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Would Selling its Oil-Field Services Business be Good for Chesapeake?

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In an effort to raise much-needed cash to repair its balance sheet and fund its capital program, Oklahoma City-based oil and gas producer Chesapeake Energy (NYSE: CHK  ) has sold off more than $11 billion worth of assets over the past couple of years.

This year, it expects to peel off an additional $1 billion worth of resources, including the recently announced sale of midstream compression assets to Access Midstream Partners  (NYSE: ACMP  ) and Exterran Partners  (NASDAQ: EXLP  ) for total proceeds of about $520 million.

But that's not all. Chesapeake is also looking to monetize its oil-field services division, which could bring in proceeds in excess of $1 billion. Let's take a closer look at what impact a sale or spinoff of its oil-field services business would have on the company and its shareholders.

Photo credit: Chesapeake Energy.

Chesapeake to divest oil-field services division
Chesapeake announced in late February that it is pursuing strategic alternatives for Chesapeake Oilfield Services (COS), which could include either a spinoff to Chesapeake shareholders or an outright sale of the unit.

Chesapeake Oilfield Services is an affiliate of Chesapeake Energy that provides oil-field operations and equipment primarily to Chesapeake and its working interest partners, as well as to other upstream energy producers in the United States. These services range from contract drilling and hydraulic fracturing to rig relocation and water transportation.

COS reported $2.2 billion in revenue last year, and as of year-end 2013 owned assets including nine hydraulic fracturing fleets; a diversified oil-field rentals business; 260 rig relocation trucks; 67 cranes and forklifts used to move drilling rigs and other heavy equipment; and 246 trucks used to haul fluids.

Chesapeake's management says a spinoff or sale of COS would maximize its value to Chesapeake shareholders by optimizing capital allocation in line with the parent company's strategic objectives of financial discipline and profitable and efficient growth from its existing assets. In other words, Chesapeake believes COS is more valuable as a stand-alone company.

A good move for Chesapeake?
According to an analyst at Sterne, Agee & Leach, an outright sale would be the preferable method of monetization for COS, since it would immediately raise cash and also fits better with the company's strategy of reducing financial complexity. So just how much might COS be worth?

Though the segment's book value was estimated to be approximately $2.2 billion as of the end of the 2013 second quarter, Sterne, Agee & Leach analyst Tim Rezvan pegged the unit's value at about $1.2 billion. However, other analysts estimate it could be worth as much as $1.75 billion, according to The Wall Street Journal. If Chesapeake decides to sell COS and is able to fetch a fair price for the assets, the deal could certainly be a catalyst to push shares higher.

Not only would an outright sale bolster Chesapeake's balance sheet and improve its financial flexibility, it should also quell investor concerns about the company's funding gap and remove worries that it may resort to an equity issuance to raise funds. Sterne's Rezvan said "even a fire-sale price below book value could raise enough to retire the [company's] lingering preferred equity shares outstanding (believed to be $1.25 billion)."

Easing liquidity and funding concerns
Thanks to a combination of asset sales, drastically reduced spending, and improved capital efficiency, Chesapeake's funding and liquidity concerns have eased significantly. Even without the $1 billion in planned asset sales this year -- a figure that doesn't include the oil-field services spinoff or sale -- Chesapeake is confident that it can cover its estimated capital expenditures of $5.2 billion-$5.6 billion with the $5.1 billion-$5.3 billion in operating cash flow it expects to generate.

While I expect oil production growth concerns to continue to weigh on the company's share performance this year, improving liquidity and reduced concerns about a potential dilutive equity issuance should allow Chesapeake to concentrate more forcefully on its highest rate of return upstream opportunities. That should drive stronger, more profitable growth in the years ahead.

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Arjun Sreekumar

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.

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