The biggest leveraged buyout in history is beginning to look like a bust. In 2007, two private equity firms purchased Dallas-based TXU, the state’s largest utility, in a debt-ridden $45 billion deal.
At the time, consumer advocates and some legislators warned that the transaction was too risky and could end up being a bad deal for ratepayers. They pointed out that similar private equity takeovers had been rejected by regulators in Arizona and Oregon.
“The biggest red flag in the buyout was this enormous debt they were taking on,” says Tim Morstad, a consumer advocate for AARP.
The Public Utility Commission blessed the deal anyway. Its chairman, Barry Smitherman, mocked AARP for “crying wolf” about the risks of the buyout.
Now, TXU, blandly rebranded as Energy Future Holdings, is struggling under a mountain of debt and financial analysts are predicting that the company will eventually have to sell off its assets. “This was foreseeable,” said Geoffrey Gay, an Austin utility attorney who represents groups of cities in rate cases. “The buyout partners were putting a higher value on the company than the company officials themselves.”
Gay says the buyout was essentially a giant gamble on natural gas prices staying high. The deregulated electricity market in Texas is structured so that natural gas almost always sets the price of power. Two years ago, TXU’s fleet of nuclear and coal-fired power plants looked like a mint. But gas prices have taken a tumble and so has the company’s profitability. In the third quarter, Energy Future Holdings posted a net loss of $80 million compared to $3.6 billion—yes, with a “B”— income for the third quarter of 2008.
As part of the buyout deal, the regulated portion of the company—Oncor, which oversees the electric grid—is supposed to be protected from the risky retail and power-generation components of Energy Future Holdings. But consumer advocates worry that executives could move to drain Oncor of its assets, putting the electric system in danger. “It’s clear that the wires company is the cash cow,” said Gay, “and it funnels money up to the company, its owners.” In a recent rate case, Gay says the PUC awarded Oncor suspiciously high rates, perhaps in a bid to prop up the parent company. “There’s part of me that believes that the financial loads of the parent were a motivating factor in Oncor getting as much relief as they did,” he says.
Whatever the fallout for TXU’s customers, Wall Street will probably do OK. The New York Post reported in October that the two private equity firms, along with investment giant Goldman Sachs, stand to pocket $13.5 million in fees for a debt restructuring bid.