Is Chesapeake in Drive, or In Reverse?
Despite whatever macroeconomic flags we might try to hang from the story, it nevertheless boils down to what may be declining confidence in the company's founder and CEO, Aubrey McClendon. While Chesapeake unquestionably holds the mantle of the leader of the pack among the early developers -- and even discoverers -- of unconventional plays, it continues to be run like a private company that happens to enjoy access to public capital.
Bloating the balance sheet
Through the years, McClendon and his team have concocted a host of often convoluted financial maneuvers to provide operating capital with a balance sheet that has often groaned under a debt load resulting from the gobbling up of massive amounts of acreage in the nation's key shale plays. That approach might have gone swimmingly, were it not for the plummeting of gas prices from the mid-teens per thousand cubic feet a few years ago to just above $2.50 currently.
Chesapeake's reputation as a company that tends to lean toward the best interests of McClendon was enhanced in 2008, when he sold 94% of his Chesapeake shares to meet margin calls after their value fell 60% during the year. Following that essentially forced sale, the company's board awarded him a $75 million bonus and agreed to pay $12 million for his collection of antique maps -- an amount he later reimbursed Chesapeake after shareholders' anger at the transaction.
During the past several years, McClendon et al have frequently employed the stratagem of forming joint ventures with the likes of BP (NYS: BP) and China's CNOOC (NYS: CEO) to gain funding assistance for the development of the large acreage tracts the company has acquired in many of the nation's unconventional large plays. At the same time, they have occasionally sold whole tracts outright, as when they unloaded their ownership in Arkansas's Fayetteville Shale to Australia's big mining company, BHP Billiton (NYS: BHP) , for $4.75 billion.
Too cute by half?
But now, given the moribund state of gas prices, combined with the downgrading by Moody's of Chesapeake's $11 billion in debt this week, the company has an ultra-ambitious plan that it hopes will yield it between $10 and $12 billion. Included in the scheme is the creation of a " volumetric production payment" on its Granite Wash fields in the Texas Panhandle. This approach will generate about $1 billion in upfront cash in exchange for a promise of repayment in the form of oil and gas from those fields. This approach is, of course, tantamount to the creation of a new, off-the-balance-sheet debt instrument.
In addition, the company will form a subsidiary to hold a portion of its assets in the Cleveland and Tonkawa plays in Ellis and Roger Mills counties in Oklahoma. To do so, it will issue about $1 billion of perpetual preferred shares -- essentially another form of debt -- to finance the development of these plays.
They're really selling oil properties?
Perhaps as the coup de grace, it also will sell joint venture interests in its Mississippi Lime and Permian Basin plays in Kansas and Texas. However, should its (importantly, oil-rich) Permian positions prove sufficiently compelling to industry shoppers, the company would consider a "complete exit" from the Basin. In total, management believes that a Mississippi Lime venture, a Permian Basin transaction, and other lesser deals could add to its coffers by $6 billion to $8 billion. (I trust you'll agree that it's extremely strange for a solid company to jettison primarily oil properties in the face of current oil/gas price disparities and given its avowed desire to increase its oil and liquids production.)
Add to those plans the approximately $2 billion that Chesapeake expects to realized from the spin-out of its drilling and oilfield services unit, along with its plans to drop down (sell) to its midstream assets into its MLP unit and, by golly, you have $10 to $12 billion in proceeds. As I noted above, however, a portion of those funds -- those involving the volumetric production payments and the preferreds -- can be construed as de facto debt, a fact that Chesapeake higher-ups deny. But the company also incurred "purer" debt earlier in the week when it floated the $1.3 billion principal amount of senior notes due in 2019, which bear an interest rate of 6.775%.
Great taste: less drilling?
As this is occurring, you likely are aware that last month, due to sliding natural gas prices, Chesapeake, the nation's second-largest producer of natural gas, intended to chop by 67% its number of rigs drilling for gas and its gas production by 8% in 2012. Recently, the company has been joined by a steady stream of additional producers, including Tulsa-based Unit Corporation (NYS: UNT) , which will spend 11% less on drilling and completion this year than it did in 2011.
My current sentiment regarding Chesapeake is that I'm hardly likely to scratch the company from my list of intriguing producers -- especially given its strong remaining positions in significant U.S. producing plays. But neither am I inclined to urge Fools to add to or initiate positions in the company. At this juncture, until its fancy-pants approach to deal-making begins to subside, I'd urge Foolish investors with a taste for energy simply to monitor the company on your personalized version of My Watchlist.
At the time this article was published Fool contributorDavid Lee Smithdoesn't own shares in any of the company's named in this article. Motley Fool newsletter services have recommended buying shares of Chevron and Unit. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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