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McClendon Wildcats for Junk Funding: Corporate Finance

Aubrey McClendon is returning to his wildcatter roots as the ousted co-founder of Chesapeake Energy Corp. prepares to tap the junk-bond market to help finance what will be the most highly leveraged energy exploration company.

A unit of McClendon’s American Energy Partners LP is seeking $1.4 billion, according to a statement from Moody’s Investors Service, which assigned the debt a Caa1 rating. That grade, denoting securities of “very high risk” and “poor credit standing,” reflects undeveloped reserves and “prospective” acreage in Permian Basin drilling rights being purchased from closely held Enduring Resources.

American Energy management and two partner firms are putting up $1.15 billion of equity, leaving potential creditors to finance the bulk of the purchase in a business that will be the most highly leveraged among energy exploration and production companies rated by Moody’s, according to the statement. McClendon previously saddled Chesapeake with $13.3 billion of debt and turned to asset sales in 2012 after falling gas prices led the company to warn it might not be able to service its obligations.

“The underwriters have the confidence they will be able to raise money despite the baggage that comes with Aubrey,” Stuart Miller, a Moody’s analyst in New York said in a telephone interview. “He’s raised a lot of equity and there’s also the technical expertise that this management brings with it.”

Revolving Loan

Steven Lipin, an American Energy spokesman who works for Brunswick Group LLC, declined to comment on the financing.

The company is also seeking a $1 billion revolving credit line with an initial allowance of $500 million, according to the Moody’s report. A condition of the loan would be that at least $350 million is unused and available for liquidity at the time of closing, the report said.

American Energy, formed by McClendon in the wake of his departure from Chesapeake in April 2013, is receiving financial backing from private-equity firms First Reserve Corp., a Greenwich, Connecticut-based company that focuses on energy, and Energy & Minerals Group, controlled by John Raymond, son of retired Exxon Chief Executive Officer Lee Raymond. Oklahoma City-based American Energy has raised about $10 billion for acquisitions, and it has amassed or announced deals to acquire drilling rights on about 400,000 acres.

The company’s strategy of quickly raising large amounts of capital through a variety of means is reminiscent of Chesapeake under McClendon’s leadership, according to Mark Hanson, an analyst at Morningstar Inc. in Chicago.

‘Every Avenue’

“McClendon has shown before that he doesn’t have an aversion to leverage,” Hanson said in a telephone interview. “Chesapeake was historically one of the most heavily levered E&Ps out there. Between equity issuance, the bank debt, and the very, very high-yield market, it seems like every avenue he can pursue for funding he will go down.”

McClendon started Chesapeake with Tom Ward, now Chief Executive Officer of Tapstone Energy LLC, in 1989 with a $50,000 investment. The company is the second-largest U.S. producer of gas behind Irving, Texas-based Exxon Mobil Corp.

Energy exploration and production companies are the biggest sub-set of borrowers in the Bloomberg USD High Yield Corporate Bond index, making up more than 7 percent of the $1.45 trillion gauge.

The company’s leverage would be higher than other exploration and production companies rated by Moody’s, which calculates that metric based on debt in relation to reserves and production.

Leverage Measures

With $1.5 billion of debt, the ratio of borrowings to daily production would be about $100,000 per barrel of oil equivalent, and $58 for debt-to-proved developed resources.

That compares with about $30,000 and $9 to $12 for similarly rated companies, according to Miller.

McClendon is a “land man,” he said. “A lot of his purchase price is being spent on undeveloped and unproven acreage position.”

“They are taking advantage of the liquidity that is available,” Miller said. “You couldn’t do this necessarily in a difficult market.”

Issuance of junk-rated bonds is poised to exceed last year’s record, with $206.5 billion of the debt raised in the U.S. this year, Bloomberg data show. These bonds are graded below BBB- by Standard & Poor’s and less than Baa3 by Moody’s.

This isn’t the first time McClendon has shown an interest in the Permian Basin.

‘Second Life’

The region in western Texas and southeastern New Mexico accounted for more than 5 percent of Chesapeake’s total production when McClendon was chairman. The company, which is also based in Oklahoma City, sold the majority of its Permian properties in September 2012 to help close its cash gap. The holdings were the most valuable assets the company put up for sale that year, fetching $3.3 billion but falling short of McClendon’s $5 billion target.

McClendon, who oversaw a 500-fold increase in Chesapeake’s market value from 1993 to June 2008, agreed to resign after a shareholder revolt by Carl Icahn and Southeastern Asset Management Inc.’s O. Mason Hawkins cost the CEO his annual bonus and the chairmanship in 2012. A board inquiry into McClendon’s use of personal stakes in company-owned wells to obtain more than $800 million in private loans cleared him of any intentional wrongdoing.

Permian Basin

Interest in the Permian Basin has picked up in recent years, as horizontal drilling and hydraulic fracturing techniques have given it “a second life,” said Hanson. “On its surface it doesn’t look like a foolish purchase, it doesn’t look overly speculative,” he said.

Occidental Petroleum Corp. is the largest owner of Permian property, with more than 1.9 million acres of drilling rights. Five other companies, including Chevron Corp. and Exxon Mobil, own at least 1 million acres of drilling rights there, according to data compiled by Bloomberg Industries.

The company’s proposed bond offering, which may be sold next week, will be used to help fund the acquisition of 63,000 acres of leasehold in western Texas. S&P rated the bonds CCC+, equivalent to the Moody’s ranking and seven levels below investment grade.

S&P also assigned a B corporate credit rating with a stable outlook to American Energy-Permian Basin LLC, the unit issuing the notes.

The stable rating reflects S&P’s expectation that “ the company will be successful in significantly expanding its production and reserves from initial levels,” Scott Sprinzen, an S&P analyst, said in a statement.

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