So There's a Good Chance Energy Future, Texas' Largest Power Generator, Goes Broke

Categories: Biz

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Peter Ryan
A major credit-rating agency is expressing grave doubts about the ability of the state's largest nonregulated power generator to pay off its debt.

Energy Future Holdings, the Dallas-based parent company of power generator Luminant, transmission company Oncor and retail electricity provider TXU Energy, has been downgraded to a CC rating by Fitch Ratings, a long-term credit rating agency.

A "CCC" rating means Fitch believes there is "a real possibility" that EFH will not be able to pay its debts. The "CC" rating it bestowed upon the company Tuesday, however, means that "default of some kind appears probable at some point in the future." A spokesman for Energy Future declined to comment.

As detailed in a recent cover story, the $45 billion leveraged buyout of TXU by Kohlberg Kravis Roberts and Goldman Sachs buried the company in a mountain of merger debt. At the time, natural gas prices -- which usually set the marginal rate of electricity in the most of Texas -- were soaring, and TXU had a fleet of coal-fired power plants that could produce electricity for a fraction of what they could sell it for. Then the Barnett Shale got fracked and the gas market got glutted. Natural gas prices hit the floor and never really recovered. Nor did Energy Future's profit margins -- at least not enough to service all that merger debt. So they pushed that debt back. And back, taking advantage of robust credit markets to refinance.

Fitch isn't convinced that a refi will be enough to stave off default, and seems to believe Energy Future will hit a brick wall soon. "The downgrade ... is driven by a further sharp deterioration in the company's business outlook over the last few months such that the current highly leveraged capital structure is no longer sustainable and some kind of default seems inevitable, in Fitch's view."

Part of the problem is that TXU Energy has lost retail customers to the competitive market. The rating agency sees liquidity problems past 2014. Energy Future is leveraged to the hilt. "Fitch's forecasts include an increase in leverage from an already untenable level due to a need for higher borrowings to fund operations."

The biggest kick in the rear comes from low electricity prices, which Fitch doesn't see changing anytime soon. They've had a huge impact on the company's valuation, which it estimates is about half of what KKR, Goldman and Warren Buffett paid for it.

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49 comments
courier service
courier service

The majority of UK courier companies cater for an express service, and some of the larger more established couriers will provide an express international courier service so you can get your delivery overseas in a short period of time.

Carol
Carol

Two weeks ago Public Citizen had a op-ed run in the Fort Worth Star Telegram on this very issue addressing what is happening at other utilities around the state.  Go to http://wp.me/phIHj-3Vr to read that op-ed.

Oak Cliff Townie
Oak Cliff Townie

So how is this going to Spin so its the fault of someone else ?

Willie
Willie

EFH has been spinning, for quite some time, that it's the fault of new EPA regulations.

JRinDallas
JRinDallas

What's so great about the blame the EPA refrain is if people only knew how slow, reactive, and ineffective the EPA is at actually doing anything big (like shutting down an industry as big as coal). By the time the EPA is getting kicked, it's safe to assume the issue has been through a decade or more of rulemaking and litigation usually culminating in a state or parties finalizing a half measure rule or settlement that leaks like a sieve and no real enforcement for many years out.

Linkin-park640
Linkin-park640

KKR,TPG,GoldMan Sachs Capital Partners & some co investor put US$8.5 Billion in equity then borrowed some US$32 Billion if I'm not mistaken,not even 20% of the target value,just what the hell were they thinking ? the Interest expense must be drying up the cash flow

As if things were'nt bad enough already,The Hedges(financial protection against the fluctuations of nat gas prices)expire in 2014 thus EFH will face another decrease in revenue

you know I'm currently reading "the barbarian are at the gates"....For TXU,which used to be one of the most profitable utilities,the barbarian were effectivly knocking on their gate back in 2007...

Paul
Paul

What is even worse about the EFH natgas hedges is that the EIA reported that the average cost of natgas as boiler fuel for electric generation in December was about 20% higher than the spot price for the month of December.

One can infer that EFH is paying about 20 to 25% above open market price for natgas right now.

They can't afford to unwind the contracts in order to be able to buy gas at a lower cost.

The loans that KKR and TPG took out for the LBO were repaid when the bonds were sold that were based upon the equity that was in TXU.  The current indebtedness is by EFH and not KKR and TPG.

In a default it is EFH that is left holding the bag, not KKR or TPG.

Once again we see the results of an LBO based on optimistic rather than realistic economic analysis.

The people who have made money on this deal are KKR and TPG through their management fee and the equity strip from TXU; and, the investment bankers who floated the bonds and short term financing.

None of these parties will suffer if EFH defaults on the bonds.

BTW, IIRC these bonds were rated junk to begin with and have just gotten worse over time.

janet9413
janet9413

KKR, TPG and Goldman Sachs have not gotten back their investments yet.

There are 2 ways to get money out of the LBO --- (1) management fees and (2) dividends.

The sponsors get some management fees, the directors (from KKR) gets some fees, When EFH floats a bond, Goldman Sachs is the bond underwriter and gets a few hundred thousand dollars in fees.  Tens of millions in fees a years --- nowhere near the equity amount that they sank in.

Loan covenants have prevented EFH from declaring dividends since the LBO.

janet9413
janet9413

My mistake --- I was thinking about KKR only, they have $2 billion TXU investment on their books and they are currently valuing it at $200 million.

But there was the only mistake I made on this thread here.

janet9413
janet9413

KKR/TPG/GS put in about $2 billion in equity on the TXU LBO --- whether it is their own money or their hedge fund's client money, that's hard to say.

But if you look at the finances, they haven't gotten close to taking out that amount of money off TXU --- either from sponsor management fees, bond underwriting fees, or dividend payouts.

janet9413
janet9413

To Linkin-Park640,

You don't understand at all.  Buffett doesn't care about his $2 billion "losses" in TXU bonds when he can buy $30 billion worth of power stations for $20 billion cash in a bankruptcy auction.  He just made $8 billion.

Linkin-Park640
Linkin-Park640

Janet:With all due respect I think you're Misunderstanding,EFH's Debts(US$40Billion) exceeds by far its Assets(Plants,ect).In an event of Bankruptcy,when assets are sold off to pay back the Credotors,the Proceeds with go to Senior BondHolders,the rest will be left,nursing their losses,that's why Buffett said in his latest annual letter to shareholders that the likelihood of his Investment being Wiped off is High                                                                                                                                  KKR and the Likes of the PE Goons are Investing other people's Money(Public Pension Funds,Sovereign Wealth Funds,Rich Individual...) they're not betting their own shirts,so the risk undertaken is fathomable

@ Paul,so the Hedges Expiration would be a relief for them ?                                                                                    

janet9413
janet9413

To Paul and Anon,

Warren Buffett owns more than half of all bonds due in 2015/2016.  If TXU can't pay in 2015/2016, the other bondholders can't out-vote Buffett.  Berkshire Hathaway bought Fruit of the Looms from bankruptcy auction --- that's the way Buffett buys cheap stuff.

All Buffett has to say is that TXU hasn't been putting money in fixing and improving TXU's power station --- which leads to Texas having power shortages in the summer time.  Berkshire Hathaway spends $3-4 billion a year improving MidAmerican Energy's power stations every year --- never have a power shortage.  What is the judge going to do?

Paul
Paul

 Ummm ... we are talking about the fact that the value of the underlying assets is not accurately represented in the market cap of the company.  While a premium is paid over the current stock price, only a fool (or GS et al) would pay more than the value of the underlying assets.

I do know how LBOs work because I have done them.

Have a nice day.

Paul
Paul

 This is to Anon --- If I remember correctly, a coalition of creditors can force a company into BK court.  A hearing is held and the burden is on the debtor to show why the creditor's petition should not be granted.  If the debtor is able to come up with a reasonable response as to why the creditor's petition should not be granted, the court will generally side with the debtor.

Nevertheless, it is not a good sign when creditors do this.

WB may hold enough bonds such that in a BK proceeding, WB would be able to take control of the creditors group to be able to lead and determine the secured creditors course of action.

As I have said before, it is not a question of if EFH will go under, but when.

JRinDallas
JRinDallas

And?  Daubert is just a basic framework for the judiciary to sort through who and what can be considered as expert testimony.  If you mean to say the EPA has slipped a few past the goalie, then sure.  But that assumption also applies to the mountain of experts that are lined up on any given day, by any industry, on any topic.

So-called science?  Someone has to be the final arbiter of the stuff or we can rely on the solemn word of industry for everything.  I can't foresee any problems with that.

Anon
Anon

My point was that it isn't Buffett's fault if it files. He is owed money, and they will be unable to pay him when it comes due. He is under no obligation to change the contract just because it would help someone else out. The equity took on the debt, they have to live with it. Obviously they won't file it until one class of debtholders (with a legitimate claim) accelerates after a non-payment default. I mean, if you stopped paying your mortgage but nobody started foreclosure proceedings, would you move voluntarily?

janet9413
janet9413

Why would equity holders want to put TXU into bankruptcy?  Fitch is projecting that only first lien loans/bonds are getting paid --- at 50-70 cents on the dollar.  Any creditor further down the pole gets nothing.  And the equity owners gets wiped out.

Also TXU fought hard 2 years ago --- against a distressed bond investor who wanted to declare TXU in default. They don't want to be pushed to bankruptcy proceedings. I don't know what are you talking about.

Buffett is not like the other bondholders.  The other bondholders aren't in the energy business.  Buffett has a bigger electricity generation subsidiary than TXU itself.

Buffett can cut a cheque without asking the banks for a loan to buy the whole TXU (no financing condition).  And Buffett has good regulatory records on his utility business --- it is a certainty that Texas regulator will okay a "rescue" by Buffett who is one of the bondholders losing his money.

Texas regulators got burned by this LBO and they aren't going to okay anyone without solid gold regulatory histories.

Anon
Anon

The only people pushing TXU into bankruptcy are the equity holders who took on far more debt than they could ever hope to service. This could be a good play for Buffett, but there is still a huge likelihood that bondholders like him will be impaired.

Anon
Anon

you do not know how a leveraged buyout works. and 5% equity checks were rare, even in 2007. there is no excess "equity" in a business following an LBO because the acquirer pays a premium for control, which generally puts the trading multiple well in excess of others in the space. the basis for paying inflated prices is because most of the deal is funded with debt which has tax advantages in the near term and the sponsor always believes they will be able to cut costs or aggressively grow the top line to make a profit on the back end of the deal.and KKR and TPG absolutely have not taken out their original equity investment in this deal. please stop posting your uninformed opinions. 5-10% is also way off base for underwriting fees on this deal. seriously, writing long responses full of nonsense does not add authority to your statements.

Max from the Sandspit
Max from the Sandspit

Alright kid, not sure if you've ever really ever dug into this shit but the best place to start is with the Daubert Opinion by the Supreme's. Start there and then follow to dots as they connect with so-called EPA science.

Brantley Hargrove
Brantley Hargrove

 Slapped indeed. I actually reached out to Luminant for comment on this story. You see a conspiracy, Max, but I promise it's really not that sexy. Just a reporter who has obligations apart from this blog, and who felt as though, by the time he got around to it, the news was stale and had been reported competently elsewhere.

janet9413
janet9413

The interview was from 2 years ago.

Buffett always has a backup plan when he makes an investment. He knew from the start (5 years ago) that this thing can blow up.

KKR has to find the money to pay back Buffett 100 cents on the dollar, or has to sell TXU to Buffett at a large loss.  Or Buffett pushes TXU into bankruptcy and then Buffett buying the whole TXU at an even cheaper price.

Buffett is getting better with age.

Max from the Sandspit
Max from the Sandspit

And in other this kid refuses to cover. The Fifth Circuit Court of Appeals has once again slapped the shit out of his sainted EPA and found in favor of TECQ with a vengance. Just remember Ron Kirk and EDF's role in this debauchery

Paul
Paul

 In other words, the vultures are already circling waiting for EFH to die.

Paul
Paul

 Janet9413, dividends are not the only way to strip equity out of a company.

The payment of dividends is like milking a cow, you feed and you get something out of it over time.

In the case of TXU, it was taken straight to the slaughterhouse.

janet9413
janet9413

Here is Buffett on CNBC in March 2010 talking about the possible end game.  He likes TXU to blow up and then pick it up on the cheap.

"It’s possible, Joe, but on balance, if you notice, the private equity firms are very reluctant, it seems to me, to come forth with anything that involves big losses. I mean, they–what they usually try and do is get bond holders to make concessions or something. But I’ve not seen them wanting to sell the businesses at large losses. Now, you know, if they go into bankruptcy, then you buy them for the bankruptcy process. I mean, if the old TXU gets to 2,014 and they can’t meet the maturities that they have at that time or they haven’t done it earlier, you know, we may buy–we might think about buying the whole place, you know. But we’ll–we might buy it cheaper after a bond default than we would buy it from a private equity place."

http://streetcapitalist.com/20...

Paul
Paul

Thank you Brantley for staying on top of this story.

Right now I am of the opinion that it is not if EFH goes bankrupt, but when.

This deal was hucksterism at its best when it was announced.

janet9413
janet9413

They didn't have the time to strip anything substantial --- because within a year, gas prices crashed.  No big dividend payouts.

Brantley Hargrove
Brantley Hargrove

 They're paying 60 cents of every dollar toward interest. The industry average  is like 6 cents.

Paul
Paul

 Janet1943:

IIRC the transaction was typical of any LBO;

The buyers had their own equity; perhaps 5% initially and obtained a bridge loan for the rest of the acquisition.

Once control was obtained of the target, bonds were issued in the targets name based on the equity available in the target.  The bond proceeds are then upstreamed to acquiring party, who use the proceeds to repay the bridge loan and strip excess equity from the target.

The initial EFH bonds were rated as junk to begin with.

In this case the equity available in TXU was greater than the amount that KKR and TPG borrowed for the acquisition.

This is generally the case in any LBO.

While in some cases an acquirer will attempt to use the LBO in order to modernize or streamline the operations of a company in order to improve the financial condition of a concern outside of the spotlight and scrutiny of quarterly results, I do not believe that this was ever the intention of KKR or TPG in taking TXU private.

In the takeover, I do not remember anything from KKR and TPG about being able to improve the profitability of TXU, reducing costs or reducing overheads; or, streamlining operations.

The fact that all cash flow above immediate month to month operating needs is dedicated to the management fee and bond repayments indicates to me that the takeover was indeed nothing more than an equity strip.

Also given KKR and TPG's typical IROR targets for takeovers also points out another reason why electricity deregulation has not worked in Texas and is not in favor of the consumer.

PS:  Typical GS fees for underwriting are in the range of 5% to 10% of the package, so the GS clip on the deal is on the order of $1B to $4B.  IIRC, the "management fee" by KKR and TPG is on the order of tens of millions per month.

It is likely that KKR and TPG have already recaptured their initial capital outlay.

The takeover of TXU is no different from the initial takeovers in the early 80's where the net worth of a company was not reflected in its stock prices.

Dullard
Dullard

the bad guys actually lost? what kind of story is that?

Brantley Hargrove
Brantley Hargrove

 That book should have been required reading before state legislators consented to the deal. But money talks.

Paul
Paul

And this comes as a surprise?

Of course KKR and TPG have already pulled all of the available cash and equity out of the former TXU .

What will be interesting is to see how the company is eventually bailed out.

Anon
Anon

they have pulled management fees from the company but the private equity sponsors will lose most if not all their money on this deal unless the nat gas price situation changes. maybe that's not what you were implying but let's not pretend they are somehow making out like bandits here.

Montemalone
Montemalone

Bail out?No, the way it works is bankruptcy, then someone buys the carcass for pennies,  operates for a while with all that pesky debt gone, goes public, takes a huge profit, then a few years later management proposes an LBO.

Anon
Anon

but you understand that in bankruptcy the former creditors become the owners? the debt doesn't just vanish.

janet9413
janet9413

Creditors can't seize the power line because Oncor is ring fenced and will not be in any bankruptcy proceeding.

Warren Buffett is going to "rescue" TXU by buying it from bankruptcy auction at huge discount --- that's his end game.

scottindallas
scottindallas

And, I somehow doubt the creditors can physically sieze the powerplants, or powerlines.  The big point is that we will be getting hosed in this deal.

Paul
Paul

 True, the question though is what are the debt/bond covenants.

Equity disappears in BK court because ... anyone ... anyone ... there no longer is any equity!

Anon
Anon

um, this company has loads of debt with a perfected lien on all the assets of the operating company. it has bonds with a subordinated claim. one of those two classes of creditors will become the equity once the deal files. everyone loses in bankruptcy but the equity loses the most, generally speaking. that's by design.

Paul
Paul

 Creditors always lose in BK.

The only thing would be the covenants in the bonds as to where ownership of the underlying assets go in the event of bond default.  In this case the bond owners may be considered to be a secured lender (not a creditor) to the company.

The other creditors would then have to show in BK court that their claim is superior to that of the bondholders.

An analogy would be a perfected lien.

Paul
Paul

 Perhaps "bail out" was the wrong way to describe it.  Perhaps I should have inquired about the "exit strategy".

In reality, the tab for this adventure will probably be picked up by Texas consumers.

Bob
Bob

Whatever happened to James Baker III, the boldface name who was was the public figure for this leverages buyout of TXU?

Montemalone
Montemalone

He took his huge payout of the LBO bonus and scampered off?

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