Credit analyst: Chesapeake could be takeover target; don't pass on this "tight" debt

By Ronda Fears

Nashville, Nov. 17 - Chesapeake Energy Corp. is probably not for sale, but Gimme Credit high-yield analyst June Giroux said in a report Monday that she would not be surprised if it became a takeover target. Moreover, she said that due to Chesapeake's track record, she recommends its paper even though it seems rather tight.

"While we don't believe the company is up for sale, we wouldn't be surprised to see Chesapeake become a takeover target. Investors who pass on its debt as 'too tight' run the risk of not participating in price appreciation, if the company is acquired by an investment-grade purchaser," Giroux said in the report.

With more than $2 billion of public debt, Chesapeake is a significant issuer in the high-yield energy sector and a driver of sector returns.

Giroux recommends traditional buy-and-hold high-yield investors maintain a market weighting in Chesapeake to match the market's performance. Specifically, she mentioned Chesapeake's 8.13% debt due 2011, 9% debt due 2012, 7.5% issue due 2013, 7.75% debt due 2015 and 6.875% debt due 2008. All are rated Ba3/BB-.

Just last week, Chesapeake sold $150 million of perpetual convertible preferreds at par of 100 to yield 5.0%, with a 37.5% initial conversion premium; the converts are non-callable for three years, then with 130% hurdle for life. Concurrently, Chesapeake sold $200 million of 6.875% senior notes due 2016, non-callable for five years, at 98.977 to yield 7.0% and with a three-year equity call for 35% at 105.875.

Chesapeake said those proceeds would be used to fund its recently announced tender offer for all of its $111 million outstanding 8.5% senior notes due 2012 and go toward repaying the bank facility.

The company said it also is considering offering to exchange, in a private placement, up to $500 million of its existing 8.125% senior notes due 2011 for additional senior notes issued in one or more series maturing after 2011 from existing series or the series of new notes.

"Chesapeake has been a whirl of activity in recent weeks. In late October, it announced strong third quarter results and a pending $200 million acquisition of 196 billion cubic feet equivalent of assets in south Texas," Giroux said.

"After drawing on its revolver to fund the purchase, Chesapeake turned its attention to more permanent financing," the convert and 6.875% senior notes.

For the September quarter, Chesapeake's production rose 5% over the June quarter and 52% over the prior-year quarter, she noted, while EBITDA increased 7% over the June quarter to $285 million, covering interest expense 7x.

On a last 12 months basis, she said, the company earned $914 million of EBITDA, which led to interest coverage of 6.1x and debt/EBITDA of 2.2x.

Using management's recent guidance for production growth of more than 11%, the analyst expects $1 billion of EBITDA next year, with interest coverage of 5.8x and leverage of 2.1x. Also, she estimates $20 million of free cash flow after interest expense, amortization, taxes, common and preferred dividends, with $700 million in capital expenditures.

"Chesapeake has an enviable debt maturity schedule with only $42 million of notes coming due in 2004. Management faces no other mandatory refinancing until the 2007 expiry of its revolver and 2008 maturity of $210 million of senior notes," Giroux said.

"In a series of transactions, the company has exchanged over $150 million of notes for lower coupon, longer maturity debt. Chesapeake actively manages its amortization schedule and has demonstrated its willingness to use equity, as well as debt, to finance growth."

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