Pricey Chesapeake medicine highlights its sickness

May 12, 2012

By Christopher Swann and Robert Cyran

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Pricey medicine can help. But in Chesapeake Energy’s case, it shows how sick the company is. The embattled energy firm is borrowing $3 billion at 8.5 percent to repay a loan whose terms might otherwise prevent asset sales. This buys time. But it makes even more obvious Chesapeake’s unsustainable reliance on selling assets to fund its persistent cash drain.

Chesapeake, America’s second-largest natural gas producer, has been cash-flow negative for a decade. Fitch Ratings reckons it faces a $10 billion shortfall this year. Aubrey McClendon, the chief executive now beset by questions over financial conflicts of interest, recently sounded characteristically confident that the gap could be bridged by asset sales. The company is targeting up to $14 billion of them this year.

But the firm’s quarterly filing with regulators on Friday – curiously delayed – painted a less optimistic picture. Chesapeake said it might have to delay and rejig asset sales to avoid flogging off assets needed as collateral or cutting cash flow below the level required by its debt covenants. The shares slumped 14 percent, and have lost about half their value in the past year.

The main stumbling block appeared to be the firm’s $4 billion revolving credit facility. The new, much more expensive loan from Goldman Sachs and Jefferies unveiled later on Friday will repay that, easing concerns that a cash flow squeeze could force more asset sales only to have lenders demand repayment, creating a fresh cash deficit.

But it’s a temporary reprieve. Chesapeake still needs to reduce its debt and wring more dollars from its wells. Selling choice oil assets while gas properties suffer with ultra-low prices only whittles away further at the company’s long-term earning power.

And McClendon’s credibility is diminishing fast. Unsavory revelations about his dealings and the company’s governance, Chesapeake’s complexity and off-balance sheet obligations, and tough gas market conditions have hammered the share price and the company’s credit. McClendon has convened a conference call on Monday, less than two weeks after the last telephonic gathering. Analysts may not cut him the same slack this time. The expensive injection of new debt makes Chesapeake’s illness look worse, not better.

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