Chesapeake Energy (NYSE:CHK) recently sold its subsidiary's midstream compression assets for roughly $520 million. This sale is on top of other assets the company plans to sell this year, which are expected to generate around $650 million. Was this another step in the right direction? How will this decision affect the company's valuation?
The company sold a total of 437 compression units to Access Midstream Partners (UNKNOWN:ACMP.DL) and Exterran Partners (NASDAQ:APLP). Access Midstream Partners purchased 103 units for $160 million and Exterran Partners bought 334 units for $360 million. This acquisition adds to Access Midstream Partners' and Exterran Partners' natural gas compression assets, which were historically leased from Chesapeake's solely owned subsidiary, MidCon Compression. These newly acquired assets will provide these partnerships the opportunity to own a core cost element of their operations. Chesapeake agreed to receive these payments in cash by the end of March. Since MidCon Compression used to lease these assets to these partnerships, this sale won't affect its core operations. Moreover, the sale won't have a strong negative impact on Chesapeake's cash flow or profit margin. Let's explore why.
The assets Chesapeake sold are related to its marketing, gathering, and compressing operations. This business segment accounted for 54% of its revenue in 2013. But the operating profitability of this segment was only 1% last year, and in 2012, this segment's profit margin was 2.2%. These numbers suggest this segment accounts for a small portion of Chesapeake's operating cash flow or earnings. These assets were also related to the natural gas market, a sector that Chesapeake is slowly trying to reduce its exposure to.
The positive side of this sale is the additional transfusion of cash Chesapeake will get out of it. The company's cash on hand was around $837 million in December 2013. Because the company slashed its 2014 capital expenditure guidance by 20% to around $5.4 billion, this additional half a billion from the sale could go toward increasing its capex.
This transaction could also improve its balance sheet: The company's debt-to-equity ratio is 0.8. This ratio measures its burden of debt. In comparison, Chevron (NYSE:CVX), one of Chesapeake's competitors in producing and selling oil and gas, has a debt-to-equity ratio is only 0.13. Therefore, this sale could go toward reducing Chesapeake's debt burden and slightly cutting down its financial and cash flow risks.
Chesapeake's decision to sell assets related to midstream operations isn't likely to have a substantial negative effect on its operations, cash flow, or valuation. Finally, this is another step toward freeing up some cash to put into its capital expenditure, or perhaps even paying off part of its loans, which could reduce the company's financial risk.