Welcome to the twenty-ninth Pari Passu newsletter,

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Today, we will learn more about:

1. Talen Energy Restructuring

2. David Einhorn - Cambridge Union Interview

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Talen Energy Restructuring

Talen Energy Corporation is a power generation company owned by Riverstone Holdings LLC, a private equity firm focused on the energy and utility space. In 2022, Talen filed for bankruptcy due to a liquidity crisis. The liquidity crunch faced by Talen Energy was primarily caused by the surge in natural gas prices in 2021. Talen hedged against commodities risk through derivatives contracts, but the Company was forced to put up $451mm of cash as collateral to maintain the contracts. This compounded the effects of Winter Storm Uri, which caused a $78mm loss for the Company. To help carry itself through the downturn, Talen Energy secured a rescue loan of $848mm from GoldenTree Asset Management and Silver Point, but reduced energy demand coupled with higher input prices caused by Russia’s invasion of Ukraine made it difficult for the Company to survive. Thus, on May 29, 2022, Talen filed for Chapter 11 bankruptcy. Talen was represented by our friends at Evercore.

Utilities Hedging

One of the key reasons driving Talen’s bankruptcy was the Company’s failure to properly hedge against rising input prices. Power generators will typically make money from the spread between power prices (what they sell their energy at) and input prices (typically natural gas, which is what they used to produce energy). To ensure stable and recurring revenue, power generators will enter contracts to purchase and/or sell power and inputs at set prices through futures contracts. Talen, however, did not hedge against rising natural gas prices – thus, when prices spiked, Talen was forced to eat the difference, which significantly cut into the Company’s bottom line. The Company tried to enter contracts ex post facto, but due to the Company’s risky debt profile, counterparties demanded a large amount of cash collateral ($451mm), reducing Talen’s liquidity. In theory, higher gas prices would lead to higher revenue and make the company more profitable, but the rising price causes an immediate need to put up capital.

Talen RSA

Prior to the bankruptcy, Talen entered into negotiations with some of its creditors to create a restructuring support agreement (RSA). An RSA is a legally binding contract between a company and its creditors, typically entered into during a financial crisis. The purpose of an RSA is to expedite the restructuring process (or in some cases, avoid it and go out-of-court entirely) by coming to an agreement with key creditors early. In Talen’s RSA, ~62% of unsecured bondholders came to an agreement on a few things: first, all DIP facilities would be paid 100% in cash, and all secured claims would be a) paid in cash or b) have the option to roll those claims into newer exit debt. Talen’s existing $848mm financing from GoldenTree and Silver Point would be refinanced, while Municipal Bonds and Union/Pension Contracts would remain unimpaired. Existing equity holders would have their shares completely canceled. Unsecured noteholders would receive a pro rate share of new equity, as well as an opportunity to participate in Talen’s equity rights offering. An equity rights offering (ERO) is when shares are offered only to a company’s existing shareholders. Additionally, unsecured noteholders would also get a chance to invest in Cumulus, a ~$175mm data-center focused subsidiary of Talen.

Talen ERO

Talen’s RSA also included provisions for a $1.65bn equity rights offering. Essentially, Talen would offer $1.3bn in new equity, which certain parties (“backstop parties”) would agree to buy if no one else did, in exchange for a 20% fee. The proceeds from the ERO would be used to pay off secured claims and the aforementioned exit financing. Talen ended up updating the ERO on May 31st, 2022, with amendments that increased the upper limit of the ERO to up to $1.9bn, which includes an increase in the backstop parties commitment from $1.30bn to $1.55bn.

Talen/PPL lawsuit

One thing that made the ERO appealing was the opportunity for a large, one-time settlement as a result of Talen’s lawsuit against its former parent company, PPL.

In 2014, before Talen was acquired by Riverstone, it operated as a subsidiary of PPL Corporation, a Pennsylvania-based utility company. According to Talen, the cash proceeds from a ~$900mm sale of its hydroelectric assets were improperly distributed to PPL. While Talen originally filed a lawsuit against its former parent in 2018, they brought the case back up during their bankruptcy proceedings. According to Talen, the fraudulent transfers left the Company in "dire condition" financially, unable to generate "adequate future income or assets to pay its liabilities," effectively implying that PPL had caused the bankruptcy. If Talen were to win the lawsuit, ~$700mm could be distributed through shareholders as a special dividend. Remember, post-reorganization equity holders would just be the holders of unsecured claims, so it represented a substantial potential payday. Currently, there’s been no verdict, but according to PPL’s Q1 2023 earnings call, “the case is expected to be resolved...by the end of the year”.

Talen Exit Financing

Another unique part of the Talen case was the magnitude of exit financing the Company received. The DIP package consists of a ~$1bn term loan, a ~$300mm revolver, and a $457.90mm letter of credit facility. The size of Talen’s exit financing is the largest since June 2020, when Chesapeake Energy filed with $1.85bn of DIP financing total. The DIP package is also the second largest ever of Chapter 11 cases that fall under the utility sector, with the largest falling to PG&E’s $5.50bn DIP package. The package was financed at SOFR + 475 bps, which was also significantly below the median and mean interest rates for DIP financing in the utilities sector. The interest rate on Talen’s DIP facilities is also below the market mean and median for large (>$1bn) DIP financing packages. Talen was able to obtain such an attractive exit financing package for two main reasons: a) Talen pledged $4.50 - $4.75bn of assets as collateral, ~2.5x the loan value, and b) the facility was structurally sound thanks to guarantees provided by subsidiary debtors, covenants specifying minimum liquidity and maximum hedging exposures, and the requirement for Talen to provide regular cash flow forecasts and variance reports.

Finalized Plan Summary

Under the final plan, many of Talen’s debt holders received full recoveries. The main impaired classes were Unsecured Noteholders, who received nearly all of Talen’s new equity, along with access to a special equity rights offering, resulting in a ~23-46% recovery. General Unsecured Claimholders gained access to a pro-rata share of a “GUC Trust”, which consists of ~26mm in cash and 10% of the net proceeds from any potential settlement, which resulted in ~63% recovery. Talen’s final plan also included a special provision for holders of “Uri Claims”, which are claims made by insurance providers related to damages caused by Winter Storm Uri. Talen would not be liable for any claims under the plan, but claimants can pursue recoveries under separate proceedings. Essentially, the plan says that any insurance companies seeking payments as a result of Winter Storm Uri must settle those claims separately -- the Plan of Reorganization won’t cover them. Talen funded its plan through ~$3bn in total exit financing, including a $1.20bn senior secured notes offering.

Summary + Future

In summary, Talen Energy Corporation, a power generation company owned by a private equity fund, filed for bankruptcy in 2022 due to a liquidity crisis caused by rising natural gas prices and the impact of Winter Storm Uri. To expedite the bankruptcy, Talen entered into a restructuring support agreement (RSA) with its creditors, where secured claims would be paid in cash or rolled into newer exit debt, existing equity holders would have their shares canceled, and unsecured noteholders would receive a pro-rata share of new equity and the opportunity to invest in a subsidiary called Cumulus. As part of the restructuring, Talen planned to raise $1.65bn through an equity rights offering (ERO), with the option for certain parties to buy the new equity if no one else did. The proceeds from the ERO would be used to pay off secured claims and refinance existing financing. Talen also had a lawsuit against its former parent company, PPL, seeking a settlement that could potentially distribute $700mm as a special dividend to shareholders. Under the final plan, most secured holders received full recoveries, while unsecured noteholders obtained new equity and access to an equity rights offering. General unsecured claimholders gained access to a trust with cash and a share of potential settlement proceeds. Insurance claims related to Winter Storm Uri would be handled separately. Talen funded its plan through $3bn in total exit financing, including a $1.2bn senior secured notes offering. The plan was approved, and Talen exited bankruptcy on May 17, 2023. The Company seems to view its Cumulus segment as a substantial driver of growth and aims to divest its coal operations to become a more carbon-neutral energy provider. The Company continues to invest in renewable solutions and installed a new CEO following its exit from bankruptcy. The plan reduced Talen’s debt load by $2.70bn, and improved liquidity by ~$875mm, enabling the Company to continue its expansion into the data center and renewable energy spaces.

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David Einhorn - Cambridge Interview

We talked about David Einhorn in a previous edition of Pari Passu, I am a big fan of him and I am glad today we are learning from him again. Over this last week, I had the chance to watch David’s interview at the Cambridge Union. You can find my summary below my notes that can make us better investors.

David started his career as an investment banking analyst at Donaldson, Lufkin & Jenrette (DLJ), and he spent the rest of his career in finance. Five years after graduation, David went on his own and founded Greenlight Capital with $900,000. While this decision might seem risky, he did not see things that way: he was married, with no kids, and his wife had a job. They were living a low-expense life and the true risks (poverty, hunger, health) were luckily already out of the picture. He was not overly confident that he would succeed, but he felt he understood what he could control, and it was a risk worth taking.

Investment Strategy: Apple is the most profitable investment for Greenlight Capital, the difference was that they owned the stock when everyone was hating it. Apple had just released the iPhone, and everyone believe other competitors could replicate the product and the stock would collapse like Blackberry did. They bought Apple at 6-8 P/E, growing at 30%. People thought this was a temporary growth while David believed they could transition to a service company. Apple is still a great company but now it is trading at 30x earnings growing much less, therefore it is a different proposition. The time to sell was when everyone understood Apple and his differentiated view was not there anymore. David summarizes his job as finding misunderstood companies which price is wrong by a wide margin.

Greenlight peaked at $8 billion AUM in 2015 and went down to around $1.5 billion in 2020. David sees capital allocation as a commercial agreement. He always tried to keep his calm throughout redemptions (when investors withdrew money from his investment firm). His approach was not to tailor his investment process to his investors, if investors did not like his process, that was ok. Talking about the source of capital, David explained how permanent capital is not really needed for Greenlight’s strategy. All the holdings are public, and as long as you control liquidity and redemptions, you do not really need permanent capital.

Career advice: David does not blindly believe investment management is a great career for everyone. You need to figure out what are your strengths, and what career is the best fit for you. Be self-aware, and find a niche where you can distinguish yourself. Over 27 years, he learned that you are not as smart as it seems when things are going right, and you are not as dumb as it seems when things are going poorly.

Generosity: David quickly realized that being generous has importance in his life given he made more money than he needed to live. The argument that I will donate money later in life so that I can let it compound until I donate is flawed for two key reasons: 1) problems are urgent now, delaying the intervention can make it significantly harder to solve them 2) your compounding rate is not certain.

Value investing: defined by David as analyzing companies trying to understand how much they are worth and buying them for lower prices. Today, so much of the money is invested in strategies that do not consider valuation. Index funds assume the value is already correct and buy most of the most overvalued securities. Quantitative strategies do not analyze the fundamentals of a company as well. The amount of money that has come out of investment firms that look at the underlying value is tremendous, as a consequence, the research team of these firms has been cut and therefore the number of people engaging in these strategies has also decreased significantly. David believes that the bloodbath that has characterized active managers creates opportunities for funds who survived this period.

Years ago, David’s core strategy was to try to understand what big institutions would buy in 3/6 months. Greenlight could try to understand which stocks were likely to be long-only funds’ new positions and buy them before the big funds did. Today, those institutions are not there anymore or if they are, they are not deploying capital as they used to.

The old process was something along the line of: this is an ok company which we can buy at 10x earnings, earnings will be 15% better than people think and once the earnings beat happens, the company will trade up to 14x earnings, you make 60% over 18/24 months. Today, even assuming earnings go 15% higher, but the multiple has not expanded (if not contracted) since so few people are actually paying attention to value.

In part of the market, you can buy reasonable enterprises for around 4x earnings. You are compensated for not knowing who the next buyer is going to be by paying roughly 30 to 50% of what you used to pay. Besides creating a theoretical margin of safety, this also creates a second opportunity: if the investors do not figure it out, the company can do it for you. If you buy a company with no debt for 4x earnings, you are getting a 25% earnings yield. If the company takes that 25% and buys back its stock, a quarter of the share goes away. Even if the stock does not move, the company can do it again and again until it is a number exercise at which the stock has to go up. In these situations, earnings are not important: even if earnings drop, your return will be fine as worst case it will take the company a bit longer to buy back stocks.

Finally, David talks about his recent pitch called “Free Peanut Butter” (you can find it here, the date is May 9, 2023). The funny name comes from thinking about the old business (low growth and profitable) as chocolate, and the electric business (very high growth and money-losing) as peanut butter. You can put them together and make Reese’s peanut butter cup. The presentation has yet to move the stock, but we can all learn about how David analyzed these two businesses to arrive at an investment decision.

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