On January 5th of 2017, the management team of Chesapeake Energy Corp. (NYSE:CHK) announced that they had finalized the results of their tender offer, first announced late last year. This provides not only a final answer regarding their larger $1.20 billion that the company had shown prior results of before year-end but also gave a final reading on how much they would be buying back of some other convertible notes. Now that we have an answer regarding how much this should impact the company and now that the CEO has just come out announcing a major future objective, I figured it would be a wise idea to cover these topics in some more detail.
Last year, Chesapeake, in an attempt to fight its way to being cash flow neutral instead of generating hefty cash outflows in order to maintain existing output, announced that it would be accepting up to $1.20 billion worth of Senior Notes, some at a premium to par and others at a discount, plus accrued and unpaid interest, in a fresh tender offer. While I would have loved to see management be able to fulfill the full amount, holders of these notes have been incredibly stubborn, forcing the business, in order to buy back more debt, to redeem it a different way.
The end result, which is similar to management's prior disclosure last month, was that $554.1 million worth of debt had been tendered and accepted, costing the company, due to the premiums it must pay, an aggregate of $578.54 million. While this premium is unappealing in and of itself, it helps to drastically reduce near-term maturities of Senior Notes and will deploy cash that is making next to nothing (some of which comes from high-cost debt issuances put out last year) toward lowering annual interest expense by $38.61 million. I can't speak for you but, by my standards, that's a sizable reduction in costs that otherwise don't add any value to the firm if paid out instead. This excludes the interest reduction from the early redemption of the rest of Chesapeake's 6.5% Senior Notes due in 2017, which will lower annual interest expense by a further $8.70 million.
In addition to this move, however, the company also revealed financial numbers associated with its convertible notes. Their 2037 notes have a low interest rate of 2.5% per year and their 2038 notes have a rate of 2.25% so it may seem odd, given how long until they mature, for management to have put out a tender off for these securities but they are structured in such a way that holders can force the company to buy back the 2037 notes this year and the 2038 notes next year. Previously, the firm did not give any update regarding the progress of its tender regarding these securities.
Now that details are finalized, however, they revealed that they will be buying back $99.5 million worth of the 2037 notes in exchange for $100 million and they will be buying back $187.8 million of the 2038 notes in exchange for $185 million. This will not only decrease the risk of being surprised between this year and next year but will also lower the firm's interest expense by a further $6.71 million each year. Put together with the $1.20 billion component of its tender offer and adding in its early redemption announced last last month, total annual interest expense should fall by around $54.02 million. That's enough to leave me set for the rest of my life.
Management's not done fighting yet
The one problem I have with Chesapeake, and the sole reason why I haven't bought it yet, comes down to the fact that the firm is still seeing cash flow out every year under current assumptions (if you factor in capital expenditures, which they could technically cut back on and let production fall if they chose to do so). That said, management seems to be addressing this concern even in spite of major moves last year. Based on what CEO Doug Lawler announced on January 5th, the firm engaged in around $2.5 billion worth of asset sales during 2016 (including those not yet closed but that have been agreed upon). This was above the $2 billion previous goal announced.
Despite these transactions and other moves to lower debt, Lawler stated that, over the next two to three years, their goal is to lower the company's debt by around $2 billion to $3 billion. Without a doubt, some of this will be driven by Chesapeake's cash on hand today but with the firm expecting to not be cash flow neutral until at least 2018, further asset sales, debt-to-equity swaps/conversions, and maybe share issuances (hopefully preferred instead of common) will be on the agenda most likely. My money goes on any debt reduction being driven largely by cash on hand plus asset sales since any other approaches would probably leave Chesapeake's shareholders jaded.
Based on the data provided, it's clear that Chesapeake's management team is still hard at work trying to save the business. Certainly, with cash flow expected to be negative this year and maybe next (it depends on energy prices and cost-cutting measures), a lot of work still needs to be done but what matter is that the progress so far has been impressive and will almost certainly add value to the business in the months and years to come. Of course, there is still a great deal of risk should energy prices tank again, but that can be said of most players in this space. If, however, management can follow through on this very significant pledge regarding debt reduction, this level of risk should drop substantially.
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.