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A View on the TXU Leveraged Buyout

Is power a public good or a private goodie?

Fortnightly Magazine - April 2007

be ignored. Whether the LBO-related debt is held at the parent, moved away from the utility, or sophisticated ring-fencing techniques are applied, this approximately $25 billion in debt still has to be repaid. And the primary source of repayment is the cash generated from the utility.

Logically, the parent will upstream as much money as it legally can to pay down this debt. This debt load also decreases financial flexibility. Although market interest rates are closer to historic lows, should such rates spike up, this significantly could constrain the utility’s ability to access needed capital. The end result could be that TXU is unable to obtain adequate capital to meet its growing long-term customer obligations.

TXU bidders have only three primary ways to pay down its LBO debt load: 1) increase revenues; 2) sell assets; or 3) decrease costs. Recently, TXU has indicated it would not increase short-term consumer rates or sell certain assets in the next five years. Assuming this statement is true, how will this mountain of debt be paid down? Cost cutting, if not done prudently, could come at the expense of dependable and reliable service to customers. This is another critical element of the proposed LBO structure that the Public Utility Commission of Texas (PUCT) will need to explore in more detail.

Texas Economics and LBO 101

The health of the Texas economy will have bearing on the financial strength of TXU. Power companies tend to prosper most in a growing economy as energy consumption expands. In good economic times, and with companies such as TXU that throw off sizable cash flow, leveraged buyouts appear to be financial alchemy. However, should the economy turn south and anticipated earnings growth not materialize, this newly acquired LBO debt can reduce TXU’s financial flexibility substantially, causing more harm than good.

Don’t forget that less than five years ago, TXU was close to bankruptcy, and it was questionable as to whether it would survive. As we learned through the bankruptcy of California-based PG&E (2001), big utilities can and do go bankrupt and customers are the ones that are impacted immediately.

In the last five years, Texas has moved forward with deregulation, lifting rate caps, and the result has been sizable increases in the rates charged to its power customers. TXU retail consumers are paying 14.5 cents per kilowatt, 1 substantially above the national average (the price per kilowatt is based on 1,000 kW per month and includes a monthly service charge). While the LBO deal-makers have offered a 10-percent rate concession to a small sub-group of consumers through September 2008, is this concession meaningful given where rates currently stand?

Where Are the Regulators?

TXU has made comments suggesting that the Public Utility Commission of Texas (PUCT) has limited authority to review this transaction. Texas lawmakers feel differently, and have proposed expanding the PUCT’s mandate. If Senate Bill 896 is passed in part or in full, the PUCT will be sitting front and center in this debate.

The PUCT will need to incorporate numerous questions into its assessment. Will 2.4 million TXU power