Chesapeake Energy (NYSE: CHK ) announced last week it was officially spinning off its oil-field service subsidiary and selling a number of noncore assets. In one sense this is nothing new from the company, which has a history of shedding assets. However, these strategic transactions serve quite a different purpose than the company's previous asset sales. Let's look at what's different this time and how it's vastly improving one important area at the company.
A new twist on an old plan
Chesapeake Energy has been on a continual path to pare its asset base down to the core. The company's past asset sales have come in all shapes, sizes, and complexities.
Photo credit: Access Midstream Partners
One of its largest was the exit of its midstream business, initially by forming a joint venture that eventually created what is now Access Midstream Partners (NYSE: ACMP ) . Chesapeake Energy eventually sold down its stake , as well as most of the rest of its midstream assets.
That's in addition to selling several noncore acreage packages around the U.S., including a $1 billion deal last year to pass resources in the Eagle Ford shale and Haynesville shale to EXCO Resources (NYSE: XCO ) . Chesapeake, which built up an impressive land bank totaling several million acres, used that asset to bridge the company's multibillion-dolar gap between its cash flow and its capital expenses.
New CEO Doug Lawler has now cut capex to be in line with cash flow. With no need to fund capex through asset sales, Chesapeake Energy can use more recent proceeds from its asset exodus to accomplish a new purpose: reducing the complexity and size of its balance sheet, as seen on the following slide.
Source: Chesapeake Energy Investor Presentation (Link opens a PDF).
Chesapeake Energy sees the spinoff of its oil-field services business lopping off $1.1 billion from its consolidated debt. Furthermore, that deal will see the new business pay Chesapeak a $400 million dividend, which it will use to repay intercompany debt. In total, the company plans on divesting $4 billion in assets this year for the new purpose of repairing its balance sheet.
The big deal
The company's noncore asset sales will also provide a significant reduction to the complexity of the company's balance sheet. The recently announced deals will reduce the amount of subsidiary preferred stock by $1 billion, as well as eliminate $160 million in overriding royalty interest and ship off two of its volumetric production payments to new owners. These complex financial instruments had previously made it tough for investors to understand Chesapeake Energy's future obligations.
Source Chesapeake Energy Investor Presentation.
As that slide notes, Chesapeake's recent asset sales have led to a 10% improvement in the company's overall debt position. However, the biggest improvement is in addressing the more complex leverage instruments the company used to fund its great land grab a few years ago. Its recent deals have reduced this total leverage position by $6.2 billion, or 30% lower, in just the past two years.
Chesapeake Energy has changed the way it operates; it's more focused than ever on reducing complexity. This is a lesson that EXCO Resources should learn, as it funded its $1 billion asset purchase from Chesapeake Energy with one of the most complex energy deals of the year. That complexity is one of the reasons so many investors are short shares of EXCO Resources. Meanwhile, the reduction of Chesapeake Energy's complexity is a very bullish sign for investors.
Chesapeake Energy is reducing leverage and reducing the complexity of its balance sheet. Both are very positive outcomes for investors and bode well for the company's future.
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