Bloomberg News

TXU Bond Plunge Reaps $450 Million Windfall: Corporate Finance

December 10, 2012

KKR & Co.’s Energy Future Holdings Corp., struggling to avoid default, is enjoying a $450 million windfall at the expense of bondholders.

Energy Future, formerly called TXU Corp. and taken private by KKR, TPG Capital and Goldman Sachs Capital Partners five years ago in the largest leveraged buyout, exchanged $1.15 billion of new notes last week for old ones with a face value of $1.6 billion. The move came after the old securities tumbled when the firm said in an Oct. 30 regulatory filing that it may be liable for $23 billion of taxable income if it cuts ties to units that default.

The disclosure “allowed them to get a better” deal on the exchange, Andy DeVries, an analyst at independent bond research firm CreditSights Inc., said in a telephone interview. The filing probably was intended to rattle bondholders and cut the value of the outstanding debt before the swap, he said.

The assertion that Energy Future timed its tax disclosure to knock down bond prices to buy them back on more favorable terms “is patently false,” Allan Koenig, a spokesman for Energy Future Holdings, said in a telephone interview.

‘Financial Flexibility’

“The Oct. 30 tax disclosure is wholly unrelated to the debt exchange” and the swap “gives financial flexibility in the short and long term,” he said. “We have been and always will be in compliance with U.S. Securities and Exchange Commission laws.”

The Dallas-based company has posted seven consecutive quarterly losses (TXU:US) and will face a “material restructuring” in the next 12 months, according to Moody’s Investors Service. Its long-term borrowings (TXU:US) soared to $37.4 billion as of Sept. 30 from $10.6 billion before the LBO. Meantime, natural gas prices have fallen about 74 percent from their 2008 peak. The price of electricity in the Texas market is linked to natural gas costs.

When Energy Future was taken private for $43.2 billion, it was profiting from low power-generation fuel costs and rising natural gas prices. The company, under former Chairman and Chief Executive Officer C. John Wilder, earned $2.6 billion in 2006 after rebounding from a failed international expansion that left it on the verge of bankruptcy four years earlier.

Sagging Fortunes

With its fortunes again sagging, Energy Future has been trying to extend maturities through debt exchanges, borrowed to pay off intercompany loans and made efforts to shield profitable assets from potential creditor claims in the event of a restructuring. Fitch Ratings said it’s likely the company may remove provisions in its bond indentures that would further protect those assets.

Andrea Raphael, a spokeswoman at Goldman Sachs, didn’t return telephone and e-mail messages seeking comment on Energy Future’s finances. Kristi Huller, a KKR spokeswoman, declined to comment. Owen Blicksilver, a spokesman for TPG with Owen Blicksilver Public Relations Inc., declined to comment.

Energy Future disclosed in October, along with a $407 million third-quarter loss (TXU:US), that it had a $19 billion excess loss account and $4 billion deferred intercompany gain that are reflected in the tax basis of the stock it holds of Energy Future Competitive Holdings and may be triggered as taxable income if those shares are sold.

Bonds Plummet

The announcement caused its bonds to plummet, with the market value of the old debt involved in the swap falling to $991 million from $1.1 billion, according to CreditSights. Its 5.55 percent notes due 2014, which traded at 83 cents on the dollar before the quarterly filing, fell as low as 50 cents in November before rebounding to 88 three hours after the exchange deal was made public, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The bonds increased to 88.5 cents to yield 12.4 percent on Dec. 7, Trace data show.

“We think there is a better chance the disclosure was meant to drive down the price of EFH bonds so management can commence an exchange offer,” DeVries wrote in a Nov. 4 report.

The new bonds allow Energy Future to pay interest with extra debt instead of cash. That may improve the company’s near- term finances as it works to shield an 80 percent stake in its profitable Oncor Electric Delivery Co., which is regulated and distributes power to homes and businesses, from a potential restructuring of other units that generate and sell power in competitive markets.

Exchange Premium

Energy Future issued the new bonds through its Energy Future Intermediate Holding Co. and EFIH Finance units, which sit between the parent and Oncor in the firm’s capital structure.

The securities, which are due in 2018 and pay 12.25 percent interest with extra debt, were exchanged at a 16 percent premium to the market value of existing debt held at the parent level, according to CreditSights.

Had it conducted the swap six weeks ago, before the market value of the securities plunged to as low as $700 million in the days following the tax disclosure, Energy Future would have had to spend $1.27 billion to give creditors the same premium.

The new bonds were exchanged for $234 million of 5.55 percent debt due November 2014; $510 million of 6.5 percent notes due in 2024; about $453 million of its 6.55 percent securities due in 2034; $94 million of 10.875 percent debentures due 2017; and $313 million of 11.25 percent bonds due 2017.

Energy Future expanded on the tax liability in a Nov. 6 filing known as a “8-K” in response to investors’ questions.

‘Internal Restructurings’

“The excess loss account and deferred intercompany gain described in the Energy Future Holdings form 10-Q were created in connection with financing transactions and internal restructurings that involved Texas Competitive Electric Holdings and its assets but not Energy Future Intermediate Holding or Oncor Holdings,” Energy Future said in the filing.

The debt exchange is part of a move to improve the finances at the portion of the firm linked to Oncor while distancing those assets from units such as Texas Competitive Electric Holdings Co., where Moody’s said a default is “highly likely” to occur in the next 12 months.

After cutting legal and financial ties, “you can then look at Energy Future Holdings and Energy Future Intermediate Holding pretty much as a standalone entity,” Shalini Mahajan, an analyst at Fitch, who doesn’t expect the tax implications to be triggered, said in a telephone interview. “We don’t think Oncor gets pulled in, in any kind of bankruptcy proceedings.”

Buying Time

Energy Future also benefits from the ability to pay interest on the new bonds with additional debt, giving the company more time to improve its balance sheet, Mahajan said. The so-called payment-in-kind feature may save $360 million in interest costs over three years, helping boost liquidity to a level adequate until 2016, she wrote in a Dec. 5 report.

Moody’s changed its rating outlook on the electricity provider to “developing” from “negative” after the exchange, saying in a Dec. 5 report that “the probability of a default occurring simultaneously across the Energy Future Holdings family, excluding Oncor, is diverging.”

The parent company is rated Caa3 by Moody’s and CCC at Fitch, levels that denote bonds with high default risk. S&P changed Energy Future’s rating to SD from CCC on Dec. 6, characterizing the exchange offer as a “selective default.”

Losses have been tempered by Energy Future’s stake in Oncor, whose rate of return on investment is set by regulators. The unit reported net income of $321 million for the first nine months of 2012 and paid a $100 million dividend to Energy Future, the size of which is regulated, up from $64 million in 2011. The parent said in its Oct. 30 filing that it expected to receive a distribution of about $47 million from Oncor that day.

Gas Plunge

“Lenders accepting the exchange might be looking to the value, if any, of being closer to the asset that provides essentially all cash flow” that Energy Future uses to meet obligations, Terry Pratt, an analyst at S&P in New York, said in a Dec. 6 report.

Natural gas futures cost $3.55 per million British thermal units last week, down from $6.88 on Oct. 11, 2007, the day KKR and TPG took Energy Future private. Prices have plunged from a peak of $13.58 in July 2008 as the worst financial crisis since the Great Depression sapped demand and as expanded drilling in the gas-rich Marcellus shale in the eastern U.S. created a supply glut.

“Natural gas prices are never going to get where they need them to get to be able to make that capital structure work,” Peter Thornton, an analyst at high-yield researcher KDP Investment Advisors Inc., said in a telephone interview.

A decision by Energy Future to put Energy Future Competitive Holdings and its Texas Competitive Electric Holdings unit into bankruptcy protection would raise the question of whether those units’ creditors, “if they’re going to get zero or are otherwise severely impaired, will they have a claim on that Oncor equity value, because of the tax liability or the intercompany loan or some other link to the parent?,” Thornton said.

To contact the reporters on this story: Charles Mead in New York at cmead11@bloomberg.net Mark Chediak in San Francisco at mchediak@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Susan Warren at susanwarren@bloomberg.net


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