The media are full of environmental buzz over the TXU deal, but the NYTimes looked hard at the debt structure and sees big problems (full article after the jump). Meanwhile, an energy executive who is a TXU competitor told me yesterday that in two years we can expect (a) rolling brownouts, and (b) higher TXU prices. TXU probably only expected to get 5 new coal plants out of the 11 it proposed, but electricity prices are set by burn rate of the least efficient plants — and TXU still has plenty of those, which the new plants were planned to replace. Meanwhile, the ERCOT requirements are still in place: we need new energy sources to meet our state’s population growth. All in all, there are many questions about this deal, which the temporary environmentalist euphoria does nothing to answer. Meanwhile, there are dangers in the financing:
Private Equity Buyout of TXU Is Enormous in Size and in Its Complexity By ANDREW ROSS SORKIN Published: February 27, 2007 Wall Street banks have provided billions of dollars to finance takeovers in the last year, essentially serving as mortgage lenders to deal-hungry private equity firms, which are among the banks’ best-paying customers. Regulatory Clearance Seen as Slow but Sure (February 27, 2007) Now the lenders have created a new type of loan that has them ponying up part of the down payment on these deals as well. That trend is vividly illustrated in the $45 billion buyout of the Texas energy giant TXU, which was announced yesterday. There are risks in the transaction, as there are in any large buyout, but for the Wall Street banks behind the deal, it could be even riskier. In an unusual twist that may soon become common, the banks are going one step further than simply providing the debt financing involved in the deal, in this case a daunting $24 billion of debt. The banks are also lending $1 billion to TXU’s buyers, Kohlberg Kravis Roberts & Company and the Texas Pacific Group – not as secured debt, but in the form of equity using the bank’s own cash. Known as an “equity bridge,” the arrangement allows leveraged buyout firms to buy companies with even less cash upfront. The idea is that the leveraged buyout firms will find other investors to ante up cash after the deal is announced. These bridges can lead to trouble, however. If the private equity firms cannot find new investors – and it is their job, not the banks’, to find them – or if the value of the asset falls sharply, the banks are left holding the bag. “This is how things blow up; people take more risk,” said Andy Kessler, a former research analyst and hedge fund manager who has written books about Wall Street. “If you go back to the crash of 1987, all the banks had huge bridges that went bust.” Some have compared the use of the equity bridges to a much more risky version of Michael R. Milken’s famous “highly confident” letters in the 1980s takeover boom, which gave assurances that his firm, Drexel Burnham Lambert, could sell junk bonds to finance deals for its clients. Investment bankers say that the private equity firms, which have become some of the largest fee payers to Wall Street, put pressure on them to extend an equity bridge in exchange for syndicating the debt, a job that can prove very lucrative. “The bridge may be a pay-to-play,” Mr. Kessler said. The new tactic has appeared in a handful of deals recently, including the $39 billion takeover of Equity Office Properties this month. It lets a private equity firm pursue enormous transactions without bringing in partners, at least until it has negotiated a deal on its own terms. Indeed, the advent of the equity bridge could spell the end of giant consortium transactions, or club deals, in which often rival private equity firms team up on a bid. In the $11.3 billion buyout of SunGard Data Systems in 2005, for example, seven private equity firms banded together, each with a seat at the negotiating table. The use of the equity bridge may instead spur private equity firms to be more competitive in bidding, because they would not need to forge temporary alliances of convenience with rivals to mount large bids. And that would take some pressure off the firms, which have been under scrutiny by the Justice Department over whether the consortiums constitute a form of collusion. In the case of TXU, Kohlberg Kravis and Texas Pacific are expected to invite their limited partners – the investors in their own funds, like big pension plans – to invest directly in this deal. By investing alongside the private equity firms, these investors can share in the rewards if the deal pays off without paying the same enormous fees to the firms that they typically do to invest in their funds. Private equity firms offer direct investment as an inducement to also invest in their funds that do carry fees. The TXU buyout calls for about $8 billion of cash upfront, $24 billion of new debt and the assumption of about $13 billion in debt. Kohlberg Kravis and Texas Pacific are each putting up about $2 billion in cash. Goldman Sachs, Lehman Brothers, Morgan Stanley and Citigroup plan to invest $3 billion from their private equity arms. That brings the cash total to only $7 billion, $1 billion short of the $8 billion required. That’s where JPMorgan Chase, Morgan Stanley and Citigroup are planning to come in with a $1 billion equity bridge. The risk to the banks is that the value of TXU could fall sharply below the $69.25 being offered. Yesterday, TXU shareholders welcomed the deal, driving up the shares 13 percent, to $67.93. The deal still must undergo months of scrutiny from state and federal regulators. And while the deal has won support through pledges to cut electric rates and scale back a plan to build coal-fired power plants, the private equity firms must still overcome a perception that buyout buyers are temporary owners who are not beholden to shareholders or customers. Talk about building bridges.
