Chesapeake says ‘running our business right’ will lead to IG ratings

By Paul Deckelman

New York, Aug. 6 – Chesapeake Energy Corp. continued to reduce its debt levels during the 2014 second quarter and simplify its complex capital structure via a strategic transaction totally funded from cash on hand.

And the Oklahoma City-based oil, natural gas and natural gas liquids producer’s chief executive officer essentially told analysts on its Wednesday conference call following the release of its results for the quarter that rather than take specific actions aimed at lifting the company to investment-grade status, it would just keep on doing what it’s been doing, with the expectation that such a status will be achieved in the end.

“It’s not specifically that we are targeting investment grade,” declared CEO and president Robert D. “Doug” Lawler in answer to an analyst’s question, continuing that “investment grade is a by-product of running our business right. So we expect to reach investment grade because we’re going to clean up the excessive debt that can be a burden on our capital program in high [energy]-price environments or low-price environments.”

Chesapeake’s executive vice president and chief financial officer, Dominic J. “Nick” Dell’Osso Jr., added that “we are very proud of our operational and financial performance year to date as well as the significant progress we’ve made towards our strategic objective of leverage reduction and balance sheet simplification.”

Ratings agencies note progress

Dell’Osso noted that the company is currently in the process of reducing debt and other commitments by over $6 billion in two years and that the ratings agencies apparently took notice of Chesapeake’s progress in this area with a two-notch upgrade in its ratings during the quarter, “such that we are now positioned just below investment grade.”

After the company reported favorable first-quarter results in early May and subsequently announced several asset-sales agreements and a definitive plan to spin off its Chesapeake Oilfield Operating subsidiary at the end of June, thereby reducing its adjusted debt by almost $2.5 billion and raising cash proceeds of $915 million, Standard & Poor’s raised Chesapeake’s corporate credit rating two notches to BB+ from BB- with a stable outlook. It also raised its issue-level rating on Chesapeake's senior unsecured debt to BB+ from BB- and its rating on Chesapeake's preferred stock to B+ from B-. S&P further revised the liquidity assessment on the preferreds to “strong” from merely “adequate,” and the comparable rating analysis assessment was revised to “favorable” from “unfavorable.”

Moody’s Investors Service upgraded Chesapeake’s corporate family rating to Ba1 from Ba2; probability of default rating to Ba1-PD from Ba2-PD; senior convertible bonds, senior exchangeable bonds and senior regular bonds to Ba1 (LGD4, 58%) from Ba3 (LGD4, 62%) and speculative grade liquidity rating to SGL-2 from SGL-3, with the outlook remaining stable.

Fitch Ratings revised the company’s outlook to positive from stable and affirmed its long-term issuer default rating at BB-, senior unsecured notes at BB-, senior secured revolving credit facility at BBB- and convertible preferred stock at B, citing Chesapeake management's stated intention of deleveraging the company and simplifying its capital structure.

Balance sheet is improved

One such deleveraging transaction occurred at the end of the second quarter on June 30 as the company completed its previously announced plan to spin off its oilfield services business into an independent publicly traded company, Seventy Seven Energy Inc. Chesapeake gave its shareholders one share of the new Seventy Seven Energy for every 14 Chesapeake shares they held. The transaction allowed Chesapeake to chop $1.1 billion of debt associated with the spun-off assets from its balance sheet, effective June 30.

Chesapeake also remained busy with sales of non-core assets. Proceeds were mostly applied to deleveraging.

During the second quarter, it received total proceeds of about $675 million from the sale of non-core assets, including $362 million of net proceeds from the sale of compression assets to Exterran Partners, LP. That followed a first quarter during which the company had received total proceeds of about $520 million from asset sales, including $209 million of net proceeds from the sale of its common equity ownership interest in Chaparral Energy, Inc., $159 million from the sale of compression units to Access Midstream Partners, LP and $152 million of net proceeds from the sale of real estate and other non-core assets. During the remaining second half of the year, Chesapeake expects to receive more than $700 million of additional proceeds from various asset sales that have closed or are still underway.

Lawler and Dell’Osso meanwhile pointed to a recently announced measure to streamline the capital structure – Chesapeake’s repurchase of all of the outstanding preferred shares from the third-party holders of its Chesapeake-Utica LLC subsidiary, which Chesapeake set up in 2011 to develop a portion of its oil and gas assets in the Utica Shale formation in eastern Ohio, Western Pennsylvania and northern West Virginia.

It announced on July 29 that the slightly more than 1 million shares, carrying a listed balance-sheet value of $807 million at June 30, had been bought back for $1.26 billion, translating to a redemption price of about $1,235 per share.

Lawler called the transaction “another important step in our strategy to simplify the company’s balance sheet while reducing high-cost leverage instruments.

“Importantly, we were able to fund the $1.26 billion repurchase price of these securities entirely through unrestricted cash on hand as of June 30.”

The repurchase retired Chesapeake’s highest-cost leverage instrument and eliminated about $75 million of annual cash dividend payments to the third-party preferred shareholders.

At the same time that it announced the Chesapeake-Utica transaction, the company also unveiled a separate deal with RKI Exploration & Production, LLC, under which the two companies would exchange non-operated interests in about 440,000 acres of the Powder River Basin formation in southeastern Wyoming, with Chesapeake additionally paying RKI $450 million in cash at the closing, which is supposed to take place this month.

Dell’Osso said that between them, the Utica and Powder River transactions would cost Chesapeake about $1.7 billion – but he said that as of June 30, Chesapeake already had $1.46 billion of unrestricted cash on hand and would be getting the $700 million from second-half non-core asset sales, leaving the company a cash balance in excess of $450 million once all of the various transactions have been completed and paid for.

“I’m very pleased that we have the ability, using our existing capital resources, to pursue this kind of accretive, high-value transaction that will materially improve our net asset value,” he declared.

Debt levels declining

As of the end of the second quarter, Chesapeake had about $11.55 billion of long-term debt on its balance sheet, with its nearest-term maturities being $396 million of 2.75% contingent convertible senior notes nominally due in 2035 but with an investor put option effective in 2015 and $500 million of 3¼% senior notes due in 2016.

The June 30 debt figure also includes $3 billion of senior notes that it priced at par in a quick-to-market two-part deal on April 10 – $1.5 billion of floating-rate notes due 2019 and yielding 325 basis points over Libor and $1.5 billion of 4 7/8% notes due 2022. Proceeds from the bond deal were used to repay term loan borrowings, tender for the company’s more than $1.2 billion of outstanding 9½% senior notes due 2015 and redeem the last $97 million of outstanding 6 7/8% notes due 2019.

The long-term debt figure was down from $12.65 billion at the end of the first quarter on March 31, $12.89 billion at the end of the 2013 fourth quarter and fiscal year on Dec. 31 and $13.06 billion at the end of the 2013 second quarter.

With $1.46 billion of cash on the balance sheet at June 30, Chesapeake’s net debt was $10.09 billion, down from $11.97 billion in the first quarter, $12.05 billion on Dec. 31 and $12.38 billion a year ago.

The company’s ratio of debt as a percentage of total capitalization stood at 36% at June 30, down from 39% on March 31 and 40% on Dec. 31 and a year ago.

Its quarterly interest expense had declined to $27 million from $39 million in the first quarter, $63 million in the 2013 fourth quarter and $104 million a year earlier.

During the question-and-answer portion of the call following his and Dell’Osso’s formal presentations, Lawler asserted that “the financial strength of the company creates optionality for when we can either pay off debt, pay off other obligations [or] continue to mold and improve the portfolio to capture the greatest value we can from these high-quality assets.”

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