Txu Going Private: Private Equity Buys Into Competitive Power Markets

Lynne Kiesling

TXU is going private. KKR and other private investors will acquire TXU and take it private. This is fascinating. Note from the press release two important things: the focus on environmental attributes of the deal, and $400 million planned for “demand side management”:

Planned Coal Units Reduced from Eleven to Three, Preventing 56 Million Tons of Annual Carbon Emissions

This scale-back represents a 75 percent reduction in new coal capacity. In addition, the company is committed to continuing its efforts to meaningfully reduce existing carbon emissions and seeks to join the United States Climate Action Partnership (USCAP). USCAP is a broad-based group of businesses and leading environmental groups organized to work with the President, the Congress and all other stakeholders to enact an environmentally effective, economically sustainable and fair climate change program. As part of the company’s support for USCAP, TXU is also pledging to support the mandatory cap and trade program to regulate carbon emissions.

To satisfy ERCOT’s requirement for immediate additional capacity to meet the state’s increasing electricity demand, TXU expects to build two coal units at the Oak Grovesite and one coal unit at the Sandow site. TXU will immediately seek to suspend the permit application process for the other eight units and withdraw them once the transaction closes. TXU does not intend to apply or reapply for permits to build additional coal units utilizing current pulverized coal-fueled technology.

$400 Million Investment in Demand Side Management Initiatives

TXU will implement an aggressive demand reduction program through a $400 million investment in conservation and energy efficiency activities over the next five years.

Conservation and energy efficiency, fine. But where’s the dynamic pricing and commitment to offer customers differentiated products that will reduce the need for further investment in new generation and wires?

The new coal plants were controversial, so some recognition that active demand can reduce the need for them is a step in the right direction. What I find fascinating is that private equity would be interested in a play like this. Why? According to this Bloomberg story,

Shares of TXU surged $7.89, or 13 percent, to $67.91 at 2:30 p.m. in New York Stock Exchange composite trading. That’s a more than fivefold increase since Chief Executive Officer C. John Wilder took over in February, 2004. The buyout was first reported after the market closed on Feb. 23. …

The company, after almost going bankrupt in 2002 because of a failed overseas expansion, has rebounded and may earn $2.6 billion in 2006, up 51 percent from a year earlier, according to the average of six analyst estimates compiled by Bloomberg.

Wilder returned TXU to a focus on electric generation and distribution in the Dallas region. Natural-gas prices that more than tripled this decade have raised Texas power prices, making TXU’s coal and nuclear plants more valuable.

The plants can produce more than 18,100 megawatts, and the company is also the largest electricity retailer in the state, selling power to more than 2.1 million homes and businesses. TXU owns a transmission business that could be sold to pay off debt used to fund the LBO.

TXU “turned into a good cash machine,” said Perry Sioshansi, president of Menlo Energy Economics, a consulting firm in Walnut Creek, California.

Note in particular the environmental policy aspect of this buyout, a focus that distinguishes it from earlier KKR buyouts. From the NYT article about the deal:

Within TXU, the controversial plan to build a raft of coal plants had become so damaging to its stock price that its board had been privately weighing a plan to scrap part of the project, said people involved in the talks, bringing the number of new plants to 5 or 6 from 11. Shareholders had sent the stock on a roller coaster ride from more than $67 a share to as low as about $53 over concerns about the risk and vast expenditure; the stock closed at $60.02 on Friday.

Indeed, it was the quick drop in TXU’s stock price that got the attention of Kohlberg Kravis and Texas Pacific, which look for undervalued companies and try to turn them around. Together, both firms approached C. John Wilder, TXU’s chief executive, in January with an offer for the company, these people said.

At the time, neither Kohlberg Kravis nor Texas Pacific told TXU about their ambition to scale back its controversial coal plants. But behind the scenes, both firms had been developing a new strategy for the company with the help of Goldman Sachs, their lead adviser.

Goldman Sachs has been a longtime proponent of reducing carbon emissions. Its former chief executive, Henry M. Paulson, now the secretary of the treasury, was also the chairman of the Nature Conservancy, an environmental activist group.

This will be very, very interesting to watch play out.

7 thoughts on “Txu Going Private: Private Equity Buys Into Competitive Power Markets

  1. It seems this buyout happened for two economic reasons:
    1. TXU’s share price became vulnerable from its announcement about building 11 new plants
    2. If KKR succeeds in the buyout and in eliminating the plans for capacity increases, and also eliminates plans for capacity increases outside of Texas, it is achieving in the short term a potential supply shortage, which will be recouped in the usual way: by higher prices.

    Who stands to benefit from having only 3 new plants instead of 11 new plants in Texas? When demand nearly catches up to supply in 2009, the non-marginal producers (i.e. TXU, which has mostly coal plants) will benefit even more from a lack of supply.

    Similarly in other states: Who’s willing to bet that KKR, TPG, Goldman’s Private equity group, etc. have investments in utilities in states that TXU was considering entering? This is a classic case of a group attempting to (re)create a cartel. Seen another way, “deregulation” has advanced only enough that new capital can come in and create new, but this time, private, cartels (previously the cartel was the utilities and the regulators, the losers were the taxpayers/consumers as always). KKR is betting on deregulation continuing to be stalled in states around Texas, and to own the only dominant player in Texas with plans to expand.

    What else points to the attempt to create a new cartel? Precisely the insinuations that TXU will turn an about-face and support a federally imposed cap-and-trade carbon program. This is the most obvious clue that KKR plans to profit on the backs of consumers – combine a lack of expansion with the incredible demographic engine driving Texas population and industrial growth with the more-and-more-likely governent carbon-limiting scheme, and you get a cartel that will pass on the costs to the consumers.

    Is there a strong argument against?

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