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Chesapeake to Start Generating Cash After Years of Deal Making

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Feb. 8 (Bloomberg) -- Chesapeake Energy Corp., the most active U.S. driller, is poised to start generating cash by cutting interest payments and slowing oil and gas field acquisitions that reached $5 billion last year.

The company announced plans yesterday to sell its holdings in the Fayetteville gas-shale formation in Arkansas, as well as minority stakes in two companies. The sales may yield more than $5 billion in pretax funds, which will be used in part to cut debt, the company said. That may cut costs by $400 million a year, adding to profit, said Michael Bodino of Global Hunter Securities in Fort Worth, Texas.

In the past, no sooner would Chesapeake sell assets than it “spent the money somewhere else,” said Bodino, one of two analysts to raise his rating on the stock to “buy” on yesterday’s news. “Now, they’re set up to be able to increase their earnings without meaningful additions of debt.”

Chesapeake has had eight consecutive years of negative free cash flow, according to data compiled by Bloomberg. In the third quarter of 2010, it burned through $3.15 billion, or $4.98 a share, as it generated net income of $558 million, or 75 cents.

The company, based in Oklahoma City, rose 4 percent yesterday to $31.27 a share after announcing the plan, the day’s best performance by an energy company in the Standard & Poor’s 500. The shares have risen 23 percent this year after ending 2010 little changed.

Chesapeake, which spent $5 billion to buy oil and gas property in 2010, has vowed to slow its spending. The company said it needed to spend money on new leases in 2010 in order to expand its oil production. Oil rose 15 percent in 2010, while natural gas fell 21 percent.

Reducing Debt

On Jan. 6, Chesapeake said it will cut debt 25 percent within two years while scaling back its rate of production growth to 25 percent through the end of 2012 from a previous target of 40 percent.

The holdings in the Fayetteville Shale, one of the most-productive U.S. gas reservoirs since its discovery in 2004, may be worth as much as $4.6 billion based on other recent sales in the formation, Bodino said. Chesapeake will use proceeds from the sales to pay down about $3 billion of its debt, which the company said last month was $12 billion.

By using its cash for oil and gas production instead of buying more fields, Chesapeake can double earnings before interest, taxes, depreciation and amortization within five years to about $10 billion, driving up the share price, Bodino said.

Growing Confidence

The cost to protect Chesapeake’s debt from default fell to the lowest level since August 2008. Credit-default swaps on the company’s debt declined 48.1 basis points to 252.9 basis points yesterday, according to data provider CMA. The contracts are down from 545.9 in May.

Credit swaps, which typically fall as investor confidence improves and rise as it deteriorates, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Chesapeake raised about $10 billion in cash from selling acreage and producing wells over the past three years to companies including Cnooc, BP Plc, Total SA and Statoil ASA. The deals also included agreements, totaling as much as $7.8 billion, for the partners to pay Chesapeake’s costs for new wells.

Chesapeake already quit two so-called unconventional plays entirely, selling a group of Oklahoma wells to BP and assets in North Dakota’s Williston Basin to Continental Resources Inc.

More Buying?

Exiting the Fayetteville is another sign that Chesapeake is restructuring itself as a more diversified producer, Scott Hanold, an Austin, Texas-based analyst for RBC Capital Markets, said yesterday in a note to clients.

Not all analysts agree that Chesapeake is done with acquisitions. The additional asset sales give Chesapeake the ability to cut its debt even more than it plans, Eric Hagen of Lazard Capital Markets, said -- a sign that the company hasn’t finished its buying spree.

“We expect that the smaller debt reductions reflect significant ongoing acreage acquisitions,” Hagen wrote in a note. “It will drastically have to cut back acreage spending, in order to convince investors it is serious.”

The Fayetteville sale will include 487,000 net acres in the Arkansas shale field that produce the equivalent of 415 million cubic feet of gas daily, Chesapeake said in a statement yesterday. Exxon Mobil Corp. paid $650 million cash in December for Fayetteville operations of Petrohawk Energy Corp.

Cnooc Buys Stake

In addition to the Arkansas holdings, Chesapeake will sell its 26 percent stake in Frac Tech, a hydraulic-fracturing contractor that in December filed for an initial public offering. Chesapeake also is selling its 20 percent of Chaparral Energy, an Oklahoma City producer that reported proved reserves equivalent to 149.3 million barrels of oil from U.S. onshore fields as of Dec. 31.

Cnooc Ltd., China’s largest offshore energy producer, in January agreed to pay $570 million in cash for a one-third stake in Chesapeake’s Niobrara shale project in Colorado and Wyoming. It also will pay up to $697 million of Chesapeake’s drilling costs in the basin.

Chesapeake is the most active U.S. driller, according to data from Baker Hughes Inc.

To contact the reporters on this story: Jim Polson in New York at jpolson@bloomberg.net; Michael Lee in Dallas at mlee326@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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