HOUSTON -- The takeover of TXU Corp., Texas' largest electricity producer, turns seven this year. Odds are good the company marks the anniversary by reorganizing through a bankruptcy filing.
Kohlberg Kravis Roberts & Co., TPG Capital and Goldman Sachs led the record leveraged buyout of TXU, with an estimated value of $45 billion in 2007. Critics warned that the company, whose name became Energy Future Holdings Corp., was taking on too much debt. The buyers said the deal would enable the company to embark on a long-term strategy to help meet Texas' energy needs.
Much of Energy Future's plan was staked on a robust outlook for natural gas, which helps set the price of power in Texas. At the same time, the reality of shale drilling was taking hold. U.S. gas production surged in the years after the transaction and prices tumbled, dragging with them the fortunes of a proud Texas company that had a big chunk of production from plants fueled by coal and nuclear energy.
"The investment thesis didn't play out because highly volatile commodity prices went in the opposite direction," said Joseph DeSapri, a credit analyst who tracks the power sector at Morningstar in Chicago. "Power prices are related to natural gas prices, so it's very difficult to run a business when your primary driver of value has been depressed for the past five years."
Gas prices dropped 64 percent from about $11 per million British thermal units in mid-2008 to $4.03 on Dec. 31, 2012, for 2014, according to an Energy Future regulatory filing last year. The company reported losses that totaled more than $17 billion from 2008 through 2012, the filing shows. For the first nine months of last year, Energy Future posted more than $600 million in losses, though it had a $5 million profit in the third quarter.
When the 2013 annual report comes out this spring, auditors will weigh in on Energy Future as a going concern, and a negative report could lead to a bankruptcy. So a reorganization may begin around that time, DeSapri said.
"The primary next hurdle to cover is the solvency opinion in March by the auditors," he said. "That will likely trigger the bankruptcy."
Tough road ahead for TXU
Energy Future listed total liquidity of about $2 billion as of the end of September. The company is due to make a debt payment of about $3.8 billion this October.
The company has three main businesses: Luminant, which produces power; TXU Energy, which sells electricity to consumers as a retailer; and a large stake in Oncor, a regulated transmission and distribution business.
The takeover of TXU drew sharp questions after it was announced in February 2007. One part of the deal that emerged was to put in place a so-called ring fence to protect Oncor and its regulated assets. The backers also agreed to reduce the number of coal-fired units that would be built through the generation business.
Regulators and lawmakers made inquiries about the buyout, but the company was able to navigate them and obtain shareholder approval in September 2007. On Oct. 10, 2007, TXU declared its merger complete.
"We have maintained open and productive dialogues with legislators, regulators, customers and consumer advocates," Michael MacDougall of TPG Capital said in a statement that day. "Together, we are proud to be part of a transformation that will benefit -- and in fact already is benefiting -- customers and residents of the state of Texas."
The news release quoted Donald Evans, a former U.S. Commerce secretary who became non-executive chairman of Energy Future, about plans for stronger environmental policies and well as reliable and affordable power. The board included such names as William Reilly, former administrator at U.S. EPA, and Lyndon Olson, former U.S. ambassador to Sweden. James Baker III, former secretary of State, was listed as an adviser to the company.
The star power couldn't change the path that was ahead for Energy Future, however.
The buyers acquired "a very coal-heavy generation company with the expectation that natural gas prices would remain very high," said Ed Hirs, an energy economist at the University of Houston. "It was a straight-up leveraged commodity price bet, and they were wrong."
An 'unforced error'
The company's retail electricity customer count also fell, from about 2 million at the end of 2010 to about 1.75 million at the close of 2012, according to a regulatory filing. Energy Future labored under its debt load, as it wasn't generating as much cash as many had expected. In a quarterly filing last year for the period that ended Sept. 30, the company listed about $38 billion in long-term debt.
Tom Johnson, a spokesman for the consortium that includes Kohlberg Kravis Roberts, TPG and Goldman Sachs, declined to comment on Energy Future.
Even Warren Buffett, who heads up Berkshire Hathaway Inc., didn't make the right call on Energy Future. In a letter to shareholders in 2012, Buffett said he had previously spent about $2 billion buying bond issues of the company, a decision he called a mistake. He said his company received some payments but wrote down the investment by $1 billion in 2010 and later by $390 million more. Gas prices play a major role in the power company's outlook, he said.
"However things turn out, I totally miscalculated the gain/loss probabilities when I purchased the bonds," Buffett wrote. "In tennis parlance, this was a major unforced error by your chairman."
Discussions about the company's future are related to the balance sheet and debt, not operations, said Allan Koenig, a spokesman for Energy Future. The company doesn't plan to change its operations in the event of a restructuring, he said. Energy Future invested about $10 billion in projects across Texas over a five-year period and added 1,900 jobs, according to a company fact sheet.
Koenig said there's "significant value in this company operating as it does." The company has "a highly complicated and complex financial structure," he said, and it has been in discussions with stakeholders.
"We continue to have an open door and open dialogue with our creditor groups and their advisers," he said.
Who's on the hook?
Environmental groups worry about what a wobbly Energy Future would mean for potential liabilities related to its assets.
New owners of the company could end up facing $3.5 billion in environmental liabilities, said Tom "Smitty" Smith, director of the Texas office of Public Citizen, an advocacy group that tracks energy and other issues. The group plans to communicate possible liabilities to bondholders in a letter next month, he said. Smith said the Texas Railroad Commission needs to require the company to post a cash bond to ensure that adequate funds are available for more than $1 billion in possible mine reclamation.
Koenig said the company will continue to meet any obligations to the state or regulatory agencies, whether it's in or out of a court restructuring.
The possible reorganization swirling around Energy Future isn't the only source of uncertainty in Texas. Businesses are taking sides on what market structure will best make sure the state has adequate reserves in the future so that lights stay on during Texas' hottest and coldest days. The state is considering options such as a capacity market, in which companies would get paid regardless of whether volumes are needed.
"Even if they ended up with a full-capacity market, TXU's so far underwater that the payment wouldn't make any difference to what's going to happen with the company," said David Power, deputy director of the Texas office of Public Citizen.
Earlier this month, the Electric Reliability Council of Texas, the state's main grid operator, asked for conservation as a blast of cold weather left the state with tight supplies as some generation went offline (EnergyWire, Jan. 9). ERCOT, as the grid operator is known, said on Jan. 17 that electric use in its region rose 2.1 percent in 2013 compared with a year earlier. Natural gas was the top fuel used to produce power at 40.5 percent, followed by coal at 37.2 percent, nuclear at 11.6 percent and wind at 9.9 percent.
Interest remains in Texas as regulators consider changes to the market. Last week, Direct Energy said it had completed the sale of three Texas gas-fired power generating facilities to Blackstone, another investment firm.
Once Energy Future settles on a path forward, its holdings may have more value in the future, said Morningstar's DeSapri.
"I expect all of those assets to be retained by whoever ultimately owns the firm," at least in the near or medium term, DeSapri said. "I think most of the assets are valuable."
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