Termsheet: Energy Future Holdings

Not all buyouts are created equal.

Some are big, others are small. Some generate returns, others stumble. Some cost $48 billion and eventually wind up in bankruptcy. Energy Future Holdings will likely fall into the latter category.

On 15 April, Energy Future Holdings filed documents with the US Securities and Exchange Commission that shed light on a bankruptcy solution the company and its private equity sponsors – which include Kohlberg Kravis Roberts, TPG and Goldman Sachs – proposed to creditors earlier this year.

The proposal includes a restructuring of a major EFH subsidiary’s $32 billion of debt through Chapter 11 bankruptcy. Under the restructuring, first lien creditors would exchange their claims for a combination of EFH equity and a pro rata share of $5 billion cash or new long-term debt of the subsidiary (known as Texas Competitive Electric Holdings Company).

EFH’s private equity sponsors informed creditors that they would support the restructuring if they could retain a 15 percent stake in EFH’s equity interests, thereby granting the creditors the remaining 85 percent of the company. The sponsors also indicated they would provide additional equity capital to facilitate the deal.

The proposal would have given TCEH access to $3 billion in liquidity, comprised of a $2 billion first lien revolver and a $1 billion letter of credit facility, along with $5 billion in new long-term debt.

EFH’s creditors turned down the proposal. 

“They expect to restart negotiations at some point,” said one source familiar with the negotiations. “There was no agreement on the proposal … I don’t think there was ever a counter proposal given.”

Spokesmen representing EFH’s sponsors and creditors declined to comment to Private Debt Investor.

The struggles of EFH

Although EFH and its affiliated subsidiaries do not have any material debt maturities due until October 2014, according to its 15 SEC filing, the energy company remains burdened with what appears to be an insurmountable quantity of debt as its core businesses struggle in an inhospitable market.

KKR, TPG and Goldman Sachs acquired Energy Future Holdings (then known as TXU) through a $48 billion buyout in 2007. The buyout, the largest in private equity’s history, included only $8.3 billion in equity from the deal’s sponsors, with more than 80 percent of its enterprise value accounted for by debt financing.

“Our substantial leverage, resulting in large part from debt incurred to finance the merger, and the covenants contained in our debt agreements, require significant cash flows to be dedicated to interest and principal payments and could adversely affect our ability to raise additional capital to fund operations and limit our ability to react to changes in the economy, our industry (including environmental regulations) or our business,” according to EFH’s 2012 10-K SEC filing.

The company’s ability to pay off that debt hasn’t been helped by developments within the energy industry, which have contributed to declining values of EFH’s assets.

The sponsors made their investment under the assumption that natural gas prices would continue to rise. Instead, advances in hydraulic fracturing and other drilling techniques contributed to a boom in the natural gas supply, which in turn has led to a steep drop in the price of natural gas.

Over the life of the private equity firms’ investment in EFH, natural gas wellhead prices peaked at $10.79 per thousand cubic feet in July 2008, according to the US Energy Information Administration. That price had fallen to $3.35 as of the end of last year.

“A continuation, or further decline, of current forward natural gas prices could result in further declines in the values of TCEH’s nuclear and lignite/coal-fueled generation assets and limit or hinder TCEH’s ability to hedge its wholesale electricity revenues at sufficient price levels to support its significant interest payments and debt maturities, which could adversely impact TCEH’s ability to obtain additional liquidity and refinance and/or extend the maturities of its outstanding debt,” EHF disclosed in the 10-K filing.

The decline in natural gas prices has mirrored KKR’s valuation of the company. As of Q4 2012, the private equity firm valued its investment in EHF at five cents in the dollar, according to an earnings report. In describing his firm’s pre-credit crisis investment portfolio, KKR co-founder George Roberts made no bones about it being one of the biggest obstacles facing the firm.

“The biggest issue is no big secret – it’s TXU,” Roberts told Private Debt Investor’s sister title Private Equity International in 2011.

Moving forward

Despite its misfortunes, Energy Future Holdings has been able to delay its all-but-inevitable bankruptcy for some time. Since 2009, EFH and its affiliated companies have captured $2.5 billion of debt discount and extended the maturities of approximately $25.7 billion of debt to 2017-2021, according to SEC filings.

However, that time seems to be running out.

In February, the company reported its net losses reached $3.4 billion in 2012, a significant worsening in performance relative to its $1.9 billion losses reported in 2011 and $2.8 billion losses reported in 2010. EFH’s most recent disclosure about conversations surrounding a possible restructuring included information about the hiring of Kirkland & Ellis and Evercore Partners to advise the company on potential changes to its capital structure, which included $40.1 billion in total debt against $41 billion in assets as of 31 December, according to a 14 March Debtwire Analytics report.

A huge chunk of that debt, $3.8 billion in 3.75 percent TCEH term loan facilities, is scheduled to mature in October 2014. A $42 million 3.71 percent letter of credit facility matures the same day.

“They’re going to limp out of 2013 and run out in 2014 according our projection model,” Moody’s senior analyst Jim Hempstead told the Dallas Business Journal in March.

Meanwhile, creditors also appear to be circling their wagons. An ad-hoc group of lenders – led by Oaktree Capital Management and Apollo Global Management – who hold positions in TCEH’s $19.2 billion term loan facilities has hired Paul, Weiss, Rifkind, Wharton & Garrison as legal counsel, and Franklin Templeton has unloaded a $400 million block of its holdings in TCEH 15 percent second lien bonds due 2021, according to Debtwire. 

Paul Weiss and Franklin Templeton declined to comment on this story.

When asked whether any timeline had been set for EFH’s eventual bankruptcy, one source iterated that the discussions between creditors, sponsors and the company remain fluid, and that they expect to negotiations to restart soon. 

“No idea at all. Just don’t know,” said one force with knowledge of the negotiations. “The creditors asked their advisors to keep working the deal, to stay in touch.”

“This was kind of the opening round,” says another source. “We’ll see where it goes from here.”  n

Energy Future Holdings Timeline

1912 –  Electric Bond and Share Company consolidates 13 electric companies to form the Texas Power & Light Company, which served North Central and East Texas

1917 – Dallas Power & Light Company formed by Electric Bond and Share, serving Dallas area

1929 – Texas Electric Service Company formed by Electric Bond and Share, serving Fort Worth area

1932 – A transmission network all three companies is essentially completed

1945 – Texas Utilities Company formed, a holding company that links all three companies

2007 – TXU becomes a private company after its acquisition by KKR, TPG and Goldman Sachs in a $48bn buyout, renamed Energy Future Holdings

2008 – John Young named President & CEO of EHF

2008 – Natural gas wellhead prices peak at $10.79 per thousand cubic feet

2011 – EFH subsidiary Luminant launches new Oak Grove power plant. George Roberts admits TXU is “the biggest issue” in KKR’s pre-crisis portfolio

2013 (February) – EFH announces net income losses of $3.36bn in 2012, driven largely by declining natural gas prices

2013 (March) – The company speaks with creditors about a possible restructuring. A proposal allowing the company’s private equity backers to retain a 15% equity stake is shot down.