Credit analyst still sees TXU paper vulnerable to downside pressures

By Ronda Fears

Nashville, Tenn., Oct. 15 - TXU Corp.'s common dividend cut plus its move to extricate itself from its European operations will go a long way toward moving into positive cash flow, but Carol Levenson, director of research at Gimme Credit, still sees downside pressure on the paper.

"The $850-$950 million in cash savings from yesterday's actions [common dividend cut] means TXU, if it meets its cash flow guidance, should move into a positive free cash flow position, which is a good start," Levenson said in a report Tuesday.

"However, we still view bonds at all levels of the TXU system as vulnerable to further downside."

TXU (Baa3/BBB) cut its common dividend by 80% and essentially withdrew parental support from TXU Europe, plus put the European subsidiary on the sale block.

"The cash preservation moves announced yesterday did appear to forestall a substantial rating agency action at the parent level, although TXU Europe was downgraded by several notches, one of the most severe one-move downgrades we can recall," Levenson said.

"The real challenge facing TXU is whether it can extricate itself from its near-insolvent European subsidiary without doing further damage to its U.S. and Australian subsidiaries.

"The company officially put TXU Europe up for sale, but we fear most potential buyers would consider this overleveraged and overcommitted company to be more attractive after a restructuring, when they can cherry-pick the assets and escape the liabilities."

Furthermore, the analyst said, drawing down all its bank lines, as TXU did last week, is not the sign of a healthy or even an investment-grade credit.

TXU did, however, amend its bank agreement to remove the cross-default language related to its foreign subsidiaries, she added.

This implies there's some amount of constructive dialogue going on with TXU's banks, she said, noting though that TXU is negotiating an additional $1 billion credit facility at its transmission and distribution subsidiary, Oncor.

"We are somewhat handicapped in our analysis by the lack of a balance sheet more recent than June 30, but we believe the parent has little if any cushion beneath its leverage covenant, especially after Friday's additional borrowing," Levenson said.

The inevitable write-down of TXU Europe, which carries nearly $6 billion in goodwill on its balance sheet, compared with only $3 billion in equity, would almost certainly violate this covenant at the parent level, she said, although it appears as though TXU U.S. Holdings will remain well within its covenants.

"Once again, much depends on how cooperative TXU's banks decide to be. If TXU Europe won't continue to be a drain on the parent's cash and resources, the banks may decide TXU and its other subsidiaries are worth more alive than dead and grant the company some breathing room," Levenson said.

"As the banks were already owed some $2.2 billion by the North American operations before Friday's drawdown, however, we're surprised the company had to take this extreme measure rather than negotiate an amendment or waiver."

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