by Aaron Levitt | March 18, 2014 11:03 am
Former natural gas leader Chesapeake Energy (CHK) is still haunted by the ghosts of previous CEO Aubrey McClendon. As the natural gas/fracking boom took hold, McClendon plowed CHK headfirst into a variety of the country’s newest (read: expensive) shale fields. Essentially, those moves caused CHK to outspend cash flows for 19 out the 20 years that McClendon was in charge.
It also caused CHK stock to become bloated with a hefty debt load.
In order combat that high debt load, CHK has undergone a huge divestiture of assets. In the last two years, Chesapeake has managed to sell off nearly $11 billion dollars worth of wells, midstream assets and drilling rights pay off its creditors. Many of the prime assets are now gone, and Chesapeake may have now reached “the kitchen sink” in terms of what’s going.
Which brings to the latest asset sale/spin-off: CHK is planning on selling a stake in its drilling and oil services unit. However, for CHK stock, the planned spinoff of the unit might not be all that valuable to Chesapeake or its shareholders.
Chesapeake is making good on the promise it made last month to do something with its oil field services unit. Today, CHK filed a Form 10 with the SEC in order to begin the process of spinning off that business into a separately managed firm. Dubbed Seventy Seven Energy (SSE), the Chesapeake IPO will distribute 100% of the firm into shareholders hands via a potential tax-free spin-off.
That’s all well and good, except it may not be the panacea that CHK stock is hoping for. Overall, the new Chesapeake IPO may not be the best option for the ailing firm.
The problem is that Seventy Seven energy is kind of a lightweight in the oil services industry. The firm’s only assets are 115 conventional-style land drilling rigs and nine hydraulic fracturing rigs. The bulk of those rigs are actually leased and not fully owned outright. CHK remains SSE’s largest client by far.
Given its small stature in oil services industry, SSE as suffered recently alongside other small fry oil service stocks like Basic Energy Services (BAS) and Key Energy Services (KEG). In the filing, CHK reported that Seventy Seven’s EBITDA was only $368 million dollars on revenues of $2.2 billion. Adding in other factors, SSE managed to produce a $20 million loss for all of 2013. That compares to a $70 million profit in 2012. As with KEG and BAS, higher operating expenses at SSE were the key reason for the loss.
Early estimations of what the oil service business would be worth were north of $2.5 billion. However, many of those estimates were made before CHK announced results for the unit as standalone firm. It hadn’t reported SSE as separate unit since 2011. The reported EBITDA numbers for SSE were on average about 12% lower than first thought.
Given those new numbers, analysts now predict that the unit may only be worth around $1.2 to $1.6 billion when spun off.
While $1.6 billion would certainly help CHK stock, it doesn’t necessarily go too far at plugging the expect hole in Chesapeake’s cash flows this year.
The preliminary filing didn’t show any pricing information, the exchange that will be given to current shareholders or exactly how many shares CHK will own. So it’s really hard to gauge just how successful CHK will be in raising money from the spinoff. However, even with the spinoff, the firm is still facing a cash crunch and will be forced to sell more assets this year and next to pay off its debts and fund its $5.2 billion capex budget.
The problem for CHK stock is that it’s really hitting the nitty-gritty in terms of assets the firm can sell. Soon enough, Chesapeake is going to have to start really dipping into its back of tricks and begin selling off some of prime production fields. Places like the Granite Wash or Mississippian Lime aren’t cutting it anymore. Potential buyers want the juicy bits — like the Marcellus.
Overall, that’s only going to exacerbate the problem of falling production at the firm. CHK expects its shale oil output to grow by just 1% this year. Meanwhile, overall natural gas production will fall 2%
At the same time, investors may not really want the newly minted Chesapeake IPO. After all, many of the smaller players are struggling in a very cost competitive environment when it comes to fracking in North America. There’s still a glut of pressure pumping equipment, and many of the cheapest/high-tech rigs are owned by the big three — Schlumberger (SLB), Halliburton (HAL) and Baker Hughes (BHI). Investors are better suited in any of those three major players.
The bottom line continues to be that CHK stock is a turnaround play — one that has only managed to solve a few of its problems. The newly minted Chesapeake IPO of Seventy Seven Energy isn’t really going to help CHK stock much in the grand scheme of things.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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