Ten years ago, a group of the biggest private-equity companies joined to pay $44 billion to buy TXU Energy in a leveraged buyout.
About $37 million of the purchase price was financed with debt and just $7 million by equity. With that much leverage, it is a bet that nothing will go wrong.
But something did. These private-equity giants bet that higher natural-gas prices were the new norm, they were wrong.
As soaring shale gas production caused natural-gas prices to plummet, it took electricity prices along with it. For TXU Energy, which generates 50% of its power from coal, that was a big problem.
With coal power costs unchanged but electricity sales costs depressed the company experienced a big margin squeeze and a decline in cash flow. Without the $37 billion of LBO debt the business could have managed, but with that debt and all the interest that came with it the company was doomed.
Seven years later, this largest ever non-financial LBO became the largest ever non-financial industry Chapter 11 bankruptcy in history.
This past fall, the first lien bondholders took over the business and brought the company public as Vistra Energy (VSTE) . As often happens with a company emerging from bankruptcy, there aren't many eyes looking at it, but people should be watching it because it looks like an attractive opportunity.
Vistra Energy is split into two parts: Luminant and TXU Energy
Luminant generates power, and TXU Energy provides electricity to 1.7 million customers. The businesses are run separately, but they are very much integrated.
Luminant generated 47% of the company's earnings before interest, taxes, depreciation and amortization last year, while TXU Energy generated 53%, a near even split.
Luminant is the largest power generator in Texas, generating nearly 25% of the power in the region with almost all of it sold to TXU Energy.
Of TXU Energy's customers, 1.5 million are residential, and the other 200,000 are commercial and industrial. TXU Energy is the largest retail electricity provide in Texas, with 25% of the residential market.
The TXU Energy business involves the company buying electricity from a power generator, and then selling it to its customers at a small mark-up.
This is a utility, a stable business with predictable cash flows.
Because Vistra Energy's EBITDA is split almost evenly between the two units, the company has a nearly perfect natural hedge. Some competitors are integrated as well but not nearly to the same degree.
This is a big competitive advantage for Vistra Energy and should be a big selling point to equity investors as it reduces cash flow and earnings volatility.
Before TXU Energy filed for Chapter 11 protection, the company was carrying $34 billion of debt. Net debt for Vistra Energy is now $3 billion.
Compared with its peers, Vistra Energy's balance sheet has gone from worst to best. A case could actually be made that the business is under-leveraged for a utility.
Adding some debt would certainly free up quite a bit of cash that could be returned to shareholders. Keeping debt low would result in free cash flow that could also be returned to shareholders.
For this year, Vistra Energy expects EBITDA of $1.35 billion to $1.50 billion. After capital expenditures and interest expense the company expects to have $745 million to $925 million in free cash flow.
Against a $9.5 billion enterprise value, the mid-point of that free cash flow would be an $835 billion/$9.5 billion or 8.8% free-cash-flow yield.
The company could really pay that cash out as a dividend, especially when considering that there is room to add some debt to the balance sheet.
Valuation wise, the company appears inexpensive. That shouldn't be surprising, considering that the large enterprise value trading on the over the counter market and since it is fresh out of bankruptcy and hasn't even filed one quarter of its financial statements.
How inexpensive? The enterprise value-EBITDA ratio is 6.7 times.
Competitors Calpine, Dynegy and NRG Energy trade at an average of 8 times EBITDA, with the latter weighing that down.
At 8 times EBITDA, Vistra Energy would trade for $20 a share. At 9 times EBITDA like Calpine and Dynegy, Vistra Energy would trade at $22.52 a share.
But there is something else very important to consider. Looking at the earlier debt-2017 EBITDA image shows that these three companies have three times the debt that Vistra Energy does.
One would think that the company that has one-third the debt would have a premium multiple, not a discounted one.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.