KKR’s TXU Buyout Facing 91% Odds of Default: Corporate Finance

Jan. 19 (Bloomberg) — The bond market has never been more pessimistic on the chances of KKR Co. and TPG Capital being able to salvage the biggest leveraged buyout in history — the $43.2 billion purchase in 2007 of the electricity provider known then as TXU Corp.

Since the private equity firms bought the Dallas-based company, now known as Energy Future Holdings Corp., with $45 billion in debt financing, natural gas prices have tumbled 50 percent as a process for extracting the fuel from shale called fracking rises in popularity. That has cut electricity prices in half as well.

Less than a year after extending the maturities on more than $17.8 billion of debt, credit-default swaps traders are pricing in a 91 percent chance that the company will fail to meet its obligations in the next three years. Its debt securities yield about 21 percent on average, up from 15 percent when the refinancing was announced in April.

“The clock has gotten much louder for TXU with this recent falloff in natural gas,” said Jon Sablowsky, the head of trading at investment firm Brownstone Investment Group LLC in New York. The company is overlevered and doesn’t have “enough revenue to service that debt going forward, nor enough revenue to provide the confidence to investors to help them refinance that debt,” he said in a telephone interview.

KKR and TPG are losing a bet they made in 2007 that natural gas prices would continue to drive wholesale power prices higher, a wager that soured when a recession sapped demand just as drilling expanded in the gas-rich Marcellus shale in the eastern U.S.

Losing Bet

Wholesale electricity prices plunged as gas prices dropped, hammering independent wholesale generators such as Energy Future that don’t have the protections given to regulated utilities where states allow a certain level of profits.

The concern among credit traders has grown more urgent as the plunge in natural gas prices raises the potential cost of renewing hedges against price swings that expire in 2015.

Three-year credit-default swaps tied to Texas Competitive Electric Holdings, the company’s unregulated merchant power unit known as TCEH, have soared 45.7 percentage points during the past seven months to 69.5 percent upfront yesterday, according to data provider CMA. That’s 4.4 percentage points less than the cost for five years of protection, compared with 24 percentage points on June 15.

The price means the initial cost to protect against a default on $10 million of the company’s debt through March 2015 has climbed to $6.95 million from $2.38 million in June.

Recovery Rate

The contracts are trading at levels that imply a 91 percent chance of default, based on market assumptions that bondholders would recover 14.5 cents on the dollar in such a scenario, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Kristi Huller, a spokeswoman for KKR in New York, whose co- chairmen are Henry Kravis and George Roberts, and Owen Blicksilver, a spokesman for Fort Worth, Texas-based TPG, declined to comment.

Energy Future “generates stable cash flow through solid operational performance in a growing market, has adequate liquidity and has re-worked its capital structure to reduce debt and extend debt maturities,” Allan Koenig, a spokesman for the company, said in an e-mailed statement. The power producer employs more than 9,000 people, up 25 percent from 2007, he said.

Gas Supply Grows

Gas supply in the U.S. has grown since producers learned to use hydraulic fracturing and horizontal drilling to tap deposits locked in dense shale rock formations.