Chesapeake Energy (NYSE:CHK) could possibly spin off its oilfield services division, according to the company’s filings with the SEC.  Under the proposed plan, Chesapeake Oilfield Operating, L.L.C. (COO) would be converted into a separate publicly traded corporation and renamed Seventy Seven Energy Inc., with all its outstanding shares being distributed to Chesapeake’s existing shareholders on a pro-rata basis. While the company did not provide details of the number of shares that would be distributed, it has indicated that there are unlikely to be U.S. Federal tax implications for shareholders. We believe that the move could be positive to shareholders, since an independent oilfield services entity could see a better valuation and is likely to have better scope in ramping up sales to third parties. Below is a brief look at the company’s oilfield services division and how it could benefit from a spin-off.
We have a $26 price estimate for Chesapeake Energy, which is slightly above the current market price.
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Details of Chesapeake’s Oilfield Services Business
COO provides services to Chesapeake Energy, its working interest partners as well as some third-party exploration and production companies. During 2013, the business posted revenues of around $2.19 billion while operating profits stood at around $28 million. In comparison, Chesapeake’s total revenues for 2013 stood at around$17.5 billion. Services provided by the division include contract drilling, hydraulic fracturing, oilfield rentals, trucking and other operations. Drilling and fracking together account for over 75% of the division’s revenues. Chesapeake Oilfield Operating currently has around 71 active drilling rigs and 9 pressure pumping fleets with a total pumping capacity of about 360,000 horsepower.
Possible Impacts of A Spinoff
1) Possibility Of A Better Valuation: Oilfield services stocks have been finding favor with investors of late, driven by strong oil-direct drilling and offshore activity in the United States, as well as higher exploration and production overseas. The PHLX Oil Service Sector index, which tracks the performance of a broad group of oilfield services companies, is up by nearly 17% over the last year. While it maybe unfair to compare Chesapeake’s oilfield division with larger and more established companies, given that its services are limited to certain sectors of the U.S. land market, we believe that it could nevertheless see a better valuation as an independent entity. Spinning off the division could ease any valuation discounts that investors may be placing on it as a part of Chesapeake Energy. Chesapeake Energy’s stock has been weighed down by some corporate governance and liquidity related concerns over the last few years.
2) Higher Sales To Third Parties: As of 2013, COO derived just about 10% of its total revenues from third-party exploration and production companies. However, we think that this percentage could grow following a spinoff, as the business would have a more recognizable identity as an independent company rather than as a subsidiary of Chesapeake. Additionally, the new company is also likely to have more freedom in making operational as well as strategic and financing decisions that will benefit its business, without having to worry about Chesapeake’s interests. The new company could also benefit from its track record in developing wells for Chesapeake, which has been one of the most prolific unconventional drillers in the United States.
3) Reduces Chesapeake’s Debt Load: Over the last year, Chesapeake has been trying to cut down its debt load while closing its capital expenditure funding gap through assets sales and lower drilling spending. As of Q4 2013, the company had a total debt load of close to $13 billion.  If the oilfield services division were to be separated, the company would be able to offload close to $ 1 billion in debt.Notes: