TXU: A Very Green Deal

Everything is bigger in Texas, right? Well, now we may have the biggest buyout deal from that part of the country: TXU (NYSE: TXU  ) . A Motley Fool Income Investor pick, TXU has accepted a bid of $32 billion, or $69.25 a share, from buyout firms Kohlberg Kravis Roberts & Co. (KKR) and the Texas Pacific Group (TPG). Adding the existing debt, the enterprise value comes to a massive $45 billion.

Buyout firms, flush with cash and empowered by the current low cost of borrowing, have as of late shown an increasing willingness to break the piggy bank, as seen with other megadeals -- such as the recent $39 billion buyout of Equity Office Properties (NYSE: EOP  ) . Even among the megadeal class, though, this deal sets itself apart not only for its size but for the ingenuity of the investor group. In fact, if the deal gets done, the unique approach taken by the investors is likely to serve as a blueprint for other deals in the utility sector, a sector that has proven inhospitable to buyout funds in the past.

Founded in 1944, TXU is a major electricity generation company, with businesses across the supply chain: development/construction, wholesale, and transmission/distribution. The majority of TXU's revenues and its 2.1 million customers hail from the state of Texas.

Since 2004, TXU has been undergoing a three-phase restructuring process. The first phase was to divest non-core businesses and to improve hedging strategies. The next phase was to enhance TXU's operations to increase productivity and customer service. The current and final phase: Look for ways to grow the company.

So far, it's been a huge success. Over the past three years, the stock has gone up nearly six times.

TXU's financials have been particularly strong. In the fiscal third quarter, for example, net income increased from $565 million, or $1.16 per share, to $1 billion, or $2.15 per share. Revenues increased 5.9% to $3.51 billion.

To accommodate the growth in Texas, TXU has been planning major infrastructure investments. One key part of that plan was to spend $10 billion to build 11 coal-fired plants.

While this would be a cost-effective alternative, the coal-fired plants are not exactly environmentally friendly, resulting in large amounts of greenhouse gases. As a result, there has been a major protest from a variety of political groups and legislators.

Both KKR and TPG have certainly learned hard lessons from dealing with such politically sensitive matters. KKR and TPG have both made bids over the past few years for utility companies, Unisource Energy (NYSE: UNS  ) and Portland General Electric (NYSE: POR  ) , respectively, which ended up falling through after regulatory blowback.

So, this time, KKR and TPG are dealing with this using a classic good cop/bad cop approach. While TXU's CEO, John Wilder, has certainly inflamed part of the Texas community and legislators, KKR and TPG are instead seen as peacemakers.

In an effort to avoid the barbarian perception with which private equity firms -- KKR in particular -- have so commonly dealt, the buyers here have proactively gone warm and fuzzy. The investor group took a step toward appeasing environmental concerns by hiring as an advisor William Reilly, chairman emeritus of the World Wildlife Fund and former administrator of the EPA. The group has a 10-point program, sure to stoke a fire in the heart of many an environmentalist, which includes major concessions like scrapping the plans for building eight of the 11 plants, reducing carbon dioxide emissions to 1990 levels by 2020, and supporting a $400 million energy efficiency initiative.

Another brilliant move: KKR and TPG are proposing an esteemed and very well-connected board. It includes Donald L. Evans, a former U.S. Secretary of Commerce, and James R. Huffines, chairman of the University of Texas Board of Regents. Moreover, Texan and former U.S. Secretary of State James Baker will serve as the advisory chairman for KKR and TPG.

There are not many data points for investors to work with in analyzing the TXU valuation. In its presentation to shareholders today, management made the claim that similar "integrated merchants" were currently receiving a 7.9 times enterprise value/EBITDA multiple. With the current EV/EBITDA offer for TXU standing at 8.5 times, management is implying that TXU's shares are commanding a premium.

For additional context, there's a recent comparable deal: Kinder Morgan (NYSE: KMI  ) . Two firms, Morgan Stanley (NYSE: MS  ) and the Blackstone Group, performed an in-depth valuation of the transaction. Looking at a select number of acquisitions (since September 2001), the valuation range was 8 times to 13 times EV/EBITDA (the Kinder Morgan deal was about 9.8 times). The current 8.5-times offer for TXU falls on the low end of that range.

The TXU merger agreement contains a "go shop" provision, which allows TXU to seek other offers (until April 16). But the stock price is still below the bid value, indicating that investors don't see a counterbid. In other words, it's probably not a bad idea to take money off the table.

Further Foolishness:

TXU is an Income Investor pick.

Fool contributor Tom Taulli does not own shares mentioned in this article. He is currently ranked 1,623 out of 19,864 in Motley Fool CAPS. He is also author of the book The Complete M&A Handbook. The Fool's disclosure policy at night is big and bright, deep in the heart of Texas.


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