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


  1. I agree I don't like being on a different footing than other shareholders (one issue I always had with PE IPOs). However it is not a real liability right - they only pay when they get tax benefits? Especially if you aren't adding any value of the 15% of NOLs to the enterprise value. I would essentially take enterprise value and deduct 15% of the PV of the NOLs to get a true EV for new shareholders. What do you think?

    1. Also, do you think there any issues associated with met coal price increases recently?

    2. Adding 15% of the tax attribute would be the argument from the other side, but this brings up the issue of what else have the PE owners stripped away? Carving up the economics among different parties in this way just seems questionable to me.

      Should I be worried about met coal prices? I guess I didn't spend much time on it since Vistra supplies most (all?) of their own coal. I could be missing the point.

    3. Met coal isn't very important to power producers, as its primarily used in steel production. Regardless, 2/3 of Luminant coal generation is supplied with fuel from mines dedicated to generation plants and adjacent to reserves. Luminant is actually the 7th largest coal miner in the US. Luminant traditionally blends its coal with PBR coal in Wyoming (multiple contracts under various lengths and transported by railcar). PBR coal has not experienced the hockey stick recovery demonstrated by Met coal -- PBR has generally been between $9-12/ST (current levels of ~$0.6/mmbtu).

    4. Good point both. It was too late when the article came out and I forgot the difference between the two types of coal. Mdc - yes that's unfortunately the fear. These PE guys are smarter than us and likely have other benefits to themselves we can't see.

  2. Good write up and interesting idea. If you include the TRA of $938MM in the EV, then the 8.5x EBITDA yields a $19 stock price.

    1. I struggled with whether to include the TRA in the EV, but I don't believe you should, if you include you're effectively penalizing it versus other full tax payers too. I don't like the signal it sends of shareholders being on different economic terms than the actual accounting entry of turning an entity with a valuable tax asset to one that doesn't.

  3. Any thoughts on what's driving the stock lower? Is it potential acquisitions they are looking at?

    1. No thoughts really, seems just like market fluctuations and nothing material has changed to the business? They seemed to hint at more tuck in and smaller acquisitions on their recent conference call, hopefully nothing big like some have speculated where they'd team up with DYN.

  4. If the TRA was only a step up of the tax basis of assets and not NOL, I don't think it is a real problem for the company. The same money would've been paid to the government in the form of smaller depreciation deductions. If we are looking at a profitable business, should it accrue expected future tax payments? No. TRA is essentially future tax - just paid to the pre-IPO owners rather than the government.

    The biggest concern for this investment is the chronic oversupply in ERCOT and the relentless march of renewables. VSTE owns a bunch of coal generators which are really the marginal producers in the market. If price continues to weaken, those legacy assets may become worthless.

    Aside from that, the adjusted EBITDA uses too many adjustments (lots of them not related to the reorg). EBITDA / Cash flow conversion in this case seems surprisingly low...