Avoiding the Living Dead

Done during the heyday of leverage buyouts in the 2006-2007 period, TXU (now called Energy Future Holdings) went down in the books as the largest LBO in history.  With its massive size came the issuance of a huge chunk of debt that went into the high yield indexes and the products that track them.  However in the five years since, TXU has run into tough times as natural gas prices have declined and taken electricity prices down with them.  The expected cash flows that were going to be used to service this massive debt load have not materialized.

Just last week, they undertook the seventh (yes you read that right) distressed bond exchange, swapping existing bonds for new, longer dated bonds as they attempt to address their refinancing risk.  In today’s wide open new issue market, the fact that the issuance market is not there for them and they are instead  having to turn to distressed exchanges should waive a big red flag.  And some of the new bonds are PIK-toggles (pay-in-kind), meaning that the company has the option to pay the interest payment with more bonds in lieu of cash.  This allows the company to reduce their cost of interest, but as an investor begs the question, if a company already can’t service their existing debt, why would you want more of their bonds?

We view this company as case and point of the value of active management in the high yield space.  Active managers can avoid investments in companies such as this that are in essence the living dead.

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