Chesapeake (CHK) is unquestionably my favorite company to follow - not just because I think it is an excellent investment opportunity, but because it is exciting and controversial. Consider what Chesapeake has to offer from an entertainment perspective:
- A charismatic CEO who lost almost all of his shares of the company in a margin call in 2008
- A board of directors who subsequently granted the CEO an outrageous bonus in the same year when the country was mired in the worst recession since the 1930s
- A company that led a revolution in the natural gas industry through its massive shale gas production growth
- A company that now is a victim of its own success as booming shale gas production has killed the price of the commodity
- A love/hate relationship with Wall Street that loves the massive asset portfolio the company has accumulated but hates the constant spending and high level of debt
For years Chesapeake watchers have heard the company promise that there will be no more equity or debt issuances to fund large land accumulations. And for years the company has followed up those promises with either equity or debt issuances to fund large land accumulations.
Personally, I think these equity and debt issuances have worked out fantastically for the company. We have repeatedly seen the company sell off portions of the acreage that it has purchased, recover all of the cash invested and still retail 75% plus of the acreage. I think it has been a massive creation of wealth for shareholders. Here are the major monetizations that Chesapeake has done previously:
- Haynesville 20% to Plains Exploration for $3.1 billion
- Marcellus 32.5% to Statoil for $3.4 billion
- Barnett 25% to Total for $2.25 billion
- Eagle Ford 33% to CNOOC for $2.2 billion
- Niobrara 33% to CNOOC for $1.3 billion
As an investor I've bought into Chesapeake largely because of the value that these monetizations imply about the retained acreage. Here are the numbers I come up with when I value Chesapeake's properties based on the values suggested by these asset monetizations:
- Marcellus - $7bil
- Haynesville/Bossier - $10bil
- Barnett - $7bil
- Utica - $20bil
- Eagleford/Niobrara - $7bil
- Conventional assets - $8bil
- Midstream/Drilling Rigs - $6bil
- Drilling carries - $3bil
Total of the above: $68 billion
Less Debt $12 billion
Value for Shareholders $56 billion
Value per share $73.20
Current share price $22
Now don't get me wrong, I don't think that Chesapeake is worth exactly $73.20 per share. But I do feel pretty confident that it is worth considerably more than $22 per share. So why the big spread between the share price and valuation?
I believe there are two reasons. One is that the market believes that Chesapeake is overleveraged. The second is that the market does not trust Chesapeake management to reign in its aggressive style. To address the first concern, which is debt, Chesapeake set a goal to reduce debt to $9.5 billion by December 31, 2012 which would provide it with investment grade metrics on debt to reserve value. Today Chesapeake gave us specific details on how it plans to reduce debt to the desired level.
Here is the meat of the plan:
First, Chesapeake anticipates receiving total proceeds in the next 60 days of approximately $2 billion in two separate transactions. The company plans to complete a volumetric production payment on its Texas Panhandle Granite Wash assets and a financial transaction (similar to the company's recent CHK Utica financial transaction) by a new unrestricted subsidiary formed to hold a portion of Chesapeake's assets in Ellis and Roger Mills counties, Oklahoma, in the Cleveland and Tonkawa plays.
In addition, the company is pursuing joint venture transactions in its Mississippi Lime and Permian Basin plays where it owns 1.8 million and 1.5 million net acres of leasehold, respectively. Chesapeake has also recently received industry inquiries about a complete exit from the Permian Basin and today is announcing that it may consider a 100% sale of its Permian Basin assets if it receives a compelling offer. Chesapeake's assets in the Permian Basin represent approximately 5% of the company's total net proved reserves and current production. Chesapeake believes the Mississippi Lime joint venture, a Permian Basin transaction and various other minor asset sales could result in cash proceeds to Chesapeake of approximately $6-8 billion in 2012. The company is targeting completion of these transactions by the end of the 2012 third quarter.
Furthermore, Chesapeake anticipates monetization proceeds of approximately $2 billion during 2012 involving a portion of its midstream assets, service company assets and miscellaneous investments, bringing estimated total monetization cash proceeds in 2012 to $10-12 billion.
I've long thought that Chesapeake should deal with this debt issue by doing a major asset sale that completely restructures the balance sheet. Chesapeake is so asset rich that a major asset sale would hardly dent the asset value that the company would retain.
Chesapeake indicates raising at least $10 billion above and the properties that it will part with really represent only a small fraction of the assets that Chesapeake has. As a shareholder, the one thing I have learned about Chesapeake is that if the company announces a monetization plan, it follows through on it. So I would expect to see these transactions occur as advertised.
Now the question becomes whether Mr. Market will care about this announcement, or even when these deals happen? That is not a question that I have an answer for. My position is that at some point, the fact that Chesapeake's assets are worth far more than the current stock price will be realized. What might surprise the market and get the share price moving is the rise in Chesapeake's operating cash flow over the next few years that is going to far outpace its growth in production as the company becomes more heavily weighted to liquids.
A rebound in natural gas prices wouldn't hurt either. In the meantime, I'll sit on my Chesapeake shares and wait.