Energy Future enters bankruptcy, proposes break-up

Energy Future Holdings, the result of the largest leveraged buyout in U.S. history, has finally gone bust.

More than six years after a trio of Wall Street private equity firms bought out the former TXU Corp. for $45 billion, its successor company filed for Chapter 11 protection in U.S. Bankruptcy Court in Wilmington, Del., early Tuesday.

Under a proposal released by EFH management, the company will split its power generation and retail businesses, Luminant and TXU Energy, from its regulated transmission company, Oncor. The two new entities would then be handed over to creditors, who control $40 billion in EFH debt.

As Texas’ largest power generator, EFH was closely watched by regulators as it moved toward bankruptcy. The Texas Public Utility Commission issued a statement Tuesday reassuring customers the filing would have little effect on the state’s power market.

The bankruptcy filing was the culmination of months of negotiations involving some of the most powerful figures on Wall Street, including Leon Black of Apollo Global Management and Howard Marks of Oaktree Capital Management. At more than $40 billion in debt, EFH ranks as the largest corporate bankruptcy in U.S. history not including financial companies, according to Moody’s Investors Service.

KKR & Co., TPG and Goldman Sachs Capital Partners, which partnered on the 2007 buyout, would see their stake reduced to less than 1 percent of the new transmission holding company, according to a person close to the company.

Uncertain future

Whether EFH will get its restructuring proposal through remains to be seen.

So far, the company has agreements from large creditors including Apollo, Franklin Resources and Fidelity Investments, whose debt holdings total at least $13.5 billion, according to an affidavit by CFO Paul Keglevic filed Tuesday.

But that leaves more than $25 billion in creditors outside the deal. And many of them are expected to see their investment wiped out, likely setting off a bitter campaign to disrupt EFH’s plans for bankruptcy. But the company was optimistic Tuesday, saying it expected to emerge from the bankruptcy process, which usually takes years, in just 11 months.

“Today, we took an important step to address our balance sheet issues and put the company on a sustainable path for a stronger future,” EFH CEO John Young wrote in a letter to employees Tuesday morning.

But the battle has already begun in the courtroom of U.S. Bankruptcy Judge Christopher Sontchi.

In a motion filed Tuesday, the trustee for a group of junior creditors accused the company of mismanagement by “extending a crippling debt load long enough to benefit the [owners’] speculative investment.”

The Wilmington Savings Fund Society represents creditors controlling $1.6 billion in second-lien debt at EFH’s Texas Competitive Electric Holdings who would see their investment wiped out under the restructuring.

But the view among most analysts and observers Tuesday was that EFH had managed to drum up enough creditor support that the bankruptcy process should move smoothly.

“This process continues to follow the script,” said Jim Hempstead, an associate managing director at Moody’s. “We have long taken a position that at the end of the day it will be a relatively organized restructuring. That is not to say that some creditor classes are not going to object and fight.”

Company’s history

EFH traces its roots to the founding of the Dallas Electric Lighting Co. in 1882. Later, it became known as TXU Corp., a name many in Texas still refer to it by today.

In 2007, during a boom in private equity deals, KKR, TPG and Goldman Sachs bought out shareholders on a bet that natural gas supplies were shrinking. Because gas is a major fuel for power plants, that should have driven up the price of electricity. They borrowed more than $30 billion to fund the deal, according to a bankruptcy filing Tuesday.

Their timing proved to be terrible. Sophisticated horizontal drilling and hydraulic fracturing techniques opened up natural gas deposits in formations like the Barnett Shale and Marcellus Shale, driving down natural gas prices.

Wholesale power prices in Texas are about half what they were in 2008. And with $4 billion in annual interest payments, the company began sustaining billions of dollars in losses in 2010 and never recovered.

“They issued a huge amount of debt, and they were betting on gas prices staying high. One can question the size of the LBO [leveraged buyout] and whether it made sense, but six or seven years ago that was the conventional wisdom,” said Bernard Weinstein, associate director of SMU’s Maguire Energy Institute. “Fracking was still in its infancy.”

But the wrong-way bet was the beginning of the end for the old TXU Corp.

Oncor, which delivers electricity to 10 million customers across Texas, is expected to be sold off by creditors. With steady profits, its list of potential suitors is long. Among them are Dallas oilman Ray Hunt and his son Hunter, who runs Sharyland Utilities and has tried to buy Oncor in the past.

Under the proposal released by EFH, the power plants and TXU Energy would be passed on to first-lien creditors in Texas Competitive Electric Holdings. Among them are Apollo and Oaktree, which are believed by many analysts to be interested in holding on to the operations as an investment likely to increase in value if U.S. power prices improve.

Tax liability

A critical issue in the negotiations was tax liability.

The company for months said any breakup would trigger a tax bill in the billions, making such a move unattractive. It reversed Tuesday, saying attorneys had found a way to minimize the tax exposure. But whether that strategy will withstand legal scrutiny remains a question.

“If the IRS allows them to spin it tax-free, which is a big if, I don’t believe the liability goes away. It just doesn’t need to be paid today,” said Joseph DeSapri, a credit analyst with the research firm Morningstar.

So far, the bankruptcy appears to have had little impact on Energy Future operations.

In order to continue operating through bankruptcy, EFH announced Tuesday it had obtained debtor-in-possession loans worth up to $11.8 billion.

Attorneys filed motions in court Tuesday to keep the company’s commodity trading desk and other operations running. Young staged meetings to reassure the company’s 9,100 employees their jobs were secure.

The filing of the bankruptcy in the predawn hours Tuesday followed calls to state officials to reassure them there would be no impact on the state electrical grid.

State Sen. Troy Fraser, R-Horseshoe Bay, got calls from both Young and Oncor CEO Bob Shapard late Monday and said he was reassured the bankruptcy process would not disrupt the state’s power supply.

“The private equity managers who put this together, they gambled and lost and came close to destroying one of the most important businesses in Texas. We dodged a bullet,” Fraser said.

The filing Tuesday ends what some have described as the most anticipated bankruptcy in recent memory.

EFH began negotiations to restructure its debt almost two years ago. Then last fall, the company appeared on the brink of filing for bankruptcy when it came under pressure from senior creditors to skip an interest payment due lower-level creditors. But when a deal failed to materialize, the company made the payment.

But the timetable seemed to shrink late last month when EFH delayed another interest payment, saying it needed more time to negotiate.

“I think this has been such a long time coming. It’s almost anticlimactic,” Hempstead said.

On Twitter:
 @osborneja