1 Reason to Avoid Chesapeake Energy Corporation's Spinoff

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Chesapeake Energy (NYSE: CHK  ) recently announced that it filed a registration statement on Form 10 with the U.S. Securities and Exchange Commission for the possible spinoff of its oilfield services division. The announcement comes after the company said last month that it is exploring strategic alternatives for the business. Chesapeake plans to distribute 100% of the spinoff's common stock to its shareholders. Once that happens, the key question for Chesapeake shareholders becomes whether they should continue holding shares in the spinoff. 

Spin off of oilfield services business
Chesapeake, which is looking to reduce its debt level, last month said that it is pursuing strategic alternatives for its oilfield services division, Chesapeake Oilfield Services (COS). Earlier this month, Chesapeake added that Chesapeake Oilfield Operating, which conducts the operations of COS, filed a registration statement on Form 10 with the SEC for a possible spinoff of the business.

Chesapeake Oilfield Operating will be converted into a corporation and renamed Seventy Seven Energy. The company expects that the spinoff will be tax free for shareholders. Chesapeake has not said when it plans to spin off the unit. Also, the number of spinoff shares that Chesapeake shareholders will get remains unclear. However, the company has said that 100% of Seventy Seven Energy's common stock would be distributed to its shareholders. But should investors keep their shares of the standalone oilfield services company?

Robust outlook for oilfield services business
Oilfield services stocks have had an excellent run over the past year; shares of Halliburton (NYSE: HAL  ) and Schlumberger (NYSE: SLB  )  have posted significant gains. In the past year, Halliburton shares have gained nearly 50%, while Schlumberger has seen its stock advance more than 28%. One reason for the strong performance has been the robust outlook for the oilfield services business.

According to Barclays, global spending on exploration and production is set to increase 6.1% in 2014 to a record $723 billion. The spending growth will be driven largely by the development of U.S. shale and Gulf of Mexico deepwater fields. Analyst research firm Cowen is slightly conservative in its E&P spending forecast. Still it expects an estimated 4% increase in spending to $687 billion. Similar to Barclays, Cowen forecasts a rebound in U.S. exploration and production spending; it is projecting an increase of 5.3% in 2014.

Given that Chesapeake's oilfield services division focuses on the United States, this is good news. But this is not the whole story. There is one major concern when it comes to Seventy Seven Energy.

Reliance on Chesapeake
Seventy Seven Energy, whenever it is spun off, will rely heavily on Chesapeake for its revenue. The unit reported revenue of around $2.2 billion in 2013; however, Chesapeake accounted for the majority of that revenue. The unit only generated around 10% of its total revenue from third-party exploration and production companies.

At least initially, Seventy Seven Energy as a standalone company will be relying heavily on one customer. And that customer happens to be a company that is cutting its capital spending. Last month, Chesapeake said that its capital expenditures for the year would fall around 20%. In such a scenario, one can expect a negative impact on Seventy Seven Energy's top line.

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Read/Post Comments (6) | Recommend This Article (3)

Comments from our Foolish Readers

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  • Report this Comment On March 27, 2014, at 9:44 AM, TruthSeeker47 wrote:

    Uh, isn' it obvious, Varun, that once the spin off is spun off, they can then solicit businesses from other companies, which they could not seek when still part of Chesapeake Energy?Thus your whole premise anticipates a new company frozen in its old ways, which is likely not to happen with a new board and leadership, able to make decisions independent of old Chesapeake.

  • Report this Comment On April 02, 2014, at 6:36 PM, mikewatson021 wrote:

    Since 2010, they have invested in CAPEX in significantly bigger portion of their cash flow. 2014E total CAPEX is expected to be somewhere In between $5.2 - $5.6 Billion.

  • Report this Comment On April 02, 2014, at 6:37 PM, stevebry56 wrote:

    They have always been to capture supply Chain management efficiencies. They continue to invest in development projects and make sure they get the most benefit out of it.

  • Report this Comment On April 02, 2014, at 6:39 PM, mikewatson021 wrote:

    I heard they are spinning off their oilfield services division which is a strategic decision. And the company will distribute all of that common stock to its shareholders.

  • Report this Comment On April 02, 2014, at 6:40 PM, stevebry56 wrote:

    The energy landscape is changing radically. As oil exports from the US are rising as we are gaining energy independence. And Chesapeake plays a major role here

  • Report this Comment On April 14, 2014, at 5:40 PM, mikewatson021 wrote:

    Chesapeake Vitality got long-term credit card debt promises totaling $12. 74 million in finally fraction economical year 2013, without having part of your debt because of older in 2014.

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Varun Chandan

I have a Master in Finance degree from IE Business School in Madrid. I use the top-down approach when it comes to investing. I like to analyze macroeconomic factors and how they impact individual companies.

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