On September 27th, investors and followers of Chesapeake Energy Corp. (NYSE:CHK) found out the final results of the company's tender offer and have a good idea now of how much of an impact it will have, for better or worse, on the enterprise moving forward. In what follows, I will dig into the news and give my own thoughts on the matter and detail what it means for investors in the firm moving forward.
A look at the debt offering and tender offer
One problem facing Chesapeake that has had some investors scared (probably many of its investors) is the fact that, between now and the end of 2017, the firm has to come up with as much as $1.38 billion in debt maturity payments. However, $730 million of it is a wildcard that may or may not come due since the debtholders have the right to force a payment next year, but if that right is not exercised (and it could be in any amount from $0 to $730 million), there is no obligation to pay that money at that time.
This has created for Chesapeake a great deal of uncertainty that investors do not like but, earlier this month, the firm began working on a way to confront some of these debt fears. Initially, management announced plans to issue debt totaling $1 billion, later upping that to $1.5 billion with a floating rate that is at around 9% right now, and using the proceeds of it to tender the nearer-term debt on the company's books. For the nearest-term debt, this was done at par, but the debt stretching out just a tad bit was done at a discount, pricing some debt as low as $0.7525 on the dollar.
Due to the tough energy environment, this move was likely necessary for Chesapeake, but the downside is that the interest rate of debt tendered ranged from a modest 2.25% to no more than 7.25%. Because of this, unless the firm could get a tremendous discount to par value, the increase in interest expense would prove an issue. However, since the firm had to focus on the nearest-term debt and had to offer up par or close to it for the different classes of that, the chance of getting a large enough discount was next to zero.
We now know the results
After management released a statement on September 27th, we now know the end result of the tender offer. According to management, Chesapeake will be buying back $897.7 million worth of non-convertible senior notes in exchange for $800 million in cash. This represents a nice discount of 10.9% on that debt. The firm is also acquiring $708 million in convertible senior notes in exchange for $699.3 million, which comes out to a small discount of only 1.2%. Overall, the firm is reducing principal on its total debt of $8.68 billion by $106.4 million, which is nothing to sneeze at, but is not enough to make a massive difference in the company's solvency situation.
Though any sort of principal reduction is a great thing, there is a downside that investors need to be cognizant of. From the Non-Convertible Senior Notes, the firm will be reducing annual interest expense by $43.89 million and from the Convertible Senior Notes (which carry rates of between 2.25% and 2.5% per year), the interest expense deduction comes out to $17.43 million. This looks great on paper but if we assume that the 9% interest rate I estimated in my prior article on Chesapeake's debt offering remains unchanged, the annual expense there will come out to $135 million.
This is kind of scary and the picture could worsen materially if interest rates increase over the next couple of years (modest increases are probable, but a meaningful increase is extremely unlikely unless inflation kicks up). If we make the assumption that rates don't move, then Chesapeake's total annual interest expense under this scheme will rise by $73.68 million, meaning that the discount to par achieved on its tender offer will disappear in a little over a year and five months.
Of course, there is a positive side as I already mentioned; debt is being pushed back. Instead of being on the hook for a minimum of $652 million and a maximum of $1.38 billion between now and the end of next year, the company has reduced that liability to between $529.85 million and $660.06 million. This is still a large chunk of change that management needs to address between now and the end of 2017, but it's far more reasonable than the larger range.
In my opinion, management entered into these debt transactions because, likely, it had little choice if it wants to increase its chance of survival. Based on this, it's hard to say anything bad about the deal, but I do wish management had, instead of increasing the size of the tender offer, used the excess cash to buy back debt at a discount to par on the open market over time. This is due solely to the high interest expense investors who decide to stay invested in the firm must now contend with, but this transaction may not necessarily be a dealbreaker for the company as a whole.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CHK over 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.