TXU: Honest Graft, Private Equity Style

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Politics creates opportunities for private profit. That's not exactly news. We've known it at least since Senator Plunkitt of Tammany Hall explained the difference between honest graft and dishonest graft.
More recently we've seen how the regulatory and legislative response to the corporate scandals of the turn of the century—in particular, Sarbanes-Oxley and its accompanying regulations—have contributed to buying opportunities for private equity. Firms and managers find the public capital markets unwelcoming and unrewarding), regulatory overhead and legal distractions push down company valuations, and the threat of gigantic civil fines and criminal penalties make increase the risks of operating a public company. Private equity offers an escape from this hazards with promises of greater riches. And if the laws and regulations get repealed or reformed someday, well that will just create new IPO and other exit opportunities for private equities. Call it timing the political market.
This morning's Wall Street Journal carries an editorial explaining how a different kind of politics—environmentalism—contributed to the fall of TXU's share price and made it a more attractive takeover target for private equity.

TXU had painted a green bull's-eye on itself when it announced plans last year to build the 11 new plants. Never mind that the plants were to be built on the sites of existing plants, that a number of them would replace older, less-efficient plants, or that Texas is already bumping up against the limits of its ability to produce the electricity it needs for its growing population and economy. The announcement sent the environmental movement to the barricades against TXU, and may be one reason that the company's stock, after going up regularly for several years, sputtered and stalled in 2006.
That stock slide wasn't all bad for Kohlberg, Kravis Roberts, which is leading the group buying TXU for not much more than its all-time stock-price high, which it hit in the middle of last year. But then again, giving in to the pressure not to build all 11 plants may not turn out to be all bad for KKR and TXU, either.
Ercot, Texas's independent electric-grid operator, figures that peak electricity demand in the state will catch up with available capacity by 2009, if not sooner. Tight demand means higher electricity prices, which is good for TXU's profits. That squeeze will, in turn, rejuvenate calls for more capacity, which may allow TXU to dust off the plans for the new plants at a moment when the current environmental concerns weigh more lightly in the political scales than skyrocketing electricity bills. The private-equity crowd didn't get to be billionaires for nothing.

To sum up: Tree-huggers push down the price of TXU. KKR and TPG swoop in and pick up the pieces, making peace with the greens by agreeing to shut down the plans for the new plants. The resulting higher electricity prices enrich TXU and perhaps even creates a demand for those now-pariah plants in the future.
Here’s how the WSJ concludes the editorial:

As for TXU's current shareholders, the agitation of the greens may have helped bring down TXU's share price last year, so the environmentalists probably did KKR and partners a favor. There may even be a trend in the making here -- environmental protesters bring down a stock, making a private-equity transaction look more attractive, and in return, the equity firm and its management partners buy off the greens with this or that environmental promise. We're not suggesting any such quid pro quo here, but if we were TXU's mom-and-pop investors or Texas energy consumers we'd certainly be asking some pointed questions.


The New Greenmail
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