November 22, 2011 / 6:28 PM / 9 years ago

DealTalk: Long odds for former TXU as gas prices drop

NEW YORK (Reuters) - The Texas power company taken over in the largest ever leveraged buyout needs what many consider long-shots, higher natural gas and power prices, to help keep the lights on.

Formerly known as TXU Corp when it was taken over in 2007 by private equity, Energy Future Holdings is now struggling under a heavy debt load, and faces strong headwinds in the form of low power prices and higher costs related to environmental regulations.

Despite refinancing nearly $18 billion of debt earlier this year, EFH could face its day of reckoning as soon as 2014 if it is not able to make key changes to its current debt structure.

“It’s kind of like Greece — by any cold, sober analysis, the math doesn’t work,” said one power investment banker who spoke on the condition of anonymity.

Despite the huge refinancing, “they haven’t fundamentally changed the answer,” the banker said.

TXU was taken over by a consortium of private equity firms including KKR and Co (KKR.N) and Texas Pacific Group TPG.UL, in 2007, but gas prices have fallen sharply since that deal. And that’s bad for power companies in Texas where power prices generally track natural gas prices.

EFH declined to comment for this story. It said earlier this year that the extension of the debt it completed in April “provides the company with more time to create additional enterprise value and give power markets the opportunity to recover.”

Still, the company is already facing skepticism from investors and ratings agencies.

Standard & Poor’s said in October that the company faces high refinancing risk from 2014 through 2017 when around $25 billion of debt comes due, and has given the company a junk bond rating of CCC that indicates a high chance of default.

The company’s debt is trading at distressed levels. Its $3.8 billion term loan due 2014 is trading at around 73 cents on the dollar, while the $15.4 billion loan due 2017 is trading around 67 cents on the dollar, according LSTA/Thomson Reuters LPC MTM Pricing.

Credit default swaps show that financial markets are pricing a 91 percent chance of default for Energy Future Holdings in the next five years.

“The end of 2013 and the beginning of 2014 is going to be critical for them,” said Fitch Ratings analyst Shalini Mahajan. “From a liquidity perspective, they break even in 2012, but by 2013 they start becoming free cash flow negative ... What the power markets do is very important to them.”

The company’s current debt load is $40.7 billion, down just $100 million from the debt load it carried at the end of 2007, according to Fitch. And the company’s leverage has increased to 9.3 times earnings before interest, taxes, depreciation and amortization for the 12 months that ended June 30, up from 8.4 times EBITDA at the end of 2007.

While Energy Future Holdings in April was able to push out the repayment on a large chunk of its debt, the company still has to address a more than $3.8 billion due in 2014. The amount may be smaller, but the credit markets have become much pickier in the past few months because of concerns about the global economy, making its success uncertain.

GAS PRICE WORRIES

The TXU takeover was built on hopes that natural gas prices would stay high. But they have instead fallen sharply since the deal was announced, with benchmark U.S. prices dropping around 60 percent to around $3 per million British thermal units from around $7.50 per mmBtu in February 2007.

Investors currently do not expect natural gas prices to top $6 until late 2018, based on forward natural gas contracts.

“There’s no equity value in the business. They’ve kicked the can down the road as much as they possibly can unless there’s a major commodity price change,” said another investment banker, who guessed that the company needs gas prices between $6 and $8 to start to dig itself out from under its debt load.

Some investors following EFH hope that supply shortages in Texas’ power markets will translate into high enough power prices to make the company viable.

A protracted heat wave in Texas over the summer pushed power demand and real-time prices to record levels, with wholesale prices rising to $200 to $500 per megawatt-hour on 11 days.

Higher prices and a shrinking power reserve margin, worsened by looming federal emission restrictions, have improved the outlook for power prices next summer.

But this has done little to improve forward prices beyond that, especially as state regulators are currently looking at market rule changes to improve price signals during scarce supply periods to boost wholesale prices and attract investment in new generation.

New emissions rules proposed by the U.S. Environmental Protection Agency that may go into place in January could also be a drag on EFH, which has already taken hundreds of millions of dollars in charges related to the rules.

CHANCE TO THREAD THE NEEDLE

Nevertheless, there are some options as the company approaches 2014.

One investment banker suggested that the company could look at selling its 80 percent stake in its regulated transmission and distribution unit Oncor to help pay down debt.

And CreditSights analyst Andy DeVries said the company could work on exchanging the debt due 2014, which is held by the company’s competitive electric holdings unit, for debt in the unit that holds Oncor. That unit is protected in the event of a default at one of EFH’s other units.

In this scenario, KKR, TPG and its other private equity partners could even end up making some cash back from their investment if everything goes well.

But EFH would need to thread the needle for the plan to work, DeVries said.

“The Fed needs to keep rates low, gas prices need to not decline again, and they need the (debt) exchanges to go off without a hitch. They need a lot of things to go right,” DeVries said.

Additional reporting by Caroline Humer, Lisa Lee and Melissa Mott in New York and Tom Hals in Delaware, Editing by Ed Tobin and Tim Dobbyn

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