Feb. 21 (Bloomberg) -- Chesapeake Energy Corp., the second- biggest U.S. natural-gas producer, completed an unprecedented bond offering Feb. 13 that could limit returns in the event of an asset sale, according to bond analysts from Wells Fargo & Co. and Covenant Review.
The $1.3 billion of 6.775 percent notes due March 2019 are callable at par for a four-month period from mid-November 2012 to mid-March 2013, after which they convert back to non-callable bullet bonds until maturity. This is the first bond deal to include a par call window, said John Rote, head of high-yield syndicate at Bank of America Corp. that arranged the deal.
The company is seeking as much as $12 billion from asset sales and joint ventures in order to pay down some of the $11.8 billion in debt on its balance sheet, according to a Feb. 13 statement. Holders of the new bonds are incurring risk related to the sales since gains will be capped at par for that four- month period, James Spicer, a Charlotte-based high-yield analyst at Wells Fargo, said in a telephone interview.
“If they do an asset sale for a really strong price that improves the credit rating, then those bonds would go up in value,” said Adam Cohen, the New York-based founder of Covenant Review LLC, which analyzes the terms of bond offerings. “But because those bonds can be called at par, investors may not see that increase in value.”
The call provision gives Oklahoma City-based Chesapeake the flexibility to conduct an asset sale during that four-month window. The money raised through divestitures in 2012 would be used to reduce the company’s long-term debt to no more than $9.5 billion at Dec. 31, according to the statement.
The company’s capital spending has exceeded cash from operations in every quarter since October 2003, according to data compiled by Bloomberg. During the third quarter of 2011, as U.S. gas prices were tumbling 16 percent, Chesapeake swelled its net debt by 18 percent to $11.7 billion.
If the asset sale happens and Chesapeake calls back the bonds at par, then assuming the bonds continue to trade in their current range, the high coupon and the new-issue discount still make the investment attractive, according to Bank of America’s Rote.
“If the bonds don’t come out in that November to March time frame, you’re still getting a much better return on a pure yield basis versus a bond of similar maturity,” said Rote. “If it does come out, it’s basically a one-year piece of paper with an 8-percent-plus IRR, and obviously a lot of investors found that to be attractive,” he said, referring to the internal rate of return.
The bonds were sold at 98.75 cents on the dollar, reducing proceeds for the company and boosting yield to investors. The bonds traded at 100.06 cents on the dollar today at 8:25 a.m. New York time, with a yield of 6.761 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Jim Gipson, a spokesman for Chesapeake, declined to comment on the structure of the deal. Exxon Mobil Corp. is the largest gas producer and energy company by market value.
Chesapeake was able to take advantage of large inflows into high-yield bonds in the month of February to complete the deal, according to Covenant Review’s Cohen. High-yield inflows were $2.5 billion for the week ended Feb. 3 and $2.9 billion in the week ended Feb. 10, the highest levels of 2012, according to data from Cambridge, Massachusetts-based research firm EPFR Global.
Moody’s Investors Service gives Chesapeake a Ba2 corporate family rating and Standard & Poor’s gives it a BB+ grade.
“When there are fund flows at that level for a few weeks in a row, that money eventually has to go somewhere,” said Cohen. “Chesapeake was smart to issue in a week where there was a lot of money flowing into high-yield funds.”
The company is one of the most actively traded names in high-yield, with its new bond accounting for 7 percent of trades over $1 million on Feb. 16, according to Trace. Demand for the new securities was high enough to allow the deal to be increased to $1.3 billion from $1 billion.
“The technical picture in the market is very strong right now,” said Rote. “That’s helping all deals and it certainly helped this one. It would’ve been more difficult and costly to get a transaction like this done in a more challenging market.”
Chesapeake tends to do complicated bond issues, and investors would rather see the company simplify its debt structure and adopt more straightforward solutions, said Spicer. It should now focus on cutting back capital expenditures to combat low natural gas prices, he said.
The company has been issuing debt without normal high-yield bond covenants for the last several years and the new bonds don’t currently have an asset-sale covenant in place, according to Cohen.
“Generally speaking, the contract terms are riskier for Chesapeake than they are for a normal high-yield company,” Cohen said. “This deal is just another example of them pushing that envelope a little bit further.”
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