What Marcellus Asset Sale Means for Rice Energy and Chesapeake Energy

Rice Energy (NYSE: RICE  ) on Monday announced that it signed a definitive agreement to acquire roughly 22,000 net acres in Pennsylvania's Marcellus shale from Chesapeake Energy (NYSE: CHK  ) for approximately $336 million. Let's take a closer look at the deal and why it looks to be positive for both companies.

Photo credit: Chesapeake Energy

Rice to buy Chesapeake's Marcellus acreage
The transaction, expected to close in August, includes the purchase of roughly 22,000 net acres and 12 developed Marcellus wells in western Greene County, Pennsylvania. Current net production from seven of the wells is roughly 20 MMcf/d, while the other five wells are in various stages of development.

Rice expects to fund the acquisition through a combination of cash on hand, borrowings under its revolving credit facility, and potentially through the equity capital markets. The company says it's on track to achieve its goal of organically adding 30,000 net leasehold acres this year.

What it means for Rice
From Rice's perspective, the deal will significantly increase its high-quality drilling inventory in the Marcellus, one of its core assets that it has been developing since 2009. Once the transaction closes, it will boost Rice's net acreage position in the Marcellus by nearly 25% and its inventory of net risked Marcellus locations by almost 50%, representing an additional seven years of drilling inventory.

Rice, which went public earlier this year, has a concentrated portfolio focused on the Marcellus, where it held 44,000 net acres as of the end of March 2014, and Ohio's Utica Shale, where it held 46,700 net acres. Thanks to strong performance in these plays, the company's first-quarter net production surged 135% year-over-year to 209 MMcf/d, while EBITDAX jumped 65% year over year to $64.8 million.

In addition to strong production growth, Rice's returns are highly competitive. At a wellhead NYMEX gas price of $4.50 per MMBtu, its dry Utica wells earn an unhedged internal rate of return (IRR) of 108%, while its wet Utica wells earn an unhedged IRR of 160% and its Marcellus wells an unhedged IRR of 162%. With such exceptional returns, it's no wonder that Rice is so eager to expand its inventory.

What it means for Chesapeake
The deal should also be an incremental positive for Chesapeake as it highlights the company's strong progress with its asset sale strategy. The proceeds from the sale will allow the company to further delever its balance sheet, improve its credit metrics, and focus more fully on its most profitable opportunities in south Texas' oil-rich Eagle Ford shale and Ohio's liquids-rich Utica shale.

In combination with the recently completed spin-off of its oilfield services business into Seventy Seven Energy (NYSE: SSE  ) , which debuted on the New York Stock Exchange this month, and other recent and planned sales, Chesapeake should be able to greatly reduce its debt and improve its liquidity position.

Overall, the company expects to raise more than $4 billion in asset sale proceeds this year, which will allow it to slash debt by nearly $3 billion, reduce its interest expense and dividend payments by about $70 million, and eliminate $200 million from its projected 2014 capital expenditures.

Meanwhile, sales of producing properties are expected to reduce its 2014 production by about 2% and its operating cash flow by about $250 million. In other words, Chesapeake's asset sales should significantly improve liquidity, reduce leverage, and position the company for a brighter future, while having a relatively small impact on its near-term performance.

Investor takeaway
Buying Chesapeake's acreage should prove to be a good move for Rice Energy, since it provides the company with additional low-risk, high-return drilling locations in the Marcellus shale that should support continued growth. The transaction should also be good for Chesapeake since it will allow for further debt reduction and an improvement in liquidity, giving it the financial flexibility to focus on its most profitable liquids-rich opportunities.

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