REITs

Publication September 10, 2015

REITs take center stage in two plans to emerge from bankruptcy.

A consortium led by the Hunt family said in August that it has reached agreement to acquire Oncor, the electric transmission and distribution company that owns 119,000 miles of power lines and serves three million customers in north and west Texas.

The Hunt consortium will acquire Energy Future Holdings, the bankrupt parent of 80% of Oncor. EFH, which also owns a separate generating subsidiary, is essentially being split in two. The generating subsidiary will be spun off tax free to a group of first-lien creditors of the generating subsidiary in satisfaction of $25 billion in debt. Secured creditors of the transmission business, who are owed another $10 billion, will be repaid in cash. The Hunt consortium will raise about $12.5 billion in new money that will be used in part to pay the creditors who are receiving cash.

Energy Future Holdings, a Dallas, Texas-based utility formerly known as TXU, filed for bankruptcy last April. The company was acquired in 2007 by two private equity groups, KKR and TPG, in a record-setting leveraged buyout. The debt burden proved too much. The Hunts offered $10.5 billion for Oncor in 2006.

The Hunt consortium will turn EFH into a real estate investment trust, or REIT, to own the transmission and distribution lines. REITs are not subject to corporate income taxes provided they distribute all their earnings to shareholders. The REIT will be owned by the consortium members, who are unsecured creditors of Oncor, and be managed by Hunt. Hunt will form a separate operating company to which it will transfer all the Oncor employees and the Oncor name. The Hunt family will own the operating company. The REIT will lease the T&D assets to the operating company, which will use them to supply electricity to Oncor customers and pay a share of the revenue to the REIT as rent for use of the assets.

The transaction will require a number of government approvals, including from the Public Utility Commission of Texas. The commission approved the Hunt family’s acquisition of Sharyland Utilities, a relatively small electric utility in south and central Texas, in 2008. The Sharyland assets are also held through a REIT.

Moody’s Investors Service warned that the acquisition may lead to arguments over the proper tax component that Oncor is allowed to pass through to customers in electricity rates. Ratepayer groups are starting to line up for rate cuts.

The Hunts launched a separate REIT called InfraREIT as a vehicle to build a power-line business across Texas, New Mexico and Arizona.

In another use of a REIT to escape from bankruptcy, Caesar’s Entertainment said in late August that it has agreement from the most senior creditors of a bankrupt subsidiary, Caesar’s Entertainment Operating Co., to spin off the subsidiary’s real estate assets into a new real estate investment trust that would be owned by the subsidiary’s creditors and then lease them back to the subsidiary. The move is expected to reduce the subsidiary’s debt by about $10 billion out of $11.7 billion in total and allow it to emerge from bankruptcy. Use of a REIT enlarges the value available to creditors since the REIT will eliminate corporate-level income taxes. The subsidiary filed for bankruptcy on January 15.

The company said it will rely on a “should” opinion from outside counsel that the spinoff will not trigger income taxes on the real estate assets. The IRS has a hold on rulings about tax-free spinoffs where passive assets with only a relatively small amount of active business are spun off together. The agency put the issue on its latest business plan, or a list of issues it hopes to tackle by the end of June next year.

There is only one casino REIT trading currently – Gaming and Leisure Properties Inc. – that Penn National Gaming spun into a REIT in 2013. The shares peaked at $46.80 a share in November 2013 and were trading as the NewsWire went to press at $31.37 a share.

Pinnacle Entertainment, another gaming company, said in July that it hopes to complete a spin off into a REIT in the second quarter 2016.


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