The recent announcement by private equity firms Texas Pacific Group and Kohlberg Kravis Roberts that they were buying TXU Corp (NYSE: TXU), a Texas utility company, for a record $45 billion has been received with shock and awe owing to the size of the transaction.
Why All the Fuss?
Private equity is as much a deal maker's forum as it has ever been. The elixir of cheap credit and the joined forces of two veteran private equity players makes the acquisition look like a case of déjà vu.
Familiar is what may well be the attendant fall in creditworthiness of the energy provider. Both TXU and TXU Electricity, the former's electricity provider, face rating cuts to the netherworld of junk bond status after the planned acquisition is complete, according to Reuters.
Ratings for the parent company and TXU Energy, its retail electricity provider, may be cut even further to "CCC" levels, in the lower tier of high-yield debt, S&P said last week, after the rating agency lowered TXU's rating to "BB," two levels below investment grade at the beginning of this month.
Who Stands to Benefit Here?
Wall Street banks, no doubt.
Goldman Sachs (NYSE: GS) is to act as M&A advisor to TXU and provide debt and equity financing. Lehman Brothers (NYSE: LEH), Citigroup (NYSE: C)and Morgan Stanley (NYSE: MS)are kicking in equity as well.
Credit Suisse (NYSE: CS) and Lazard (NYSE: LAZ)are to oversee the review of alternate bidders and several law firms stand to make money as well.
It would seem that the bondholders could well draw the short lot due to the imminent increase in debt burden. A day after the announcement of the planned acquisition, markets swooned worldwide with most of last week proving to be a white-knuckled event for traders. It remains to be seen whether this downdraft is just a brief bout of indigestion, or a harbinger of growing concerns over personal indebtedness, cheap credit, high oil prices, the twin deficits and the like. Perhaps being taken out might be a good choice at this time for shareholders of TXU.
A Good Deal on the Surface
On the face of it, the deal would seem to have merit. The deal seeks to accommodate not only environmental groups, but regulators and politicians as well. The private equity firms' commitment to a greener approach to managing the company by canceling plans to build eight out of eleven coal plants and invest in alternative energy sources would appear to curry favor among the environmentalists and socially conscious.
As a result of this transaction, the newly privatized company will deliver price cuts and price protection benefits to electric customers, strengthen environmental policies, make significant investments in alternative energy and institute corporate policies tied to climate stewardship.
Wolves in Sheep's Clothing?
All well and good, but will this deal simultaneously draw the ire of the skeptics who deem the actions of the private equity players predatory and self serving -- the proverbial wolves in sheep's clothing?
Which brings one to ponder -- is this buyout with the acquirer's ostensibly good intentions a case of the company looking to do well by pursuing socially conscious, and smart, business policy or might this be but another rapacious debt-laden acquisition to benefit primarily the interests of the soon-to-be private shareholders at the expense of the debtholders and consumers?
After all, TXU came close to bankruptcy about five years ago, PG&E (NYSE: PCG) went bankrupt and several other energy companies struggled to survive in the wake of Enron's collapse.
The Bottom Line
Will investors' hunger for yield continue to fuel cheap credit? The ability of banks to make paper readily accessible for such deals and lay off risk by purchasing collateralized debt swaps whose premia are quite low across a wide stratum of industries may be viewed as a double-edged sword.
Will a newly privatized TXU be able to service its debt burden and provide dependable service? Only time will tell. Pursuant to the terms of the merger agreement, TXU is permitted to solicit alternative bids for 50 days.
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