Reports are circulating that the private equity held, Texas based, huge energy company Energy Future Holdings, may be close to filing for Chapter Eleven bankruptcy proceedings in the US.
Energy Future Holdings was acquired in October 2007 for US$45 billion, in the largest ever leveraged-buy-out in American history. The purchasers were gambling at the time on ever rising energy prices, particularly for natural gas which they thought would give a competitive advantage to Energy Future Holdings’ coal fired generating stations.
Instead the world economy collapsed and, with huge progress also made by the United States since in finding massive new quantities of natural gas, through fracking and other novel drilling techniques, the price of natural gas in the US plummeted instead. This makes EFH’s balance sheet today simply too over-burdened with debt for its current cash flow capabilities to sustain.
However in 2007, when the deal was cooked, the world economy was apparently healthy, still awash with money and the soon-to-be-forthcoming severe and systemic financial crisis had not yet broken apart so many people’s personal and business hopes and dreams. In October 2007, too, the US stock market actually peaked, only for it to later all unravel in the months that followed.
October 10th, 2007 was the day one of the last mega deals of that go-go business cycle was completed, and the newly organized private holding company, Texas Energy Future Holdings LP, later shortened to just Energy Future Holdings, completed a merger agreement it had previously entered into to acquire all the shares of the, publicly listed and Texas based, energy company TXU Corp.
In the previous month of September, TXU shareholders had approved the takeover at their Annual General Meeting in what was at the time, and indeed since, the largest leveraged buy-out in American history. But the deal itself goes further back and it was definitively agreed to among the parties even earlier, in February 2007 when it was announced to the world. It was only ready for closing by October, however, which is pretty much par for the course for such large transactions.
Energy Future Holdings has three separate, and distinct, lines of business. The first is its regulated electrical transmission and distribution business, called Oncor, which has 14, 000 miles of transmission lines and over 100, 000 miles of associated local distribution. The second is its power generation, and coal mining, business called Luminant, which has over 18, 000 mega watts of generating capacity in Texas from coal, nuclear and gas powered generating plants The third is its retail energy business which is called TXU which has over 2 million retail customers.
Including the US$13 billion of debt already in the TXU balance sheet at the time of closing the total enterprise value of the leveraged transaction was US$45 billion. The purchasers were a partnership between three heavy weight private equity giants; New York based Kohlberg Kravis Roberts (KKR), Texas based TPG Capital (then Texas Pacific Group) and Goldman Sachs Partners, the private equity arm of New York based investment bank Goldman Sachs.
KKR is run by two of its original co-founders Henry Kravis and George Roberts. TPG is managed by private equity legend David Bonderman and his co-founder James Coulter. Goldman Sachs is led by its Chairman Lloyd Blankfein.
If, by the time of the closing in October 2007, the new purchasers had any qualms about going ahead they certainly didn’t show it, and the press release put out that day positively bursts with pride over the transaction. To its’ credit that press release is still available on the KKR web site, though not on the web sites of the other two investors.
At the time, in 2007 the KKR partner involved Marc Lipschultz said at the closing, “Our investment horizon allows the board, management and employees to formulate and implement a long-term strategy to meet customer needs and to respond to the significant energy challenges in Texas.” Marc Lipschultz today is head of KKR’s energy and infrastructure group. Later those words would come back to haunt him.
When the acquisition closed in 2007, a very distinguished new Board of Directors was established for the new entity, of the best and the brightest and Chaired by Donald Evans, who had previously served as US Secretary of Commerce under President George W Bush.
The basic strategy post-acquisition was to continue to separate further the three different business lines of the company, as Tom Baker, the former Vice-Chairman of TXU who was kicked upstairs to become Chairman Emeritus of Energy Future Holdings said at the time, “This company and its employees are ready for the next step. We look forward to implementing additional separation of our three businesses so each can focus on the distinct customers they serve.”
Well the crash came in 2008, the deal was under water likely not much later and the drop in the price of natural gas later may simply have sealed its fate as the success of shale gas discoveries in the US seems to have changed the whole American energy landscape in the last five years.
When a big private equity LBO like this takes place, or even one with fewer zeros in the price tag, it is always structured so that the risks involved are sliced and diced in a number of different ways in what is known in the business, affectionately, as the capital “stack”.
The primary sponsors put in enough equity to get the deal done, in this case reported to be around US$8 billion. Then conventional commercial banks take on some, well-secured, hard asset lending at reasonable interest rates. After that a number of levels of what were once known as “junk” bond financings – from the days of the famous, or perhaps infamous, Michael Milliken – are layered on top.
Many of these layers of debt are sold to different departments in the same private equity firms that do the equity part of the deals as well. Only, this time to the departments which are looking for initial fixed income yield rather than long term equity gain. And since it is a comparatively small group of companies, frequently these firms end up taking in each others laundry a good deal of the time, which can be helpful if things should get a little ugly as they have here.
For example, one group of existing lenders involves Apollo Global Management and Oaktree Capital as suppliers of credit, while another involves Blackstone Group’s lending arm GSO Capital Partners.
However if these giant firms cannot agree between them on an amicable form of restructuring when they all have breakfast together at the newly re-opened Regency Hotel, moreover in a way that leaves KKR and its partners still in charge too in order to fix things for the longer term presumably, then a long and complicated bankruptcy proceeding could ensue.
Energy Future Holdings’ CEO John Young has tried to make the case that the three different elements of the business should all stay together, but in a full bankruptcy proceeding they could just be split apart to offer maximum return, or to minimize the loss if you will, to the various existing investors, lenders and potential new lending groups. Tax allocations to all the different kinds of assets involved can complicate the picture as well undoubtedly. If a break up is indeed the eventual outcome many more people are likely to lose their jobs, too which one should not overlook.
Last month, KKR’s energy group head, and the man who set the deal up for them originally in 2007 Marc Lipschultz, resigned from the Board of Directors of Energy Future Holdings, which is probably not a good sign of the way some of the conversations are going.
So was it hubris for KKR and their friends to make such a massively leveraged deal in the first place in 2007, and then to just walk away from the consequences if that is what is happening now? Does Mr. Lipschultz indeed fall on his own sword as a good soldier now, or is it just another day at the office for him? Can they somehow still rescue the company – “rescued at a stroke” as it was put in the Superman comics – by an imaginative piece of financial re-engineering? I guess we will find out when the next moves are announced by the company, by its investors and by its creditors.