Description

Management is diluting the bejeebers out of shareholders to repay bonds and the shareholders don’t seem to mind, so I recommend you buy a few Chesapeake bonds due in August of 2020 that trade at 75 cents on the dollar with a 15% ytm.

Chesapeake 2017 bonds were written up a little over 6 months ago – a great time to buy.  6 months ago management’s mission was to improve liquidity and manage debt maturities.  The market doubted Chesapeake’s survival.  The bottom appeared to have been when their ex-CEO got indicted with no recourse action to CHK. 

Over the last 6 months oil has bounced and the outlook for natural gas has improved.  Management has delivered on their promise to manage debt maturities in a particular way that no one expected – via equity issuances.   Given recent events it is hard to make a case that the bonds due in 2020 are not money good, offering investors a 15% ytm.  The company has shown us where their priorities are. 

Chesapeake has great analyst coverage and up-to-date investor presentations so this is not a full analyst report.   I just want to point out these equity issuances, which aren’t touted (and rightly so):

March 14, 2016:  CHK dilutes equity by 2.6% to repay $105 million in debt.

May 12, 2016:  CHK dilutes equity by 4.1% to repay $153 million in debt.

May 23, 2016: CHK dilutes equity by 5.2% to repay $166 million in debt.

June 8, 2016:  CHK dilutes equity by 2.9% to repay $125 million in debt.

Ever wondered what kind of stock goes from $1.60 to $5 in just a few months all the while being continually & significantly diluted?   Answer: a stock for a company with good assets but the wrong capital structure… a stock where the owners do not want to give up the company to the bondholders.  An equity holder might be looking at it like this:  CHK assets were worth $22 billion when oil was $89 and gas was $2.68 (PV-10 from 2014 year end reserve report).  Roughly the same pile of assets were worth $4.7 billion when oil was $50 and gas was $2.68 (from 2015 year end reserve report).    There is $8.7 billion in debt standing between the owners and these very valuable assets (at slightly higher commodity prices).

In their original projections for how they’re going to repay debt they highlighted asset divestures, spending less on capex and enhancing operating cashflow.   Recent equity issuances work out to be $500 million on top of all the other promises they made (and over-delivered on).  Best of all, it appears the equity holders don’t mind as the share price is hovering in the $4-$6 range. 

Coming due [ahead of us] over the next 3 years is $2.1 billion in debt repayments. 

There are a few ways we can get over this hump:

(1)  EBITDA!   In the first quarter of 2016 ebitda, interest, and capex that were a wash.   Commodity prices have since improved.  Locking in at current prices would get us an additional $700 million per year over 1q run rate. 

(2)  DIVESTING ASSETS.  Divesting more assets and issuing more equity could get us there.  Year to date they’ve sold $1.2 billion in assets and issued $500 million in equity.   They sold less than half their “Stack” assets for $500 million (recent Stack writeup in WSJ didn’t even mention CHK).   

(3)  ABL  As a last resort, leaning on their $4 billion ABL could get there, as well.   As of the most recent quarter they’ve drawn out $619 million.  Their borrowing capacity could increase as commodities recover.

Summary:

Their debtload is not as threatening as it once was – down 33% from all time high, down 13% from yearend. 

Perspectives have changed – survival is focus.  Intentions have been made clear - equity holders are going to pay.

Expectations have been adjusted  - not banking on a return to $100 oil.  The status quo will do nicely.

I realize it is hard to buy bonds for 75 cents that were trading at 12 cents just 6 months ago but this is a different beast now.   A cashflowing, 15% ytm investment isn’t too bad these days.  PS Whatever you do don’t tell the equity holders.

Catalyst

time

generous equity investors