Energy Future Paves Way for Unit’s Bankruptcy: Corporate Finance

Energy Future Paves Way for Unit’s Bankruptcy: Corporate Finance
Natural gas prices have tumbled 80 percent since July 2008, dragging down electricity rates. Photographer: Daniel Acker/Bloomberg

An $850 million bond sale from Energy Future Holdings Corp. is paving the way for the power producer KKR & Co. and TPG Capital bought in 2007 for $43.2 billion to potentially put its unregulated unit into bankruptcy.

Proceeds from the sale, a portion of which was secured by the firm’s equity interest in Oncor Electric Delivery Co., will be used to repay a loan to Energy Future’s Texas Competitive Electric Holdings Co. Repayment allows the power producer to put Texas Competitive into bankruptcy without triggering defaults elsewhere in the company, according to Covenant Review LLC.

Natural gas prices have tumbled 80 percent since July 2008, dragging down electricity rates and cutting Energy Future’s cash flow, leading to six consecutive quarterly losses. The Dallas-based company’s $36.6 billion of long-term debt, $23.5 billion of which may be due in 2015, make the capital structure “untenable,” Moody’s Investors Service wrote last week.

“Texas Competitive is so under water and so far out of the chances of making money at current gas prices that they would have to sale leaseback every single asset they had, and it just doesn’t make sense,” Andy DeVries, a New York-based analyst at CreditSights Inc., said in a telephone interview. “It’s like putting a Band-Aid on a heart attack.”

Clear Path

Energy Future sold the secured debt last week to pay off a $680 million loan it owed to its unregulated Texas Competitive, which owns a generation unit, the biggest electricity producer in the state, and a unit that sells power directly to customers.

Paying the loan helps clear a path for a restructuring of the division without jeopardizing the parent or its regulated business, Oncor, which distributes electricity to about 3 million homes and businesses in Texas.

Chief Financial Officer Paul Keglevic said last month that the Texas Competitive unit is frozen out of the debt markets and may have to sell and then leaseback assets to raise funds.

Molly Sorg, a spokeswoman at Energy Future, declined to comment on the company’s finances.

Lenders demanded the firm pay about $85 million in annual interest on the bonds, which included a $250 million first-lien portion due in 2017 and $600 million of second-lien debt that matures in 2022, according to data compiled by Bloomberg.

“One read, perhaps, on the repayment of the loan, is that they are preparing to be able to file Texas Competitive Electric Holdings at some point in the future in a way that would not result in bankruptcies elsewhere in the capital structure,” Chris Chaice, an analyst at credit research firm Covenant Review, said in a telephone interview.

Bond Prices

KKR and TPG’s 2007 leveraged buyout of Energy Future, then known as TXU Corp., is the largest private-equity transaction on record, Bloomberg data show.

Energy Future’s $1.1 billion of 10 percent first-lien notes due January 2020 dropped 0.1 cent to 110 cents on the dollar yesterday to yield 8.17 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Texas Competitive’s $1.83 billion of 10.25 percent unsecured notes due November 2015 fell 0.3 cent at 10:30 a.m. in New York to 30 cents on the dollar, Trace data show. The unregulated Energy Future unit had $29.4 billion of outstanding long-term debt as of June 30, according to a July 31 regulatory filing with the U.S. Securities & Exchange Commission.

“Everything that will move the bonds is beyond management’s control, and that’s natural gas prices, heat rates and anything coming out of the regulatory side or the Environmental Protection Agency,” DeVries said.

Accelerated Loans

Energy Future has about $4.2 billion in bonds and loans that come due in 2014, according to the filing. The company has $3.1 billion of long-term debt due in 2015 that could surge to $23.5 billion if it fails to prepay certain obligations and breaches a financial maintenance covenant.

That provision requires Texas Competitive to retire certain bonds before they mature and forbids it to exceed a leverage ceiling, according to the filing. Should it fail to comply with both of those elements, its term loans would come due the following day under a so-called springing maturity.

Natural gas futures have fallen 60 percent to $2.75 per million British thermal units yesterday in New York since Oct. 11, 2007, the day KKR and TPG took Energy Future private just as the recession sapped demand and drilling expanded in the gas-rich Marcellus shale in the eastern U.S. creating a supply glut.

‘Strong Enough’

Hedges that are supporting profit by locking in natural gas prices expire by 2015, according to the regulatory filing. The hedges lock in natural gas at a weighted average price of $7.32 for 2012, compared with an average monthly forward natural gas price of about $2.96, according to a July 31 earnings presentation.

Texas Competitive has 96 percent of its estimated natural gas price exposure hedged for 2012, according to the presentation. That hedge decreases to 67 percent in 2013 and 33 percent in 2014.

“The hedges look strong enough to get them through the end of 2013 without tripping the maintenance covenant,” CreditSights’s DeVries said. “With just the hedges you’re looking at an early-2014” restructuring event.

Moody’s lowered its credit grade on Energy Future to Caa3, nine steps below investment grade, and that of Oncor to Baa2, two levels above junk, according to an Aug. 9 rating report. The New York-based rating company said it expects “material balance sheet restructuring in the next 12 to 18 months” amid “low natural gas prices” that will damp Energy Future’s ability to generate cash.

Credit Amendment

Texas Competitive had leverage, or secured debt to adjusted Ebitda, of 5.53 times as of June 30, according to the regulatory filing, and is not permitted by a financial maintenance covenant to exceed eight times.

The unit amended its credit agreement in April 2011, allowing it to extend $17.8 billion of loans to 2016 and 2017 with loosened financial covenants, according to an April 13, 2011, regulatory filing. In exchange, it agreed to pay lenders fees and increased interest that may top $1 billion, according to the filing.

“When they did the amend-and-extend effort they eased up all those covenants in the credit agreement,” Terry Pratt, an analyst at Standard & Poor’s, said in a telephone interview, saying that upcoming debt maturities are the company’s most pressing matter. “To refinance all the debt under these market conditions, I think that is going to be difficult to do.”

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