Not Much Value in the Chesapeake Energy Spinoff

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

With a high debt load, it is understandable that Chesapeake Energy (NYSE: CHK  ) is cutting back on spending and spinning off some of its assets. Unfortunately, the combination doesn't necessarily portend well for a separated subsidiary that depends on the previous parent for a substantial portion of its revenue.

Chesapeake Energy spent the last several years struggling with a superior asset base of leading acreage positions in most of the primary shale areas. The company's stock continues to struggle due to expenses and the high debt load that is now causing it to cut capital spending at a time of low natural gas inventories.

A few weeks back, the company submitted documents to spin off the oilfield services division in order to reduce corporate debt by $1 billion and allow the independent firm to better attract non-Chesapeake clients. The division primarily operates a land-based drilling fleet and hydraulic fracturing fleets that might compare favorably to combination of Helmerich & Payne  (NYSE: HP  ) and C&J Energy Services (NYSE: CJES  ) . While those two companies are trading at 52-week highs, one shouldn't expect similar peak pricing for the spinoff.

Seventy Seven Energy
Though the company had intentions of either taking the old Chesapeake Oilfield Services division public or selling it outright to fill capital holes, the only remaining option appears to be a spinoff of the assets to existing shareholders. It's hard to blame the market considering that the division was originally created as the oilfield services arm for Chesapeake, and that particular customer is currently reducing its spending by up to 20% this year. In essence, the company is unintentionally weakening the business prior to unloading it on the market.

Chesapeake has chosen to rename the oilfield services subsidiary Seventy Seven Energy, and it will trade on the New York Stock Exchange under the symbol SSE. In a somewhat surprising revelation, the division generated revenue of $2.2 billion in 2013, up from $1.9 billion in 2012. Somehow revenue has actually grown nearly 70% from 2011 levels in a difficult climate for domestic drillers. Not surprisingly in a tough pricing market, the revenue gains were obtained at the expense of margins with adjusted EBITDA dropping from $439.2 million in 2012 to only $368.6 million last year.

Seventy Seven Energy operates a land-based drilling rig fleet consisting of 85 rigs, but the company only counts 20 as Tier 1 rigs with 1,300 horsepower or greater. According to the below table, the company has 79 rigs under contract with 51 contracted to Chesapeake Energy.

Table-Contracted Rigs

Source: Chesapeake

With the land-based drilling fleet of Helmerich & Payne obtaining a market valuation of over 3x revenue, Seventy Seven Energy hopes to unlock a similar value in the future. The hydraulic fracturing fleet of C&J Energy Services only trades at slightly over 1x revenue and provides a more attractive known asset than what Seventy Seven Energy provides in the near future.

Bottom line
At this point, it's difficult to place a valuation on this division or suggest that investors look into buying it. As always with any asset, price matters; that will be key to review after the spinoff.

The issue is that removing this asset isn't going to create value for Chesapeake. While other oilfield services firms like Helmerich & Payne and C&J Energy Services trade at recent highs and suggest an ideal timing for spinning off the Seventy Seven asset, the uncertainties could leave the stock trading at sub-industry valuations.

While it's true that the division will now be open to more work with other firms, it's also very possible that Chesapeake will open up a more competitive bidding process for its work. The net impact is that investors will avoid this stock for now.

3 stock picks to ride America's energy bonanza
Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don’t miss out on this timely opportunity; click here to access your report -- it’s absolutely free. 

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2905233, ~/Articles/ArticleHandler.aspx, 9/3/2015 11:34:23 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Mark Holder

Mark has been writing for TMF since Dec. 2012 with a primary focus on taking advantage of opportunities provided by the market in the energy and tech sectors.

Today's Market

updated Moments ago Sponsored by:
DOW 16,510.62 159.24 0.97%
S&P 500 1,969.06 20.20 1.04%
NASD 4,789.38 39.41 0.83%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/3/2015 11:18 AM
CHK $7.50 Up +0.12 +1.63%
Chesapeake Energy CAPS Rating: ****
CJES $5.21 Up +0.28 +5.68%
C&J Energy Service… CAPS Rating: ****
HP $56.33 Up +1.72 +3.15%
Helmerich & Payne,… CAPS Rating: ****