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Chesapeake Buys Gothic for $345M, Boosts Gas Reserves 25%

Chesapeake Buys Gothic for $345M, Boosts Gas Reserves 25%

Longtime industry basement dweller Chesapeake Energy is finally pulling itself up by its bootstraps with a little help from the gas market and Gothic Energy. The company announced on Friday that it plans to buy Gothic, its frequent Midcontinent region drilling partner, in a stock and cash transaction valued at about $345 million.

The deal will make Chesapeake the 10th largest independent gas producer in the U.S., the company said. It also will increase Chesapeake's reserves by 25% to 1,600 Bcfe and its daily gas production 22% to 450 MMcfe/d. Chesapeake said it expects $10 million/year of administrative and operational savings and $15 million in non-cash interest savings from retiring Gothic's $104 million in 14% senior discount notes.

"This acquisition fits perfectly with Chesapeake's business strategy of creating value by acquiring and developing low-cost, long-lived natural gas assets onshore in North America, with a principal focus in the Midcontinent, while at the same time steadily improving our balance sheet," said Chesapeake Chairman Aubrey K. McClendon. "Predominantly all of Gothic's assets were once owned by Amoco Corp. and are among the highest quality gas assets in the U.S. These properties are characterized by very low operating costs, long reserve lives, abundant upside opportunities and are 96% natural gas.

"The transaction will be accretive to Chesapeake, increasing projected 2001 ebitda by 24%, projected 2001 cash flow by 23% and projected 2001 net income by 23%. Considering other announced transactions in the industry, we believe Chesapeake will now be the 10th largest independent producer of natural gas in the U.S.

"In addition, including the impact of this transaction, projected excess cash flow and the retirement of $170 million of Chesapeake's outstanding preferred stock (including accrued dividends) to date, we anticipate 400 Bcfe of proved reserves additions during the year with no net increase in fixed obligations," McClendon added. "This will result in a significant de-leveraging of our balance sheet. Given projected natural gas prices, further balance sheet improvement should occur in 2001 as we continue to grow our asset base and reduce our liabilities."

Analysts see the transaction as a step in the right direction. "I think they finally are going to be able to attract some institutional interest," said Dain Rauscher producer analyst Steve Smith. "They have been in the penalty box since their problems occurred in the Austin Chalk in 1997. Their stock price, you've got to remember, was at $35 and went from $35 to less than $1 (actually 67 cents/share at the bottom). That was ugly. But for those that sensed that this thing could be turning it has been a 10-fold increase."

Although low gas prices certainly contributed to Chesapeake's woes, it started really having problems in 1997 when it began to expand aggressively in the Louisiana Austin Chalk, paying a lot for poor producing acreage and drilling multiple unsuccessful wells. "They were aggressively drilling about 10 new wells, all in a brand new experimental area, none of which panned out and that was $5 million a pop so that was $50 million for the acreage and $250 million down the drain," said Smith.

Chesapeake decided to put itself on the auction block in July 1998 but ended up finding no buyers (see NGI, July 13, 1998). As a result, it decided to exit the Chalk and return to its roots in the Midcontinent region and was able to secure some fixed-rate debt before its stock price plummeted.

"The story would have paid off sooner except the gas market weakened on the weather," Smith noted. "Now that the gas market has come back and they are having good drilling results and this deal looks further accretive, we'll be likely taking up our target price again," he said. Smith said his 12-month target on the company is more than $9/share. Chesapeake's stock closed up 50 cents on Friday to $7.50 following the announced purchase of Gothic. Gothic shares jumped 199% to $1.09.

"It looks like they got a good deal with this one," said Smith. "$1.05/Mcf for the reserves is a good price, and it appears to be accretive on all the cash flow measures. That's not bad."

Chesapeake will acquire Gothic's common stock in exchange for four million shares of Chesapeake's common stock. Upon closing of the transaction, Gothic's shareholders will own 2.7% of Chesapeake's common stock. In addition, Chesapeake has recently purchased in a series of private transactions 96% of Gothic's $104 million of 14.125% Senior Discount Notes for consideration of $77 million, comprised of $22 million in cash and $55 million in Chesapeake common stock (7.8 million shares at Chesapeake's stock price prior to the announcement Friday).

Including Gothic's $235 million of senior secured notes, the total acquisition cost to Chesapeake will be $345 million. This values Gothic's 310 Bcfe of proved reserves at $1.05/Mcfe after allocation of $20 million of the purchase price to Gothic's leasehold inventory, 3-D seismic inventory, lease operating telemetry system and other assets. Gothic's proved reserves are 96% gas, 78% proved developed, have an average lifting cost of less than $0.20/Mcf, are located exclusively in Chesapeake's core Midcontinent operating area and are unhedged after October 2000. Based on current production rates of 80 MMcfe/d (or 30 Bcfe/year), Gothic has an 11 year reserves-to-production index.

"It is obvious that an acquisition of our assets by Chesapeake made sense strategically, operationally and financially," said Gothic CEO Michael K. Paulk. "The acquisition will result in a significant premium for our shareholders, will enable our bondholders to realize a full return on their investment and helps solidify Chesapeake's position as one of the top three producers of natural gas in the Midcontinent. Chesapeake's asset base completely overlaps Gothic's and there will be substantial operational and exploration efficiencies resulting from this combination. In addition, Chesapeake will now be the largest owner in two of Oklahoma's most prolific gas fields, Watonga-Chickasha and Cement, and together with its existing large ownership position in Bradley, the Golden Trend and Knox, Chesapeake will have built the premier exploration platform in the Midcontinent."

Gothic's previously announced plan of restructuring, which contemplated the redemption of Chesapeake's holdings of Gothic's preferred and common stock for oil and gas properties and other considerations, the exchange of the $104 million senior discount note issue for 94% of Gothic's equity and an equity rights offering of $15 million, has been terminated in anticipation of this transaction.

Although the boards of both companies have approved the transaction, it still is subject to regulatory and shareholder approval. Completion of the transaction is expected by year-end. Gothic has agreed to provide Chesapeake with a $10 million break-up fee in the event the transaction is not completed.

Rocco Canonica

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