Is Chesapeake Energy Corporation (CHK) going to file for bankruptcy, or isn’t it? The company says it isn’t. But the fact that CHK stock is still 28% in the red today says the market doesn’t believe the energy company can avoid it … even if it’s not going to happen right away.
The rumor — and that’s all it is at this point — began late Friday when fixed income news and research outfit Debtwire reported that Chesapeake Energy had retained law firm Kirkland & Ellis to help the natural gas company restructure $9.8 billion in debt.
Simply put, Debtwire doesn’t see Chesapeake Energy being able to pay all of its bills (now and/or later).
It’s not a completely crazy notion. As yours truly here noted in late January, Chesapeake’s decision to suspend the dividend paid to preferred stock owners would only make a small dent in the amount of money it needed to stop bleeding if it wants to survive.
Is Chesapeake Energy Too Far Gone to Save?
Debtwire isn’t wrong to be concerned about Chesapeake Energy’s lack of cash. A whopping $1.3 billion worth of debt, or bonds, are going to come due by the end of 2017, with $500 million worth of notes coming due next month.
It’s a problem, as Chesapeake Energy only had $1.76 billion in cash as of the end of Q3, and only $545 million in other current assets. That’s enough to pay March’s debt bill, but leaves the company pretty well dead in the water to do much else after that. CHK lost $4.6 billion in that same quarter, and free cash flow for Q3 2015 was negative $372 million.
In other words, Chesapeake Energy is running out of money fast with crude oil prices at rock-bottom levels. The oil and gas driller is expected to be underfunded by $1 billion for the next couple of years.
Former Centaurus Advisors hedge fund manager John Arnold flatly summarized the issue, saying:
“Legacy costs are overwhelming… They have too much debt… Margins were not bad in 2015, but companies had a high percentage of oil price hedged. They’re not as highly hedged in 2016 and saw a steep change in revenue on January 1st.”
In that light, Debtwire’s assumption makes sense. The market doesn’t disagree.
Death Spiral for CHK
CHK stock had been down as much as 50% following the proliferation of the premise it was on the verge of bankruptcy, though shares rebounded to a loss of “only” 32% by mid-day. The company’s near-term debt maturing in March, however, didn’t recover nearly as well.
Though trading at 95 cents on the dollar just last week, the rumor sent those notes to a value as low as 74 cents on the dollar today. The bond market is concerned that the bankruptcy rumor is a red flag, whether or not the company is actually going to file Chapter 11.
While the risk of a massive debt burden came to an evident head today, this risk has been brewing for quite some time, and may have actually reached the tipping point last month.
Although significant leverage isn’t uncommon for energy stocks, the balance between the upside and downside of leverage is a delicate one. Most highly leveraged energy outfits enjoy being able to pay off old debts by issuing new ones … and the era of stunningly low interest rates encouraged the likes of Chesapeake Energy to leverage themselves to the hilt.
The advantage of cheap money, however, was up-ended by the jaw-dropping implosion of oil and gas prices. Now the company is struggling to refinance its debt.
Case in point? Last year, Chesapeake issued $3.8 billion worth of notes to pay off $2.4 billion worth of second-lien debt. More recently, Chesapeake Energy’s credit rating fell further into junk status, with Fitch downgrading it from BB to BB-. The lower credit rating makes it even more expensive and difficult for the company to borrow money.
It didn’t take long for the company to slip off that leverage balance beam, and as is the case with most balance beams, Chesapeake isn’t apt to recover now that it has started its debt death spiral.
Bottom Line for CHK Stock
Per the company’s official statement this morning, Chesapeake Energy probably isn’t planning on filing for bankruptcy right now. To that end, Debtwire arguably should done a little more digging before voicing its conclusion.
On the other hand…
Now or later, Chesapeake has a debt problem that’s now becoming an operational problem. Barring a massive rebound in the price of oil, and soon, the company is going to have to raise money through the sale of equity, or via the sale of more debt. Neither are going to be cheap; investors generally don’t like to jump on a sinking ship.
In other words, whether bankruptcy is in the cards or not, CHK stock and bondholders both have a serious uphill battle ahead of them.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.