It was reported here this morning, per BusinessWire, that Chesapeake Energy (NYSE:CHK) has closed on a deal with Haymaker Resources, Inc. allowing them to acquire non-operated oil & gas royalty interests from the second largest U.S. shale oil & gas producer, including 8,500+ wells spanning 24 states and 324 counties throughout the U.S., for $128mm USD (adjusted at closing for unspecified market changes).
While this was not the sizeable sale that many of us longs had hoped for, it is none-the-less positive news and a step in the right direction. Maybe even an explanation for, considering the timing, Chesapeake's use of Kirkland & Ellis? An asset sale rather than a bankruptcy filing? This was a suspicion of mine for some time, as CEO Doug Lawler made it quite clear dating back to fall of last year, when he mentioned in a conference call that we are to expect further asset sales to be reported in Q1 2016. I had also gathered the hint that it would surpass the $200-300mm mark, leaving me to believe that the shedding of this complex, non-operated/non-core asset is one of many asset sales to follow.
Many have argued that no board in their right mind would authorize a large multi-billion dollar acquisition of Chesapeake Energy in the current state of commodities, specifically energy related. But why not multiple smaller deals to various counterparties? Not to mention, by breaking these assets up over time and appealing to the portfolio of the buyer -- much like the royalty interest did in regards to the Haymaker deal -- it is likely they will be able to negotiate a much higher net sale price for the lot. Hopefully more of this will be discussed in tomorrow's conference call. I believe Lawler is feeling the pressure now more than ever to shed some light to investors and really instill the confidence they need to help weather the storm.
The next big event, in my opinion, will be investors reaction to the paying off of $500mm in bonds come March '16. Surely any company planning to file bankruptcy would not be making all the moves that CHK has as of late. Sure, you can argue that many companies deny such a thing ... or be witty and say "CHK may not be pursuing BK, but BK is pursuing CHK" ... but from what I am seeing in the sale of assets, reduction in costs, and the commitment to pay near-term maturities leads me to believe they truly are working in the interest of all shareholders and will exit this bear market with their heads still above water.
They can achieve this, by deleveraging the company over the next year to the point where debt risk no longer threatens the possibility of default, and then focus on organically growing the company with their remaining core assets as we start to see commodities recover.
So if you read into the company's actions the way I do, and take the March '16 bonds into consideration (which have already seen significant recovery in price over the past week), how do you think the market is going to value these issues after seeing $500mm paid without even so much as a grace period necessary, and the more risk-tolerant investors cashing in with such astronomically high yields?
My opinion is that investors will feel much more secure buying debt going forward, with bond prices likely to see further retracement as more confidence is gained. Not to mention, a preferred stock owner like myself is happy to see $500mm that was once above me on the payout waterfall in a liquidation scenario, disappear and move me up a notch on the ladder. And last, but not least, the positive sentiment it will pass onto the equity holders when they see the company they are invested in is slowly but steadily shoring up its balance sheets and making positive steps towards recovery (Why is it the more depressed energy markets get, the more it starts to sound like a recovering drug addict? And people thought there was no humor on Wall Street). Morale of the story, positive news overall.
Regarding external factors this March, I am most excited to see how much of an impact we see in crude prices this year with an increase in seasonal driving and Memorial Weekend right around the corner. Historically, crude oil and gasoline are the most common to experience a very bullish uptick at this time of year. And with auto sales as strong as they have been over the past year, I would not discount the possibility. We are talking about supply & demand, after all.
Couple that with open negotiations throughout OPEC that doesn't quite yet have Wall Street sold, however, I believe things have gotten to the point where something HAS to get done. From there, we will likely see a serious change in sentiment and see a major impact on pricing over the short-term. And, if successful, could be just what we need to get crude trading back over $40/bbl in as little as the next month.
My only true concern regarding OPEC (which I do believe will sort itself out soon), is the absolute pissing match you can see going on between Saudi Arabia-Iran. You would think in this scenario, the answer would be simple. Well ... not when you have a "my oil production is bigger than your oil production" back-and-forth going on at the nearby urinals. If I had a guess as to how that situation could actually end up resolving, it would be that neither Saudi Arabia nor Iran publicly admit to agreeing on any formal production cuts as a way to keep face and not have to swallow their own pride. But, in the end, ALL producers will be making cuts behind the scenes. Hence, why I expect to see big dips in inventories from where we are now vs looking out to YE 2016, and further explains why oil experts are collectively predicting $60 oil as a very real possibility and consensus price target.
Last, I would like to point to the recent bankruptcies, M&As, and big-name investor purchases recently that in many historical cases has signified a recovery. It was reported that 40 oil and gas E&Ps went bankrupt over the past year in the U.S. alone! We have seen significant consolidation over the past year, and certainly have not seen the end of it.
Then you see someone like Warren Buffett, who is not only known for his incredible track record in investing, but also his reputation for timing the right entry point in any given stock. So when I see him making significant purchases in pipeline operator Kinder Morgan (NYSE:KMI), a counterparty of CHK that has seen significant declines since 2H 2015, and continues to be at risk of further impairment simply due to counterparty risk involving CHK (Or at least that is what the shorts would have you believe with all this unwarranted bankruptcy talk) -- tells me his decision to buy indicates Buffett's low risk assessment regarding CHK, and says a survival is more likely than a bankruptcy. So while Buffett did not directly invest in CHK, his calling a bottom in a sense in KMI tells me that he is confident the damage has been done and the company avoiding BK is becoming more and more likely. And will likely no longer have any significant negative impacts on KMI, as a result. I take this as a very welcome endorsement from the legendary investor, and am extremely bullish at these levels, myself.
You could also argue that Carl Icahn, while a bit early to the party, has an incredible track record as an activist investor. And is known in many cases to buy companies and hold them for 10-20+ years. So maybe purchases in companies such as Chesapeake Energy , Cheniere Energy (NYSEMKT:LNG), Transocean (NYSE:RIG), and Freeport-McMoran (NYSE:FCX) are really investments looking so far out into the future that investors cannot comprehend the losses at the current point in time. But something tells me, Carl Icahn is likely going to be the one to get the last laugh. He certainly has the capital to be patient and do what he has to behind-the-scenes.
Conclusion: While I am in no way acting in the capacity as an investment advisor (it is always advised to do your own due diligence), I am bullish CHK and am simply long the preferred 4.5% cumulative convertible shares, as well as long CHK '18 $0.50 Calls. While I am not against the idea of shorting the common, and buying the bonds/preferred for the liquidation preference and higher payout priority, I believe the downside from here is minimal and would not want to minimize my upside in a reversal. We have already seen a significant decrease in short interest as % of float, and I expect to continue seeing a decline as shorts begin to take more profits off the table as we inch closer to a recovery in commodities. From there, let the bulls lead the charge and leave the bears running for their caves to hibernate!
Disclosure: I am/we are long CHKPD, CHK JAN '18 $0.50 CALLS.
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.