Chesapeake Continues to Divest

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Chesapeake Energy Corporation (CHK) announced three divestiture agreements that will raise cash of $2.6 billion in total to cope with the mounting debt level as well as to fill the funding gap for its 2012 expenditures that resulted from low natural gas prices.

The first deal involves the sale of $1.25 billion worth of preferred shares in a subsidiary – CHK Cleveland Tonkawa LLC – to an investment group led by an affiliate of  Blackstone Group LP (BX). The purchasers also comprise private equity firm TPG Capital, hedge fund Magnetar Capital as well as EIG Global Energy Partners LLC.

The agreement gives the purchasers a share of royalties from 1,000 oil and gas wells in the Cleveland and Tonkawa plays in Oklahoma. They will also be entitled to a 6% annual distribution, while Chesapeake will hold an option until 2019 to repurchase the shares, at a valuation equivalent to an above 9% internal rate of return or a return on investment of 1.35x.

For the second accord, Chesapeake struck a $745 million natural gas production agreement with a subsidiary of Morgan Stanley (MS). This 10-year volumetric production payment (:VPP) contract enables Chesapeake to receive upfront cash for future hydrocarbon production related to certain assets in the Anadarko Basin Granite Wash.

These assets in southern Midwest, with a daily production of an estimated 125 million cubic feet of natural gas, have the proved reserves of 160 billion cubic feet of natural gas equivalent. The deal also represents Chesapeake's tenth VPP concord, since December 2007, which raised approximately $6.4 billion.

Finally, the company struck a purchase and sale agreement with a subsidiary of U.S. behemoth ExxonMobil Corporation (XOM), XTO Energy Inc. The transaction – expected to close on April 30 – is valued at approximately $590 million in cash that excludes certain deduction and standard closing adjustments.

This latest deal entitled Chesapeake to sell 58,400 net acres of leasehold in the Texoma Woodford play in Bryan, Carter, Johnston and Marshall counties in Oklahoma to XTO that has a current net production of approximately 25 million cubic feet equivalent per day.

These deals make it clear that the U.S. second largest natural gas producer is facing a crisis to pull down its debt level that amounted to $10,626 million, representing a debt-to-capitalization ratio of 39.0% at the end of the fourth quarter of 2011.

We believe Chesapeake is one of the most active players in the industry to manage its asset portfolio through a combination of acquisitions and disposals. However, since natural gas accounted for about 82% of Chesapeake’s production in the fourth quarter of 2011 and as near-term speculations of challenging natural gas fundamentals remain, we are apprehensive that the company’s results will be vulnerable to fluctuations in the relevant markets. Hence, we believe that the stock will perform in line with the group and maintain our long-term Neutral recommendation.

The company holds a Zacks #3 Rank, which is equivalent to a short-term Hold rating.

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