Chesapeake Turns to Jefferies’ Eads in $28 Billion Deals: Energy

When Chesapeake Energy Corp. (CHK) Chief Executive Officer Aubrey McClendon went on an oil and natural gas buying spree, Ralph Eads was the banker who found the money to fund it.

The vice chairman at Jefferies Group Inc. (JEF) and former fraternity brother of McClendon helped his firm win work advising Oklahoma City-based Chesapeake on more than $28 billion of transactions since 2007. He assisted Chesapeake in asset sales to raise cash the company then plowed back into locking up new prospects across the U.S., what Chesapeake often calls a “land grab.”

McClendon is depending now on his Jefferies confidant at an even more crucial moment. Falling gas prices, combined with the buying binge, is forcing Chesapeake to unload assets to keep the company afloat. Along with Goldman Sachs Group Inc. (GS), Jefferies bankers are seeking buyers for oil-rich prospects and lending Chesapeake $4 billion in the meantime.

“Without Wall Street, Chesapeake wouldn’t be able to do what it has done,” said Phil Weiss, an analyst at Argus Research in New York who rates the shares “sell.”

Eads and New York-based Jefferies declined to comment.

“Ralph Eads and Jefferies have unmatched expertise in the E&P business and have added enormous value to Chesapeake’s business and its shareholders over many years,” Chesapeake said in a statement, referring to the exploration and production industry. “We deeply value our long-term relationship.”

Cash-Flow Shortfall

Fitch Ratings estimates the company’s cash-flow shortfall may reach $10 billion this year. The stock has dropped 36 percent this year and McClendon said this week that Carl Icahn, the activist investor, may be buying shares. Chesapeake rose 6 percent to $14.36 at the close in New York.

The Chesapeake board said last month it will strip McClendon of his chairmanship after revelations about his personal borrowings prompted it to investigate any overlap between his lenders and the company’s.

Eads and McClendon, both 52, have known each other since at least the early 1980s, when they were Sigma Alpha Epsilon fraternity brothers together at Duke University. McClendon entered the oil and gas business and eventually founded Chesapeake in 1989. Eads went to Wall Street, making stops at Merrill Lynch & Co., Lehman Brothers Holdings Inc., S.G. Warburg & Co. and Donaldson, Lufkin & Jenrette.

In 1999, Eads joined banking client El Paso Corp., helping the pipeline company ramp up its merchant energy business to compete with Enron Corp. of Houston.

Off-Balance-Sheet Debt

Under Eads, who was an executive vice president in charge of the merchant energy unit, El Paso created off-balance-sheet partnerships of a similar type to what Enron was using.

El Paso’s merchant energy business was shut down three years later, after Enron’s collapse in an accounting fraud led to regulatory investigations and increased scrutiny from credit- rating companies and investors. The El Paso unit had a loss before interest and tax of more than $1.6 billion in 2002.

Some former El Paso energy traders later pleaded guilty in a government investigation of market manipulation. Eads wasn’t accused of any wrongdoing.

Eads returned to the banking business the next year, joining Randall & Dewey Inc., a Houston-based energy banking boutique that was acquired by Jefferies in 2005.

By then, Chesapeake was preparing for an aggressive acquisition program across the country, buying up oil and gas acreage in emerging prospects. Many of the targets were in areas where gas was trapped in shale rocks, formations that were just beginning to be open to development because of advances in technology, including the use of hydraulic fracturing and horizontal drilling.

Work With Aubrey

Eads and Jefferies advised Chesapeake on the deals that would help them pay for it: selling future production in the form of “volumetric production payments,” and creating joint ventures with deep-pocketed partners to fund the cost of drilling wells.

The work was particularly profitable for Jefferies, which took the joint-venture model used at Chesapeake and sold it to companies across the energy industry. A wave of the ventures followed, as oil majors and national oil companies sought to get in on the U.S. shale boom.

Jefferies played a role in almost all of those transactions, helping the firm jump to the top ranks of merger advisers in the energy industry through deals like Encana Corp.’s $1.45 billion partnership with Mitsubishi Corp., established this year, in a gas field in Canada.

Chesapeake Chief Financial Officer Domenic Dell’Osso joined after serving as an investment banker with Jefferies for two years, according to the company’s website.

League Table Success

The New York investment bank was the fifth-biggest adviser on oil and gas exploration and production transactions in North America last year, compared with 16th place in 2005, the year it acquired Eads’ firm, according to data compiled by Bloomberg. Of the 19 deals where Jefferies had a role in 2011, only four involved Chesapeake, the data show.

Jefferies has even helped advise McClendon on two volumetric production payment transactions for his personal stakes in Chesapeake wells, according to court documents. Those 2008 transactions raised $132 million.

As Jefferies’ business expanded in 2010, Eads, a Houston resident, bought an $8.2 million home in Aspen, Colorado, according to land records. He’s also a big donor to Duke University in Durham, North Carolina.

Along with his friend McClendon, Eads jointly owns a vineyard in France, according to Forbes magazine. And they sit together on the board of the American Clean Skies Foundation, a group that Chesapeake helped found that advocates for gas use.

Permian Assets

For the $4 billion loan, Jefferies and Goldman Sachs are charging Chesapeake 8.5 percent, a rate that increases to 11.5 percent if it isn’t repaid within a year.

Chesapeake and its advisers at Jefferies and Goldman Sachs are in talks with potential buyers for acreage in the Permian Basin, an oil-rich prospect in Texas and New Mexico. The company is also exploring a joint venture for another field in Kansas and Oklahoma known as the Mississippi Lime. McClendon said in a March interview that the Permian assets alone could fetch $5 billion.

Michael Kelly, an analyst at Global Hunter Securities LLC, estimates that they may fetch $6.8 billion, considering the valuation that a similar parcel of acreage in the Permian fetched in a takeover this week.

The new loan “answers the most important question about Chesapeake in the marketplace today,” McClendon said on a call with analysts this week. “Will we have enough financial firepower to be able to complete our pending asset sales?”

To contact the reporter on this story: Zachary R. Mider in New York at zmider1@bloomberg.net

To contact the editor responsible for this story: Jennifer Sondag at jsondag@bloomberg.net

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