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Texas Ring Fence

TXU’s buyout structure creates a potential model for utility M&A and refinancing deals

Fortnightly Magazine - January 2008

and low liquidity usage.

Oncor filed with the Texas PUC in April 2007 to be bound by a number of commitments. In the same month the regulator required Oncor to file a rate case by August 2007. Since then, Oncor and a number of parties have reached a settlement that would be favorable to credit if and when the Texas PUC approves it. Foremost, the Texas PUC would scrap the rate filing and require Oncor to file a new system-wide rate case by July 1, 2008, using the 2007 calendar year as the test period.

Putting it all together, Oncor has agreed to meet these and other commitments that have factored into ratings assessments for Oncor and EFH:

• Limit debt leverage to no more than 60 percent. Even though their regulators might view them as having such a capital structure when examining rates, almost no utilities would agree to maintain such an exact capital structure;

• Allow independent directors, acting on a majority, to stop equity distributions if they conclude Oncor needs the cash to support its operations or reduce debt leverage;

• Limit distributions to no more than 100 percent of net income (subject to certain adjustments) through 2012;

• Commit to at least $3.6 billion in capital spending over the next five years, under certain situations, such as continued demand growth;

• Commit to meeting certain system-reliability and customer-service standards;

• Report to the Texas PUC annually on compliance with commitments;

• Forgo rate recovery of any acquisition costs;

• Forgo debt issuance to help finance the buyout. Oncor’s holding company will not have any debt or other liabilities; and

• Transact with EFH and its subsidiaries through arm’s-length agreements.

More to Come

Private equity interest in the utility business is probably here to stay. Just after the TXU deal closed in October, Puget Energy Inc. (BBB-) headquartered in Bellevue, Wash., agreed to sell itself to Macquarie Infrastructure Partners for $7.4 billion. Puget Energy’s electric and gas utility subsidiary, Puget Sound Energy Inc., (BBB-) has about 1 million electricity and about 720,000 natural gas customers.

At the same time, however, given that almost all utilities are regulated and a number of states have increased their ability to approve such acquisitions, private-equity buyers will have to show that their deals shield ratepayers from financial and operational risk. The structural and financial commitments TXU’s buyers adopted for Oncor may well be adopted by others to receive regulatory approval for their deals — while still achieving their required returns for investors, even after paying substantial acquisition premiums.