Chesapeake Energy: Disappointing Price Tag Of Mississippi Divestiture Sends Shares Lower

Feb.26.13 | About: Chesapeake Energy (CHK)

Shares of Chesapeake Energy (NYSE:CHK) traded with losses of up to 7% in Monday's trading session. The natural gas exploration and production company announced a joint venture with Sinopec International Petroleum Exploration for its Mississippi Lime play in Oklahoma.

The Joint Venture

Chesapeake announced the "joint venture" on Monday. In reality, the company will sell a 50% stake in 850,000 of net oil and gas acres in the Mississippi Lime play in Northern Oklahoma. Chesapeake will receive $1.02 billion in cash, of which 93% will be achieved upon closing of the deal.

During the fourth quarter of 2012, the operations averaged a production of 34,000 barrels of oil equivalent. In total, the operations had proven reserves of 140 million barrels of oil equivalent. Chesapeake will remain the operator of the project, conducting the leasing, drilling, completion and operations for the joint venture. COO Steven C. Dixon commented on the divestiture:

"We are excited to announce the execution of our Mississippi Lime joint venture with Sinopec, which moves us further along in achieving our asset sales goals and secures an excellent partner to share the capital costs required to actively develop this very large, liquids-rich resource play."

The divestiture of the 50% stake in the activities will generate roughly $1 billion in cash, needed to reduce the net debt position of roughly $12 billion.

The sale of the 50% stake in the field will reduce pro-forma production by approximately 17,000 barrels per day, and proven reserves by roughly 70 million barrels. In total, Chesapeake has oil-equivalent proven reserves of approximately 2.6 billion barrels.

The deal is expected to close in the second quarter of this year.

Valuation

Chesapeake ended its full year of 2012 with $287 million in cash and equivalents. The company operates with $12.2 billion in total debt, for a net debt position of approximately $11.9 billion. The company generated full year revenues of $12.3 billion for the year. Chesapeake reported a full year loss of $1.7 billion on the back of a $3.3 billion impairment on natural gas and oil properties.

Factoring in the share price decline on Monday, the market values Chesapeake at $12.8 billion. This values the firm at approximately 1.0 times annual revenues. Chesapeake pays a quarterly dividend of $0.09 per share, for an annual dividend yield of 1.8%.

Some Historical Perspective

Shares of Chesapeake have lost roughly a quarter of their value over the past year. Trading around $25 in March of 2012, shares have lost almost half of their value, hitting lows of $13 in May. Shares gradually recovered, trading around $19.55 as of this writing.

Shares are still trading roughly 75% below their all time highs of $67 back in 2008 when the shale revolution was taking over America, thereby boosting the valuation of natural gas exploration companies. The collapsing natural gas prices, as a result of the production boom, was disastrous for shareholders. Chesapeake was, and continues to be highly leveraged.

Between 2009 and 2012, Chesapeake grew annual revenues by roughly 60% from $7.7 billion to $12.3 billion. The company reported large losses in recent years on high write-downs of acquired assets, but it remains profitable on an operating basis.

Investment Thesis

Chesapeake has been running behind its targets for asset sales. Originally the company planned to sell up to $19 billion of assets until the end of 2013. Since the second quarter of 2012, Chesapeake has sold almost $5 billion in midstream assets, which excludes Monday's $1 billion divestment.

In December of last year, shares reacted positively after the company sold a majority of its midstream assets to Access Midstream Partners LP (NYSE:ACMP) for $2.16 billion.

On Monday, shares reacted much less positively, as the $1 billion price tag came in below analysts' expectations. The deal values an acre in the area at around $2,400 dollar, which is far below prices in the Bakken or Eagle Ford formation, which command between $10,000 and $40,000 per acre.

Furthermore, the lower price valuations could lead to further write-downs and impairments on existing assets. Investors are also wondering why the company is selling oil-producing assets, given the superior profitability and Chesapeake's goal to increase its share of oil production.

The company is still trapped between the need to grow production, which requires increased capital expenditures, and debt repayment schedules. While asset sales raise capital, sales at distressed levels will lead to further write-downs and impairment charges. The net debt position will fall to approximately $11 billion as a result of the deal, while capital requirements will be reduced as well.

While the debt position and low natural gas prices remain a worry, there are bright points as well. Activist investor Carl Icahn, who is well-known in the energy sector, has already taken a large stake in the troubled company. Despite its troubles, Chesapeake has large proven reserves and the potential for production growth, which makes it an interesting target for a large integrated energy player.

Another positive point is the fact that CEO Aubrey McClendon is stepping down on April 1, after the company had nearly gone bankrupt in 2012 in a severe liquidity crunch.

The long term risk-reward ratios continue to look good, as the company most likely has averted a liquidity and bankruptcy crisis. The process of divestitures is painful, as it dilutes value for shareholders and leads to possible renewed asset impairments, while it brings in much-needed cash. Investors with a higher tolerance for risk could pick up some shares during this recent correction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.