Shareholders of Chesapeake Energy (NYSE:CHK) received one share of Seventy Seven Energy (NYSE:SSE) common stock for every 14 shares held of CHK common stock. Now that SSE is trading on the public exchange, should shareholders who received the SSE distributions, hold on to the company, or sell and buy back CHK shares.
Chesapeake Energy Corporation is the second-largest producer of natural gas and the 10th largest producer of oil and natural gas liquids in the U.S. Chesapeake has spun off what was recently known as Chesapeake Oilfield operating L.L.C, and has now renamed the division Seventy Seven Energy Inc. Seventy Seven Energy Inc operates drilling rigs, fracking equipment and wastewater trucks from the Rocky Mountains to Appalachia.
Following the distribution of SSE common stock, the company becomes an independent publicly traded company, and Chesapeake will retain 0% equity in SSE. SSE announced that it will offer $500 million in senior unsecured notes due 2022 in a private placement. The new spin off intends to use the proceed to make a cash distribution to COS Holdings, L.L.C, its direct parent company, in order to repay all indebtedness outstanding under its new revolving credit facility that will serve the company's credit line after the spin-off for general corporate purposes.
So SSE is trying to clear itself of debt from Chesapeake Oil Services, and become almost completely unrecognizable from the former company. However, shareholders must recognize that Seventy Seven Energy is in a highly competitive subset of the Petroleum Industry. Competitors include Schlumberger (NYSE:SLB), Haliburton (NYSE:HAL), and Baker Hughes (NYSE:BHI), among others.
Chesapeake Service Operations Revenues increased from $173 million in 2008 to around $521 million in 2011 as exploration and production activity picked up during the period. Revenues grew further to around $607 million in 2012 and $895 million in 2013 due to an increase in third-party utilization of the company's oilfield services.
According to Barclays, global spending on exploration and production is set to increase 6.1% in 2014 to a record $723 billion. New technology will be the driving factor for growth and production of U.S. shale and reservoirs in the Gulf of Mexico deepwater fields. Recently, competitor Schlumberger's management laid out a comforting forecast for revenues, operating margins and earnings for the next several years. This is a positive for the sector overall, but one has to go back to the idea that SSE is now on its own, not a sole provider of service operations for Chesapeake.
Seventy Seven Energy, whenever it is spun off, will rely heavily on Chesapeake for its revenue. The unit reported revenue of around 5% of total revenue which amounts $2.2 billion in 2013. Chesapeake accounted for the majority of that revenue. The unit only generated around 10% of its total revenue from third-party exploration and production companies.
A large part of this new spin offs business will be competing to serve companies like Exxon (NYSE:XOM), Anadorko (NYSE:APC), BP and hundreds of small to medium sized oil and natural gas exploration and production companies that outsource the drilling, casing, and completion portions of production process. Considering Chesapeake has zero equity stake in SSE, it would not be a wild assumption that Chesapeake will start to use other service companies to do the jobs that were done in-house in the past.
Trying to become another service company will be difficult, and shareholders need to realize that one of the primary reasons Chesapeake looked to spin-off this service division was to decrease the debt the company was taking on. So with this move Chesapeake just strengthened their balance sheet. SSE's reliance on Chesapeake will be an interesting metric when the company's first earnings report is released, but shareholders may want to dump, and wait until then.
Disclosure: The author is long CHK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.