than at Ken Lay, whose company had done the snookering.
Among the old-line InterNorth directors, the biggest fear of all was that the Texans were planning to move the company’s headquarters to Houston, even though everyone concerned, including Lay, had repeatedly promised that the company would remain in Omaha “for the forseeable future.” This wasn’t just a matter of jobs (though 2,200 were at stake); it was also a question of civic pride. It quickly became evident that the promises really weren’t worth much. Houston, after all, was the center of the U.S. energy business. Once the merger went through, the issue became so heated that the board created a special committee to study the matter. The committee retained the management-consulting firm, McKinsey & Company, to make a recommendation.
The McKinsey consultants, who included Lay’s old friend John Sawhill and a young partner named Jeff Skilling, were scheduled to unveil their recommendation to the board on November 11, 1985, a frosty day in Omaha, at the Marriott Hotel. They were indeed going to advise the company to move to Houston. But the meeting quickly took a different turn, and the consultants were told to wait outside. Hours later, Segnar stepped out of the board meeting with tears in his eyes. He shook Sawhill’s hand. “I’m leaving InterNorth,” he told the consultant.
Afterward, all parties claimed that Segnar had voluntarily resigned. In truth, the meeting had been a bloodbath, and he hadn’t really had a choice. Convinced that Segnar had made a series of secret side deals with Lay to betray Omaha, the old InterNorth directors demanded his head. Of course, since the board didn’t have another CEO candidate, it also meant that Ken Lay would become chief executive immediately, instead of having to wait the agreed-upon 18 months.
As a counterweight to Lay, the board brought back Bill Strauss as nonexecutive chairman and some even tried to mount a bid to reclaim the company for the River City. But the effort quickly fizzled when Strauss refused to lead the charge and quit after just four months, giving Lay the chairman’s title, too. It wouldn’t have succeeded in any case, for Lay had quietly won control of the board. A father-son pair of old InterNorth directors, Arthur and Robert Belfer, had lined up behind Lay. Two new directors, appointed after the merger by agreement between both sides, also turned out to be Texas partisans.
Over the next three years, the Omaha bloc was purged, and Lay started packing the board with his own directors, including a powerful Washington lobbyist named Charls Walker—Pinkney Walker’s brother—and an old Pentagon friend named Herbert (Pug) Winokur. John Duncan, the HNG director who had hired Lay, became head of the executive committee. And the corporate headquarters? The directors resolved to split the difference, maintaining an executive headquarters in Omaha and an operating headquarters in Houston. But that arrangement obviously couldn’t last long, and it didn’t. In July 1986 Lay announced that the company’s corporate headquarters would relocate to Houston, to a silver-skinned downtown skyscraper at 1400 Smith Street.
In Omaha, this decision was bitterly resented for years to come.
There was a second issue looming, of far more consequence than the question of where to put the company’s headquarters. It was this: all the good things Ken Lay assumed would happen once the HNG-InterNorth merger took place simply weren’t happening. For the moment, Lay’s get big fast strategy was only bringing bigger problems.
Irwin Jacobs? Even though the new company was now drowning in debt, the raider and an investor group allied with him still wouldn’t go away. Lay wound up having to shell out about $350 million—a modest premium to the market price—to buy out the group’s 16.5 percent stake. There wasn’t enough cash in the corporate coffers to pay the greenmail, so Lay had to tap the company’s pension plan for the money.
Deregulation? All of a sudden, there was a glut of gas on the market, prompting prices to plunge to levels no one had ever imagined. That only multiplied the company’s take-or-pay problem. Lay’s new business had more than $1 billion in take-or-pay liabilities.
Lay seemed unable to assemble a coherent management team amid bitter political infighting involving not just the old HNG and InterNorth executives but also the pipeline businesses he’d acquired the year before and a handful of well-paid friends that Lay had hired from outside.
Lay even ran into trouble coming up with a trendy new name for the company. After four months of research, the New York consulting firm Lay had hired had settled on Enteron in time for the merged business’s first annual meeting, in the spring of 1986. But then the Wall Street Journal reported that Enteron was a term for the alimentary canal (the digestive tract), turning the name into a laughingstock. Though it meant reprinting 75,000 covers that had already been printed for the new annual report, the board convened an emergency meeting and went with a runner-up on the list: Enron.
Oh, and just for good measure, Lay had to battle the government of Peru, which nationalized the company’s Peruvian production assets just a month after he’d become CEO. That alone produced a $218 million charge to earnings.
In early 1986 Enron reported a loss of $14 million for its first year. Lay announced a series of cost-cutting measures and job cuts. He froze pay for top executives and started selling off assets to cut debt, including 50 percent of the Florida pipeline he purchased just two years earlier.
Enron’s financial situation had grown so dire that by January 1987 Moody’s had downgraded its credit rating to junk status. One former executive recalls that during this period there was even worry about meeting payroll. “The company was in deep shit,” Bruce Stram, then vice president of corporate planning, says.
What Ken Lay and Enron desperately needed was a fresh source of profits—while there was still time.