© The Financial Times Ltd 2015 FT and 'Financial Times' are trademarks of The Financial Times Ltd.
April 24, 2014 5:24 pm
Negotiations to avoid a disorderly bankruptcy of Energy Future Holdings, the indebted Texas power group that ranks as the biggest casualty of the pre-crisis buyout boom, have come down to last-minute efforts to split the company without triggering a tax bill worth billions of dollars.
EFH, bought for an enterprise value of $48bn, still has more than $40bn of debt. After missing $109m of interest payments due on April 1 and the expiry of a grace period at the end of this month, the company will be formally in default.
That may not force it to file for bankruptcy protection, but it increases the danger that one player in the long, drawn-out drama surrounding the largest leveraged buyout ever could throw out a wild card, such as attempting to press an involuntary filing on the company in an unforeseen jurisdiction.
EFH and most creditors would prefer to avoid that and the company would be likely to seek bankruptcy protection to pre-empt it.
Creditors are pressing for a split of EFH to separate its 80 per cent stake in Oncor, a regulated power distribution and transmission business, from its deregulated merchant businesses in wholesale generation and sales.
However, such a split would normally be considered a sale for tax purposes, creating a potential liability at the parent company of as much as $7bn-$9bn, people involved in the negotiations said.
Senior creditors, who hold debt trading at about 73 cents on the dollar, argue that they have the upper hand. “If there is a tax liability it isn’t ours,” said one.
At the same time, creditors in the merchant businesses are seeking to use net operating losses as a tax shield against future earnings from the parts of the business they expect to take over. They calculate these benefits could be worth $1.5bn on a net present value basis.
The prospect of the Internal Revenue Service being deprived of a large tax payment adds a politically sensitive dimension to already fraught financial negotiations.
“If the IRS is left holding an empty bag, the private equity guys will look like baby killers,” said one person close to creditors. “To lose rich people’s money is one thing. It is another thing to create stranded taxes.”
However, one person familiar with the thinking of EFH’s owners said: “The IRS could always change its policy to deprive the creditors of any tax benefits.”
EFH, formed when the Texas utility TXU was taken over in 2007, has been a victim of the US shale revolution and excessive debt. The fall in natural gas prices since 2008 drove down the price of electricity, because gas is the marginal fuel for power generation.
The owners of EFH, which include the investment arm of Goldman Sachs, KKR and TPG, have already written off virtually their entire $8bn investment. At year end, KKR marked down the value of its stake to a penny on the dollar. As of September, TPG valued its $1.5bn investment at $68m.
The potential tax liability arises because the Oncor stake is held on EFH’s books for tax purposes at a value of less than zero. If it is sold or spun off, the parent would expect to face capital gains tax at 35 per cent on the difference between that negative figure and the realised value of the stake.
As of April 10, EFH held $815m in cash, according to regulatory filings.
However, there is uncertainty over the view the IRS will take of any deal and the timing of any opinion. The agency can clarify the tax position with what is called a private letter ruling, but it does not usually do that until it is presented with the details of a proposed transaction.
The IRS has the right to object to any restructuring plan and could delay or block a deal that it considers does not offer fair treatment for the US government.
Neither the owners nor the creditors wish to see a messy bankruptcy proceeding lasting several years, given how costly it would be. However, the timing of the widely expected bankruptcy filing probably still rests in the hands of the EFH board.
Copyright The Financial Times Limited 2015. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.
Sign up for email briefings to stay up to date on topics you are interested in