Chesapeake Energy (NYSE:CHK) has become an even more compelling investment after the last week's developments. The company has exceeded the assets sale target for the year and the elimination of near-term debt maturities. This has left it in a position where ample cash is available to increase production with the recovering commodity prices. Since I have regularly covered the impact of these moves on the debt profile and the debt metrics of the company, I will first start with the debt portion of this article.
There were two announcements from the company before Christmas. Both of these announcements are connected if we take a deeper look. The early results of the tender offer is a regulation news as the company was going to come out with these numbers. However, the second announcement regarding the complete redemption of 6.5% 2017 notes was not expected at this time. The response to the tender offer was better than my expectations. I was expecting the 2017 notes holders to stay put and wait for the final call from the company. The advantage in offering the notes for redemption looks insignificant and collecting interest payments might have been a more attractive option to most investors, in my opinion. However, the result was different and the early tender results show that almost 40% of the total outstanding amount was tendered. The image below shows the details of all the notes tendered.
Source: Press Release
Keep in mind that the 2017 6.5% note was trading at a premium of more than 3.2% the day this tender offer was announced. Since then, the price has come down gradually and the current premium is close to 2.75%. If we look at the cash consideration offered by the company in the tender offer, the premium offered (3.4%) is close to the premium offered by the market at that time. This might have also played a role in bringing down the market price of the notes. If we take into account the costs, the differential of 20 basis points becomes negligible. As a result, there is no benefit for the investors to pick it in the market at that price and offer it for redemption.
Chesapeake management, however, was probably expecting an even better response. I have said before that the cash is present and the management will certainly want to settle the 2017 maturity as soon as possible. Tender offer did not yield the desired results as there was still a substantial portion of debt outstanding. This prompted the management to go for the redemption call for the whole issue at a price of $1056.88, including the accrued and unpaid interest. This redemption call was announced on December 22. We can see a sharp fall in price on this day and the notes traded as low as $100.33. However, in the following week, the prices have recovered and the current price is close to $102.75. The image below shows the price action of the bond in the last twelve months.
Results for the 2018 7.25% notes were more encouraging as more than 81% of the total amount outstanding was offered for redemption. We might see another full redemption call as the management would most likely want to eliminate the near-term maturities. The response to the notes maturing after 2020 has been extremely poor. A total of $150 million were earmarked for these notes. We might see this amount also diverted towards the priority I notes (2017-2019). This move makes sense. Chesapeake can eliminate its debt obligations for the next three years by spending around $1.1 billion. For this, the management will have to either call the other two issues completely or buy them from the open market. 2018 notes are trading at a premium of about 5% while the 2019 floating rate notes are offering a discount of 1.5%. Both of these issues are callable and can be called at any time. I believe we might see another full redemption from the company.
The elimination of near-term maturities will leave enough room for the management to go ahead with the capital spending without a fear of any major debt obligation for the next three years. As the oil prices have started to recover, this is an ideal scenario for the management. Keep in mind that these issues are mainly being replaced with longer-term maturity debt. So, the effect on the debt metrics will be small. Some of these debt payments will come from the assets sold in the last few weeks. As a result, there will be a slight reduction in the overall debt of the company.
After the second sale in the Haynesville area and the private placement, Chesapeake will be left with around $1.4-1.5 billion in cash for the next year. I am assuming full usage of $1.2 billion earmarked for the tender offers. If the tender offers are filled according to the plan, the management will have a lot of freedom to make operational decisions in the next few quarters. These cash balances will provide ample liquidity. Also, the recovering commodity prices will bring in more cash and the chances of the company becoming cash neutral in 2018 will be enhanced. Another important factor to remember is the revaluation of assets at the end of the year. Since the commodity prices have been rising, the value of assets will go up and we might see a non-cash benefit in the fourth quarter of the year. This will further strengthen the balance sheet and Chesapeake's collateral will have more value. As a result, the management will have more options if they need to raise cash for short-term liquidity. These developments are the final piece of the jigsaw and the future direction of the company has become crystal clear. It is an excellent investment if you are willing to hold it for 2-3 years.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.