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by Ahmed Isthiaq

As the prices for natural gas fell to a record low, Chesapeake Energy Corp. (CHK) suffered massively due to its status as the second largest natural gas producer. Chesapeake was overexposed to the natural gas prices, which hurt it and the stock suffered. In addition, the company faced a liquidity crunch, and had to borrow at extremely unfavorable rates. However, the oil company has changed its focus recently and currently it is working on reducing its exposure to natural gas. In order to achieve its goal, the company has decided to sell almost $14 billion of assets during 2012. Chesapeake has sold almost $12 billion worth of assets till now. Recently, the company announced the sale of assets in Permian Basin; let's look at how the company plans to use the proceeds and how it can affect it.

Asset Sales:

Chesapeake agreed to sell a major share of its infrastructure and properties in west Texas for a total consideration of $6.9 billion. The company agreed deals worth $3.3 billion, with Chevron Corp. (CVX), Royal Dutch Shell Plc (RDS.B) and Houston-based EnerVest, Ltd. to sell the properties. On October 22, the company announced that it had completed the sale of assets in the Permian Basin area. The Permian Basin assets produced about 90 million cubic feet of natural gas and 21,000 barrels of liquids per day during the 2012 second quarter. The production from the Permian base accounted for around 5.7% of Chesapeake's total production during the quarter. Chesapeake is trying to reduce CAPEX and an additional $4 billion to $5 billion worth of assets will be sold in 2013.

Where Will The Net Proceeds Be Used?

Net proceeds from the most recent transactions were about $3.3 billion, of which the company received around $2.8 billion in cash at closing. The payment of the remaining proceeds will be subject to certain title, environmental and other standard contingencies. The company plans to reduce the existing balance of term loan. The term loan currently stands at $4.0 billion, and the company will bring it down to $1.2 billion by the end of October. Chesapeake will completely repay the term loans by year-end. The term loan was made in May, and went a long way in solving the liquidity problems at that time. However, the loans came at an extremely high rate of 8.5%, which can rise to more than 11% if the company does not pay it off by the end of the year. So far, the company has sold about $12 billion of its assets, a situation that has eased its liquidity crunch.

How Does It Affect The Balance Sheet?

Recent assets sale will help solve the company's short-term cash needs, but overall production will be affected. The assets accounted for almost 6% of the production of the company. Chesapeake was facing serious troubles concerning its debt and cash flows. As a result, the lenders of the firm were putting pressure on the company. Under a range of debt covenants, the company had promised to raise cash through divestitures, in order to keep itself from going into default. However, the company was successful in convincing its lenders to modify the terms of its debt covenants in order to protect the loans from further problems.

The proceeds from these sales will go a long way in solving the debt problems at the company. The company has covered the funding gap for the current year with the sales during the year. However, there will still be funding gap of around $3.3 billion in 2013. The company intends to tackle the issue with the same approach and hopes to sell $4.2 to $5 billion worth of assets in 2013. I believe the company is moving in the right direction, and the financial situation at the company will improve.

Funding Gap Is An Issue For The Industry:

Companies in the oil and gas sector have been spending excessively in order to increase earnings and exploit the Shale plays. As a result, the funding gap has become a common problem for companies in the industry. Big players like Exxon Mobile (XOM) and Halliburton (HAL) have been spending excessively in the plays. Most of the companies have been borrowing to fund the capital expenditures, resulting in deteriorating balance sheets. Halliburton spent $919 million during the third quarter, bringing the total for the first half of the year to over $2.519 billion. For the same period, the company reported net income of just over $1.9 billion.

Chesapeake spent almost $1.3 billion in capital expenditure during the second quarter, as compared to a net income of $972 million. However, Exxon was the biggest spender after spending more than $8.3 billion in the second quarter. Although, Exxon reported a net income of $15.9 billion, almost double its capital expenses; it reported a net cash outflow of $868 million.

Summary:

Chesapeake is certainly on the right track and the company will benefit from increasing its exposure to oil. Recent sales of assets will help ease the cash issues and increase the liquidity of the company. Natural Gas prices are rising, but it is unlikely the prices will reach old heights again. The gas supply will be high due to the massive reserves in the Shale plays, which will keep the prices in its lower ranges. However, increased supply creates the potential for exports. Chesapeake is not completely out of its troubles, but the company is not far from reaching safety either. In the long term, the company will be able to get back to its previous high.

Disclaimer: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Chesapeake: Another Comeback Story?