Investors Wary Of Chesapeake As Finances Deteriorate
Chesapeake Energy (NYSE:CHK) had viewed asset sales as its financial savior in this tumultuous time for the company as its core natural gas business performed dismally on account of falling prices. However the company recently disclosed that it will have to delay selling certain assets in order to avoid violating debt covenants.
As it stands, Chesapeake will fail to meet its previously promised 25/25 plan to reduce debt by 25% to $9.5B and also increase production by 25% by the end of year. On top of that, the company is facing tremendous criticism over the fast few weeks due to its management issues. CEO Aubrey McClendon was removed as Chairman due to issues related to his Founder Well Participation Program, and it was later revealed that he ran a hedge fund within the company. (See Chesapeake Searches For New Chairman, Scraps Founder Well Participation Program and Chesapeake CEO Found Running In-House Hedge Fund) Compared to competitors such as Linn Energy (NASDAQ:LINE) and Exxon Mobil (NYSE:XOM), the company has performed poorly owing to its largely undiversified business model.
We are in the process of revising our price estimate for the company’s stock in order to incorporate the asset sale delays as well as the current pricing environment. Additionally we will likely reflect the stock’s volatility by increasing our cost of capital for the firm.
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Additional debt to keep company afloat until divestitures
Chesapeake has taken a $4 billion loan from Jefferies and Goldman Sachs which has an initial interest rate of 8.5 percent, more than twice the rate of the loan it partially replaces. [1] [2] While the loan’s maturity is December 2017, it is really a short-term loan as the interest rate will increase if it is not repaid by the end of this year. This loan was taken to mitigate the delay of one or more of its currently planned asset monetizations in order to maintain compliance with some of its debt covenants. The company already has a staggering $13 billion debt load and the situation does not appear to be getting any better.
Asset sales delayed
Chesapeake’s announcement that it will delay some of its planned asset sales in order to remain compliant with debt covenants [3] was worrisome to investors, as the company’s operations are burning cash and it was banking of asset sales in order to bolster its liquidity.
Under its divestment plans, the company is going to sell many of its liquid-rich assets in the Permian basin, which provides 30% of the company’s total liquids production. [4] Chesapeake has recently shifted its focus towards liquid plays instead of dry gas plays in order to diversify and take advantage of current market dynamics. While asset sales would improve liquidity, sales of natural gas and oil assets would adversely affect the company’s operating cash flow and would also reduce the value of its collateral underlying its secured debt.
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Notes:- Chesapeake wins breathing space with $3 billion loan, reuters.com, May 11, 2012 [↩]
- Chesapeake Energy Increases Loan Sale to $4 Billion, wsj.com, May 15, 2012 [↩]
- Chesapeake May Delay Asset Sales on Loan Agreements, bloomberg.com, May 12, 2012 [↩]
- Where Will Chesapeake Energy’s Cash Come From?, seekingalpha.com, May 14, 2012 [↩]