Warren Buffett Calls His Investment in Dallas-Based Energy Future Holdings a "Big Mistake," At Risk of Being Wiped Out

Categories: Biz

buffet.jpg
Warren Buffett, the inimitable Jesus of Investing, got it wrong, he admits. Investing in the highly leveraged buyout of Texas utility TXU by Kohlberg Kravis Roberts and Goldman Sachs was a bad bet, plain and simple, he told his shareholders in a letter Saturday. And if things at the former TXU (now Energy Future Holdings) don't turn around, the most revered investor in the world warns there's a good chance his entire $2 billion investment will be "wiped out."

Moody's never liked the deal to begin with. Private equity and the single biggest purveyor of electricity in Texas -- which is a "commodity" we can't do without -- made for extremely awkward bedfellows, the investors service pointed out. Not to mention the fact that they bet on the high price of an historically volatile commodity in natural gas. In Texas's deregulated market, it happens to set the marginal price of electricity.

When it was soaring high at $13 per million British Thermal Units, TXU's fleet of coal-fired power plants could generate electricity at a cost that was a fraction of the wholesale price. A honey of an investment, for sure, until gas prices tanked shortly after the purchase, and the renamed generation (Luminant), transmission (Oncor) and retail (TXU Energy) arms of Energy Future Holdings struggled to service a mountain of merger debt.

Now, in his jocular, sporting parlance, Buffett's mea culpa comes at a time when investors' held stock in Energy Future has negative equity in the billions. "We wrote down our investment by $1 billion in 2010 and by an additional $390 million last year," Buffett wrote. You read that right. He wrote down his $2 billion investment by that much.

"If gas prices remain at present levels, we will likely face a further loss," he continued, "perhaps in an amount that will virtually wipe out our current carrying value. ...However things turn out, I totally miscalculated the gain/loss probabilities when I purchased the bonds. In tennis parlance, this was a major unforced error by your chairman."

Of course, Buffett's Berkshire Hathaway will survive. Two billion isn't pocket change, but it won't break him either. Energy Future Holdings -- the biggest generator of electricity in Texas -- on the other hand, needs a miracle. They've pushed the maturities on a substantial amount of their merger debt, but unless natural gas prices rise (and soon) it may only be a matter of time before they default. What happens after that is anyone's guess.

My Voice Nation Help
41 comments
Sparky
Sparky

One of the more intelligent series of comments I've read on Unfair Park. 

Now, I'll add, none of this would have happened had Rick Perry and the Texas Legislature refused to allow the deregulation of our electrical grid.  What happens when TXU falls?  What happens when any privately held generator /utility falls?  Private equity groups don't invest for the good of the people. As a public utility, if more plants are needed, they're built.  Now our system is falling into disrepair because maintaining it as it should be done isn't profitable to it's owners.

This is why public utilities need to be publicly held.  Period.

Informed Dallas
Informed Dallas

Brantley, 

Why are we on the Buffett bash wagon. Isn't the local/better story the guys who put this together and then cashed in/out on the deal.  Pull the original documents and track the DCAD upgrades to their mansions and put a microphone in their face.  Do you think the guys who came up with the idea and made the money will express the same humility as WB?  I doubt it...

You're just scratching the surface. 

What's next? 

Alfredo
Alfredo

I hope everybody also caught his comments yesterday that the banks were victimized by ousted homeowners, foreclosed homeowners.  His company has major stakes in Wells Fargo and Bank of America

Warren Buffett

Warren Buffett, who controls thebiggest shareholding of the No. 1 U.S. mortgage lender, said banks were victimized by some homeowners who refinanced their loans before getting evicted. “Large numbers of people who have ‘lost’ their house through foreclosure have actually realized a profit because they carried out refinancings earlier that gave them cash in excess of their cost,” Buffett, chairman and chief executive officer of Berkshire Hathaway Inc. (BRK/A), said Feb. 25 in his annual letter.“In these cases, the evicted homeowner was the winner, and the victim was the lender.” Foreclosures have claimed about 5 million homes since theproperty market began its slide in 2006. That has saddled lenders like Bank of America Corp. with defaults, vacated properties and lawsuits. Berkshire, whose stake in Wells Fargo & Co. (WFC), the largest U.S. mortgage lender, is valued at more than $11 billion, invested $5 billion in Bank of America last year. “It’s the mercenary side of Buffett,” said Jeff Matthews, a Berkshire shareholder and author of “Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett.” “Rationally, it’s an interesting observation. But it ignores the huge human-cost side of the equation.” Buffett, who publicly defended Goldman Sachs Group Inc. in 2010 against accusations it misled clients, used the letter to renew his support for banks. The industry is facing criticism from Democrats including President Barack Obama, who in his January State of the Union address said bets by lenders prompted the 2008 credit freeze and “left innocent, hard-working Americans holding the bag.” ‘Enough With the Lambasting’ Buffett, an ally of Obama’s, has won praise from Democratic lawmakers as the billionaire campaigned for higher taxes on the wealthy. Omaha, Nebraska-based Berkshire owns warrants to purchase $5 billion of stock in New York-based Goldman Sachs. “Maybe this was kind of a message to his Democratic buddies,” said David Rolfe, chief investment officer of Berkshire shareholder Wedgewood Partners Inc. “Buffett is saying, ‘We know where the egregious acts were, so enough with the lambasting of the banking system and all these bankers.’” Blame for the housing bubble and subsequent slump should be shared among lenders and borrowers, as well as the government, bond-rating firms and the media, Buffett has said. In his letter, read by investors around the world, Buffett praisedJamie Dimon, CEO of JPMorgan Chase & Co., and Bank of America’sBrian T. Moynihan. JPMorgan, Goldman Sachs, Wells Fargo and Bank of America have all repaid U.S. bailout funds. “The banking industry is back on its feet,” Buffett said. ‘Megalomania, Insanity’ Buffett and Berkshire Vice Chairman Charles Munger, 88, have criticized bankers for contributing to the housing bubble. Munger, in July, blamed the real-estate boom on “megalomania, insanity and evil in, I would say, investment banking, mortgage banking.” Buffett said in October 2010 that Wall Street helps society through finance, while its bets may do harm, “like a church that’s running raffles on the weekend.” Charles Ortel, managing director of Newport Value Partners, said lenders failed to do sufficient underwriting because they counted on selling the mortgages to investors. “So nobody had any skin in the game, except we the taxpayers, as it turned out,” Ortel said. “Banks didn’t do the required credit work.” Wells Fargo posted record profit for the fourth quarter as mortgage financing improved, the San Francisco-based company said last month. Charlotte, North Carolina-based Bank of America has gained 42 percent this year in New York through Feb. 24 as it swung to a quarterly profit. “Wells Fargo is prospering,” Buffett said. “At Bank of America, some huge mistakes were made by prior management. Brian Moynihan has made excellent progress in cleaning these up.

Bob
Bob

I remember when the buyout was proposed that James Baker III (former WH chief of Staff and U.S. Treasury Sec.) was front and center. Where did he go?

Max from the Sandspit
Max from the Sandspit

The Oracal from Omaha is taking one for the team or rather his investors are. That would be Team Green, the dodering ol' fool been suckin' hind tit for a decade. But not to worry he, his kids and secretary are doing just fine and so are thier 501 (c) 3+4 tax dodges. So is former mayor Ron Kirk and the Environmental Defense Fund, meanwhile the peanut gallery will be forced to deal with brown outs and rolling blackouts for the forseeably future. Gasbaggers rejoice, this was y'all's goal in the breakup of TXU, y'all win, we're screwed.   

1800PetMeds Coupons
1800PetMeds Coupons

 Buffett's philosophy on business investing is a modification of the value investing approach of his mentor Benjamin Graham. Graham bought companies because they were cheap compared with their intrinsic value.

Paul
Paul

Warren Buffet has not made very many mistakes in his career.  When he does, people do sit up and take notice.

I am surprised to hear that he bought into this one as his investment is about 5% of the total deal and that the profitability was based on marginal price for natural gas.

Montemalone
Montemalone

"...TXU's fleet of coal-fired power plants could sell electricity for a fraction of what it cost to generate"

I don't think that's what you meant, but it is apparently now true.

Jay
Jay

I can only smile when Buffett other bankers whine about consumers defaulting on mortgage loans, loans which any bank underwriter, exercising just a small degree of due diligence or common sense, should have known would never be repaid. As Buffett should know, from about 1998 until 2008, banks didn't loan money based on the value of the collateral, or a borrower's qualifications and income, they made loans because loans  generated massive up front fees for the bank, then they made even more money by selling the loans to Wall Street, hopefully before the borrowers went into default. I suppose if Warren actually loses $2 billion this year on EFH, his effective tax rate may slip below 14% after deducting his losses.

Max from the Sandspit
Max from the Sandspit

He's in Houston regretting he ever got involved with Big Green. His name is on the door, but he ain't been runnin' the show for several years, word is he ain't happy but he's too old to do much of anything about it.

janet9413
janet9413

The breakup of TXU means that Buffett is going to buy up all the pieces at a big disount in a bankruptcy auction.

scottindallas
scottindallas

I appreciate his admitting to his mistake and his analysis of why.  This puts him lightyears ahead of other high profile investors who seem to deny and double down.  I often wonder about these people's true positions.  I suspect that they are bailing out of markets that they are touting--see gold and precious metals.  If there is a sovereign debt crisis, the price of gold will likely fall, as austerity creates DEflation, not inflation.  Gold is zero hedge against deflation and of course pays no dividend.  If you ain't already there, get into dividend paying stocks that are in competitive markets, this means they are less able to fudge their books.  Utilities rely on gov't associations.  I dare suggest that our current deficit crisis portends a re-analysis of these private public relations.  

janet9413
janet9413

TXU has been trying to buy back or exchange Buffett's portion of the bonds (at a discount) for the last 2 years now.  Buffett would have lost less money with the debt exchange, but Buffett is not interested, why?

Buffett intends to keep the bonds until all hell breaks loose, forces a bankruptcy proceeding, and picks up the whole TXU on the cheap in a bankruptcy auction.

janet9413
janet9413

Actions speak louder than words.

Buffett could have exchanged his bonds for 70 cents on the dollar a couple of years ago --- he didn't.  He could have exchanged his bonds for 50 cents on the dollar last year --- he didn't.

Buffett is holding ALL the cards right now as he owns about 1/2 of all the bonds that will mature in the crucial 2015/2016 period --- he has enough "votes" to declare TXU in default and forces a bankruptcy auction.  He bought Burlington Northern for $34 billion + $11 debt = $45 billion.  KKR took TXU private for $45 billion.  Buffett can afford to buy TXU in a bankruptcy auction.

If KKR offers to exchange those bonds for 99 cents on the dollar --- Buffett won't even accept that.  KKR either has to pay back 100 cents on the dollar or KKR gets completely screwed in a bankruptcy auction in which KKR will end up with nothing.

Brantley Hargrove
Brantley Hargrove

 So environmentalists are responsible for KKR's highly leveraged purchase of TXU, which subsequently wasn't such a good idea when the high gas prices they anticipated were anything but? How imaginative!

Paul
Paul

 TXU has been trying to buy back or buy down everybody's bond or loan ...

And KKR and TPG keep collecting their management fee ...

Anon
Anon

If/when TXU goes bankrupt (it's pretty much inevitable at this point), it will have little to do with Buffett's unwillingness to be repaid less than he is owed, and everything to do with the massive amounts of debt that were placed on the company in the take-private. Buffett may choose owning the company as the ultimate path to recovery here, but I doubt it. He typically does not invest in utilities for his equity portfolio.

scottindallas
scottindallas

 what do you know?

 Great stuff Janet, thanks for the thoughts and figures. 

scottindallas
scottindallas

 there's no way anyone can imagine TXU can pay what they owe. 

janet9413
janet9413

I think what is likely going to happen is that TXU will try to get other 2015/2016 bond holders to exchange/extend their bonds at a big discount.  Then after that TXU will have to sell 80% of Oncor that they owned (which TXU is not allowed to sell until the end of 2012) and use that money to pay Buffett back 100 cents on the dollar.

Buffett bought $1.1 billion 2015 bonds --- there are about $3 billion outstanding, so Buffett owns about 1/3 of the 2015 bonds. Buffett also bought $1 billion 2016 bonds --- they are pay-in-kind bonds (interest payments are paid by giving Buffett more bonds). So Buffett now owns something like $1.5-$1.6 billion 2016 bonds --- which is something like 90% of the 2016 bonds outstanding.

I don't think Buffett is actively trying to force bankruptcy. If anyone is going to actively force a bankruptcy, I think it will be the distressed debt investors like Aurelius who understands that there may be a Buffett play down the road.

janet9413
janet9413

Of course, there are always a chance like TXU trying to move money around, trip up something --- like TXU did 2 years ago.  A distressed debt investor cried default in 2010 and the rest of the lenders (in exchange for some additional money up front) --- voted that TXU didn't default.

No such thing can happen in 2015/2016 because of Buffett's large holdings in the 2015/2016 bonds.

Anon
Anon

in which case, almost any bondholder has the right to declare a default and put the company in bankruptcy. it's not a special right that Buffett has on account of his large position.

Brantley Hargrove
Brantley Hargrove

 This is a pretty fascinating discussion. I know Aurelius tried to declare EFH in default over those inter-company loans. Clearly, they're small potatoes compared to Buffett, and there endgame is different. What do you think will be the tripwire for Buffett to force the company into default?

janet9413
janet9413

TXU doesn't have to trip anything.  The mere fact that TXU can't pay back the principal in 2015/2016 will be enough to get the default.

I don't really care about KKR.

All I am saying is that Buffett is in the energy business in a big way (via MidAmerican Energy), has a history of buying businesses in bankruptcy auctions (Fruit of the Loom) and expertly uses his folksy image.

Buffett could have sold his TXU bonds after declaring that he made a massive mistake. He declared his other massive mistake in ConocoPhillips and then sold much of that stock holding at a loss. But why did he not sell/exchange his TXU bonds?

Anon
Anon

he can't declare them to be in default unless they trip something from the bond indenture. as a practical matter, unless they default on another piece of debt or stop paying him, that won't happen. I'm not sure why you care how much KKR loses on this deal. they proved they were the dumb money this time around. 

Max from the Sandspit
Max from the Sandspit

Kid you obviously don't know much about Henry Kravis. It was presented to him as a hit job and jumped at the chance, he's already churned and burned his way through it and is now laughing his ass off in his penthouse in NYC. The presenter was Ron Kirk, your former Mayor who fled to Houston and is now trade crackhead for the Chosen One. You wanna educate yourself get a hold of Sam Gwynne, he writes for Texas Monthly.   If you think EDF and Nature Conservancy didn't set this up, you've been conned or are delusional or both. You also might wanna checkout Aubry McLendon's role in this with the Sierra Club, like 25 million out of his own ass pocket. The games been rigged by those that know how to play it, Shrub II called them on it in 08' that's why nat gas dumped from 14 bucks an mcf to 7 bucks in a matter of weeks in the Summer of 08'.

scottindallas
scottindallas

From ERCOT, they worked 8% of the time.  That's not reliable enough to do a damned thing.  Those things actually DRAW energy when the wind is really low, cause they need to keep turning lest they warp.  They aren't pollution free, and are quite expensive for what they deliver.  Beyond that, they need total backup supply that can be intermittently turned on and off.  

Brantley Hargrove
Brantley Hargrove

That ain't how it went down. TPG approached EDF first. If anything, I'd bet KKR used EDF as a patsy to greenwash its reputation. I wouldn't assume that KKR, or even TXU, ever really planned to follow through on building those 11 new plants. I don't believe it for a second. For KKR in particular, spending all that money on new plants would run counter to the private equity model. You also seem to imply that these shrewd private equity guys got duped by a bunch of environmentalists, which just sounds absurd to me. Like they'd ever do anything for altruistic reasons.

Max from the Sandspit
Max from the Sandspit

Kid- Big Green recruited KKR through EDF, they did so cuz Earl Nye was granted fast track for some new coal fired plants to meet projected demand. They also were gonna retrofit Big Brown and run sweet low sulfer coal from Powder River. The next gen plants would run on lignite. Big Green went berzerk, where the hell were you, in kindergarden.  

Brantley Hargrove
Brantley Hargrove

Coastal wind turbines played a major role in supplementing the grid during that hellacious summer, especially during times of peak demand. I don't think it's fair to call it a wash. 

scottindallas
scottindallas

 Greenwashing certainly has a role Brantley.  We have spent $7.8 billion on windmills all for energy generation 8% of the time, and zero during our hottest Summer months.  For that money, we could have replaced the dirtiest coal plants with newer, cleaner, more efficient gas plants.  Much of that money went to subsidize T. Boone Pickens greenwashing initiative.  We need to be less focused on "green" and more focused on Cost Benefit Analysis, and due diligence.  Again, I am an Organic Gardener by trade.  I honestly do more day in and out than blind advocates like you will ever do.  Unless, you get down into the nitty gritty and we get hard, unbiased analysis of the effectiveness of various programs.  We don't have unlimited budgets, and we need to learn what moves, in that scarcity will return the greatest benefit.  I appreciate your story.  You got it right, and it deserves elaboration without regard to Buffett.  The debt incurred to purchase TXU is a looming mystery, and doesn't augur well for Texans.  I mean to encourage you, to develop a more jaundiced eye, and to keep up the good work.  (we know one good way to develop jaundice, hit the bottle baby)

Anon
Anon

which is why I'd never buy equity in a PE firm. I'd love to see the assumptions they showed the accountants so that they'd sign off on that valuation. 

janet9413
janet9413

KKR still value their TXU equity at 10 cents on the dollar.

Anon
Anon

the equity sponsors will be left with nothing in this deal regardless of what Buffett does. they overspent on a business with borrowed money and lost. sorry.

janet9413
janet9413

Notice that Buffett ain't exchanging the bonds.

Buffett bought Burlington Northern for $34 billion + $11 billion debt (for a total of $45 billion).  That is the same dollar amount that TXU was taken private.  So he can afford to buy TXU out of a bankruptcy auction with a big discount.

So it comes to this --- either KKR/TPG/Goldman Sachs have to pay back Buffett every single cent on those bonds OR Buffett forces a bankruptcy auction in which he buys TXU on the cheap and leave  KKR/TPG/Goldman Sachs with nothing.

Duckiepooo
Duckiepooo

This is true, but TXU is not a "wires" company.  Luminant has far more protection than TXU and TXU can easily fail as Texas is de-regulated.  TXU is nothing more than a retailer like a kohl's or target.  If they go bankrupt it means nothing.  Oncor is 100% protected and they actually have solid business ratings as they are ring-fenced and they are the only company out of the 3 that is churning a profit.  I'm not sure about Luminant's future though.

scottindallas
scottindallas

to perhaps bolster your point, a utility has certain immunities from some actions.  A bank can't simply shut one down, "sorry Texas."  This could roll out in any number of ways, and I bet the tax payer/consumer will get the brunt of it.   

janet9413
janet9413

The banks have limited choice simply because there aren't many players who can swallow up TXU whole.  So if Exelon or NextEra want to buy TXU (each have market cap of $25 billion), they will have difficulty in buying a TXU minus Oncor for $25 billion.  Either the banks have to lend them the money to buy TXU or the banks have to accept the fact that they have to become a post-bankruptcy TXU shareholder.  

Then of course, you have to get regulatory approvals to buy TXU.  The Texas regulators already have eggs on their face with the original TXU deal that is blowing up.  What are the chances of say Exelon getting regulatory approval when Exelon is too small to eat the whole TXU --- and they would have to borrow so much money to buy TXU that we may see a TXU 2.0 bankruptcy auction.

So from the banks' point of view, Buffett is giving them pure cash, no financing requirement and pretty sure bet to get regulatory approval to buy TXU.

Anon
Anon

You still haven't given me a single reason that Buffett should agree to accept less than he is owed. Voluntary debt exchanges are, by definition, voluntary. The company's current owners hope that its lenders will agree to accept less than face but no one is obliged to do so, and frankly, I don't understand why anyone should be made to feel guilty that they aren't trying to help the equity preserve their option value. They made a horrible, horrible play, and they should be forced to go to their investors and let them know that sometimes they blow billions of dollars on behalf of others.As for the bank debt covenants, I am well aware of them. They're standard clauses in bank loans. And the bank debt on this deal trades in the 60s, so if Buffett thinks he is going to snag the equity in this deal through his bond position, he might have some undersecured lenders to fight.

janet9413
janet9413

You do realize that Berkshire Hathaway's utility subsidiary (MidAmerican Energy) generates more electricity than TXU.  In the middle of the 2008 financial crisis, Berkshire Hathaway tried to buy Constellation Energy for about $5 billion as well.  Also Buffett has a history of buying companies in a banckruptcy auction (Fruit of the Loom).

Warren Buffett owns about 1/2 of the bonds that matures in 2015/2016 --- he has enough "vote" to declare a default of said bonds.  TXU managed to postpone about $17 billion in bank debt that matures in 2014 to 2017.  But here is the kicker in the fine print of the bank debt extension --- the $17 billion bank debt that is supposed to mature in 2017 will spring back to mature in 2015 if (1) the Buffett bonds are not dealt with and (2) certain loan ratios in the covenants are not met.

The Oncor division is ring-fenced so they are not going to be dragged into bankruptcy.  But for the rest of the company, in a bankruptcy auction where banks prefers to get the cash up front (i.e. the banks don't want to get shares that they can't sell right away).   Buffett can pay say all secured debt for 70 cents on the dollar and all unsecured debt (that includes 2015/2016 bonds Buffett holds) for 10 cents on the dollar --- he can pick up TXU minus Oncor for about $20-25 billion.

Buffett doesn't care about recovering a mere $2 billion when he has a chance to buy a big elephant on the cheap. So what if he loses 90 cents on the dollar for those bonds, when he can buy a $30 billion business for $25 billion in a bankruptcy auction. He will make $3 billion on the first day he owns TXU.

Now Trending

Dallas Concert Tickets

From the Vault

 

General

Loading...