Energy Future Holdings- Leveraged Buyout and Junk Bonds Performance (May 2010)


 
Luminant Is Part of EFH

Energy Future Holdings- Leveraged Buyout and Junk Bonds Performance (May 2010)
 


29 May 2010 at 8:44:48 AM
salon

May 21st-from Bloomberg

First Data Corp. and Energy Future Holdings Corp., among the biggest leveraged buyouts in history, are leading junk bonds to their worst performance since 2008 as the sovereign debt crisis sweeping Europe makes it harder for the neediest borrowers to refinance.

First Data notes have lost 15 percent this month and securities of Energy Future, the largest ever buyout, have declined 9.9 percent. Sales of high-yield notes this week dropped to the lowest this year, amid signs the global economic recovery is being derailed.

What does being leveraged mean?

Leveraged companies come with an additional level of risk. Whereas a company without leverage risks only the capital invested in any specific project or activity, the leveraged company risks not only the invested capital, but the amount of money required to repay the loan. Thus, wrong decisions and losses are amplified in a leveraged company, which can make their performance more volatile.

What are junk bonds?

What Does Junk Bond Mean?
A bond rated 'BB' or lower because of its high default risk. 

Also known as a "high-yield bond" or "speculative bond"

So what WAS this *biggest leveraged buyout in history* for EFH?

The company was known as TXU until its $45 billion leveraged buyout by Kohlberg Kravis Roberts, Texas Pacific Group and Goldman Sachs. That purchase was the largest leveraged buyout in history....

Hmmm. Goldman Sachs is part of EFH that owns Luminant.

Private equity firms KKR, TPG Capital and Goldman Sachs purchased TXU in 2007; the sale became final on October 10, 2007. As part of the buyout, the electric distribution part of the company is now called Oncor Electric Delivery, the electric generation business is called Luminant, leaving TXU Energy as solely a retail provider of electricity without any electrical distribution or production assets. Luminant owns and operates the Comanche Peak nuclear power plant

From Feb 2010 WSJ

the administration also wants to prohibit banks from making private-equity investments, in which they use their capital to acquire stakes in companies, often using large sums of borrowed money.

So why would it be okay for the government to do that in the form of guaranteed (DOE) government loans????????

If I'm understanding even a glimmer of this, EFH had the largest LBO in history, meaning that the group that bought TXU pumped in a whole lot of their own cash without having a corresponding amount of capital to offset in case of, say, bankruptcy, to repay the loan. So companies that rate whether investors should invest in EFH give the investments a lower rating of BB (making them junk bonds) because there's a high risk of default on the loan. IF people lose their shirt on EFH, seems to me that it's because they are doing the market equivalent of gambling, with high risk stakes, right? Should the GOVERNMENT be in on helping out companies that are so high risk?

But if the company can manage to get the government to get into the act with a loan that the taxpayers have to guarantee, like with the loans that Obama wants to make to nuclear power plants, including perhaps Comanche Peak for two more reactors? I mean, investing in these reactors is a poor risk and the people investing are very likely to lose their money UNLESS the government becomes a partner? If, as these articles say, EFH is drowning in debt, and may possiby default when the chickens come home to roost, what would happen if they shift the responsiblity to the taxpayer for the new nuclear reactors? Would like someone who understands the junk bond market to weigh in, with sources. Again, from Bloomberg

Investors around the world are ditching corporate bonds at the fastest pace in 19 months and turning to the safety of Treasuries. High-yield debt has lost 3.5 percent, on pace for the first monthly drop since February 2009, after gaining 7.2 percent this year through April, according to Bank of America Merrill Lynch Index data.

Bloomberg also says in this article that this period has the weakest creditor protections since 2007

About 60 percent of high-yield borrowers this year offered weaker investor safeguards than on debt they issued previously, according to Covenant Review LLC, a New York-based research firm that analyzes bond offerings. Those include no limits on the amount of debt companies can have and few restrictions on using assets as collateral for future borrowing, reducing what’s available to satisfy creditor claims in a bankruptcy.

“This trend represents more than an episode of ‘back to the future,’” Moody’s analysts including Alex Dill, the firm’s senior covenant officer, wrote in their report. “It reflects a weakening in covenant protections even below those existing at the peak of the market, in 2006 and 2007.”

Here's a must read article that shows what EFH is going to face.

Two years later, a steep drop in natural gas prices and the swooning Texas economy have caused EFH's cash flows to plunge. The afterglow of the LBO is extinguished. In its place there are gnawing questions over EFH's ability to meet its obligations. In particular, the chilling prospect looms that five years hence, when a towering $22 billion of EFH debt comes due, or perhaps a year or two earlier, when a pair of multibillion-dollar credit facilities vital to EFH run out, the entire edifice of borrowings may buckle.

"EFH's capital structure is untenable" and must be deleveraged, Moody's Investors Service senior vice president Jim Hempstead proclaimed in a report last month. Either that, or the energy market will have to rebound with enough vigor to restore the status quo of 2007. Says a trader at one of EFH's largest senior creditors: "Given how volatile [the price of] natural gas is, they've got to hope that commodity bails them out" before the debt falls due. If EFH faced having to refinance $22 billion of debt just now, he notes, it could not afford the richer interest rates the market would exact to compensate for the risk....

Even so, time could be as much EFH's enemy as its ally if it dawdles or its efforts to delever falter, as happened recently with its exchange offer. The company is a time bomb with a long fuse, and as the fuse shortens, EFH's options narrow, the 2014 deadline to refinance or retire half its debt approaches and the death watch begins. The mad scramble to avert bankruptcy and the battles between EFH's creditors and owners over financial concessions have the makings of a life-and-death drama that could transfix Wall Street and the citizenry of Texas for months on end. The unique magnitude of EFH's debt load, spread, as it is, among subsidiaries with distinct profit profiles and creditor groups, could yield fascinating side skirmishes and subplots.

In the end, EFH's financial fate may turn on whether KKR, TPG and Goldman tap their own treasuries for the equity to purge a significant amount of the debt. Big-scale equity cures have a high failure rate in the realm of LBOs, and sponsors are notably loath to throw good money after bad. Indeed, only a handful of now-wobbly megadeals completed during the mid-decade buyout boom have subsequently been propped up with additional equity from their sponsors. In some cases, though -- most famously in 1990, when KKR doubled down its investment in RJR Nabisco, whose $31.3 billion LBO in 1989 set an earlier, long-standing size record -- sponsor bailouts have done the trick.

With EFH, an extended dip in power rates and a failure to restructure debt by other means would put it in the kind of bind RJR was in when KKR helped save it. Well before things reach that point, EFH's sponsors and creditors will square off in efforts to erase debt bit by bit while pressing the other side to give up more in value.

For the sponsors the stakes are colossal. The buyout group plowed $8.3 billion in equity into the deal and are fighting to salvage their wager. By KKR's latest accounting, the investment is 50% under water. The debt market thinks otherwise: With EFH's midlevel and junior bonds trading at steep discounts to par, junk-bond speculators put the equity's value at zilch....

Unfortunately, the underpinnings of this imperfect but tolerable status quo will give way: In December 2012, an unlimited credit facility for EFH's hedging program runs out; failing to renew it would crimp EFH's efforts to hedge and leave it more exposed to vicissitudes of the market. In 2013, EFH's cash interest costs will soar because several billions of pay-in-kind toggle bonds, whose principal value has grown as EFH, in order to conserve cash, has paid the interest with additional bonds, will turn cash-pay. That same year, TCEH's $2.7 billion senior secured revolving credit facility will expire. And in 2014, TCEH's $22 billion of bank loans fall due.

Bing-bing-bing-BANG. Unless EFH takes a big bite out of its debt and unless pricing and the Texas economy improve, the company's world will unravel. That prospect has observers mulling in extremis possibilities such as the sale of EFH's 80% interest in Oncor, which Hempstead reckons could fetch from $6 billion to $14 billion, netting EFH $3 billion to $9 billion in cash. Even the seizure of EFH's assets is conceivable, he says, "if the situation becomes dire enough."

In October 2009,. Alcoa sued Luminant

Alcoa is seeking the $500 million in damages and return of a coal mine for what it says is wrongful conduct by Energy Future Holdings. The aluminium maker's case revolves around a decades-old agreement to supply power to Alcoa's smelter in Rockdale, Texas, from a coal-fired power plant known as Sandow Unit 4 now owned by Energy Future Holdings' subsidiary Luminant.

Alcoa said Luminant manipulated power prices and mismanaged a coal mine for the Sandow plant, among other claims, driving up what Alcoa paid for electricity by as much as 100 times the average price. Alcoa partially curtailed production at the Rockdale plant in June 2008 and has since curtailed the smelter's remaining output.

"We think Luminant, Energy Future Holdings and their investors KKR, TPG and Goldman intentionally and deliberately manipulated electricity prices in an attempt to relieve them of a relationship they didn’t want," Alcoa spokesman Kevin Lowery wrote in an e-mail Friday.

A spokesman for Energy Future Holdings said the company continues to dispute the allegations by Alcoa and will vigorously defend itself.

The massive buyout of TXU has been challenged by a large debt load and a weakened power market. Energy Future Holdings faces increasing questions on how it will handle the massive debt it took to complete the buyout. The company recently moved to reduce its overall debt by $2 billion to $42 billion through a debt exchange. The proposal hasn't yet won approval from investors.

In January of 2010, KKR looked to shift some of the debt onto Oncor

KKR is talking with Franklin Templeton Investments about trading lenders' riskier unsecured debt in Energy Future's holding company for debt guaranteed by the stronger piece of its business, Oncor.

The new debt would be valued at roughly a 20 to 25 percent discount to the former obligation -- better than the 30 percent in the October offer.

If the swap is successful, it would shift billions in debt out of the holding company and into Oncor, the regulated side of the energy company. The PE firms could then split off Oncor assets from the unregulated side, Texas Competitive Electric, which is drowning in debt, and get some money out of the LBO.

In an article from May 10, 2010, KKR marked DOWN the value of EFH, this while KKR was marking other of its investments up

It marked down the value of Energy Future Holdings Corp., the power producer formerly known as TXU Corp. that KKR bought in 2007 in the biggest leveraged buyout in history.

In EFH's slide deck for 2010, they talk about their partnership with Mitsubishi (joint venture) and thre's a slide that shows how much debt they have and where it is.

Just kind of amazing. EFH has a venture with a company that is from OUTSIDE the United States. IF they get the DOE loan guarantee, does that mean that Mitsubishi would profit in case of a default, from the US taxpayer? How does that work? Certainly it seems that the investors into EFH would have a guarantee that their high risk investments would be guaranteed by the US government taxpayer. Why? They're a private equity firm. Why is the govenrment in the business of shoring up private companies?

Reminds me, on a related level, of the local county government bailing out private, non profit GRMC so that the taxpayer here now is paying for a 14.4 million dollar CO that GRMC wanted AND SAID THEY WERE GOING TO PAY FOR THEMSELVES... except that they, too, knew that the clock was ticking and they weren't going to be able to pay it, so the county took it over at the end of last year. EFH, likewise, has debts that come due in the new few years, what happens if the financial markets don't turn around?

P.S. One more side note to consider. I've seen articles and video on KKR and Goldman Sachs. The people at the top are making sure they are getting theirs, including high salaries and bonuses. Kravis has a net worth of 4.3 billion at last count. If the holding company they, along with Texas Pacific, created goes under, it won't take the entities that made them. But it WILL stick the rest of us with bailing out the company, much the same as the Texas S&L fiasco that we are STILL paying for, and the more recent banks bailout (of which all the money didn't actually have to even get paid back! )

You know, people can agree or disagree about nuclear energy. I happen to believe that using an uncertified, untested nuclear reactor technology that will be using our water supplies, AGAIN, and has unpleasant and health risking radioactive waste side effects makes using that type of energy a last resort, if at all. But what people ought to be considering is the dang cost of this, both the cost upfront, the years it would take to build, the cost overruns that will no doubt come from it not being completed on time, and, as this points out, the cost to the taxpayer from taking over guaranteed government loans while the rich walk away to spend their billions elsewhere.


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Comments!  
1 - humanbeing   29 May 2010 @ 10:33:52 AM 

Excellent reporting, salon. Readers might keep in mind that Mitsubishi is also the company whose reactor model they want to use here at CP for units 3 and 4. Also, this article points out how ridiculous is this idea that taxpayers back their loans for these two new units. Fill Chet Edwards inbox with your objections, citizens. i certainly don't support this. This article should go to both the GR newspapers.


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2 - salon   1 Jun 2010 @ 8:16:27 AM 

Thanks, HB. I completely agree with letting Chet Edwards know, although I'm sure you're aware he is very pro-nuclear power and government loan guarantees. As a side note, an advantage online news has over a newspaper is that one can put an extensive article, with links to the sources, and of course I compiled this to be read here in our popular online news site. We get over 10,000 unique visitors every month and the reach here is extensive. What I would suggest is, in order to additionally reach those who read the local weekly, is for you or anyone else interested to write a letter to the editor, so that this serious situation appears in as many media outlets as possible.


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