Largest Leveraged Buyout Ever Is Finally

Bankrupt
1 Apr 29, 2014 6:24 PM EDT
By Matt Levine
Every microgeneration is molded by its own financial bubble. Right now, for instance, there's
a vigorous debate about a tech bubble in which WhatsApp, a service that I am definitively too
old to use, is worth $19 billion. But for me, the bubble closest to my heart will always be the
one that peaked in 2007, a year that was so frothy that I was able to get a job in investment
banking.
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And so I have a hipsterish attachment to TXU, the Texas electric utility LBO that
was, and remains, the largest leveraged buyout ever, and that stands as one of the symbols of
that bubble.
Also I have a hipsterish attachment to the name "TXU," though the company is now called
Energy Future Holdings.
Anyway TXU/EFH/whatever filed for bankruptcy today, rudely ending its era right in the
middle of the current, techier era. It was ... it was not a good deal, you'd have to say. Its
private equity sponsors have lost, in round numbers, all of their money.
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And it's filing for
bankruptcy with something north of $40 billion of debt, relentlessly unfavorable natural gas
prices, and a rather unfriendly environment for electric generators in Texas. But, still. It was
the buyout of my era and I'll shed a tear for it.
What else can we say about it? Well, for starters, today Apple did a $12 billion bond deal to
avoid taxes, and Pfizer is working on a $98.7 billion merger to avoid taxes, and both of those
things have come in for some criticism. But Energy Future actively chose not to avoid taxes.
It could have avoided taxes. Energy Future is structured like so:

Most of the debt is on the purple side of the chart, at Texas Competitive Electric Holdings.
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The prepackaged bankruptcy plan is not public yet, but from the company's announcement
it's clear that the plan is to hive off TCEH to those lenders and keep the regulated business
within the Energy Future corporate structure. One way to do that would be to sell TCEH's
assets to those lenders, with the lenders paying for the assets with their debt. Those assets
have a very low basis (are very depreciated), but selling them to the lenders would lead to a
basis step-up, letting the lenders take a lot of future tax deductions (by depreciating the assets
again, more or less). This would have saved the lenders something like $5 to $8 billion.
There's no free lunch in the tax code, so TCEH's future tax savings would come at the
expense of saddling Energy Future with a huge tax liability right now. Except! Energy Future
has no money. So the IRS would get paid at some number of pennies on the dollar, and
Energy Future would pay off its senior creditors at the expense of the IRS. This would make
the IRS mad.
Energy Future decided not to make the IRS mad:
TCEH and its subsidiaries would separate from EFH without triggering any material tax
liability, and TCEHs first lien lenders would receive all of the equity in the reorganized
TCEH and the cash proceeds from the issuance of new debt at the reorganized TCEH in
exchange for eliminating approximately $23 billion of TCEHs funded debt.
The plan seems to be for a tax-free spinoff of TCEH, in which TCEH's new owners (and old
lenders) would not get any basis step-up or tax savings, but in which the IRS would not be
stuck coming after the very bankrupt Energy Future for its money.
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This seems like sort of a weird choice? Like, the IRS wasn't in the room, why not take their
money and give it to some of the people in the room? You can sort of understand why -- a tax
claim might hold up the case, and "the nature of the proposed transaction, in which private-
equity funds would benefit from a deal that creates a massive and perhaps unpayable debt to
the IRS, makes the case particularly sensitive" -- but, for an industry known for its tax
aggressiveness, this seems a little tame.
And it's already made some other people mad. Here you can read some complaints from a
group of second-lien creditors at TCEH,
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and they make sort of an interesting case. The claim
is that Energy Future's managers are colluding with the big TCEH secured lenders -- Apollo,
Oaktree and Centerbridge -- to drive down the value of TCEH. The goal, in this theory, is "to
allow the Senior Lenders and management to print cheap reorganized equity and wipe out
billions in legitimate creditor claims": If the bankruptcy court finds that TCEH is worth less
than the amount of the secured claims, then the secured lenders can just take it, giving the
junior lenders nothing.
The tax-free spinoff, which reduces the value of TCEH, is supposedly part of that plan:
[T]he Sponsors and the Debtors management have shifted gears and appear to have refused
to meaningfully consider any restructuring that would expose EFH (the Sponsors investment
vehicle) to tax liabilities that might result from a separation of the merchant power and
transmission business, despite the unambiguous economic interests of subsidiary creditor
groups. This refusal appears designed to avoid the reputational repercussions to the Sponsors
from having massive tax liabilities go unfunded at EFH. Instead of addressing fiduciary
responsibility of TCEHs management to TCEHs creditors, the Debtors now appear, with the
approval of Senior Lenders, intent on saddling TCEH with future tax liabilities via a tax
free spinoff of the unregulated business that would be to the direct detriment of the Second
Liens and other junior creditors largely excluded from restructuring discussions to date. With
expected recoveries in excess of their claims, the Senior Lenders appear all too willing to
accept such future tax liability in exchange for a quick trip through Chapter 11 that would
extinguish junior interests.

The restructuring agenda seems all too clear and all too common. The Trustee believes that
management and the Senior Lenders hope to be able to extinguish junior obligations and
reward themselves with newly-minted, underpriced equity, predicated on an intentionally
depressed valuation measured at a historic industry trough
Ehh I don't know about this, but there's a circle-of-life element to the motion that I sort of
like. Broadly speaking, the point of an LBO is for patient, smart, financially savvy private
investors to buy a company when valuations are depressed, and then wait for a recovery. That
is what happened to TXU in 2007: Natural gas prices were low, and the private equity buyers
thought they'd go higher and make them lots of money.
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Naturally, some shareholders
objected that private equity was trying to steal their company at a depressed valuation -- that
the deal was "unfair, inadequate and substantially below the fair or inherent value of the
company," and that the directors who approved it were conflicted.
But in fact, prices went lower, and the sponsors lost a lot of money. And in hindsight, their
bid looked way too rich, not too cheap: They paid 8.5x EBITDA to buy TXU in 2007, a bit
above market valuations, and they they never looked on that much EBITDA again.
Now, once again, TXU -- sorry, sorry, Energy Future -- is being sold to savvy investors, and
once again excluded junior claimants are complaining that the company is being undervalued
and the deal is conflicted. Once again, the savvy investors seem to be betting on gas prices
going up.
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Once again, they seem to be paying about 8.5x EBITDA.
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Eventually, somebody
is going to make this deal work; if KKR, TPG and Goldman couldn't do it in 2007, maybe
Apollo, Oaktree and Centerbridge will do it in 2014. The TXU era may be over, but the
Energy Future cycle will begin again.