Wednesday, January 11, 2017

Vistra Energy: Energy Future Holdings Reorg, Discount to Peers, Uplisting

Another company that recently emerged from bankruptcy is Vistra Energy (VSTE), the unregulated businesses that made up the old TXU/Energy Future Holdings, the largest leveraged buyout at one point.  Energy Future Holdings filed for bankruptcy in 2014 after years of low natural gas prices squeezed their margins, making their coal power plants less competitive and as result they were unable to service their large debt load.  As part of the reorganization, Energy Future Holdings was effectively split into two, NextEra Energy (NEE) bought Oncor, the regulated traditional utility transmission lines and sub-station business that acts as a natural monopoly, and Vistra Energy which contains the competitive power generation and electricity retailer businesses was spunoff to senior creditors.  Vistra Energy now trades over-the-counter but in late December filed a registration statement with the SEC and should uplist to NYSE/Nasdaq in the spring.  The combination of Vistra's low valuation and the uplist could create an interesting short term opportunity as shares rerate closer to peers and more institutional investors get comfortable with the new company.

Company Overview
Texas was an early adopter of introducing competition into the electric utility industry.  Most people think of utilities as stodgy widows and orphans stocks, that perception is still correct for the regulated parts of the business, but the unregulated parts of the business can be very competitive and cyclical.  Vistra is in this second bucket, but their business model which pairs both generation and retail together helps mute some of the cyclicality of each business.

Vistra Energy is an independent power producer (IPP), through its Luminant subsidiary it is the largest power generator in Texas with 15 plants capable of generating 17,000 MW of capacity.  Electricity demand varies greatly during the day and the time of the year, and electricity can't be efficiently stored, so power generators need to vary their output throughout the day which creates some operational challenges.  Luminant's baseload plants are nuclear and coal based power plants, these run at near capacity at all times of the day/year, their intermediate and peaking plants that go to work during high volume times are primarily fueled with natural gas.  

The predecessor company ran into trouble after the leveraged buyout because they're effectively long natural gas prices in relation to coal (which they are vertically integrated by owning/mining their own supply) since their baseload plants are coal and other independent providers are more skewed towards natural gas.  As natural gas prices dropped, marginal natural gas power plants became competitive with Luminant's baseload coal plants which squeezed margins.  I'll let others speculate on the day-to-day or month-to-month movements of natural gas, but overall the glut in supply has started to recede as high-cost E&P companies have gone under and as exports begin to ramp, I think we see a little more rational actors in the industry, but never know.

The TXU Energy side of the business is the retail arm that interacts with residential and commercial consumers, they'll source the electricity from the power generators, transmit the power over the regulated transmission assets to the eventual end consumer where they'll earn a small clip to bill, collect payments, and handle most customer service issues, etc.  TXU is the incumbent brand that was in place before deregulation and thus still has a strong competitive position as the largest retail provider in Texas.  However, this is a competitive business with new entrants driving down margins and pricing; its fairly easy to setup a retail electric provider business, at least in comparison to the upfront investment required to build/buy transmission or power generation assets.

The company believes the combination of the two businesses reduces the cyclicality of either business, when margins are up in the retail business they're likely down in the power generation business and vice versa.
December Lender Presentation
In early December, Vistra added some additional leverage and paid out a special dividend of $2.32 per share as a step towards right sizing their capital structure slightly.  However, they're still fairly unlevered on traditional metrics compared to peers, which makes sense for a company emerging from bankruptcy and trying to repair its reputation with the investor community.

Vistra Energy is significantly less levered than its independent power producer peers (NRG, Calpine, and Dynergy) and arguably has a more durable business model and competitive position than all three, yet trades at a significant discount to the peer group.
NRG Energy is the closest peer as it also pairs power generation with retail (thanks to its purchase of Reliant in 2009/2010), it trades for 8.5x EBITDA, at the same multiple, Vistra would be worth ~$21 per share versus just under $16 today.

Tax Receivables Agreement
One nagging concern I have with Vistra Energy is the presence of a Tax Receivables Agreement (TRA) that essentially creates two sets of shareholders.  A TRA is an agreement between the company and its former owners to share in the tax savings that were created through the formation of the new company (usually a step up basis on their assets, but sometimes an NOL) that wouldn't have been present without the former owners savvy structuring (or that's the pitch given).  In a typical arrangement, and in Vistra's case, 85% of the tax savings are sent to the former owners and 15% are kept by the company as an incentive to create the tax savings through generating taxable income in the first place.

This arrangement gives the former holders, the senior creditors turned controlling shareholders, a preferred economic return over anyone buying the shares now.  Vistra's TRA shows up on the balance sheet as a $938MM estimated liability, not an insignificant sum, that will stretch out over a decade and can't be prepaid like other debt unless there's a change of control event, which the presence of the TRA would also likely discourage.  But in effect, Vistra is a little better off than a full tax payer as they will get to keep that 15% tax savings, but the company is more leveraged in reality than it looks or screens.  If Trump gets his way and corporate taxes come down, so will the TRA, which could be another potential benefit of lower rates.

Why separate out the tax attribute assets from the rest of the company?  There could be some valid reasons like the market wouldn't value them correctly (likely true) but I don't conceptually like the idea of not being on an equal economic standing in the overall business as other shareholders.

Other Considerations
  • Apollo, Brookfield Asset Management and Oaktree own 39% of the company.
  • As alternative energy technology continues to improve and makes wind/solar more competitive with fossil fuels that will put pressure on Vistra Energy's baseload coal power plants.
  • Operates solely in Texas (ERCOT), particularly concentrated in Dallas/Fort Worth one of the fastest growing MSAs.
  • No clearly articulated capital allocation strategy, likely acquisitions over dividends or buybacks.
Disclosure: I own shares of VSTE