Biggest LBO failure is Energy Future purgatory for KKR

Five years after their record- setting leveraged buyout of Energy Future Holdings Corp., KKR & Co. and TPG Capital are moving closer to a possible new milestone: the biggest bankruptcy of a private equity-backed company since the failure of Chrysler Group LLC.

Texas Competitive Electric Holdings, the utility’s wholesale power unit, faces an October 2014 deadline on the maturity of a portion of its loans.

Informal restructuring talks already have taken place, according to two people with knowledge of the matter. Senior lenders — including Franklin Resources Inc., Apollo Global Management LLC, Oaktree Capital Group LLC and GSO Capital Partners — probably would seek to seize the unit if there is a bankruptcy, said one creditor, who asked not to be identified because the process is private.

The buyout of Energy Future, the Dallas-based company formerly known as TXU Corp., in 2007 for $48 billion marked the peak of a private-equity boom that went bust a year later with the onset of the financial crisis. A bankruptcy would wipe out much of the $8.3 billion investment made by buyers including KKR, TPG and Goldman Sachs Capital Partners in what was the biggest LBO in history. It would be the highest-profile private equity-backed company to go under since Chrysler was bailed out by the U.S. government in 2009.

“This deal never made sense,” Erik Gordon, a private- equity and law professor at the University of Michigan, said in an interview. “It could only have been done during the times of hysterical overoptimism by everybody — by KKR and TPG and by all the lenders who put up the money.”

Buyout Boom

Energy Future, the biggest power plant owner in Texas, traces its roots back to 1882, soon after the invention of the incandescent light bulb.

Energy Future’s units include Oncor Electric Delivery Co., the regulated business that delivers electricity to more than 3 million homes and businesses; TXU Energy, a retail electricity seller; and Luminant, which owns more than 15,400 megawatts of generation capacity in Texas.

Its LBO capped a debt-fueled boom from 2005 to 2007 that also spawned supersized takeovers of companies such as Hilton Worldwide Inc., Caesars Entertainment Corp. and Kinder Morgan Inc. Not all have faltered. KKR’s (KKR) $32.2 billion acquisition of hospital operator HCA Holdings Inc. and its $7.3 billion purchase of retailer Dollar General Corp. have fared well.

Private-equity firms combine capital from investors and borrowed money to buy companies, with the goal of improving performance and selling them three to five years down the road at a profit.

Gas Prices

The Energy Future buyout was essentially a bet, using $40.1 billion of debt, that natural gas prices would rise. Instead prices, which set the cost of electricity, have fallen 77 percent since 2008.

Adjusted earnings before interest, taxes, depreciation and amortization — a common yardstick for cash flow — dropped to $3.7 billion last year from $4.8 billion the year after the buyout, according to regulatory filings. Texas Competitive holds about $31 billion the company’s total debt. As of Dec. 31, KKR valued its Energy Future stake at 5 percent of what it had invested, according to a regulatory filing.

A Chapter 11 filing, or alternatively a bankruptcy-style restructuring of Texas Competitive done out of court, is less a question of if than of when, according to credit analysts Andy DeVries at CreditSights Inc. and James Hempstead of Moody’s Investors Service Inc. Hempstead predicted 15 months ago that Energy Future would run out of money in 2014.

Hedging Contracts

Hedging contracts that Energy Future sold to shield it against fluctuations in gas prices are expiring and will disappear entirely by the end of 2014, an event that could render Energy Future insolvent, according to the creditor who declined to named. The hedges rolling off could deflate Ebitda to $1.3 billion by the end of next year, the lender said. That’s $2.2 billion less than Energy Future’s interest cost in 2012.

A threatened breach of covenants restricting the amount of debt owed by Texas Competitive “would trigger a default some time in 2014, but no one knows when,” DeVries said in a telephone interview last week from New York, where he is based.

Energy Future and its backers have recruited advisers to restructure the company’s debt. KKR and TPG hired Blackstone Group LP (BX), GSO Capital’s parent, people familiar with the discussions said earlier this month, while Energy Future has retained Evercore Partners Inc. and Kirkland & Ellis. The utility’s Oncor unit, which has $5.9 billion in debt, enlisted the New York-based restructuring firm Miller Buckfire & Co., a unit of Stifel Financial Corp.

Kristi Huller, a spokeswoman for New York-based KKR, and Owen Blicksilver, a spokesman for Fort Worth, Texas-based TPG at Blicksilver Public Relations, declined to comment on the strategies being weighed.

Big Hurdle

Energy Future faces a potentially insurmountable hurdle in October 2014, when $3.8 billion of Texas Competitive’s bank debt falls due. Comprising loans whose holders opted not to extend in 2011, that tranche is mainly owned by distressed investors that have angled to take possession of Texas Competitive if it falters, according to the Texas Competitive lender.

Charles Zehren, a spokesman for New York-based Apollo at Rubenstein Associates Inc.; Matthew Walsh, a spokesman for San Mateo, California-based Franklin; and Christine Anderson, a spokeswoman for New York-based Blackstone and its GSO unit, declined to comment on their Energy Future holdings. Anderson also declined to address Blackstone’s dual role as adviser and creditor. The media-relations department at Los Angeles-based Oaktree didn’t respond to an e-mail seeking comment.

Term Loan

Texas Competitive’s term loan due October 2014, which was valued as high as 76.8 cents in January amid reports the company was negotiating an amendment to extend its maturity, was at 73.1 cents as of Feb. 22, according to prices compiled by Bloomberg.

That’s above the 50 cent-to-70 cent range that Standard & Poor’s says lenders may recover in a default, indicating investors expect to get about the recovery value of the debt.

Allan Koenig, a spokesman for Dallas-based Energy Future, declined to comment beyond the company’s liability-management program of improving its balance sheet by reducing debt and extending the maturities of its obligations.

Lenders’ Push

Creditors will probably force Energy Future into bankruptcy if the company lacks the cash to repay the debt, according to the Texas Competitive lender. They would then push for a reorganization that would transform Texas Competitive’s bank loans into a controlling ownership stake, the lender said.

The equity owned by KKR, TPG and Goldman Sachs Group Inc.’s private-equity unit would most likely be erased, as would all of the unit’s $10 billion of unsecured bonds, the lender said. Holders of those bonds, including Warren Buffett’s Berkshire Hathaway Inc., may resist such a reorganization plan in an effort to salvage a modicum of value.

Their chances aren’t strong, according to Standard & Poor’s, which said in a Dec. 27 report that Texas Competitive’s unsecured bondholders would receive a recovery of between zero and 10 cents on the dollar in the event of a default.

Buffett has called Berkshire’s $2 billion bond investment, which helped finance the original buyout, a “big mistake” and said Berkshire may come away empty-handed.

Texas Competitive’s $1.83 billion of 10.25 percent unsecured notes due November 2015 traded at 16.8 cents on the dollar Feb. 15, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt reached a record low Feb. 8.

For the private-equity backers, not all is lost. KKR and the others have reaped $560 million in advisory and monitoring fees since the buyout, translating into almost 8 percent of what they invested, according to regulatory filings.

Oncor Unit

The private-equity owners are also almost certain to seek to keep ownership of Oncor, which carries less debt and is a steady cash generator, the people said.

The sponsors have sought to disentangle and isolate Oncor from the rest of the utility by paying off intercompany loans, and may be able to keep control of that unit. Oncor would not be party to a bankruptcy filing by Texas Competitive. Oncor posted about $1.7 billion of Ebitda in 2012, according to a regulatory filing. Still, Oncor carries well over $10 billion in debt after intermediate layers of Energy Future’s complex organizational structure are included, according to two people familiar with the business. In the near term Oncor may not be a much of a consolation prize for the sponsors, they said.

Energy Future said this month in its annual report that it expects to negotiate with creditors to lower interest costs by offering to exchange old debt for new, debt for equity and to extend debt maturities.

Delaying Bankruptcy

The Texas Competitive loan holder and a lawyer advising an Energy Future investor said they expect KKR and TPG may try to delay a bankruptcy to salvage some equity should gas prices rise. Energy Future, they said, has gotten senior lenders to push out maturities in the past. Energy Future in 2011 persuaded lenders to extend the due date on $15.4 billion of term loans to 2017 from 2014.

That approach could be difficult if Energy Future’s performance deteriorates sharply. For now, Energy Future has enough cash to make $300 million in interest payments due in May, when the coupon obligations on as much as $173 million in so-called payment-in-kind bonds will have to be made in cash. Still, when the rolling off of hedges ends in 2014, it could accelerate a decline in Ebitda, driving up Texas Competitive’s ratio of senior debt-to-Ebitda. A lending covenant limits the ratio to eight times Ebitda. Tripping the covenant will probably be the catalyst for a restructuring, analysts including DeVries said.

“Any covenant breaches will put the company’s fate in those lender’s hands,” Peter Thornton, an analyst at Montpelier, Vermont-based KDP Investment Advisors Inc., said last week. “They could opt not to amend and force things to happen at that point.”