Energy Future Holdings Corp.’s decision to make a $270 million interest payment buys the Texas power producer as much as five extra months out of bankruptcy while inciting the ire of lenders who lose that money in a recovery.
The former TXU Corp. is making the distribution after creditors failed to agree on a reorganization (0763895D:US) plan before today’s payment deadline. The next key date comes in March when auditors may raise doubts about Energy Future’s ability to remain a going concern, which would trigger a default, said a person with knowledge of the Dallas-based company’s finances who asked not to be identified because the situation is private.
Energy Future, which was bought in 2007 for $48 billion by private-equity firms led by KKR & Co. betting on a boom in natural gas prices, came close to filing for bankruptcy before talks with creditors (0763895D:US) that included some of Wall Street’s leading investors on a restructuring fell apart yesterday. Secured lenders, who would be paid out first in a reorganization, didn’t want the interest payments made because the funds go to more junior creditors, raising the specter angry debt holders will break up the company, inducing a $2 billion tax liability.
“If they make the payment, they bought themselves two months before they trip a covenant and they have royally screwed over the guys who they need to have on their side to avoid the tax bill,” Andy DeVries, an analyst at New York-based bond researcher CreditSights Inc., said in an e-mail, indicating the company may fall out of compliance with a financial maintenance contract in the fourth quarter. At most, Energy Future would have bought five months, “and the covenant is breached for sure,” he said.
Adam McGill, a spokesman for the company, declined to comment.
In a regulatory filing today, Energy Future disclosed four rival restructuring proposals that had been discussed. The plan submitted by owners led by KKR, TPG Capital and Goldman Sachs Capital Partners would have seen them retain 4 percent equity, giving the remainder to senior creditors at Energy Future’s Texas Competitive Electric Holdings Co. unit.
The company said it had lined up $3.6 billion debt-in-possession financing to fund it through bankruptcy, as well as up to $750 million in a separate facility. Energy Future said it’s “not currently engaged in ongoing negotiations with the principals of any of the creditors.”
Texas Competitive’s $1.83 billion of 10.25 percent bonds maturing in November 2015, which are due to receive interest payments today, rose 0.5 cent to 7.5 cents on the dollar today, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The private equity owners sought a consensual deal among creditors that would hold together the target of the largest leveraged buyout ever, one of the people said. In the past two weeks, Energy Future and its advisers stepped in to try to bridge the differences between the groups, providing parameters for how such a negotiated deal could work, that person said.
Lenders including Apollo Global Management LLC (APO:US), Oaktree Capital Group LLC (OAK:US) and Centerbridge Capital Partners LLC are part of a $19.5 billion class of first-lien debt holders that offered a proposal to compensate lenders at the Energy Future Intermediate unit with $800 million, two people said.
An unsecured group, which includes York Capital Management LP, Avenue Capital Group LLC and P. Schoenfeld Asset Management LP, demanded more than three times that amount, two of the people said. The committees couldn’t resolve the difference.
The secured creditors have demanded the company be split up if the $270 million coupon is paid today, according to another person with knowledge of the discussions. They will seek ownership of the competitive unit, leaving the regulated power line business to other creditors.
“The secured lenders hate to see this money leaving the company,” Marc Gross, a New York-based money manager at RS Investments, said in an e-mail. “By paying, they are also signaling that they are not going to give into secured lenders.”
Separating that subsidiary from the rest of the company would create a gain from an asset sale that triggers a cash tax liability of at least $2 billion, according to an April 15 regulatory filing.
That raises the threat the U.S. Internal Revenue Service would assert the claim against Energy Future’s operating units, potentially wiping out the recovery for Energy Future Intermediate Holding Co.’s $1.48 billion of 11.25 percent payment-in-kind notes due in December 2018, according to Amer Tiwana, an analyst at CRT Capital Group LLC in Stamford, Connecticut.
Holders of those PIK notes, which pay interest in additional debt, will seek to challenge that tax liability in bankruptcy court, according to a person with knowledge of the matter.
Contracts tied to natural gas prices that protect Energy Future from losses selling electricity will be reduced at the end of the year, reducing earnings and putting the power producer in jeopardy of falling out of compliance with a financial maintenance covenant that limits its ratio of debt to earnings.
Energy Future’s hedges against fluctuations in gas prices will decrease to 51 percent of its exposure by 2014 and 5 percent by 2015 from 94 percent this year, according to an Aug. 2 regulatory filing. If the company exceeds its covenant threshold, creditors may force a default, propelling Energy Future into bankruptcy.
If they file for Chapter 11 without “at least a solid framework for restructuring, then the bankruptcy would get out of control with dozens of parties all challenging one another in court,” Gross said. “That could prolong the bankruptcy and lower recoveries or any chance of the equity sponsor salvaging some of their investment.”
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