Three months after Chesapeake Energy Corp. (CHK:US) said it may fail to meet debt obligations next year, credit market investors are speculating increased asset sales will help the company plug a $22 billion funding shortfall (CHK:US).
Chesapeake bond yields have fallen to 6.48 percent on average from 6.76 percent on April 30, the day before the company said it may face a cash crunch in 2013, even as yields for speculative-grade peers rose, Bank of America Merrill Lynch index data show. Chesapeake last week raised its projection for 2012 asset sales to as much as $14 billion.
The company needs divestitures of $7 billion this year to avoid a credit downgrade (CHK:US) after a wrong-way bet on natural gas prices left its cash flows exposed to a glut-driven slump, according to Moody’s Investors Service. Chesapeake replaced more than half its board at the urging of its second-largest shareholder, Carl Icahn, after disclosures of potential conflict of interests by Chief Executive Officer Aubrey McClendon.
Divestitures will help take “the near-term liquidity risk off the table,” Kristopher Keller, a senior high-yield bond analyst at Principal Global Investors, which owns Chesapeake bonds and oversees $260 billion in assets, said in a telephone interview. “They still need to sell a lot of assets.”
Chesapeake had $13.3 billion in net debt as of June 30, according to the Oklahoma City-based company’s second-quarter earnings statement, up from $9.9 billion a year earlier. Chesapeake is rated (CHK:US) Ba2 by Moody’s with a “negative” outlook and had its credit grade cut May 15 to one level lower at BB- by Standard & Poor’s on concerns about its debt load.
Michael Kehs, a Chesapeake spokesman, declined to comment beyond statements made during the company’s second-quarter earnings announcement and teleconference with investors and analysts.
Chesapeake last week reported the highest quarterly profit in the company’s history, as asset sales boosted net income by 91 percent to $972 million. The second-largest (CHK:US) natural gas producer agreed in June to sell its pipeline interest in Chesapeake Midstream Partners LP to Global Infrastructure Partners for $4.08 billion and said on Aug. 6 it would sell some of its Permian Basin oilfield assets in Texas and New Mexico to EnerVest Ltd. for an undisclosed price.
Chesapeake, which said it’s negotiating sales of two other packages of Permian Basin assets, now expects to earn $7 billion from divestitures by the end of the third quarter, McClendon said during an Aug. 7 teleconference to discuss second-quarter results with investors and analysts. It sees $13 billion to $14 billion of dispositions the end of this year, he said.
The progress on selling assets is making investors “more comfortable,” Peter Speer, a New York-based analyst at Moody’s, said in a telephone interview. “The fact that they’ve got bids in hand is certainly better than just saying they have the assets and are selling.”
Chesapeake’s asset-sales agreements come as natural gas prices climb 45 percent from a 10-year intraday low of $1.902 per million British thermal units on April 19, allowing the company to boost its 2012 cash flow projections. Gas traded at $2.767 at 10:58 a.m. in New York, after reaching $3.214 on July 30, according to data compiled by Bloomberg.
“In terms of the operating environment for Chesapeake, it’s very good right now with the rebound in natural gas prices,” Scott Carmack, a money manager at Leader Capital Corp. in Portland, Oregon, said in a telephone interview last week. “This is a much better market” and “that’s fortunate for the company.”
Average yields on Chesapeake bonds are down 28 basis points, or 0.28 percentage points, since April 30 and have fallen 2.21 basis points since climbing above 8.6 percent on May 17, Bank of America Merrill Lynch index data show. Yields for all speculative-grade energy companies have climbed 11 basis points to 7.05 percent over the same period, the data show.
Chesapeake’s $1.3 billion of 6.775 percent notes maturing in March 2019, which traded as high as 100.75 cents on the dollar in February, closed at 99.25 cents on the dollar to yield 6.92 percent yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debentures plunged to 91 cents on the dollar on May 17.
Bond prices may never fully recover “just because investors will continue to wonder if there are any additional skeletons in the closet,” Carmack said. “I don’t think, at least for us, that Aubrey McClendon has regained any trust.”
The cost to guard against losses (CHK:US) on the debt of Chesapeake using credit-default swaps slipped 0.1 percentage point to 6.8 percent upfront today, compared with 5.3 percent on April 30, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That’s in addition to 5 percent a year, meaning it would cost $680,000 initially and $500,000 annually to protect $10 million of Chesapeake’s debt for five years.
Swaps tied to Chesapeake jumped to a four-year high of 13.7 percent upfront on May 18, the day the company cut the pay for its directors and revoked their personal use of corporate airplanes after the disclosure that McClendon used stakes in company wells to secure more than $800 million of personal loans fueled calls for better corporate governance.
“For a bondholder, Aubrey McClendon is kind of a nightmare,” said Carmack of Leader Capital, which considered buying Chesapeake bonds before deciding the risk tied to management (CHK:US) concerns was too great.
Chesapeake has outspent its cash flow (CHK:US) in 19 of the last 21 years as McClendon waged an aggressive drilling-lease purchasing campaign that turned the company into the producer of more U.S. gas than any competitor other than Exxon Mobil Corp. (XOM:US) That funding gap widened to as much as $15 billion for 2012 and $7 billion for 2013, according to estimates in May from Alembic Global Advisors, after McClendon exited commodity hedges in 2011, leaving his company vulnerable to the plunge in natural gas prices.
“We thought we had received a gift, a downdraft that was unrelated to fundamentals in the U.S. gas market, and we thought we would take advantage of that,” McClendon said during a May 2 conference call to discuss first-quarter results with analysts and investors. “If we had to do it all over again with the hindsight of winter, we would have obviously done something different.”
The depression in natural gas prices contributed to a $71 million loss (CHK:US) in the first quarter, forcing Chesapeake to seek a $4 billion bridge loan to avoid violating covenants on its $4 billion revolving credit facility as it raced to complete asset sales needed to compensate for reduced cash flow.
The term loan from Goldman Sachs Group Inc. (GS:US) and affiliates of Jefferies Group Inc. (JEF:US) can be paid off early without penalty until 2013 and the interest rate of 8.5 percent increases by three percentage points if it isn’t.
“If Chesapeake sells $7 billion in assets by September 30, it should have enough cash to fund third-quarter capital expenditures and repay its $4 billion term loan, while ending the quarter with its $4 billion revolving credit facility fully undrawn and having some cash on the balance sheet,” Moody’s Speer wrote in an Aug. 9 note.
“It all hinges on delivering the asset sales,” he said in a telephone interview.
McClendon, who co-founded Chesapeake in 1989, was replaced by Archie Dunham, former ConocoPhillips chairman, as the head of the company’s board in June as the U.S. Internal Revenue Service and the Securities & Exchange Commission investigate his financial transactions. Icahn and Chesapeake’s largest shareholder, Southeastern Asset Management Inc., also succeeded in swapping four other board members for directors of their choosing.
Chesapeake’s stock has risen 41 percent through yesterday from a more than three-year low of $13.55 on May 17. The shares, which climbed 8 cents to $19.14 at 10:55 a.m. in New York, are down 14.5 percent this year through yesterday.
“There were positive incremental steps taken by the company and the new board members, we think, are certainly a step in the right direction,” Principal’s Keller said. “Liquidity, at least for now, it’s no longer a real concern.”
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