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Oncor public offering 'path of least resistance,' M&A favored by EFH creditors

With NextEra Energy Inc.'s effort to acquire Oncor Electric Delivery Co. LLC again rebuffed by Texas regulators, there are still several paths forward for the Dallas utility and its bankrupt majority owner, Energy Future Holdings Corp.

The Public Utility Commission of Texas on June 7 denied NextEra's motion to rehear its earlier rejection of the company's proposed $18.7 billion purchase of Oncor, with commissioners finding that the transaction was not in the public interest.

Oncor, the largest transmission and distribution utility in Texas, has been a much sought-after target following the April 2014 bankruptcy filing of Energy Future Holdings, or EFH. Oncor, majority owned by Energy Future Intermediate Holding Co. LLC, or EFIH, is ring-fenced from the bankruptcy. This is a point of contention for state regulators, who also demand that Oncor maintain an independent board of directors regardless of who purchases the utility.

"Obviously we can't pay $18.7 billion for a utility that we can't run and we can't control the board and we can't have access to dividends," NextEra Chairman, President and CEO Jim Robo said on an April 21 earnings call.

These conditions will likely present a "very significant obstacle" for anyone interested in purchasing Oncor, CreditSights analyst Andy DeVries said.

"Not only is it going to be tough for somebody that's willing to pay a premium, the same premium that NextEra was willing to pay, but will anyone make a bid at all knowing that the regulators want to keep the ring fence in place and not give access to the dividends? That is a huge hurdle to finding another bidder," DeVries said in an interview.

Going public

Perhaps the most likely possibility for Oncor's future is for the company to go public, according to some analysts. This would allow EFH to finance its debt through an initial public offering, or what's known in a bankruptcy case as a rights offering.

Despite raising questions on management of the IPO and its impact on EFH's bankruptcy case, along with who would pay the breakup fee to NextEra for a failed deal, Reaves Asset Management analyst John Bartlett said in an interview that a public offering is "the path of least resistance."

"I think it's going to be very difficult for somebody outside of the state of Texas to buy the company. It will be very difficult for even a holding company, frankly," he said in reference to Hunt Consolidated Inc., which led an investor group that unsuccessfully sought to convert Oncor to a real estate investment trust in 2016.

"To me, and I'm not a workout dude, the path of least resistance probably points to some sort of public offering," Bartlett added. "Nobody else can buy [Oncor]."

The Hunt group's REIT plan was approved by the PUCT, but a group of EFH creditors backed out after the commission imposed several conditions regarding the REIT's internal lease structure and tax savings.

While Bartlett believes Hunt is done attempting a deal because of its involvement in the Sharyland Utilities LP rate case, Glenrock Associates LLC analyst Paul Patterson said in an interview that the Dallas-based firm might make another run for Oncor, which the PUCT could be comfortable with because of that local touch. Hunt spokeswoman Jeanne Phillips said in an email that the company doesn't have any comment on whether it's considering an Oncor acquisition.

A Schedule 13D filing in late February by Hunt's InfraREIT Inc. mentioned that "Hunt may resume its efforts to acquire all or part of Oncor" if the NextEra deal falls through.

Patterson said the PUCT may also be more open to a deal involving the Houston-headquartered CenterPoint Energy Inc., which has been cited in previous media reports as a possible bidder for Oncor. CenterPoint President and CEO Scott Prochazka said on a May 5 earnings call that his company is focusing on internal growth and declined to comment on whether CenterPoint was interested in buying Oncor.

Whoever would end up purchasing Oncor, Patterson said, the PUCT is "looking for a conservative transaction... either more equity or local control or something of that sort. Could there be a local player who could do it? Possibly."

EFH's creditors, Patterson said, "would want the highest [deal] price. But the question is how do you structure a transaction that meets the Texas PUC's needs?" Potential suitors, he added, have seen two failed attempts by NextEra to acquire Oncor, "which should probably make three times the charm."

Other potential buyers surfacing in media reports in the past year have included Berkshire Hathaway Energy and Edison International.

M&A needed

DeVries added that an M&A transaction is essential for certain EFIH payment-in-kind unsecured bondholders. It appears that most of these notes have been sold to Elliott Management Corp., the largest creditor involved in the bankruptcy and opponent of the NextEra deal, and W.L. Ross & Co. LLC, according to LCD reports.

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"Those guys need another bid to get anywhere close to the 80-cent recovery that the NextEra bid would've given them," DeVries said. "If you IPO it, those bonds are not going back up to 80 cents. They literally need M&A."

Outside of a public offering or new deal, EFH may need to pursue a standalone reorganization plan that includes the exchange of debt for equity in a "waterfall fashion" in which top-tiered creditors, or senior lenders, are paid off first before lowered-tiered lenders receive principal and interest payments, according to analysts and LCD reports.

"The judge absolutely has to be considering equitizing these interests — converting the bonds into equity," DeVries said. "He knows there's a huge hurdle to getting an acquisition done. This bankruptcy case has dragged on for over three years now. You've got to start thinking about converting into equity. It's got to be on everyone's radar, including the judge's."

What's next for NextEra?

Outside of the future for Oncor and EFH, analysts also are focusing on the third side to the story, which is what NextEra may do next.

"From the NextEra side, it's their third failed utility acquisition," DeVries said. "They tried to buy [Entergy Corp.] a decade ago. They tried to buy Hawaiian Electric Industries Inc. two years ago. And then they tried to buy Oncor last year and all three of them have gotten shot down."

"The issue we have as bondholders is the nonutility business is growing double digits while the utility business is growing single digits," DeVries added. "Sooner or later, the non-utility business is going to be contributing as much earnings as the utility business. So that, in theory, puts some pressure on the rating agencies who want to see a higher share of utility earnings."

"Their contracted generation business is a great business, very strong credit quality, but it's not as a great as a regulated utility. So, speculation is they've got to go out and buy another utility. Maybe they make another run at Entergy or something."

Leveraged Commentary & Data (LCD) is an offering of S&P Global Market Intelligence, which is owned by S&P Global Inc.