Shareholder value creation at Dynegy

Earlier this month, Dynegy filed for bankruptcy. Well, not the entire company, just one part of it.

The bankruptcy seems to have been written on the wall after failed attempts to sell the entire company.  The old management, external auditors and rating agency Moody’s all declared that Dynegy, saddled with debt and facing declining cash flows, would be unable to survive on a standalone basis.

Some equity holders didn’t see it that way. So they took control of the company and orchestrated a scheme devised to create shareholder value. No, not the way you learn in your MBA. They split the company into two and transferred the profitable assets to Dynegy Inc, which has little debt and room to borrow more to keep operating. Most of the debt and a few less good assets were left with Dynegy Holdings. It is Dynegy Holdings which filed for bankruptcy. Dynegy Inc and its subsidiaries remain out of bankruptcy. Here’s the coverage in the WSJ. Interestingly, the documents filed with the bankruptcy court showed that Dynegy Holdings has assets worth $13.8bn, and debts of $6.2bn. Only fudging NPV calculations are the assets of Dynegy Holdings worth that much.

In control of the show, equity holders are doing everything one can imagine in the realm of bond holder-equity holder conflicts. They reshuffled and ring-fenced the assets, thus eliminating the ability of bond holders to seize them; they committed some of the assets to make them even more bankruptcy remote; they are issuing new debt with a higher priority to existing debt.

What were bond holders thinking when they bought these covenant free bonds? That the loans were relatively risk free just because Dynegy at the time was a stronger credit? That these transactions were impossible, or would be judged fraudulent (still a possibility)? That credit default swaps would protect them? It blows one’s mind that lenders didn’t think they needed covenants.

The events at Dynegy also show the risks of unsecured debt: that when things go wrong, some street smart equity holders take every opportunity to reverse the bankruptcy priority rules. That creditors, especially when they are dispersed, can be slaughtered by investors seeking fortune not by creating wealth, but by devising brilliant holdout plans that redistribute wealth to them at the expense of everybody else. No matter what the bankruptcy documents say about the proposed reorganization, the game at Dynegy is not a serious attempt to walk back the stock price to a higher value by sweating and restructuring the assets. It is pure arm-twisting and lunch-eating of the unsecured bond holders, the lease-holders and the employees.

The events surrounding Dynegy’s bankruptcy could have important repercussions in the corporate bond markets, be these in terms of restrictions on investment-grade issues, repayment triggers, risk premiums and even credit availability. Yes, the cost of capital should go up. And yes, it yields lawyers’ fees galore.

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