Bloomberg News

KKR to Goldman Skirmish for Scraps as LBO Bankruptcy Looms

October 21, 2013

TXU Corp.

Workers exit and enter the headquarters TXU Corp. in Dallas, Texas, Monday, Feb. 26, 2007. Photographer: Mike Fuentes/Bloomberg

KKR & Co., Goldman Sachs Capital Partners and TPG Capital, the firms that led the $48 billion buyout of Energy Future Holdings Corp. in 2007, are fighting to receive barely 3 percent of their initial investment when the power generator files for bankruptcy as soon as this month.

Negotiations with senior creditors including Leon Black’s Apollo Global Management LLC (APO:US) and Centerbridge Capital Partners LLC, which are poised to seize control of the former TXU Corp., are at a crucial juncture today when agreements that allow them to view nonpublic information to foster talks expire. A proposal disclosed last week that wasn’t accepted would have given the company’s owners as little as $270 million.

KKR, Goldman and TPG took Dallas-based Energy Future private in the largest leveraged buyout in history, an investment that was predicated on rising gas prices. Instead, they fell as the development of hydraulic fracturing created a surge in U.S. gas supplies, triggering 10 straight quarterly losses at the company since 2011 and leading Warren Buffett to say his $2 billion investment in Energy Future bonds was “a big mistake.”

“We see bigger potential for value leakage if this bankruptcy restructuring turns highly contentious, highly litigious and disorganized,” Jim Hempstead, an analyst at bond-rating company Moody’s Investors Service in New York, said in a telephone interview.

Urgency Building

Urgency is building. Energy Future is due to make about $270 million in interest payments Nov. 1 -- cash that senior creditors want the company to retain to boost their recoveries in a bankruptcy. A filing would be the 12th-largest in the U.S. and the fifth biggest non-financial corporate ever, according to the UCLA-LoPucki Bankruptcy Research Database, which ranks companies by assets.

Confidentiality agreements, which allow investors to access private information to facilitate the talks, signed by the groups lapse today. The participating groups have the option to extend them or allow them to expire and leave the discussions.

While creditors haggle over divvying up the biggest power plant owner in Texas, which traces its roots back to 1882, soon after the invention of the incandescent light bulb, distressed-debt funds led by Centerbridge, Apollo and Oaktree Capital Group will probably gain majority ownership of a restructured Energy Future, based on three reorganization proposals disclosed in an Oct. 15 regulatory filing and people with knowledge of the negotiations.

Bankruptcy Proposal

Moody’s estimated in a Sept. 9 report that secured lenders, who are paid out first in a Chapter 11 reorganization, may recover as much as 68 percent of the debt’s original value.

Those firms built influential creditor positions by buying large stakes in Energy Future’s secured debt as its prospects dimmed. In a proposal by the group that wasn’t accepted, secured lenders would receive all the equity in the restructured company while the current owners would share $800 million with two sets of unsecured debt holders, according to the filing.

Unsecured debt holders “would be pretty much wiped out,” recovering as little as 4 percent, the analysts, led by Hempstead, wrote. The regulatory filing last week said that a group of those investors was contemplating litigation.

The biggest losers will be the equity investors, who may see most of their $8.3 billion original investment erased. KKR and TPG put up $3.5 billion and Goldman Sachs added $1.5 billion. An additional $3.3 billion came from clients of KKR, TPG and Goldman, and from Lehman Brothers Holdings Inc., Citigroup Inc. and Morgan Stanley.

‘Unforced Error’

The rest of the record $48 billion deal was funded in debt. Buffett’s Berkshire Hathaway Inc. (A:US) bought about $2 billion of the power producer’s bonds in 2007, according to an annual letter to shareholders posted Feb. 25, 2012, on the company’s website. Berkshire wrote down the investment by $1 billion in 2010 and by an additional $390 million the next year, the letter said.

“In tennis parlance, this was a major unforced error by your chairman,” Buffett wrote in the letter.

KKR and TPG both value their investment in the power provider at 5 cents on the dollar, a plunge of 95 percent, according to a July 26 regulatory filing by KKR and a TPG quarterly report obtained by Bloomberg. Energy Future’s $1.83 billion of 10.25 percent, unsecured notes due in November 2015 closed at 3.13 cents on the dollar last week, down from 88.5 cents in the beginning of 2010, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Buyout Funds

Spokesmen for the buyout group, Apollo, Oaktree and Centerbridge declined to comment or didn’t respond to requests for interviews. Allan Koenig, a spokesman for Energy Future, also declined to comment.

New York-based Centerbridge was founded by Mark Gallogly, a former Blackstone Group LP executive, and Jeffrey Aronson, who previously led the distressed-investing team at Angelo Gordon & Co. Oaktree, headquartered in Los Angeles and led by Howard Marks, is the world’s biggest investor in distressed debt, overseeing $76.4 billion in assets.

Apollo is an alternative investment and private-equity firm with $113 billion under management, including about $62 billion in credit.

The Energy Future LBO capped a buyout boom from 2005 to 2007 that spawned supersized takeovers in which private-equity firms combined capital from investors such as pensions and endowments and a larger portion of borrowed money with the goal of improving cash flows and selling years later at a profit.

Global Deals

Private-equity firms announced about $2 trillion of deals globally from the start of 2005 through 2007, Bloomberg data show. A dozen LBOs valued at $20 billion or more were consummated from 2006 to 2008, according to data compiled by Bloomberg.

While some have generated profits, such as those of hospital owner HCA Inc., pipeline operator Kinder Morgan Inc. and British retailer Alliance Boots GmbH, others, including casino operator Caesars Entertainment Corp., broadcaster Clear Channel Communications Inc. and credit-card processor First Data Corp., continue to struggle with weak earnings and onerous debt.

TXU shows that “leveraged buyouts are quite risky,” said Jay Westbrook, a professor specializing in bankruptcy law at the University of Texas law school at Austin. “They run a serious risk if the market doesn’t break the way you planned when you did the LBO, it can create very serious problems.”

Power Prices

TXU’s acquirers paid $69.25 a share, a 15 percent premium when the deal was announced on Feb. 26, 2007. Instead of rising, natural gas prices plunged 72 percent from a July 2008 peak as shale drilling expanded, depressing rates the company could charge for its power. Power prices depend on gas costs in most markets because plants powered by the fuel usually provide the marginal power needed to meet demand. Coal is easy to store, and plants powered by it are usually slow to be turned on and off.

That left the renamed Energy Future unprofitable at the same time its interest expense (TXU:US) on bonds soared three-fold, Bloomberg data show. Energy Future, which has enough capacity to supply nearly 20 percent of Texas’s total peak demand, had a net loss of $9.84 billion in 2008 after a $637 million loss the prior year and a $2.55 billion gain in 2006, the data show. It reported a $3.36 billion deficit in 2012.

The company has dealt with its crushing debt load by extending some maturities, shifting some liabilities and negotiating principal reductions on certain loans before beginning reorganization talks this year.

Company Proposal

Energy Future creditors rejected a proposal by the company to restructure $32 billion in debt at its deregulated unit that owns Luminant, a power generator, and TXU Energy, a retail electricity seller, through a pre-negotiated bankruptcy, according to an April 15 regulatory filing. That failed deal would have seen KKR and TPG retain 15 percent of the parent company for an additional payment and senior lenders at the unit getting the rest.

In an August earnings report, the company said it was in discussions with a broader group of lenders, and in last week’s filing with the U.S. Securities and Exchange Commission, it disclosed private negotiations with key creditors were continuing after one group walked away from the closed-door discussions. Those still negotiating include the Apollo-Oaktree-Centerbridge group, and a “significant creditor” whose name wasn’t disclosed in the filing. That significant creditor is Fidelity Investments, according to people familiar with the negotiations. Fidelity declined to comment.

Salvage Value

“Bankruptcy laws are sufficiently well understood today that lenders often negotiate before going to court against the shadow of the bankruptcy code,” said Richard Levin, a partner at Cravath, Swaine & Moore LLP in New York, who heads the law firm’s restructuring practice. “Even if most lenders agree to a restructuring, in a case this size, the bankruptcy process may be necessary if the agreement is not unanimous.”

KKR, TPG and Goldman have managed to glean some value from the company. Energy Future paid them about $575 million in fees through June 2013, regulatory filings show. That breaks down to $300 million for advising on their own buyout, annual management fees totaling $210 million and as much as $64.3 million for consulting on debt deals.

“The investors take an ice water bath while the fund sponsors and the accountants, consultants and lawyers lucky enough to have helped out keep their take and put on their most contrite faces,” said Erik Gordon, a business professor at the University of Michigan.

To contact the reporters on this story: Beth Jinks in New York at bjinks1@bloomberg.net; Richard Bravo in New York at rbravo5@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Jeffrey McCracken at jmccracken3@bloomberg.net


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Companies Mentioned

  • APO
    (Apollo Global Management LLC)
    • $26.2 USD
    • -0.06
    • -0.23%
  • A
    (Agilent Technologies Inc)
    • $56.07 USD
    • -0.02
    • -0.04%
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