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

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. (TXU), 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. (CME) 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.

The commodity, which traded as high as $13.58 in July 2008,
will stay below 2011’s average price of $4.026 for the next two
years, or about $3.10 per million British thermal units for 2012
and $4 for 2013, according to Robert W. Baird (BADC) Co., an
investment bank in Milwaukee. Natural gas for February delivery
fell 12.6 cents, or 5.1 percent, to $2.346 per million British
thermal units today on the New York Mercantile Exchange, the
lowest settlement price since March 2002.

That price is “brutal” for Energy Future because TCEH
needs $6.15 to break even, and leaves “zero recovery” for
bondholders beyond the first lien, said Andy DeVries, an analyst
at CreditSights Inc. in New York.

Price Hedges

Hedges that contributed to one-time gains of $89 million
last quarter by locking in natural gas prices expire by 2015,
according to the company’s most recent quarterly filing with the
U.S. Securities and Exchanges Commission. The hedges lock in
natural gas at a weighted average price of about $7.36 for 2012,
compared with a weighted average market price of $4.24.

“They’re so well hedged in the near term, and they’ve got
some room under the maintenance covenants so weak gas prices
shouldn’t be a problem this year,” DeVries said. “It’s when
the hedges start to expire when push comes to shove.”

Energy Future reported a loss of $710 million on Oct. 28
for the third quarter, as interest expenses and related costs
rose by 50 percent and sales fell 11 percent. The company and
its wholly owned power-delivery unit Oncor Holdings had long-
term debt of $40.18 billion. U.S. Environmental Protection
Agency rules intended to reduce cross-state air pollution will
cost the company $1.5 billion through 2020, the company said in
a lawsuit with the U.S. Court of Appeals in September.

Lenders agreed in April to extend debt maturities on about
$17.8 billion of the company’s debt and swapped some holdings at
discounted prices for new securities.

Distressed Exchanges

“We view Energy Future Holdings Corp.’s multiple
distressed exchanges and credit facility extensions as
tantamount to default,” Standard Poor’s analysts Aneesh
Prabhu and Andrew Giudici wrote in a Jan. 11 note.

Texas Competitive’s $1.87 billion of 10.25 percent bonds
due November 2015 dropped 7 cents to 28 cents on the dollar this
year, yielding 60.564 percent as of Jan. 17, according to Trace,
the bond price reporting system of the Financial Industry
Regulatory Authority.

“Even if you’re secured, you have to be scratching your
head and wondering where the mechanism for repayment is coming
from,” Bonnie Baha, the head of the global developed credit
group at DoubleLine Capital LP, which oversees $23 billion, said
in a telephone interview from Los Angeles. “Given the
competitive landscape, given the changes that have occurred in
the natural gas industry that weren’t really foreseen at the
time these deals were structured, I’d say your capital is better
deployed elsewhere.”

Prospects ‘Negative’

Energy Future’s term loan maturing in October 2017 traded
at about 61.3 cents on the dollar yesterday, from 63.6 cents on
Jan. 9, according to Markit Group Ltd. The term debt due in
October 2014 was trading at 64.7 cents from 69 cents.

Energy Future unit Oncor Electric Delivery has $375.6
million of 6.375 percent notes maturing in May and $524.7
million due September 2013, according to data compiled by
Bloomberg. About $3.8 billion of TCEH loans mature in October
2014, Bloomberg data show.

“There are no near-term maturities and there’s no
maintenance covenant that can be tripped in the near term, but
there’s a view that they’re not going to be able to refinance
their debt at TCEH,” Chris Chaice, an analyst at New York-based
Covenant Review, said in a telephone interview. “Long-term
prospects are very negative for TCEH. The time at which they can
no longer support the capital structure is growing nearer.”

To contact the reporter on this story:
Mary Childs in New York at
mchilds5@bloomberg.net;
Julie Johnsson in Chicago at
jjohnsson@bloomberg.net

To contact the editors responsible for this story:
Alan Goldstein at
agoldstein5@bloomberg.net;
Susan Warren at
susanwarren@bloomberg.net

• Tweet

• More

• Print
• Email

<!—->