TXU’s debt problems may finally be coming to a head as the Texas electricity producer faces new challenges from concerned debt holders.
In a technical maneuver by one of the major holders of TXU debt has put a finer point on the troubles surrounding the largest leveraged buyout in corporate history. A leveraged buyout is a complicated term for a tactic used to buy a company by borrowing most of the money needed for the purchase. The borrowed money is often secured by the assets of the company being acquired. This allows the buyers to make larger purchases with relatively little cash. The result is a company left with large amounts of debt and no room for error. If revenues of the company fall it can spell big trouble leaving the company no longer able to meet its debt obligations.
Unsecured debt for the former TXU (now known as Energy Futures Holding Corp.) has recently traded in bond markets at around 50 cents on the dollar. This is a direct reflection of fears that the company will ultimately default on its debt obligations.
The TXU leveraged buyout is a cautionary tale about borrowing heavily to buy an asset at the exact wrong time in the market cycle. The Achilles heel of the deal to buy the giant Texas electricity producer turned out to be the recent collapse in natural gas prices. The fall in natural gas prices has been a huge win for Texas electricity consumers who are now able to take advantage of the lowest electricity rates in recent memory. For the people behind the buyout of TXU it has meant the write down of 80% of their $8 billion equity investment in the purchase of TXU.
In 2007 when natural gas prices were substantially higher than they are today, Kohlberg Kravis Roberts & Co and TPG made a Texas sized gamble by borrowing heavily to pull off the largest leveraged buyout in history. Imagine having maxed out your credit cards to buy Beanie Babies in 1997 and you will get the idea of what came next.
Natural gas prices soon plummeted falling by over 40%. Electricity rates in Texas soon followed with residential and commercial electricity users enjoying the cheapest rates in years. The connection between natural gas prices, electricity rates and TXU’s profitability can be complicated but one can boil it down to the simplest terms by considering this. TXU sells electricity and their product sells for a whole lot less than it did 4 years ago.
At the time of the acquisition, the buyers paid 25% above market price to acquire TXU. At that point, TXU had about $11 billion in debt. Four years after the buyout that debt has ballooned to $36 billion. The publicly traded debt markets have signaled their lack of confidence in the company’s abilities to meet their payment obligations. This can be seen in the falling prices of TXU bonds and the increased prices in credit-default swaps which can be seen as a kind of insurance against TXU’s default on the debt.
The new owners, Kohlberg Kravis Roberts & Co and TPG, have pinned their hopes on a recovery in natural gas prices. Their short term game plan involves maneuvering to survive until that happens. The recent activities in the credit markets are making that more difficult by the day.