When the biggest leveraged buyout in history closed in October 2007, the new owners, creditors and customers of Dallas-based electric utility and power producer Energy Future Holdings Corp., the former TXU Corp., all had cause to celebrate. The buyout's sponsors, Kohlberg Kravis Roberts & Co., TPG Capital and Goldman Sachs Capital Partners, had the wind at their backs. For some years the soaring price of natural gas, a key determinant of electric rates, had turbocharged profits at TXU, which also benefited from low production costs at its coal-fired generating plants. "The price spread between gas and coal was wide, and TXU was making supernormal profits," says a former TXU adviser. What's more, with market conditions looking up, the spread seemed poised to widen, and EFH and its backers prophesied that Ebitda would swing from $4.7 billion to $5.8 billion by 2010.

So confident were lenders in EFH's prospects -- a feeling that the steady-Eddie cash flow of EFH's regulated electric transmission subsidiary, Oncor Electric Delivery Co. LLC, reinforced -- that the company's banks succeeded in rounding up buyers for much of the $31.5 billion LBO debt package in late 2007, when the leveraged finance market was in its death throes. Even consumer advocates and politicians who had blasted TXU for gaming the market and profiteering on the backs of rate payers cooed in approval when the incoming owners volunteered to lower many retail bills by 15% for a year and to provide cost breaks to poorer customers. KKR, TPG and Goldman made nice to environmentalists by slashing the number of new coal-fired plants EFH would build to three, from 11, and vowing to double EFH's purchases of wind power. The closing was a kumbaya moment.

"EFH's capital structure is untenable" and must be deleveraged, Moody's Investors Service senior vice president Jim Hempstead proclaimed in a report last month. Either that, or the energy market will have to rebound with enough vigor to restore the status quo of 2007. Says a trader at one of EFH's largest senior creditors: "Given how volatile [the price of] natural gas is, they've got to hope that commodity bails them out" before the debt falls due. If EFH faced having to refinance $22 billion of debt just now, he notes, it could not afford the richer interest rates the market would exact to compensate for the risk.

Not standing pat and awaiting a deus ex machina-style rescue, EFH has taken steps, albeit halting and modest ones, to prune debt. An exchange it offered bondholders in October to trade in $4.5 billion of unsecured, holding-company bonds for $3 billion of 10-year bonds partly secured by liens on Oncor, the regulated utility, largely flopped when just $358 million in bonds were tendered. If gas prices fail to climb, more radical measures may be called for, including, some speculate, the sale of Oncor.

EFH's predicament, of course, is hardly unique. A slew of huge companies emerged from the 2005-'07 LBO binge freighted with buyout debt, which their sponsors have striven to slash to stave off default. Some confront tighter debt schedules and are in more perilous straits than EFH, which still has three years of lead time to trim debt, extend maturities and derisk its balance sheet.

Even so, time could be as much EFH's enemy as its ally if it dawdles or its efforts to delever falter, as happened recently with its exchange offer. The company is a time bomb with a long fuse, and as the fuse shortens, EFH's options narrow, the 2014 deadline to refinance or retire half its debt approaches and the death watch begins. The mad scramble to avert bankruptcy and the battles between EFH's creditors and owners over financial concessions have the makings of a life-and-death drama that could transfix Wall Street and the citizenry of Texas for months on end. The unique magnitude of EFH's debt load, spread, as it is, among subsidiaries with distinct profit profiles and creditor groups, could yield fascinating side skirmishes and subplots.

In the end, EFH's financial fate may turn on whether KKR, TPG and Goldman tap their own treasuries for the equity to purge a significant amount of the debt. Big-scale equity cures have a high failure rate in the realm of LBOs, and sponsors are notably loath to throw good money after bad. Indeed, only a handful of now-wobbly megadeals completed during the mid-decade buyout boom have subsequently been propped up with additional equity from their sponsors. In some cases, though -- most famously in 1990, when KKR doubled down its investment in RJR Nabisco, whose $31.3 billion LBO in 1989 set an earlier, long-standing size record -- sponsor bailouts have done the trick.

With EFH, an extended dip in power rates and a failure to restructure debt by other means would put it in the kind of bind RJR was in when KKR helped save it. Well before things reach that point, EFH's sponsors and creditors will square off in efforts to erase debt bit by bit while pressing the other side to give up more in value.

For the sponsors the stakes are colossal. The buyout group plowed $8.3 billion in equity into the deal and are fighting to salvage their wager. By KKR's latest accounting, the investment is 50% under water. The debt market thinks otherwise: With EFH's midlevel and junior bonds trading at steep discounts to par, junk-bond speculators put the equity's value at zilch.

No ingredient of the EFH drama promises to be more riveting than KKR, TPG and Goldman's maneuverings to dodge catastrophe, preserve their stakes and, in the best case, squeeze out a profit.

For all its many threads, EFH's plight is easy to explain. It's a fundamentally healthy company with a bad balance sheet. Subtract the LBO debt, says Moody's Hempstead, and the ratings agency's overall credit rating for it might be investment-grade rather than Caa1, among the lowest.

The $48 billion LBO was financed with $31.5 billion of new debt, about $8 billion of rolled-over debt and the $8.3 billion equity slug. Until 2002, Texas Electric Utilities, as TXU was known, had been a vertically integrated, regulated electricity provider serving over 2 million customers in greater Dallas and North Texas. But that year Texas deregulated power sales, and TXU was unbundled into a transmission and distribution unit, which remains regulated, Oncor Electric Delivery, and a nonregulated power generation and sales business, Texas Competitive Electric Holdings Co. LLC. Part of TCEH is Luminant Generation Co. LLC, a subsidiary that owns EFHs' 19 coal-, natural gas- and nuclear-powered generating plants. The sponsors parceled out the debt to match the operations' cash flows and, in the case of Oncor, to satisfy Texas regulators.

Oncor, the core utility, remained lightly leveraged, its debt rising from $3.8 billion before the LBO to $5.2 billion. This was a modest 4.3 times its Ebitda. Moreover, Oncor was "ring-fenced," or shielded by covenants and other barriers, from TCEH and its often volatile earnings patterns. TCEH, meanwhile, EFH's chief money engine, was laden with $28.6 billion of loans and bonds, including the $22 billion of bank debt that expires in 2014. With $3.7 billion in Ebitda, TCEH could handle the load. Yet the unit's debt-to-Ebitda was lofty, at 7.7, as was the nearly 10 times 2007 Ebitda the sponsors paid for the company.

A final, $6.6 billion pile of bonds was housed atop the structure in the holding company. Because the holding company, which served as a vessel for the sponsors' equity and the bonds, generated no cash, a mechanism was devised to upstream dividends from Oncor and TCEH so it could meet its interest payments, and it was given the ability to tap hundreds of millions of additional dollars from TCEH via intercompany loans.

Though crammed with obligations, the structure would have stood strong if only the economy and the commodities markets had chugged merrily along. In February 2007, when the buyout deal was struck, the spot price for natural gas was about $8 per million Btu, and by mid-2008 it had climbed to around $13. Going into the deal, KKR, TPG and Goldman were counting on customer growth, the additional output from the three new coal-fired plants and operational improvements to juice profits further. The richer cash flows would enable EFH to pay down at least $3 billion of debt within five years, setting the stage for an initial public offering. Refinancing the leftover debt wouldn't be a problem, assuming the capital markets stayed awash in liquidity.

The pillars of that plan have since crumbled. Only the cranking up of the new coal plants, which are expected to lift cash flow by $400 million to $500 million a year, and EFH's reversing the erosion of its customer base have followed the script.

But natural gas has plummeted to $4.60, and some experts think that a surge in supply from new discoveries and shale gas make it unlikely the price will hit $10, even if the economy revs back up. EFH's Ebitda has fallen by $826 million, or 15%, since 2006, when it topped $5.6 billion. After interest costs, according to Moody's, TCEH posted only $1.5 billion on cash flow from operations last year -- not enough to fund its capital expenses.

For now, EFH is keeping current on its debt, notwithstanding its meager interest coverage ratios. It has more than $5 billion in cash and unused credit lines, and its natural-gas hedging program has worked wonders by offsetting much, if not all, of the impact of gas price declines on TCEH. One-fifth of the unit's $2.76 billion Ebitda in the first nine months of 2009 resulted from hedges that EFH unwound. As of Sept. 30, EFH was sitting on an additional $1.4 billion of unrealized hedging gains.

Unfortunately, the underpinnings of this imperfect but tolerable status quo will give way: In December 2012, an unlimited credit facility for EFH's hedging program runs out; failing to renew it would crimp EFH's efforts to hedge and leave it more exposed to vicissitudes of the market. In 2013, EFH's cash interest costs will soar because several billions of pay-in-kind toggle bonds, whose principal value has grown as EFH, in order to conserve cash, has paid the interest with additional bonds, will turn cash-pay. That same year, TCEH's $2.7 billion senior secured revolving credit facility will expire. And in 2014, TCEH's $22 billion of bank loans fall due.

Bing-bing-bing-BANG. Unless EFH takes a big bite out of its debt and unless pricing and the Texas economy improve, the company's world will unravel. That prospect has observers mulling in extremis possibilities such as the sale of EFH's 80% interest in Oncor, which Hempstead reckons could fetch from $6 billion to $14 billion, netting EFH $3 billion to $9 billion in cash. Even the seizure of EFH's assets is conceivable, he says, "if the situation becomes dire enough."

Meanwhile, one of the men seeking a way out of this predicament, EFH executive vice president and chief financial officer Paul Keglevic, argues that it's far too soon to panic. Without going into specifics, he concedes that EFH's balance sheet needs considerable work. At the same time, though, he says there are strong signals that gas prices will firm -- 2013 gas is selling at around $7 -- and argues that EFH has enough time to find solutions.

Much will depend on "what power prices are" in 2013 and 2014, he says. "It's not just about the absolute amount of debt outstanding; it's about what my Ebitda looks like at that point and what the future looks like from that date forward. The market is pretty good about refinancing if it sees an upward trend line and expects that in two or three years, because of demand-and-supply margins tightening or inflation kicking in, power prices will rise."

For now, EFH, Keglevic says, will focus on "taking advantage of this down market" by trying to buy back, or swap out of, EFH's junior debt at the fire-sale prices at which it now trades.

"We're highly hedged for the next few years. With no pressing maturities until 2013 and 2014, we have time. It's going to take us a few years to work it out, and the good news is we've got a few years to make it work."