Bloomberg News

KKR Group’s TXU Stake Hangs on Junior Bonds: Corporate Finance

July 25, 2013

KKR & Co. (KKR:US) and TPG Capital’s best chance for salvaging their failing $48 billion purchase of Energy Future Holdings Corp. in the biggest leveraged buyout ever may hinge on $1.48 billion of junior bonds.

The odds are rising that the group of private-equity firms will try to buy the 11.25 percent debt due December 2018 and linked to the company’s regulated business, according to debt research firm CreditSights Inc. That would give them increased bargaining power to push secured lenders of the company’s unregulated unit into a reorganization that leaves a portion of the Dallas-based company in the hands of the buyout firms.

“They’re going to have to pony up cash -- there’s no ifs, ands or buts about it,” Andy DeVries, an analyst at CreditSights, said in a telephone interview. Creditors of the competitive business “would like to be a part” of the regulated side, “and that’s why the sponsors can sort of wiggle in here and make some moves,” he said.

The former TXU Corp. had proposed a pre-packaged bankruptcy plan earlier this year amid nine straight quarters of losses that made servicing its $40 billion of debt unsustainable. Creditors including Apollo Global Management LLC rejected the proposal, which would have kept the two businesses together, in part because the holding company that controls the regulated unit burns through cash.

$1.3 Billion

Purchasing the securities, whose interest can also be paid with extra debt, may cost at least $1.3 billion, based on its last trading price on June 6 of 88.5 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The notes yielded 14.6 percent last month.

Buying the bonds and converting them into equity would “kill two birds with one stone” by putting owners of the technically insolvent electricity provider in a position to capture equity in a restructured company and “at least partially resolve” projected cash deficits (TXU:US) at the Energy Future Intermediate Holding Co. unit that controls the regulated business, DeVries wrote in a July 23 report.

Extinguishing the 2018 notes would save at least $166 million of interest a year, according to data compiled by Bloomberg.

Companywide Agreement

Allan Koenig, a spokesman at Energy Future, declined to comment on the company’s finances. A message left for Kristi Huller at KKR wasn’t immediately returned. Owen Blicksilver, a spokesman for TPG at Owen Blicksilver Public Relations Inc., and Andrea Raphael of Goldman Sachs Group Inc., whose Goldman Sachs Capital Partners also owns an Energy Future stake, declined to comment.

Junior bondholders at Energy Future Intermediate hired Centerview Partners LLC and Akin Gump Strauss Hauer & Feld LLP to advise on reducing the subsidiary’s obligations, Bloomberg News reported on July 23, citing people with knowledge of the matter. A resolution of the unit’s cash-flow deficit may help smooth the way for a companywide bankruptcy agreement, said the people, who asked not to be named because the matter is private.

The 11.25 percent unsecured notes account for about 19 percent of the unit’s $7.62 billion of debt, the rest of which comprise first- and second-lien bonds, Bloomberg data show.

‘New Equity’

Those obligations have helped worsen Energy Future Intermediate’s financial position, with a combined cash flow deficit of $1.4 billion forecast between 2013 and 2017 for both the unit and parent Energy Future, according to an April 15 regulatory filing. That adds risk for unsecured bondholders, and may make them more amenable to an equity swap than secured lenders, according to Marc Gross of RS Investments in New York.

“They’re not covered because they’re free cash flow negative,” said Gross, who oversees about $3.5 billion in fixed-income funds and doesn’t own Energy Future debt. While it’s unlikely the private-equity firms will put up additional cash, “I suspect in the end you’ll probably have some new equity coming in,” he said.

Injecting equity into the regulated side of Energy Future’s business, which controls the profitable Oncor Electric Delivery Co. utility, would help address one objection by lenders of the competitive side, which include Apollo and Oaktree Capital Group LLC. They don’t want cash flows from a restructured Texas Competitive Electric Holdings Co. unit plugging deficits in Energy Future Intermediate, according to the April 15 filing.

Gas Plunge

The lenders also demanded a greater ownership portion of both debt and equity in exchange for restructuring $32 billion of obligations. Energy Future owners had proposed retaining a 15 percent equity interest in the new company, an amount that creditors rejected.

A transaction involving the 11.25 percent bonds would mark the latest attempt by Energy Future’s owners to manage a balance sheet that’s imperiled the company since a 2008 plunge in natural gas pulled electricity prices lower, hampering profitability and depleting the private-equity firms’ initial $8.3 billion investment.

The leveraged buyout was a gamble that natural gas prices would rise and give its coal-fired plants a competitive advantage. Instead, U.S. prices fell to a 10-year low last year.

Since 2009, the company has captured at least $2.5 billion of debt discount and extended the maturities of about $25.7 billion of obligations to between 2017 and 2021.

“They’re so far out of the money,” DeVries said. “It’s just a matter of at what level of valuation they put that cash in.”

To contact the reporters on this story: Charles Mead in New York at cmead11@bloomberg.net; Richard Bravo at rbravo5@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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