Energy Future Holdings‘ Chapter 11 filing today in Wilmington, Del., represents the beginning of the final act for the largest leveraged buyout in history.
The extent to which the deal announced this morning will hold up in the face of the many risks and uncertainties inherent in any Chapter 11 filing remains to be seen, but in gaming out the company’s potential paths through Chapter 11, it is worth remembering that the road to this point has been, as the Beatles might put it, a long and winding one.
As has been widely reported, Energy Future’s troubles stem from 2007’s $45 billion LBO of the company, which at the time was known as TXU Energy. KKR, TPG and the buyout arm of Goldman Sachs engineered the deal, the largest in history. It was essentially a bet that increasing natural gas prices would provide the company’s coal-based generation plants with an edge, allowing them to charge increased prices. However, natural gas prices declined in the wake of the LBO, a trend that had the precise opposite effect, depressing the company’s earnings in the face of a mountain of debt.
Indeed, it didn’t take long for the company’s situation to head south. As early as November 2009, Energy Future was included in S&P’s speculative-grade default rate after being downgraded to SD on account of a distressed exchange. What’s more, the first-lien loan at unitTexas Competitive Electric Holdings has not traded higher than the low 70s since August 2011.
More concretely, bankruptcy has been looming over the company since at least late 2012, when Energy Future began publicly discussing Chapter 11 as an option, and investors began gaming out the implications of a bankruptcy filing for the company’s complex capital structure.
The primary issue faced by the company, its creditors, and its equity sponsors as they have struggled over the past 18 or so months to develop a consensual reorganization plan has been how to apportion the company’s current value among a complicated, multi-tiered capital structure split between creditors of the company’s regulated utility business on the one hand and creditors of its unregulated power-producing and retail units on the other.
Layered over that already daunting challenge was the fact that the most efficient structure for addressing those complex capital structure and organizational issues – splitting the company between its regulated and unregulated businesses – would give rise to significant tax liabilities estimated in the neighborhood of $7-$9 billion. The issues are complex, but the liability would potentially negatively affect recoveries for, among others, holders of unsecured notes – representing the fulcrum security – at the company’s Energy Future Intermediate Holdings unit – the holding company for Energy Future’s regulated utility, Oncor, and would potentially impose a liability on TCEH first-lien lenders, as well.
Meanwhile, the equity sponsors that engineered and backed the deal, KKR, TPG, and Goldman, had already written down their $8.3 billion investment in the company to 5 cents on the dollar, but the private equity firms were nonetheless intent on using their operational control over the company during the negotiations to salvage whatever equity stake they could from a reorganization.
Following the company’s first public discussion of the implications of a bankruptcy filing in late 2012 (see, for example, “TXU bonds hit by tax-benefit disclosure,” LCD, Oct. 31, 2012, and “TXU offers tax clarification; EFH/EFIH parent bonds partly recover,” LCD, Nov. 6, 2012), the company embarked on a series of distressed exchanges aimed at extending debt maturities and improving liquidity (see, for example, “TXU debt advances after EFIH inks another distressed bond exchange,” LCD, Dec. 5, 2012; “TXU bonds mixed after co. launches RC extension, bond exchange deal,” LCD, Dec. 28, 2012; “TXU extends RC to 2016; inks $340M incremental TL,” LCD, Jan. 7, 2013; “TXU lowered again to D after EFIH inks 7th distressed exchange,” LCD, Feb. 1, 2013).
The exchanges came to a halt in mid-February of 2013, after Debtwire reported the company had hired Kirkland & Ellis to assist it with a restructuring (see “TXU debt dips further on report of Kirkland & Ellis hire,” LCD, Feb. 7, 2013). Given Kirkland & Ellis’ Chapter 11 expertise, the hire clearly suggested that whatever deal the company was ultimately able to work out, the likelihood was that it would involve a trip through bankruptcy court.
Indeed, on April 15, 2013, the company filed a Form 8-K with the Securities and Exchange Commission confirming that it had floated a prepackaged reorganization proposal to creditors.
The company also said it would make a scheduled May 1 bond interest payment in order to buy time to iron out details of a proposed plan.
Under that proposed prepackaged deal, first-lien creditors of TCEH would exchange their claims for a combination of reorganized EFH equity and their pro rata share of $5 billion of cash or new long-term debt of TCEH and its subsidiaries on market terms. TCEH would obtain access to $3 billion of new liquidity through a $2 billion first-lien revolver and a $1 billion letter of credit facility.
The equity distribution was to be in an amount to be determined, but the company’s equity sponsors told creditors they would support the proposal if they retained 15% of the reorganized equity, with the TCEH first-lien lenders receiving 85%.
The SEC filing did not provide further details, but emphasized that no deal had been reached and said that the company and its creditors were “currently not engaged in ongoing negotiations,” suggesting the disclosed terms were unlikely to lead anywhere.
Little was disclosed about the state of negotiations during the ensuing months as the company and its creditors negotiated with a non-disclosure agreement in place. Meanwhile, market attention turned to October, as the company’s next coupon payment was due Nov. 1, 2013. Indeed, this coupon payment was generally viewed as the final tripwire for Chapter 11, since it involved a $270 million payment to junior unsecured noteholders who, under virtually any restructuring scenario, would be far out of the money.
As a result, in September 2013, stories began to appear in the financial press about an imminent bankruptcy filing and details of a $2 billion DIP loan. The rumors suggested, again, that a prepackaged bankruptcy might be in the offing.
Confidentiality agreements prevented any on-the-record disclosure of the status of negotiations, however, until Oct. 15, 2013, when the company said in another Form 8-K filed with the SEC that a deal had not been reached.
At that time, the company detailed three competing proposals that were on the table, one from a creditor described in the filing only as a “significant creditor,” but widely reported to be Fidelity; one submitted by first-lien lenders at TCEH; and one submitted by certain creditors of EFIH (see “TXU Energy Future says no deal yet as creditors retreat from talks,” LCD, Oct. 15, 2013).
Over the next two weeks, negotiations and brinksmanship continued in the face of the looming coupon payment due Nov. 1, 2013. Given that the unsecured noteholders were well out of the money and trading in the low single digits, the company was widely expected to file Chapter 11 in lieu of making the payment.
But the company surprised the market and made the payment, saying it did so in order to buy more time to work out an out-of-court deal.
In a Nov. 1, 2013, Form 8-K disclosing the coupon payment and the status of negotiations, the company set forth the restructuring proposals still on the table, namely, a proposal from the company and its equity sponsors; a revised proposal from the first-lien lenders of TCEH; a new proposal from unsecured creditors of EFIH; and the proposal from a “significant creditor” that was unidentified in the filing, but was widely believed to be Fidelity.
If nothing else, the filing provided a roadmap for identifying the disputes among creditors standing in the way of a deal (see “Energy Future’s competing restructuring proposals underscore rifts,” LCD, Nov. 1, 2013).
Still, the payment appeared to come at a cost beyond the dollars involved. Upset holders of TCEH’s first-lien debt reportedly withdrew from the negotiations. Meanwhile, following the spate of SEC filings surrounding the critical Nov. 1, 2013, coupon payment, the company returned to radio silence. But given the atmosphere, and the withdrawal of the TCEH lenders – arguable the most important creditor class in the company – it is unclear the extent to which the company and its creditors made any progress over the next four months.
In late March, however, the TCEH lenders reportedly signed a confidentiality agreement and returned to the negotiating table.
By this time, of course, Chapter 11 was a foregone conclusion, although the specific timing was still up in the air.
Following payment of the Nov. 1, 2013, coupon, attention turned to March 31 as the next critical date for the company. The company had another coupon to pay on April 1, so there was the potential of a financial default, but Energy Future had dodged those bullets before.
What made the March 31 deadline different was the fact the company’s 2013 Form 10-K was required to be filed on that date. The filing was widely expected to include a going concern warning from the company’s auditors that would trip a covenant violation that would be impossible to cure. That covenant violation, in turn, would trigger a cascade of debt accelerations and defaults.
Still, on March 31, the company managed to buy itself a little more time. Rather than file Chapter 11, the company said it would, indeed, skip $119.3 million of April 1 coupon payments with respect to certain of its first-lien notes, second-lien notes, and pollution-control revenue bonds at TCEH, and instead “use the permitted grace periods” the debt indentures provide.
Separately, the company also said that it would not be filing its Form 10-K with the SEC, as required, even as it confirmed that the filing, when made, would indeed include the expected statement from the company’s auditors substantially doubting Energy Future’s ability to continue as a going concern.
The non-timely 10-K notice gave the company until April 15 to file its Form 10-K, but on that date the company said it would not be filing the annual report, effectively triggering the covenant breach.
Given the 30-day cure period for the breach, that maneuver didn’t have much of a practical effect on the bankruptcy timetable – the termination of the grace period for the missed April 1 coupon payments still loomed on April 30 as the key deadline – but it underscored the fact that, finally, Energy Future had run out of time. That set the stage for key creditors to either agree to a structure for Chapter 11 reorganization, or leave their fates to vicissitudes of the unrestrained Chapter 11 litigation gods.
The company had finally reached the final fork in the road. – Alan Zimmerman