Chesapeake Energy Strengthens Its Balance Sheet

| About: Chesapeake Energy (CHK)
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Summary

The results of the tender offer are according to the management's wishes.

There will be an increase in debt and interest expense if the management does not decide to use its cash balances.

Sensitivity to oil price is causing the stock price to be volatile.

Please follow this link to read my previous articles about the company.

Chesapeake Energy's (NYSE:CHK) early tender results show that the response has been according to my expectations. This is also what probably Chesapeake management wanted from this tender offer. I would term this a successful step in its efforts to push back debt maturities. Since the management was raising funds at 8%, tender offer would have only been efficient if the existing notes with similar interest rate were replace. This is exactly what Chesapeake was able to achieve. The premium offered by the company has certainly done the job as the amount for the notes tendered was more than twice the aggregate maximum purchase amount. This is what I highlighted in my previous article on the subject:

"The $750 million private placement has been priced with interest rate of 8%, paid on semi-annual basis. The rate looks expensive in isolation. However, if we look at the tender offer then it becomes clear that the management is trying to mainly replace 8% 2022 notes with this private placement. 2022 notes are secured and a total of $2.4 billion is outstanding under this issue. Ideally, the management would like to replace like-for-like and all the proceeds would be spent to repay 2022 notes. It is the priority level I debt in the tender offer and does not carry any tender cap. As Chesapeake is offering $35 premium for early retirement, the management will have to dig into its cash balances and/or credit facility in order to replace the exact amount of debt. There is a difference of $100 for every note. If the management only uses the proceeds from the private placement then there will be an increase in outstanding debt."

The image below shows the results of the tender offer.

Source: Press Release

As I expected, a large number of 2022 note holders offered their notes for redemption. I believe the $35 premium was too good to ignore. The amount tendered easily surpassed the maximum amount earmarked for the issue. This was a good thing for the company and exactly what the management wanted. Now they have been able to push back the maturity of a high-cost debt. In terms of cost, Chesapeake does not save anything. In fact, there will be an increase in total interest payment as the premium paid for the redemption of these notes means lower number of notes will be redeemed. So, based on the simple calculation, there will be an increase of around $68 million in the long-term debt of the company. Keep in mind that this is the early result of the tender offer and we might see some changes once the tender offer expires. If this remains unchanged, there will be an increase of around $5 million in annual interest expense.

Chesapeake Energy gets two benefits out of this transaction. First, the management has been again successful in pushing back the maturity of some of its debt. Although this debt was not maturing immediately, pushing it further back by five years gives Chesapeake some more room to breathe. Secondly, 2022 notes are senior-secured and these notes are being replaced by an unsecured issue. This means that some of the collateral will be freed up after this transaction. More collateral might help the company get better covenants and rates for its credit facility or future debt issues. As with the previous debt reshuffling efforts in the last 12-16 months, I believe Chesapeake management has done well here. We might see some more reduction in debt by the expiration of this tender offer. We will have to wait for the final results.

Stock price is under pressure again. Chesapeake Energy's sensitivity to oil prices is extremely high. It moves in tandem with the oil prices. Due to the US inventory numbers (an increase of 3.3 million barrels) and the rift between the OPEC members, oil markets have become extremely volatile. Oil and gas companies' stocks will show the same trend in stock prices. However, it should be kept in mind that Qatar is a small player in the global crude oil market and its boycott by Saudi-led Arab block will not affect the supply cut agreement. Traders in the oil and the LNG markets (Qatar is the largest LNG exporter in the world) are still weighing the effects of this tension among these countries. As a result, these markets will remain extremely volatile in the next few days. Oil lost more than 5% on June 7, but it was up 1% in the early trading on June 8.

This tender offer has further enhanced Chesapeake Energy's debt profile. The company has reduced its payment obligations in the next five years. As the oil prices recover, lower debt payments will leave more free cash flow for shareholders. I still believe oil prices will be close to $60 by the end of the year. Supply cut agreement is having an effect on inventories in Asia. The progress is slower than expected but there is certainly some progress. Also, Saudi Arabia has reduced its exports to the US in order to bring US inventors down. As the domestic consumption increase in summers, Gulf countries will be exporting less, which will result in reducing Asian and US inventories. Major agencies are also predicting a balance in the oil market in the near future. If the oil prices rise to $60, Chesapeake Energy will benefit substantially.

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.