Earlier this year, Chesapeake Energy was essentially left for dead by both bond and stock investors. Its shares plunged to the lowest since 1999 and its bonds were trading at less than 20 cents on the dollar.
But Chesapeake, the second-biggest U.S. natural gas producer, has proven all the haters wrong -- so far at least. Since touching a low in February, both its stocks and bonds have gained more than 300 percent as the company took steps to reduce debt and the panic in energy markets eased.
Investors keen to buy into this uplifting story should bear one thing in mind: They are essentially funding a slow-motion restructuring -- albeit a healthy, needed one after years of reckless spending at Chesapeake. And it may work out well for everyone, especially if oil prices tick up a bit more and borrowing costs stay low.
Still, it puts stock traders in a somewhat precarious position. This overhaul of the company's balance sheet dilutes shareholders in order to pay off bond investors. And Chesapeake is making sure to time its capital-markets transactions perfectly, in order to wring the most money from investors as possible.
Thursday was a case in point. Chesapeake announced a private placement of up to $1 billion of convertible 10-year debt less than a day after OPEC apparently agreed to cut supply, boosting oil prices. It was as though the company was just waiting with its finger on the trigger for the right moment.
Buyers will receive regular coupons, albeit likely lower than those on its regular bonds, along with the possibility of converting the debt to equity if Chesapeake's stock rise enough. The transaction is good for existing bond investors, especially those holding debt that matures in less than a decade, because it provides the company with more cash to repay them. Indeed, the company's bonds rose after the the debt offering was announced.
But it's less clear-cut for existing shareholders: while terms aren't defined as yet, in nominal terms those convertibles represent potential dilution of around 20 percent. And indeed, Chesapeake shares fell following news of the transaction.
To be clear, this is what Chesapeake should be doing -- namely, pulling every lever it can to fend off the threat of bankruptcy. It has substantially reduced its debt this year, which should be a good thing for all investors.
Shareholders, however, face something of a double-edged sword. On the one hand, every little repair of Chesapeake’s balance sheet raises its chances of a full recovery and therefore boosts the long-term option value in the stock. But these repairs may also involve selling off assets for nothing more than their liabilities, using cash to buy back bonds at a discount, or, of course, unleashing a flood of new shares.
And all the good stuff happening with Chesapeake doesn't totally remove other risks, including a subpoena it just said it received from the U.S. Justice Department over how it accounted for some of its oil and gas properties on its balance sheet.
Still, Chesapeake seems serious about immunizing itself against another crisis like the one it faced earlier this year. That's an overwhelming positive for its bonds, perhaps more so than its stock.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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