On the Money
Once-bankrupt TXU Energy deserves another look
The once-bankrupt TXU Energy, reborn as both a power producer and distributor, deserves another look
Even great investors make mistakes. Warren Buffett did just that in 2007 when he purchased the junk bonds of Texas power company TXU Energy. By 2015, when it was all said and done, Buffett’s company Berkshire Hathaway closed out this investment with a billion-dollar loss on a $2-billion investment.
He was far from the only big loser on TXU. In 2007, private equity heavyweights KKR & Co., Goldman Sachs Capital Partners and TPG Capital teamed up to acquire TXU for a whopping $45 billion. It was the single largest leveraged buyout (LBO) in U.S. history at the time. While Buffett lost half of his investment, these firms lost 100 per cent of their equity stake.
Where did all of these smart investors go wrong? Two things: using too much debt and getting the natural gas market very wrong. They loaded up a healthy company with a massive amount of debt and by doing so, bet on natural gas prices to stay high.
Of the $ 45- billion purchase price, $ 37 billion was financed with debt. Prior to being acquired, TXU’s annual interest expense was $ 830 million. After being saddled with the acquisition debt, it soared to $4.3 billion. That’s a heavy piano to drag around behind you.
If natural gas prices had stayed at the $6/mcf level that the private equity acquirers expected, this deal may have worked out. Instead, with cash flows crimped by low natural gas prices and massive interest payments, the company could not survive. In 2014, TXU Energy ( renamed Energy Future Holdings at that point) filed for Chapter 11 bankruptcy.
Vistra Energy (OTC: VSTE) In October of 2016, the first lien bondholders of TXU/Energy Futures Holdings took control of the assets of the company and put them into publicly traded Vistra Energy.
Vistra has two operating units: Luminant and TXU Energy. TXU provides electricity to 1.7 million customers, 1.5 million of whom are residential and the rest industrial or commercial. It’s the largest retail electricity provider in Texas, with 25 per cent of the residential market. Luminant generates power. The businesses are run separately but are integrated. TXU buys electricity from Luminant and sells it to its customers at a small markup. TXU generated 53 per cent of the company’s EBITDA in 2016 and Luminant 47 per cent.
This is a utility, a stable business with predictable cash flows. Before TXU filed for bankruptcy, the company was carrying $34 billion of debt. Net debt for Vistra is now only $3 billion, an incredible improvement in the company’s balance sheet.
Against its peers, Vistra’s balance sheet has gone from worst to best. A case could even be made that the business is, for a utility, underleveraged.
And valuation-wise, the company appears inexpensive. Current enterprise value to EBITDA is 6.7 times. Competitors with three times as much debt trade at 8 to 9 times. At 8 times EBITDA, Vistra would trade for $20 per share. At nine times, that figure would be $22.52. You would think that the company that has one-third the debt would have a premium multiple, not a discounted one.
A discounted valuation is good. Having onethird the debt of similar companies is better. The cherry on top is that there are catalysts that should drive Vistra’s share price higher over the next 12 months. The first is that this $10-billion company trades on the over- the- counter market. When it moves to a larger exchange, a whole bunch of additional institutions are going to be able to buy shares.
Second, having just come out of bankruptcy, Vistra has yet to file any financial statements. That means it isn’t coming up on the stock screens of investors.
Third, analysts haven’t started covering the company. Once they do, more investors will get this attractive opportunity put in front of them.
Fourth, with $900 million of free cash flow expected in 2017 and no need to reduce debt, there is a good chance that a dividend will be announced.
This isn’t a sexy business and you aren’t going to triple your money, but a 30 to 40 per cent upside is certainly possible while owning a company on solid financial footing.
“We believe our unique integrated business model will provide investors with an attractive, stable earnings profile.” – Curt Morgan, CEO, Vistra Energy
ON the MONEY