Chesapeake Energy (NYSE:CHK) is likely headed towards bankruptcy. Don’t be fooled about this. CHK stock will then be worthless if that occurs. This is not a huge turnaround play.
The evidence is pretty clear. On March 16, CHK management hired two well-known restructuring firms, Kirkland and Ellis as well as Rothschild, according to Reuters.
A recent Seeking Alpha article by WYCO Researcher skillfully analyzes Chesapeake’s current debt situation. The author shows that CHK’s massive $9 billion in debt will likely not be able to be handled by the company in 2021.
Despite Chesapeake’s futures hedging for 2020, its debt maturities in 2021 will cause problems. In addition, low futures prices for 2021 will severely limit its options to survive.
Moreover, there are numerous tranches of debt on CHK’s balance sheet. This will also make operating without a restructuring solution very difficult.
How Did Chesapeake Energy Get in This Position?
The Wall Street Journal chronicled the background to Chesapeake’s latest predicament in an article on Jan. 1, 2019. The piece describes Chesapeake’s switch from a focus on natural gas production to shale oil just as the prices of oil had fallen 40%.
Little did they know that oil prices, then down 40% from their peak, would continue to crater. Chesapeake made a big bet on finding oil in Wyoming’s Powder River Basin using fracking.
The problem, though, was that drilling in the heterogeneous rocks that are frequently laced with faults made drilling more expensive. It costs Chesapeake Energy roughly $8 million to drill and hydraulically fracture each of its wells in Wyoming, compared with about $6 million in the Eagle Ford shale of South Texas.
Chesapeake spent $4 billion on an ill-timed acquisition of Wildhorse Resource Development Corp. On top of that the company came with $1.1 billion in additional debt.
Chesapeake had over $9.4 billion of debt on its balance sheet as a result of these developments. Then the price of oil tanked even further, as we know. Now the company still has $9 billion in debt. It has little chance of working its way to paying it down without a restructuring.
Bloomberg also recently chronicled Chesapeake Energy’s attempt at the end of February to raise even more debt to work out of its situation. At that time CHK stock was trading for just 30 cents per share. Today it is just seventeen cents.
What Should Investors Do With CHK Stock?
CHK shareholders will vote April 13 to approve a reverse stock split ranging from 1-50 to 1-200. The board will decide the actual amount. The reverse split is needed to retain Chesapeake’s stock listing on the New York Stock Exchange.
For example, with a 1 for 50 reverse split, every existing 50 shares will receive one new share of CHK stock. As a result, the stock price will rise by 50 times from seventeen cents to $8.50 per share, since there would be 50 times fewer shares outstanding. A 1 for 200 reverse split would push the stock price to $34 per share.
Typically reverse splits are done for companies like CHK which are being threatened with delisting. It’s usually a sign of a company in trouble. It is no magic wand that will push the stock higher, although that often occurs.
So be careful about this. If the restructuring team manages to avoid bankruptcy, which seems highly unlikely, the next most likely thing to occur is the following: a massive dilution of shareholders.
In effect, shareholders will have to make room for debt holders in the common stock capitalization table. Debt holders will likely demand not only majority control but likely supermajority control. This will be the price for letting go or loosening the debt structure presently strangling Chesapeake Energy.
Here is the bottom line: be very careful with CHK stock. This is a turnaround play that is highly likely to not turn around. Chesapeake Energy will likely end up in bankruptcy.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
