vote for their plan. Arguing that EFH plan had no creditor support, the committee representing unsecured creditors of EFH, TCEH, as well as TCEH first lien holders objected to no avail to the length of the firm's exclusivity extension. They argued for much shorter extensions ranging from 2 weeks to 2 months. In an effort to gain support for its reorganization plan, EFH called off the bankruptcy auction of its 80% stake in Oncor on June 26,2015 , and proceeded to promote the spin-off of Oncor in a tax-free transaction. EFH would leave $805 million in cash to pay TCEH secured creditors. The bankruptcy court judge approved the firm's reorganization plan on December 3, 2015. The tax-free spin-off of Oncor was completed on October 4, 2016, paving the way for emergence from Chapter 11, almust 2.5 years after the firm had sought court protection. What can be learned from this investment debacle? Investors often are seduced by the potential for eve-popping financial returns made possible by the use of leverage: other people's money. However, it is easy to overlook the dark side of leverage. If everything doesn't go according to plan, as is often the case, the inability to satisfy debt service requirements can force the firm into default and subsequent bankruplcy. The financial sponsor group and the lenders involved in laking TXU private were well aware of this potential outcome but were confident that history would repeat itself: natural gas prices would rise significantly, which as we know did not happen. Also, the exceedingly low cost of borrowing made possible by the Federal Reserve coaxed borrowers to take on more debt than would have been prudent at higher rates of interest. All these factors combined to set the stage for the largest bankruptcy of a nonfinancial firm in US history. Discussion Questions 1. This chapter identifies a number of ways in which LBO s can create value for their investors. The financial sponsor group in this case study was relying on which of the sources of value creation identified in this chapter? Be specific. In your opinion, were the financial sponsors placing too great a bet on factors that were bevond their control? Explain your answer. 2. How does the postclosing holding company structure protect the interests of the financial sponsor group and the utility's customers but potentially jeopardize creditor interests in the event of bankruptcy? Be specific. 3. What was the purpose of the preclosing covenants and the closing conditions in the merger agreement? 4. Loan covenants exist to protect the lender. How might such covenants inhibit the EFH from meeting its 2014, \$20-billion obligations? Solutions to these case study discussion questions are available in the Online Instructor's Manual for instructors using this book (https://textbooks.elsevier. com/web/Manuals.nspx? isbn=9780128016091). END OF CHAPTER CASE STUDY: THE LEGACY OF LEVERAGE, BAD ASSUMPTIONS, AND POOR TIMING-THE LARGEST LBO IN US HISTORY GOES BANKRUPT Case Study Objectives: To Illustrate - Leverage offers the prospect of outsized financial retums for investors. - However, excessively levernged firms often have little margin for error. - If key assumptions underlying the deal are unrealistic, the only altemative may be bankruptcy. - Chapter 11 reorganization can be protracted. Energy Future Holdings Corporation emerged from bankruptcy in late 2016 bringing to a close a deal based on excessive optimism, poor timing, and unrealistic assumptions. What follows is a discussion of why the LBO seemed attractive, the deal's complex legal and financial structure, factors that ultimately pushed the firm into bankruptcy, and how the firm was ultimately reorganized. Amid great fanfare, a consortium of storied investor groups along with highly sophisticated lenders took Texas-based electric utility holding company TXU private on October 7, 2007. Immediately following closing, TXU Corp. was renamed Energy Future Holdings (EFH). EFH consisted of two subsidiaries: Oncor, a business that sells electricity in wholesale markets to other utilities and IV. DEALSTRUCTURING AND FINANCING STRATEGIES DSCUSSCNQUERTONS 497 big businesses, and Texas Competitive Electric Holdings (TCEH), which holds TXU's public utility operating assets and liabilities. The latter firm is the one that ultimately filed for bankruptcy. Valued at $48 billion, the leverage buyout consisted of $40 billion in debt and $8 million in eq. uity provided by the private equity consortium, subsequently referred to as the financial sponsor The deal was fueled by record low borrowing rates and the belief that natural gas prices that had been trending lower would tum around, dramatically improving EFH's profit and cash flow. While things looked rosy at the closing, the underpinnings of what was to be the nation's largest bankruptcy of a nonfinancial firm already were underway. The United States went into recession in December 2007 and did not emerge until June 2009 according to the National Bureau of Economic Research, the widely recognized organization that defines such things. The recession reduced the demand for electricity and forced natural gas prices lower. While the recession clearly exacerbated the situation, much of the damage done to EFH was self-inflicted by the complex financial engineering used to finance the deal and by the byzantine legal structure created to limit investors' exposure to potential liabilities. These factors made it increasingly difficult for the firm to meet its scheduled debt service payments and ultimately to reorganize in bankruptcy. Since the 2007 closing, equity investors who put $8 billion into the deal have seen their positions wiped out and bondholders have experienced large losses. By early 2014, those who bought the firm's $40 billion in debt saw its market value plunge to as low as e20-30 on the dollar. The firm struggled for years to remain afloat, renegotiating the terms of its loans with creditors. However, the \$20-billion loan repayment due in 2014 proved the downfall of the firm. Unable to meet its commitments and with lenders running out of patience, the firm sought the protection of Chapter 11 of the US Bankruptcy Court in late spring of 2014. Chapter 11 gives the debtor the exclusive right to formulate a reorganization plan that if acaptable to the court and lenders enables the firm to emerge from bankruptcy. The firm has 1 year to submit a plan for emerging from bankruptcy to the court and can get a 6-month extension if permitted by the court. At the end of this time, so-called creditor committees representing secured and unsecured debt and equity groups can submit their own plans. Such plans can range from the debtors swapping what they are owed for an equity stake in the business to forgiveness of much of the debt (or at least repayment on more lenient terms) to outright liquidation of the firm with the proceeds used to pay its obligations. How could investors with sterling reputations and sophisticated lenders make such a big mistake? Simply saying it was due to greed would be overly simplistic. The investors and lenders participating in this deal were at some level victims of their own earlier success. Private equity firms seek unusually high retums on the equity they put into projects by borrowing as much as they feel can be managed. And given Federal Reserve policies that pushed interest rates to historical lows, LBO finandal sponsors were encouraged to take on much more debt than would have been considered prudent had interest rates been higher. Investors and lenders were piling into LBO deals in 2007 in a search for higher financial retums. The prior successes of the LBO sponsors lent credibility to the deals they put together. The conditions were ripe for the addictive effects of overoptimism and cheap money to create a megadeal whose success was dependent on literally everything going according to plan. A private equity consortium consisting of Kohlberg Kravis Roberts \& Co., Teas Pacific Group, and Goldman Sachs (the financial sponsor group) considered TXU an attractive investment because 1