The biggest private equity buyout ever â€" the $45 billion deal for the Texas energy giant TXU in 2007 â€" has been steadily sliding toward becoming one of the biggest busts.
Yet even as bankruptcy is acknowledged as a possibility, the company’s private equity owners are trying to make sure they don’t walk away empty-handed.
The company, now called Energy Future Holdings, has completed a series of moves in recent months that analysts say could allow it to put only part of its business â€" the retail energy and power-generation operations â€" into bankruptcy, while holding on to the staid-but-safe utility business. And the company recently received a favorable tax ruling that could potentially allow it to save billions of dollars in a reorganization.
Still, as much as Energy Future Holdings may want to tie a reorganization into a neat little bow, some creditors, including seasoned hedge fund investors in distressed debt, are certain to make this a fight of junkyard dogs.
Those investors have amassed big chunks of the senior debt of the segment of Energy Future Holdings that houses the retail and power-generation business. The loans, which currently trade around 70 cents on the dollar, put the investors first in line to convert their debt into equity in a restructuring of the power-generation assets.
“Some of the hedge funds in this have been buying up certain pieces of the debt, hoping to force a default†and put the company into bankruptcy, said Andrew DeVries, an analyst with the research firm CreditSights.
Among the investors who have picked up some of Energy Future Holdings’ debt are Leon Black’s Apollo Management Group, fresh from scooping up Twinkies in the Hostess Brands bankruptcy; the Blackstone Group’s GSO Capital Partners, a distressed credit fund whose founders include some who cut their teeth on junk bonds at Drexel Burnham Lambert in the 1980s; and the California investment firm Franklin Resources, which, in an odd twist, voted against the 2007 buyout as a TXU shareholder because it said the $45 bilion price was too low.
Calls to Apollo and Blackstone were not returned. A spokeswoman for Franklin declined to comment.
Already, an early shot in the coming battle has been fired.
The New York-based hedge fund Aurelius Capital Management, which owns some of the senior debt, sued the directors and management of Energy Future Holdings in March, claiming that a series of sweetheart loans from one affiliate to the parent company were made at well below market rates and hurt the affiliate financially. It says the parent company owes an additional $725 million in interest on the loans.
Representatives for Aurelius and Energy Future Holdings declined to comment on the lawsuit.
A messy fight would not be a surprise; the likely restructuring of Energy Future Holdings has long been predicted by many on Wall Street. The deal for the company was the biggest in the buyout boom before the financial crisis. Other buyouts from that era have struggled as well, but cheap debt markets have enabled them to keep going.
That has not been enough for Energy Future Holdings. Plagued by low natural gas and energy prices, the company’s revenue has continued to fall while its losses have soared. Last year, more than half of its revenue went just to make the interest payments on its huge debt load of $37.8 billion, much of which was taken on to complete the buyout in 2007.
In recent months, a veritable who’s who of restructuring wizards, legal teams and financial experts have been hired by all sides. Wall Street credit analysts are furiously churning out estimates of what various groups of debt holders could be paid in a restructuring pact.
Still, exactly when the company may take the plunge remains a guessing game on Wall Street. Some analysts say a move could be made by the end of this summer; others are betting on early next year.
The company has ample cash to make its next round of interest payments in May, but some analysts say the side of the business that controls the energy generation and retail segments is running dangerously low on money.
“We think they’re going to run out of cash in the beginning of 2014,†said Jim Hempstead, an analyst with Moody’s Investors Service. “They won’t wait until they’ve completely exhausted their cash before they do something.â€
The showdown over Energy Future Holdings could focus on a $3.8 billion loan that comes due in October 2014, analysts say. The hedge fund investors have taken big stakes in that debt, giving them a seat at the table if Energy Future Holdings wants to renegotiate the terms of that loan.
Until now, the company has pushed back its day of reckoning, when tens of billions of dollars of its debt comes due, through rounds of successful renegotiations with its debt holders, but often at higher interest rates.
“That strategy is becoming more difficult,†said Terry Pratt, an analyst with Standard & Poor’s Ratings Service. “It’s been very costly to extend the maturities.â€
Allan Koenig, a spokesman for Energy Future Holdings, said that despite the company’s troubled balance sheet, it has continued to grow, increasing its full-time work force by 25 percent, or 1,900 employees, since the 2007 buyout, and has spent $10 billion on capital expenditures.
Still, its private equity owners â€" including Kohlberg Kravis Roberts & Company, TPG Capital and the private equity arm of Goldman Sachs â€" have largely written down to zero the value of the $8 billion that they and others sank into the deal. Representatives for the three firms declined to comment.
Over the last year, as Energy Future Holdings’ financials worsened, the company began taking steps that Wall Street analysts say were intended to separate the regulated electricity business, Oncor, from the unregulated power-generation business, Luminant, in an effort to keep it out of a possible bankruptcy filing, analysts say.
The 80 percent stake in the utility company that is held by the private equity firms and other investors is worth about $6.5 billion right now, according to analysts. While still less than their $8 billion investment, that stake would certainly go a long way toward reducing investors’ losses.
If energy prices rise, Oncor could wind up being worth more, said Richard M. Gordon, a private equity and law professor at the Ross School of Business at the University of Michigan.
“When they did the deal, everybody had stars in their eyes over the unregulated side of the business,†Professor Gordon said. “It’s a terrific irony that the thing that could be of any value now to K.K.R. and TPG is the regulated utility business.â€
Regulated by the Public Utility Commission of Texas, Oncor already has a separate board and is limited by regulators in the amount of debt it can borrow. But Energy Future Holdings has taken additional steps to cut any entanglements between the companies that could prove messy in a restructuring, analysts say. Last summer, for example, Energy Future Holdings terminated and paid out a pension fund for certain employees, which some interpreted as another maneuver to insulate Oncor, which had been partially responsible for the fund, in a possible restructuring.
Other companies have tried to do so-called selective bankruptcies in the past.
In 2011, for instance, the Houston-based power producer Dynegy Holdings tried to transfer certain assets to shield shareholders at the parent company from losses when a subsidiary filed for bankruptcy. An independent examiner later deemed those transfers “fraudulent,†and Dynegy reached a settlement with the creditors.
“What they’re doing is not unlike the good bank-bad bank structures where all of the trash is dumped into one side and the good stuff put into the other side,†Professor Gordon said.
“It’s just legal maneuvering. Will it work Well, we’ll see.â€
