Chesapeake on Cusp of Investment-Grade: Corporate FinanceJodi Xu
Chesapeake Energy Corp. is cutting indebtedness more aggressively than its peers as a developing energy glut makes owning cash more attractive than low-yielding petroleum assets.
The company is on the cusp of gaining an investment-grade rating for the first time after announcing yesterday that it was selling natural-gas and oil shale fields for $5.4 billion. That means Chesapeake’s ratio of net debt to cash flow, which has been shrinking since 2012, is poised to contract further. The ratio for energy exploration and production companies in the Standard & Poor’s 500 index has been stable this year.
Bond investors are bidding up Chesapeake’s fixed-income securities as it exits some shale deposits in favor of more oil-rich prospects, allowing it to reduce debt without depressing revenue. Moody’s Investors Service and Standard & Poor’s gave “positive” outlooks on Chesapeake’s ratings, which are one step from investment grade on each firm’s ratings scale.
“This deal gives them flexibility to dab into areas that they think would give them higher returns,” Philip Adams, a senior bond analyst at corporate debt researcher Gimme Credit LLC, said in a telephone interview. “I give credit to this management team to be certainly very disciplined about capital.”
Chesapeake’s $1.1 billion of 5.75 percent unsecured bonds maturing March 2023 rose 4.5 cents on the dollar yesterday and added 1.75 cents at 11:23 a.m. in New York today, reducing their yield to 4.42 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Chesapeake’s shares are up 13 percent in the past two days.
The company plans to use the proceeds from the sale, which is expected to close at the end of the year, to improve its
balance sheet including paying down bonds or preferred shares, according to a person with knowledge of the matter.
Chesapeake will record a gain of about $3.8 billion on the sale, said the person, who asked not to be identified, citing a lack of authorization to discuss the matter publicly.
Gordon Pennoyer, a spokesman at Chesapeake, declined to comment on the transaction.
Chief Executive Officer Doug Lawler emphasized the company’s longstanding goal to “achieve investment-grade metrics” in a presentation at the Barclays Capital CEO Energy-Power Conference in New York on Sept. 3.
Chesapeake is rated Ba1 by Moody’s and BB+ at S&P. The company was founded by Aubrey McClendon, who grew up near Chesapeake Bay, and his partner Tom Ward, in 1989, according to Hoover’s Handbook of American Business. It went public in 1993.
The business was last this close to investment-grade at S&P in April 2011. Its goal of getting to that level was dealt a blow a year later when reports circulated that McClendon had used his personal 2.5 percent stakes in some Chesapeake Energy wells as collateral for loans that weren’t fully disclosed to shareholders.
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 him his annual bonus and the chairmanship. A board inquiry into McClendon’s use of his well stakes to obtain more than $800 million in private loans cleared him of intentional wrongdoing.
S&P cut the company to BB in April 2012 and BB- a month later. It then reinstated the BB+ rating in May of this year as the company reduced debt through asset sales. Moody’s, whose highest previous rating had been Ba2, also gave Chesapeake its top junk grade in May.
For much of McClendon’s reign, Chesapeake focused on acquiring properties. Debt load was driven up by the need to continue to drill and the business took a nose dive when natural gas prices hit the bottom. In September 2012, total debt and preferred stock peaked at $21.6 billion, Bloomberg data show..
Yesterday’s transaction will “provide Chesapeake with sufficient wherewithal to reduce financial leverage to a greater extent than assumed in our base-case scenario,” said Scott Sprinzen, an analyst at S&P. If debt is reduced by more than $5 billion, “this could result in an upgrade,” analysts led by Sprinzen said in a ratings report yesterday. Chesapeake had about $16.7 billion total debt and preferred stock at the end of June, Bloomberg data show.
While investors showed their appreciation of Chesapeake’s sale, they punished Southwestern for paying a premium that UBS Securities LLC said was 54 percent more than Chesapeake’s assets were expected to fetch. Southwestern’s $1 billion of 4.1 percent unsecured bonds due March 2022 have dropped 1.6 cents on the dollar to 102.3 cents, raising their yield to 3.74 percent from 3.5 percent, while its shares fell 9.4 percent to $32.34.
“This large asset sale greatly increases Chesapeake’s financial flexibility to pursue future leverage reduction and invest in its core growth properties,” Pete Speer, a Moody’s senior vice president, said in a ratings report. “The positive rating outlook reflects the company’s potential to strengthen its financial profile and improve its operating cost structure and investment returns to levels consistent with a Baa3 rating over the next year to eighteen months.”
Natural gas prices have fallen 11 percent this year and oil is down by a similar amount as output climbs, Bloomberg data show. Energy companies have exploited nontraditional sources such as shale fields to increase production.
The sale includes 1,500 wells and drilling rights across 413,000 acres in the southern Marcellus Shale and eastern Utica Shale in Pennsylvania and West Virginia.
Chesapeake’s leverage as measured by net debt to earnings before interest, taxes, depreciation and amortization fell to 1.96 at the end of June from 3.9 times in the third quarter of 2012 and 2.21 at the end of last year. Its S&P peers have seen their average fall to 1.06 times from 1.08 in December.
“Given their history and previous reputation, I don’t think you are going to see them going back to leveraging mode because that’s going to fly in the face of capital discipline,” said Adams of Gimme Credit.