The United States went into recession in December 2007 and did not emerge until June 2009 according to the National Bureau of Economic Research, the widely recognized organization that defines such things. The recession reduced the demand for electricity and forced natural gas prices lower. While the recession clearly exacerbated the situation, much of the damage done to EFH was self-inflicted by the complex financial engineering used to finance the deal and by the byzantine legal structure created to limit investors’ exposure to potential liabilities. These factors made it increasingly difficult for the firm to meet its scheduled debt service payments and ultimately to reorganize in bankruptcy.

Since the 2007 closing, equity investors who put \($8\) billion into the deal have seen their positions wiped out and bondholders have experienced large losses. By early 2014, those who bought the firm’s \($40\) billion in debt saw its market value plunge to as low as ¢20–30 on the dollar. The firm struggled for years to remain afloat, renegotiating the terms of its loans with creditors. However, the \($20-billion\) loan repayment due in 2014 proved the downfall of the firm. Unable to meet its commitments and with lenders running out of patience, the firm sought the protection of Chapter 11 of the US Bankruptcy Court in late spring of 2014. They gives the debtor the exclusive right to formulate a reorganization plan that if acceptable to the court and lenders enables the firm to emerge from bankruptcy. The firm has 1 year to submit a plan for emerging from bankruptcy to the court and can get a 6-month extension if permitted by the court. At the end of this time, so-called creditor committees representing secured and unsecured debt and equity groups can submit their own plans. Such plans can range from the debtors swapping what they are owed for an equity stake in the business to forgiveness of much of the debt (or at least repayment on more lenient terms) to outright liquidation of the firm with the proceeds used to pay its obligations.it was the biggest utility in the fast-growing Texas electricity market and the only one in the state that had not been broken up as a result of the state’s deregulation of its electricity market. The key assumption underlying the deal was that natural gas prices would go up in line with the global price of oil as they had done for years. Electricity rates in Texas were pegged by regulators to natural gas prices, but since TXU generated most of its electricity with less-expensive coal and uranium for nuclear plants, it stood to profit from higher electricity rates. Instead natural gas prices plunged as hydraulic fracturing of shale rock unleashed a glut in the United States, pushing down natural gas prices and in turn electricity rates. Wall Street banks were similarly enamored with the proposed deal to take TXU private. They were competing in 2007 to make loans to buyout firms on easier terms, with the banks also investing their own funds in the deal. The allure to the banks was the prospect of dividing up as much as \($1.1\) billion in fees for originating the loans, repackaging such loans into pools called collateralized loan obligations (CLOs), and reselling them to long-term investors such as pension funds and insurance companies. In doing so, the loans would be removed from the banks’ balance sheets, eliminating potential losses that could arise if the deal soured at a later date. Furthermore, the deal appeared to be attractive as an investment opportunity as some banks put up \($500\) million of their own cash for a stake in the TXU.....

Discussion Questions:

1. T his chapter identifies a number of ways in which LBOs can create value for their investors.
The financial sponsor group in this case study was relying on which of the sources of value creation identified in this chapter? Be specific. In your opinion, were the financial sponsors placing too great a bet on factors that were beyond their control? Explain your answer.
2. How does the postclosing holding company structure protect the interests of the financial sponsor group and the utility’s customers but potentially jeopardize creditor interests in the event of bankruptcy? Be specific.
3. What was the purpose of the preclosing covenants and the closing conditions in the merger agreement?
4. Loan covenants exist to protect the lender. How might such covenants inhibit the EFH from meeting its 2014, \($20-billion\) obligations?