Biggest LBO Collapse Seen as Boon to Texas Power Market

Photographer: Ed Lallo/Bloomberg

Energy Future Holdings Corp.'s Big Brown coal fired electrical plant sits near Fairfield, Texas. Close

Energy Future Holdings Corp.'s Big Brown coal fired electrical plant sits near Fairfield, Texas.

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Photographer: Ed Lallo/Bloomberg

Energy Future Holdings Corp.'s Big Brown coal fired electrical plant sits near Fairfield, Texas.

As Texas warns of potential power shortages and blackouts this summer, the state’s biggest electricity producer is teetering toward bankruptcy. That may turn out to be a boon to the $34 billion Texas power market.

A reorganization of Energy Future Holdings Corp., which lost money because of low natural gas prices after the largest leveraged buyout, would probably leave its power-generating unit with less debt and more free cash to invest in improving output capacity, according to former Texas regulator Brett Perlman. Power demand in Texas is growing faster than supplies, which may force the state to call for conservation on the hottest days this year.

“We have the biggest generation owner in the state sidelined and unable to seriously contribute to addressing our capacity needs,” said Perlman, who served on the Public Utility Commission of Texas when power markets were deregulated more than 10 years ago and is now president of energy consultant Vector Advisors. “A restructuring could potentially help address that situation.”

The struggles of the Dallas-based company formerly called TXU Corp. illustrate the risk investors face in betting on deregulated electric markets, where wide price swings can produce big profits or big losses. Other generators in competitive markets have been hurt by falling prices, including Dynegy Inc. (DYN), which emerged from bankruptcy last year, and Edison International (EIX)’s generation unit, which filed for Chapter 11 reorganization in December.

Gas Plunge

A plunge in gas prices to a 10-year low last year doomed Energy Future’s $48 billion buyout, which was a gamble that gas rates would push up power prices and give its nuclear and coal- fired plants a competitive advantage.

Energy Future proposed a pre-packaged bankruptcy plan to restructure $32 billion in debt held by its Texas Competitive Electric Holdings subsidiary in exchange for equity in Energy Future and $5 billion in cash or new debt, according to an April 15 regulatory filing. The deal was rejected by creditors.

KKR & Co. (KKR) and TPG Capital LP, the private-equity sponsors who led the 2007 buyout, said they want to retain a 15 percent equity stake in the company as an opening salvo in restructuring talks that may take many months to resolve.

Energy Future says it has done its share for the Texas power market, spending $3.25 billion to build three new coal units, planned before the buyout, the last of which came online in 2010. Since 2008, the company has spent more than $5 billion at Luminant, its generation unit, and TXU Energy, its retail marketing arm, adding almost 1,900 jobs company wide, according to a February investor presentation.

Adding Plants

Energy Future has added about 2,200 megawatts to the state’s grid since 2007, more than any other generator and bringing it within about 1,000 megawatts of the capacity cap set by regulators in Texas for any single generator. To add more, Energy Future would need to retire older units or transfer ownership, said Allan Koenig, a company spokesman.

Falling prices have affected every generator’s ability to invest in new projects, Koenig said.

In the past three years, Energy Future’s investment in power plants and equipment hasn’t replaced the value of the assets as they deteriorate, regulatory filings show. Last year, capital spending at the company’s competitive unit were $630 million, less than half the $1.34 billion it recorded for depreciation and amortization, according to a filing.

And while competitors announced plans to spend at least $3 billion since 2011 on new plants to meet rising energy demand, Energy Future introduced no new projects.

Rebounding Investment?

Texas Competitive’s $1.83 billion of 10.25 percent notes due November 2015 rose 0.5 cent to 10.5 cents on the dollar at 4:41 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Restructuring may shift ownership of the power plants to deeper-pocketed investors at a time when circumstances are turning more in favor of expanding investment. The company expects power prices, tied to fluctuations in gas costs, to rebound over the coming years, improving cash flow.

And Texas regulators are poised to offer more financial incentives to increase the amount of power available for demand peaks during the state’s searing summer days.

Texas faces a rising risk of blackouts as it struggles to keep up with increasing demand, the Electric Reliability Council of Texas, which operates most of the state grid, said March 1.

Energy Future’s debt, a legacy of its buyout, may limit funds needed for operations or to build power plants, the company said in a February regulatory filing.

Paying Interest

In 2012, about 62 percent of Energy Future’s $5.6 billion in revenue went to pay debt interest, according to data compiled by Bloomberg. That compares to an industry average of 6.4 percent, according to the Edison Electric Institute, an industry trade group.

“If you are using a lot of your cash flow to cover interest expense, you are going to have much less available for investing in new plants,” said Peter Thornton, an analyst for KDP Investment Advisors Inc.

Energy Future expects earnings at its competitive power unit will tumble by 33 percent through 2017 as gas hedging contracts expire, according to an April 15 filing. Adjusted earnings before interest, taxes, depreciation and amortization at Texas Competitive will fall to $1.83 billion in 2017 from $2.75 billion this year, totals that don’t include “expenses to upgrade or expand” its power plants, the company said.

Depreciation Equation

Energy Future has allowed depreciation of its power plants to outpace investment in the past three years in part to save cash for debt payments, said Joseph DeSapri, a credit analyst at Morningstar Inc. (MORN)

Capital spending at rival independent power producers was about twice as much as depreciation and amortization in 2012, according to data compiled by Bloomberg.

The collapse in gas prices has led to losses in Energy Future’s last eight consecutive quarters. The company’s competitive unit, which owns nearly one-fifth of the power supplies in Texas, faces a “material restructuring” within six months to a year, Moody’s Investors Service said in March 26 note.

With profits sapped by low prices in Texas, other generators including NRG Energy Inc. (NRG) have been reluctant to expand.

Deregulated Texas

In Texas’s deregulated system, generators are paid for electricity at wholesale rates set by the market instead of state-regulated prices that allow for a certain return of profit. Some power companies are looking forward to a rebound, encouraged by regulators’ decision to raise wholesale power price caps last year and their consideration of additional financial incentives to build.

Closely held Panda Power Funds LP and FGE Power LLC plan to build nearly 3,000 megawatts of gas-fired generation, the companies have said. Spending on those units could be as much as $3 billion, based on a government cost estimates of about $1,000 a kilowatt for a new gas plant. Calpine Corp. (CPN) is adding 520 megawatts of gas generation at an estimated cost of less than $286 million.

In the past three years, competing generators have entered agreements to add about 9,500 megawatts to Texas, according to the state grid operator.

In a Luminant bankruptcy, some lenders would probably exchange some of Energy Future’s debt for ownership of power plants, said Andy DeVries, an analyst at CreditSights Inc.

Interested Rivals

Private-equity investors as well as power companies such as NRG Energy Inc. and Calpine may show interest in buying some of Energy Future’s power plants at discounted prices if they sell some assets to pay secured creditors, DeSapri said.

Energy Future owns the Comanche Peak nuclear plant, five coal plants and eight gas plants.

Southern Co. (NSC), the second-largest U.S. power producer, is among the investors scouting Texas power plants. Southern’s competitive unit, which invests in renewables and gas-fueled plants, is looking at investing in Texas and the Midwest, Thomas Fanning, Southern’s chairman and chief executive officer, said during the company’s Jan. 30 earnings call. Tim Leljedal, a spokesman for Atlanta-based Southern, declined to comment on whether it would buy Energy Future’s plants.

Reviving Plants

NRG, the second-biggest power producer in Texas, isn’t setting aside funds for potential acquisitions of Energy Future assets and doesn’t see them becoming available for several years, Chief Executive Officer David Crane said during a March 1 interview. Norma Dunn, a Calpine spokeswoman, declined to comment.

Energy Future’s old and mostly idled gas plants, which produce about 5,100 megawatts, may be repowered with new turbines for about half the cost of a new gas generator, DeVries said.

New investment will depend on the market outlook after a restructuring, said Paul Patterson, an analyst for Glenrock Associates LLC.

Still, a post-bankruptcy Energy Future lightened of debt would be in a better position to invest, said Kenneth Anderson, a commissioner with the Public Utility Commission of Texas.

“If they could retire and replace older plants with new gas-fired generation, it could improve their competitive situation.”

To contact the reporter on this story: Mark Chediak in San Francisco at mchediak@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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