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Chesapeake Comes Up Short of Investment-Grade: Corporate Finance

Chesapeake Comes Up Short of Investment-Grade
A derrick man, right, climbs down from an overhead platform after connecting a section of drill pipe on a Chesapeake Energy Corp. natural gas drill site in Bradford County, Pennsylvania. Photographer: Daniel Acker/Bloomberg

Chesapeake Energy Corp. faces more asset sales to reach an investment-grade rating after the most active U.S. oil and natural-gas driller arranged transactions that are generating $1.2 billion in cash.

Chesapeake bond yields imply a Ba1 rating, one step below investment-grade, according to Moody’s Corp.’s capital markets research group. Chesapeake has an equivalent grade at Fitch Ratings, which has a “positive” outlook on the company, and at Standard & Poor’s. Moody’s Investors Service rates it one level lower at Ba2, also with a “positive” outlook.

The cash is expected to help pay down a portion of the company’s revolving debt due December 2015, which won’t be enough to trigger an upgrade by Moody’s, said Peter Speer, a senior credit officer and vice president at the ratings firm. Chesapeake, which had $10.3 billion of outstanding long-term debt net of cash at the end of last year, according to a statement today, may save $18.3 million on annual interest for every $1 billion in debt with an investment-grade rating.

“Management has stated they want to improve their credit profile and expect to do so through executing a number of other asset monetizations over the next year,” said Robert Gephardt, a bond analyst at asset manager Neuberger Berman Group LLC in Chicago. “Their success in this effort over the next year will be key to maintaining and possibly improving their credit profile.”

Tender Offer

Similar deals may help boost the company’s credit standing, Gephardt said. Chesapeake investors resisted a $2 billion bond tender offer in April, expecting their securities to become more valuable when the company reaches investment grade, a goal reiterated at a March investor conference by Jeff Mobley, senior vice president for investor relations and research. Chesapeake reduced the amount of debt the company sought to repurchase and increased the price it would pay for some of the bonds in May.

The extra yield investors demand to hold Chesapeake bonds instead of government debt has increased 2 basis points since the end of 2010, compared with a 90 basis point jump for all BB rated bonds, Bank of America Merrill Lynch index data show. The high-yield energy index has increased 74 basis points over that period.

The company’s $660 million of 6.5 percent notes due August 2017 traded yesterday at 105.75 cents on the dollar, for a yield of 5.31 percent, up from 100.5 cents at the end of 2010.

Credit-default swaps on Chesapeake declined 21.9 basis points yesterday to 432.7 basis points, according to Bloomberg data.

Chesapeake shares decreased 8.9 percent since 2010 as of yesterday’s close, compared with a 1.5 percent increase for the S&P 500 Index over that time period.

Asset Sales

The Oklahoma City-based energy company will get $600 million of cash from its sale of a pipeline subsidiary that was expected to close Dec. 30 and $610 million from a divestiture of shale drilling assets located in Utica, Ohio, completed yesterday, according to a note from Philip Adams, an analyst at bond researcher Gimme Credit. The sales totaled $3.2 billion, including securities and other considerations.

Jim Gipson, a spokesman for Chesapeake, didn’t return a telephone message or e-mails seeking comment.

Chesapeake had $111 million of cash at the end of September, down 87 percent from $849 million at the end of March, according to data compiled by Bloomberg.

The company spent $2.1 billion on 10 bond tender offers in the second quarter of 2011, according to a Securities and Exchange Commission filing. The offers were part of Chesapeake’s attempt to reduce indebtedness and accelerate a credit upgrade, Mobley said at the conference.

‘Positive Outlook’

Chesapeake had a leverage ratio, or debt to earnings before interest, taxes, depreciation and amortization of 3.4 times as of Sept. 30, up from its two-year low of 2.97 at the end of the second quarter. The ratio was down from 3.78 at the end of 2010.

“Our positive outlook is tied to an expectation that Chesapeake will be able to reduce their leverage metrics, partly through paying down debt, but more so from growing their proved reserves and production,” Speer of Moody’s said.

Chesapeake will reach the investment-grade category this year by paying down debt and adding reserves, Domenic Dell’Osso, the company’s chief financial officer and executive vice president, told high-yield investors at a Dec. 1 conference. The company also plans to raise production by 30 percent and cut debt 25 percent in the two years through December 2012 without raising new equity, he said.

The company reduced debt by $2.2 billion in the fourth quarter of 2011 and intends to reach about $9.5 billion by the end of 2012, according today’s statement. This debt includes a $4 billion revolver due in December 2012 with $3.24 billion outstanding as of Sept. 30, Bloomberg data show.

Growth Opportunities

The company has stated that it has growth opportunities that will exceed internally generated cash flow. Asset sales have long been a part of the company’s capital program, and 2012 will be no different, Dell’Osso said at the conference.

Chesapeake intends to raise $1 billion from new joint ventures in 2012, according to an investor presentation on its website. The company expects to seek joint-venture partners to develop fields in three regions, including the Mississippi Lime located in Oklahoma and Kansas, Chief Executive Officer Aubrey McClendon said on the Dec. 1 conference call.

Fellow Oklahoma City gas producer SandRidge Energy Inc. announced on Dec. 23 its intention to divest land in the area worth as much as $1.83 billion.

“Chesapeake is a very good land speculator,” said Marc Gross, a money manager at RS Investments in New York, where he oversees $3 billion in fixed-income funds, including Chesapeake bonds. “They buy land and then later they flip it. They gear these sales to fund capital expenditures. They’re almost better at partnering than pumping gas wells.”

‘Right Direction’

The company also plans to take its Chesapeake Oilfield Services unit public, McClendon said in a Nov. 4 teleconference to discuss third-quarter earnings with analysts and investors. Doing so will help improve the company’s credit profile because much of its debt is associated with the unit and its midstream pipeline business, McClendon said on the call.

Chesapeake is the second-biggest overall producer of natural gas in the U.S., behind only ExxonMobil Corp. Chesapeake has high-quality gas assets, but with prices dropping to their lowest levels in more than a year, a loss of profitability from that segment could be a problem for the company in 2012, Gross said.

The price of natural gas ended $2.98 per million British thermal units yesterday after falling 1.3 percent on Dec. 30 to $2.989, the lowest settlement since Sept. 11, 2009, on the New York Mercantile Exchange. It rose 2.8 percent, to $3.08, at 1:14 p.m. in New York today.

If Chesapeake is able to withstand low gas prices and achieve investment-grade metrics, it will be important for the company to show a commitment to maintaining that balance sheet for in different economic environments, Gross said.

“If you look at the assets they have and what they’ve communicated they want to monetize, if they do what they say, this will be an improved credit 12 months from now,” said Gephardt. “It’s part of a longer-term process. Every deal is a step in the right direction.”

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