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Chesapeake Regains Footing with Credit Line for Midstream Partnership

Following a roller coaster ride in which Chesapeake Energy Corp. saw its share price pummeled, the independent finally caught a break last week after it landed a fresh line of credit for a new midstream spin-off and after the market responded positively to rumors that BP plc, already a joint partner, may be eyeing some of Chesapeake's natural gas assets.

The company's stock price was recovering a bit on Friday, up almost 14% in early trading at more than $21/share after opening at $18.08. That would be welcome news following the beating it has taken in just the past three months. On one of the worst trading days in its history Oct. 10 -- the day news broke that CEO Aubrey McClendon had been forced to sell nearly all of his stock on margin calls (see NGI, Oct. 13) -- Chesapeake's share price fell to $16.52. A month earlier on Sept. 10 the company had traded for $40.07. Chesapeake was trading for $43.44/share on Aug. 11, and it sold for $61.46 on July 10.

Chesapeake remains well below the $74/share price it achieved in early July, but it began to redeem itself in the eyes of some investors -- and analysts -- by the end of last week.

The independent Thursday closed a new secured revolving bank credit facility that matures in 2012 for its new midstream subsidiary Chesapeake Midstream Partners LP (CMP). The credit line initially is for $460 million, but it may be expanded to up to $750 million at CMP's option and with additional bank participation.

McClendon said "despite the turbulent financial market conditions," the new bank facility "clearly demonstrates that lenders continue to support companies with strong credit profiles and profitable businesses." Chesapeake had undertaken a series of steps in August to prepare for the midstream spin-off (see NGI, Aug. 18).

The bank facility is expected to partially fund CMP's capital spending to build additional natural gas gathering and other systems associated with Chesapeake's active drilling program in various plays, including the Barnett, Haynesville, Fayetteville and Marcellus shales. Twelve financial institutions participated in the facility, which was jointly led by Wells Fargo Bank, National Association and RBS Securities Corp.'s RBS Greenwich Capital.

Investors also appeared to have been buoyed by a report in The Wall Street Journal Thursday that London-based BP was exploring a "potential deal" to buy some gas assets from Chesapeake. BP already has completed two transactions with Chesapeake this year, spending around $365 billion to acquire gas-rich fields in the Woodford Shale in Oklahoma and in the Fayetteville Shale in Arkansas (see NGI, Sept. 8; July 21).

BP paid $1.9 billion for about 135,000 net acres of Fayetteville Shale leasehold; Chesapeake continues to own 405,000 acres there. BP agreed to pay $1.75 billion in cash to acquire all of Chesapeake's Woodford interests, which included 90,000 net acres in the Arkoma Basin. BP and Chesapeake also jointly explore the Anadarko Basin in a series of Deep Springer wells across a 155 square-mile area of mutual interest in Washita County, OK.

"A deal would be an early sign that cash-rich global oil companies are prepared to embark on a spending spree as smaller natural gas producers scramble to raise cash amid declining energy prices and tight capital markets," the Journal reported. "What's not clear is if BP is willing to pay close to what these properties were fetching in September, before the credit crunch and a 13% drop in gas prices, or whether Chesapeake, of Oklahoma City, OK, is willing to accept less.

A Chesapeake spokesman reiterated that the company wants to sell a stake in the Marcellus Shale in Pennsylvania, which is something that McClendon has recently indicated. In fact, Chesapeake already set aside $500 million for its 2009 capital budget to spend on a prospective Marcellus joint venture (see NGI, Sept. 29). However, the spokesman did not indicate whether BP was negotiating with Chesapeake over the Marcellus acreage.

Even though rumors are rampant about possible buy-outs across the energy sector by more cash-rich majors, "a person close to BP" told the Journal that BP did not want to acquire all of Chesapeake's assets. BP, however, is trying to bolster its reserves, its exploration chief Andy Inglis said last week (see related story).

McClendon, CFO Marc Rowland and other members of Chesapeake's management team worked to change the perception of the company during a two-day conference last week in Oklahoma City.

McClendon said he was perplexed by the huge drop in Chesapeake's share price because Chesapeake has done everything it said it would do, he said. He and Rowland also worked to overcome rumors within the industry that Chesapeake is cash poor.

Since Chesapeake was formed 19 years ago, said McClendon, "we have navigated a number of challenges," but the company has always managed to beat expectations and achieve its current status as the largest gas producer in the United States.

"The last couple of weeks have been challenging for me, too, but that's over and behind me," he said. He spoke briefly about being forced to sell almost all of his company shares to meet margin loan calls earlier this month.

"It's a tough deal...In the past 19 years I had been building a significant stake in the company's equity, but the circumstances were much larger than me. The stake unfortunately was lost due to margin calls. Life isn't always fair, but life has been good to me. I've started rebuilding my position in the company once again, and I am providing leadership along with our employees."

To ensure its stability in the tortuous financial markets, Chesapeake reduced its estimated cash inflows to between $7.8 billion and $9 billion for 2009 from a previous forecast of $9.9 billion to $11.5 billion. In 2010 the company is estimating cash inflow of $8.2-9.5 billion, down from a prior forecast of $9.2-10.8 billion.

Full-year production growth also was cut to 18% from a previous estimate of 21%.

The reductions were the third adjustments to financial forecasts since Sept. 22. However, the CEO said a lot of things that the company had no control over changed quickly.

Just weeks ago, "we were worth around $50 billion," McClendon said. "Now it's closer to $22 billion or so."

He said "a lot of crazy things have been said and rumored about the company in the last couple of weeks. One of the more surprising is that somehow we were going to be going under if gas prices went lower. In reality, it's the same at $5 [per Mcf] as $8. We adjust. We think we've built a company that has enormous value, and we are well protected from further downturns from here..."

McClendon said he had always thought that if he were to lose money on Chesapeake, he thought more likely it would be because of "operational mistakes or strategic mistakes that we made." The company's share price took a big dive mostly in 3Q2008, but during that period, "nothing had changed except for the innovative joint ventures that we announced...We did everything we said we were going to do in the quarter...and today we wake up and the stock price is $16," he said Wednesday. "What's happened to the company is that it's still going to earn almost $10 in cash flow, $3 in earnings, and we are well on our way in the fourth quarter to complete transactions that are just as innovative, just as valuable...

"Apparently, people are doubting our ability to do that; doubting our colleagues in the industry. Nothing's changed in the last 105 days, but the stock price is down. There's been no underperformance by the company on metrics...Chesapeake is well positioned strategically and financially to ride out the current storm."

As of Oct. 12, Chesapeake had cash on hand of $1.1 billion, said Rowland. The company also is "on track" to sell $2.5-3 billion of leasehold and producing properties by the end of the year.

"We're not going to spend more cash than what we generate," Rowland explained. "If gas prices go down from here, we'll cut our expenses...and it will be a great time to hedge again."

Chesapeake has a "vision for the future, and it's tough, but it's not tough to do what we have to do," McClendon said. "We have the best plays in America, and we come in everyday to accomplish what we intended to accomplish. We think and act like manufacturers, operating 24-7. We know what the costs are, almost down to the penny...What we don't know is what the price of the product is going to be."

Another thing that Chesapeake has little control over is "the economic environment in which we operate," said the CEO. "We have to be very careful, and we will continue to cut [capital expenditures] if we need to. We have enormous discretion in how we spend our money...We have plenty of cash today and we will continue to build that cash into 2009 and 2010."

Some energy analysts came away from the investor conference believing Chesapeake would recovery. J.P. Morgan energy analyst Joseph Allman said in a note that Chesapeake is worth $53/share, "based on the underlying value of its massive oil-and-gas reserves."

Wachovia in a research note Friday also maintained its "outperform" rating on Chesapeake and put its valuation at $44-48/share. However, analysts noted that investors would be watching Chesapeake's year-end cash levels closely, and if management doesn't deliver, "investors will shoot first and ask questions later."

Chesapeake's share price does not reflect its "true underlying value," said Wachovia, but "balance sheet and asset sale timing create higher risk than peers, so we think near-term investors will continue to play the perceived 'safer' large-cap" producers.

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