Seung Chul Seo
Chris Sert Yeo
During the negotiation with KKR and TPG (“PE Firms”) on the proposed buyout of TXU, the most significant
opportunity for Environmental Defense Fund, NRDC and its constituents (“EDF”) is the setting of a precedent for
serious representation of environmental concerns in future large buyout transactions. A secondary motivation is the ability to substantially influence TXU’s corporate environmental policy and make a positive environmental impact.
EDF can potentially gain concessions from the PE Firms worth approximately $3.6 billion that would decrease global warming pollution, as represented by a reduction of total CO, Carbon, SO and NO emissions by an estimated 84.5 22x1million tons annually. To take advantage of this opportunity, EDF should negotiate a concession package that will include the following:
; Reduction in the number of proposed TXU coal-fired plants
; Investment in IGCC technology and/or carbon sequestration programs to reduce emissions
; Subsidization of demand management and consumer efficiency programs
; Commitment of TXU to explore alternative energy and carbon offset initiatives
; Creation of an independent audit committee to ensure increased consideration for environmental factors in
TXU’s business policies
In this memorandum, we estimate that the total economic value of EDF’s blessing of the deal to the PE Firms. Based
on this implied reservation price for the PE Firms, we propose a negotiation strategy that delineates and quantifies a minimum level of concessions, which if granted will give EDF a reasonable basis to lend its blessing to the deal. We conclude by recommending a specific negotiation strategy that will facilitate the achievement of EDF’s goals.
Despite our recommended strategy, there is always a potential risk that EDF’s reputation and credibility among fellow
environmental advocates and its public supporters may be compromised for negotiating concessions perceived as unsatisfactory or worse, considered “sell-out deals”. Also, we have made a number of estimates and assumptions,
based on which the proposed negotiation strategy may not be as effective as projected. However, we are reasonably confident based on our thorough analysis that EDF can successfully negotiate a set of environmental concessions that minimizes its reputational risk and achieves its goals.
Economic Value of EDF’s Blessing
EDF must first understand how its blessing creates economic value for the PE Firms at the deal stage and after the deal has been completed. At the deal stage, EDF can substantially facilitate and hasten regulatory approval of the deal, thus allowing the PE Firms to realize cash flows earlier. After the deal has been completed, EDF’s blessing facilitates obtaining the Texas Commission on Environmental Quality’s (“TCEQ”) approval for new plants, reduces legal and
lobbying costs, defers the compliance deadline of future regulatory emission requirements and reduces customer defections. The combined impact ranges from $2.8 to $4.4 billion, with an average value of approximately $3.6
billion, shown in Figure 1.
Figure 1 provides a detailed explanation of the cost drivers and the subsequent savings brought on by EDF’s presence:
1 83 million tons of CO, 1 million tons of SO, and 0.5 million tons of NObased on average emission rates for U.S. 22X
fossil-fuel electricity plants in 1999.
Figure 1: Economic Value of EDF’s Blessing
a) Facilitate The estimated value •Given the current enormous political and social pressure on global warming and regulatory environmental issues, all regulatory bodies will be hesitant to approve any deal ranges from $47 to approval of the that might have severe negative environmental impacts. $187 million, with an deal. •EDF can provide substantial proof that the PE Firms are genuinely interested in average of $96 million
enforcing stricter environmental standards on TXU and thus allow the deal to be for a 1-year faster
approved with greaterprobability and in a shorter period of time. approval process.
•A faster approval allows the PE Firms to realize TXU cash flows earlier. b) Facilitate •EDF has filed a lawsuit against TCEQ for a temporary or permanent injunction to The estimated
obtaining TCEQ require TCEQ to follow its own rules and authorizing statutes in its permitting incremental cash flow approval for process. ranges from $2.7 new plants.•The new plants are supposed to start coming online during summer 2009 and billion to $4 billion,
any delay in obtaining the permits will mean deferred cash flows for the PE with an average value
Firms. of $3.4 billion.
•Basedon stakeholder analysis, the probability of permit rejection is
approximately 75%, largely due to EDF. As a result, EDF can facilitate in obtaining
the key permits from TCEQ.
c) Reduce The potential savings •TXU currently faces environmentally related lawsuits due to its coal power plants:
outstanding and Two lawsuitsinclude CleanCOALition and Robertson County vs. TXU,and EDF from current and future lawsuits.lawsuit vs. TXU for the Sandow coal power plant. future settlements
•Besides these current lawsuits, it is very plausible that other lawsuits will take ranges from $44-$133
place in the near future based on the immense social opposition to the new million, with an
plants.These lawsuits will have to be borne by TPG and KKR as the new owners average of $89 million.
•Based on recent environmental lawsuit settlement values by major utilities, the
expected settlement value for EDF’s Sandow lawsuit could range from $25-$100
d) Reduce This reduction ranges •In the past 6 months, TXU is estimated to have spent between $3-$7 million in ongoing lobbying for the proposed new coal plants. from $2 to $6 million, lobbying costs. •This includes a team of 27 executives and 14 professional lobbyists, paid with an average of $3
between $1.4 million and $2.6 million, as well as substantial advertising costs. million for a 6 month
•Bringing EDF on board will substantially reduce future lobbying spend for TXU period.
and the PE Firms.
e)Defer The savings rangefrom •Given California’s recent ground breaking regulation to reduce carbon emissions compliance of $4-$19 million with by 25% by 2020, the prospects for similar state and/or federal regulations is future becoming more likely with time. average of$7 million regulatory •This reduction would be above and beyond the supposed “20% carbon reduction per year of deferment.emission levels” that TXU has been proclaiming.
requirements. •EDF can help to defer/delay the compliance deadline, which would require TXU
to reduce carbon emissions using advanced technologies like IGCC. f) Reduce •Given the widespread opposition against TXU’s proposed new coal power plants, The estimated value customer TXU can expect even more customer defections (above the 17% decrease in ranges from $25-$86
defections. retail sales volume in 2005 vs. 2004) to cleaner power providers. million, with an
•EDFcan bring environmental credibility to the PE Firms and reduce customer average of $43 million.
Figure 1: Economic Value of EDF’s Blessing (continued)
Facilitate DealFacilitateReduceReduceDeferReduceTOTALRegulatoryTCEQLawsuitsLobbyingComplianceCustomerApproval Approval forCostsDeadlineDefectionsNew Plants
aImproved deal completion period by .5 to 2 years range (with 1 as medium level) based on research on how long recent buyout deals have taken.
bImproved probabilityof approval by 70 to 80% (with 75% as medium level) based on stakeholder analysis of current permit approval issue.
cReducednumber of lawsuits by1 to 3 with 2 lawsuits as medium level) based on existing legal situation surrounding EDF and TXU.dReducedrequired lobbying period from.3 to 1 year (with .5 as medium level) based on analysisof lobbying situation.eDeferredemissions reduction from 10 to 30% for 1 year (with 20% as medium level) based on California’s recent regulation.fReducecustomer defections by 3 to 10% (with 5% as medium level) based on surveysof customer attitudetowards coal power and historic defection rates.
Discount rate of6% (TXU’s WACC)
Minimum Acceptable Level of Concessions
After determining its estimated economic value to the PE Firms, EDF must estimate a minimum level of concessions that will allow it to avoid stakeholder backlash and damage to its credibility from various activist groups.
Exhibit 1 in the appendix illustrates the concessions that appeal to the broadest range of stakeholders. Stakeholders have been divided into two groups: those who do not desire specific concessions but rather wish to see the deal go through with minimal controversy, and those who oppose the deal and demand specific concessions. Critical stakeholders to placate are denoted in red, and are those who have the most to gain or lose in the deal and who possess a significant level of influence. The dependency arrows indicate that placating the general public also results in placating the TCACC, Senate and House, etc., since these stakeholders are motivated to act primarily on behalf of public interest.
From our stakeholder analysis in Exhibit 1, we have determined the following environmental concessions to be
essential, which therefore make up the minimum acceptable level of concessions:
a) Scaling back of eight of the eleven new plants
b) Reducing emissions on new plants through IGCC technology and/or carbon sequestration
c) Funding of demand management programs
d) Commitment to alternative energy
e) Commitment to carbon offset programs
f) Creation of an independent audit committee comprised of key stakeholders, and a new leadership position
dedicated to maintaining dialogue on environmental concerns as a vital component of TXU’s corporate
policies. We recommend that this position be filled by ex-EPA chairman William Reilly, the current senior
advisor to TPG, given his strong environmental leadership track record.
The first three concessions are critical since they are common across all key stakeholders. EDF should avoid compromising on any of these concessions. The latter three concessions are included because they are common across the powerful environmental groups, who pose the greatest risk to criticizing EDF for approving a bad deal. Acquiring these concessions helps guarantee that EDF’s reputation would not be harmed, but in fact be enhanced from approving the deal. In addition, these concessions are relatively cheap in cost to implement and we are confident they can be negotiated into the terms with the right negotiation strategy, which is to be discussed later. Together, these six minimum concessions allow EDF to preserve its reputation while simultaneously achieving a significant positive environmental impact.
Note that although the analysis shows price protection as crucial to key stakeholders, we consider this policy as too risky for EDF to support in this negotiation, since it does not directly cause a positive effect on the environment. Therefore, other environmental groups may not be content with this concession.
Figure 2 summarizes the estimated economic costs for implementing each concession. The total estimated cost of the minimum concessions is $2.5 billion.
Figure 2: Economic Cost of Minimum Level of Concessions
aScaling back of 8 of the 11 new plants in Texas1,706
bCreation of program to retrofit and clean up TXU's existing plants in Texas to reduce emissions 548
to standards adopted in California in 2006, or other alternatives
cFunding of demand management programs (home insulation, Energy Star rebates, time-of-178
use metering, creation of fund based on profits to subsidize customers' efforts to conserve
dVerbal commitment to develop alternative energy programs, such as solar energy, wind 45
energy, or hydropower
eVerbal commitment to develop a carbon offset program22
fCreation of independent audit committee, and creation of new leadership position dedicated 2
to maintaining environmental stewardship.
TOTAL ECONOMIC COST OF MINIMUM LEVEL OF CONCESSIONS:2,501
aPV of future cash flows of 8 new coal plants in Texas, with an expected approval probability of 25%
bMixed used of advanced coal technologies like scrubber and IGCC to achieve 20% emissions reduction
c$200 million fund for customers spent over 3 years
d$50 million spent over 3 years
e$25 million spent over 3 years
f$500k per audit, $100k salary for postion for 3 years
Discount rate of 6%
To begin formulating a negotiation strategy, we create a planning summary, shown in Figure 3. This table identifies
crucial information for each negotiation party, including:
; BATNA: Best Alternative to a Negotiated Agreement
; Reservation Price: The lowest price at which a given party would be indifferent between accepting the
negotiated deal or walking away and resorting to its BATNA
; Target Price: The best-case scenario; the ideal outcome.
Figure 3: Negotiation Planning Summary
•Walk away from deal without providing blessing •Complete the deal without EDF and NRDC’s
and continue litigation to stop the 8 proposed blessing.BATNA
Reservation •Equal to the economic value of EDF’s blessing, •See Exhibit 2: Negotiation Packages.Priceestimated at $3.6 billion.
•EDF’s blessing of the deal at the lowest Target Price•See Exhibit 2: Negotiation Packages.possible economic costs.
•Support from multiple non-market groups, •PE firms are relatively shielded from public
including environmental activists, city leaders, protest and activist groups due to inherently low
business leaders, general public, and the media.profile in the media.
•Increasing trend towards emissions regulation.•Perception of controlling the negotiation process Sources of •EDF has existing litigation against 8 plants in as initiators of the buyout.Powerprogress.•Empowered the environmentalists to participate
•EDF perceived as most business friendly groups. in negotiation. Aware that this is a rare
PE Firms unlikely to receive blessing from other opportunity for environmentalist groups to
groups if EDF does not cooperate.redress grievances.
•Limited information available due to last minute •Anticipated negative image from owning a
invitation.publicly denounced firm.
•Represents a broad consortium of interests, and •Little known experience with environmental Weaknessestherefore is unlikely to fully satisfy all opposition of comparable proportions -
stakeholders. uncertainty about outcomes.
The planning summary reveals vital information that 1) EDF has a relatively strong BATNA, being in a position to walk
away from the deal and continue its litigation to stop eight of the eleven plants, while 2) PE Firms have a relatively low
BATNA, since they would not likely be able to create comparable economic value through other environmental groups if EDF chooses not to bless the deal.
We also know the following: from the previous section, we estimated the economic cost of the minimum concessions for the PE Firms to be $2.5 billion. Since the economic value of EDF’s blessing is estimated at $3.6 billion, there is significant
quantitative support that EDF possesses considerable negotiating leverage. This range of negotiation is shown in Figure 4.
Figure 4: Negotiation Bargaining Zone
EDF’s Reservation Point:
= Economic Cost of Minimum ConcessionsEDF’s Target Offer
~ $2.5 billion
PE Firms’ Reservation PointPE Firms’ Target Price
= Economic Value of EDF’s Blessing
Equipped with this information about the negotiation parties and the bargaining zone, we can formulate a set of effective
negotiating tactics. Figure 5 below details the proposed tactics. In summary, EDF can capitalize on its considerable negotiation leverage established by its higher relative BATNA and the calculated bargaining zone.
As the negotiation continues, EDF can present three Multiple Equivalent Simultaneous Offers (“MESOs”), which represent
viable compromise packages that fall within the bargaining zone. Exhibit 2 in the appendix shows the six main issue areas,
weighted by relative importance, and details the three potential MESOs that by definition all yield equal value to EDF. Based on our estimated probabilities of the PE Firms accepting each individual concession shown in Exhibit 2, we can be
fairly certain that the PE Firms will be willing to negotiate on at least one of the MESOs. In the unlikely chance that all MESOs are rejected, EDF can resort to negotiating towards its minimum level of concessions (its reservation price).
Figure 5: Negotiation Tactics
EDF can seize this opportunity to influence TXU’s corporate environmental policy and set a precedent for serious
representation of environmental concerns in future large buyout transactions. The total economic value of EDF’s blessing
of the deal to the PE Firms is approximately $3.6 billion. Through its negotiations with the PE Firms, EDF can gain environmental concessions from TXU worth up to 84.5 million tons annually in reduced emissions that would decrease global warming. EDF should conduct the negotiation knowing its quantified minimum level of concessions, which if granted will give EDF a reasonable basis to lend its blessing to the deal. By following the proposed negotiation strategy, EDF will maximize its chances of achieving its desired environmental concessions at the negotiating table.
Exhibit 1: Stakeholder Analysis and Concession Mapping
GROUPS OPPOSED TO CURRENT DEAL (WANT CONCESSIONS)
•Preserve own credibility•Fewer plants overall•Maximize positive environmental •Reduction of harmful emissions / impact“Cleaner” technologiesEDFHighHigh•Establish model for including •Demand management programsenvironmental concerns in large •Alternative energy / Carbon offsetsbuyouts•Audit committee / New leadership
•Energy efficiency in the home•Same as that of EDF, but esp. NRDCHighHigh•Reduce global warmingdemand management programs
•Same as that of EDF, but less RAN / Sierra ClubHighMedium•Overall protection of environmentcompromising
Other Activists•Same as that of EDF, but less HighLow•Overall protection of environment(CleanCOALition, etc.)compromising
•Fewer plants in proximity to towns•Clean air / Health concerns•Reduction of harmful emissions / General PublicHighHigh•Cost of electricity concerns“Cleaner” technologies•Lower prices / Price protection
Texas Clean •Fewer plants in proximity to townsAir Cities HighMedium•Meet the needs of constituents•Reduction of harmful emissions / Coalition“Cleaner” technologies
Senate / •Meet the needs of constituentsMediumHigh•Same as that of citizensHouse•Gain visibility when big issues arise
•Ensure adequate supply of energy•Lower prices / Price protection•Avoid price shocks and blackoutsPUCTMediumMedium•Demand management programs•Plants abide by Clean Air Interstate •Audit committeeRule and Clean Air Mercury Rule
•Support the common people in big CelebritiesMediumLow•Same as that of citizensissues
Various Industry •Create / maintain image of being a LowMedium•Same as that of citizensBusiness responsible businessLeaders
GROUPS IN FAVOR OF CURRENT DEAL (BUT WANT DEAL TO GO THROUGH WITHOUT CONTROVERSY)
•Maintain long-term profitsTXUHighHigh•None specific•Avoid future harmful legislationKKR / TPGHighHigh•Maximize value of buyout•None specific
•Sufficient electricity supply to meet State of Texas demand•None specificLowHigh(Governor’s Office)•Minimal controversy, do not want to get sued again
Financial companies •Minimal controversy, do not want to LowHigh•None specific(Funders)be targeted by activists
•Minimal controversy (harmful for industry image)Other Electricity HighMedium•Avoid future harmful regulations•None specificProviders•Maintain high electricity prices and profits
Exhibit 2: Negotiation Packages
New Coal-Fired 130%Plants
5%10030Elminate new coal-fired plants across nationEliminate the 11 new plants in Texas30%601818Scale back plan, stop 8 of the 11 new plants in 80%4513.513.5TexasReduction of 220%EmissionsEstablish company-wide agreement to reduce 5%1002020emissions by 20% from all plants from current
Retrofit existing plants in Texas to reduce 20%7014emissions by 20% from current levels by 2015Reduce harmful emissions in new plants by 20% through IGCC technology and/or carbon 90%3066sequestration.Demand Mgmt 315%ProgramsSets aside $500 million to fund progams40%7511.311.25Sets aside $300 million to fund progams65%456.756.75Sets aside $200 million to fund progams90%304.5Alternative Energy 410%ProgramsSets aside $200 million to fund progams25%4044Sets aside $100 million to fund progams60%202Verbal commitment to explore alternative energy 98%1011programsCarbon Offset 510%ProgramsSets aside $200 million to fund progams25%3033Sets aside $100 million to fund progams60%202Verbal commitment to develop a carbon offset 98%1011
615%Audit / LeadershipCreate an independent audit committee comprised of various key stakeholders.Also create a new leadership position dedicated 95%507.57.57.57.57.5to maintaining dialogue on environmental concerns as a vital component of TXU’s corporate policies.Total33.575.8505050Package Value