The company formerly known as TXU Corp. – once the largest privatization ever – is now the 10th -biggest bankruptcy in US history. Dallas-based Energy Future Holdings Corp. filed for Chapter 11 protection Tuesday – undone by an aggressive strategy of using debt to finance bets on natural gas prices, which turned out to be wrong.
The company has a multitude of options to reduce its obligations and to emerge as a viable entity, which include selling its power and gas marketing division, converting bondholders to stockholders and parlaying its hugely successful wires business, known as Oncor.
“This is a story about too much debt,” wrote Jim Hempstead, an analyst with Moody’s Investors Service, in a report last fall. “It was an aggressive use of leverage and it didn’t work.”
In 2007, three private equity firms Goldman Sachs Capital Partners, KKR, and TPG Capital purchased TXU for $45 billion, which included assuming $13 billion in the assumption of outstanding debt. Private equity investors are attracted to assets that produce the steady cash flow needed to help pay down their debt. And TXU had an enormous fleet of power plants along with 2 million residential and business customers.
The demand for power in Texas had been expected to escalate and necessitate the need for more production. The private equity trio came into the deal riding a white horse, promising to take a more environmentally friendly approach and build fewer coal plants than TXU had wanted. But by borrowing big to take over the company, the private equity firms assumed that natural gas prices would remain high and that they would get their investment back. They also thought they would make more margin on the power produced from their coal and nuclear assets, which didn’t happen.
The company believed it could service that debt because it assumed gas prices would not go lower than $6 per thousand cubic feet, according to Mr. Hempstead. “The other assumption was that if natural gas prices did fall, they were volatile and would not stay low for a long period time.”
Instead, the US economy entered a deep recession while a glut of natural gas flooded utility markets, sending prices down to as low as $3 per thousand cubic feet. Natural gas prices today are still hovering around $4.80 per million cubic feet.
“It teaches a lesson, which is using debt to make a bet on gas prices is unwise,” says Bob Bellemare, chief operating officer of consulting firm Mykrobel in New Mexico, in an interview. “They bet and they lost and this is the aftermath.”
Now, Energy Future will set a course to allow it to emerge from bankruptcy and to once again become a profitable entity. Most immediately, it hopes to dump its unregulated wholesale trader called Texas Competitive Electric Holdings. News reports say that it can fetch as much as $25 billion. Such trading units buy electric power or natural gas and then sell it to other entities where those commodities can go for a higher price, called arbitrage.
News reports also say that the company is in negotiations with its bondholders to convert $1.7 billion in debt to shares of stock. That ownership would be in Oncor, which is the regulated delivery business that brings in $15 billion a year in dependable earnings. That could be an attractive option, given that several major utilities such as American Electric Power, Exelon Corp., Berkshire Hathaway’s MidAmerican Energy Holdings, and Xcel Energy have expressed an interest – something that would drive up the stock price.
Those who brave the utility winds are not all alike. Another private consortium that included Goldman Sachs bought pipeline magnate Kinder Morgan for $15 billion in 2007. In 2011, Kinder went public again, raising $2.9 billion and turning a nice profit for its owners.
Warren Buffett, whose Berkshire Hathaway is again actively on the hunt for utility assets, bought MidAmerican Energy Holdings in 2000 for $2 billion and PacifiCorp in 2005 for $9.4 billion, which is $5.1 billion in cash and $4.3 billion in debt. Mr. Buffett is known for making critical investments in the business he buys and then holding them for much longer periods than most private equity investors.
Buying regulated assets with reliable revenues are a safer gamble than making predictions as to which direction natural gas prices will head.