Description

I believe that buying Brazos River Authority Pollution Control Revenue Bonds 6.750% Fixed Series 1999B due Sep 1, 2034 (106213FZ9 MUNI) and 6.750% Fixed Series 2003A due Apr 1, 2038 (106213FY2) at 80 or better will result in a 29% cash on cash return for a 50% IRR. 

Although these bonds are nominally issued by the Brazos River Authority (“BRA”), the BRA has no liability for the repayment of these bonds.  The credit support for these bonds comes from Texas Competitive Electric Holdings Company (“TCEH”), the merchant generation and retail electricity business of Energy Future Holdings(“EFH”), the old TXU.  TCEH is a restructuring waiting to happen when a portion of its bank debt matures in 2014 or its high yield bonds approach maturity in 2015 and 2016. 

Overlooked in the whole Energy Future Holdings credit complex are these $90mm of bonds.  These bonds are puttable to TCEH in April 2013, which places them at the very front of the maturity stack.

TCEH will be able to pay off these bonds in April 2013 from cash on hand and interim free cash flow.  TCEH is a wholly-owned sub of Energy Future Competitive Holdings (“EFCH”).  As of 6/30, EFCH, had $358mm of cash on hand and $680mmof intercompany notes to EFH.  On 8/10, Energy Future Intermediate Holdings (“EFIH”), a wholly-owned subsidiary of EFH, announced a private placement of $850mm of debt (http://www.energyfutureholdings.com/news/newsrel/detail.aspx?prid=1453).  The proceeds will be used to pay a dividend of $680mm to EFH around Jan 2013.  EFH will then repay the $680mm to TCEH to satisfy the intercompany notes.  This puts TCEH with ≈$1bn of pro forma cash on hand around Jan 2013.  TCEH is currently doing ≈$3.3bn in EBITDA with ≈$2.5bn in interest expense and ≈$925 in annual capex.  This run-rate FCF of ≈$125mm leaves over $900mm in cash with which to satisfy these bonds.  TCEH also has $1.8bn in revolver and letter of credit availability (see page 11 http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDc0OTQ1fENoaWxkSUQ9NTA2OTMxfFR5cGU9MQ==&t=1).

These bonds are not without risk.  If a restructuring event occurs before April 2013, then you are levered roughly 13x to 25x TCEH’s $700mm to $1.3bn of Open EBITDA (see page 35 http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDQ2NDQ0fENoaWxkSUQ9NDY5OTAyfFR5cGU9MQ==&t=1).  The bonds will recovery ≈$0 or so under such a scenario.

Catalyst