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Chesapeake Buys 289 Bcfe of Proved Texas Gas, Oil Reserves

Chesapeake Energy said last week that it is in the process of purchasing 289 Bcfe of proved gas and oil reserves and another 277 Bcfe of probable and possible reserves in the Permian Basin, South Texas and East Texas from four small independent production companies for about $686.4 million in cash.

CEO Aubrey K. McClendon said the properties will add to Chesapeake's growing Texas presence and have "all of the attributes of successful previous Chesapeake transactions: acquisitions from private companies of low-cost, high-margin proved producing natural gas reserves; exploitation potential of proved undeveloped, probable and possible reserves; and finally, exploration potential for new reserves."

He also said the properties are heavily gas-weighted and have attractive operating and future development costs. "We are confident that Chesapeake can deliver significant shareholder value from the acquired properties for years to come."

One of the transactions has already closed for $228 million in cash and the others are expected to close by May 31, the company said. The sellers are Houston-based Laredo Energy II LLC and its partners, Houston-based Pecos Production, Midland-based Rubicon Oil & Gas I LP and an unnamed Dallas-based independent.

Chesapeake also said all of the oil and gas production expected from the properties being purchased is hedged. Current production is about 61 MMcfe/d from 405 existing wells. The production is being hedged at $58.44/bbl of oil and $7.65/Mcf of gas in 2005 and at $57.98/bbl of oil and $7.53/Mcf of gas in 2006. The company also has identified 276 proved undeveloped and 375 probable and possible drilling locations on the acquired properties.

Based on its projected development plan, which includes $683 million of anticipated future drilling and development costs, the company estimates that its cost of acquiring and developing the 566 Bcfe of total reserves will be $2.42/Mcfe. The proved reserves associated with the acquisitions have current lease operating expenses of $0.32/Mcfe.

The properties also are located in areas where Chesapeake already has extensive drilling and producing operations. Updated production guidance for the quarter ending June 30 is 1,203 MMcfe/d, up from 1,128 MMcfe/d in its last report in February. Chesapeake's production is expected to average 1,230 MMcfe/d in 2005 and 1,386 MMcfe/d in 2006.

With these acquisitions, the company believes that it will own an internally estimated 5.4 Tcfe of proved oil and natural gas reserves and more than 4 Tcfe of unproven reserves.

Chesapeake plans to hold two private placement offerings to pay for the properties: $600 million of a new issue of senior notes due in 2016; and $400 million of a new series of its cumulative convertible preferred stock with a stated value of $100 per share. The notes and preferred stock will go to eligible purchasers only.

Fitch Ratings assigned a "BB" rating to the note offering and a "B+" rating to the convertible preferred stock issuance. It also has affirmed the ratings of Chesapeake's senior secured revolving credit facility and hedge facility at "BBB-" with a stable rating outlook.

"Similar to recent Chesapeake acquisitions, these reserves are located outside of the Midcontinent region and have a large proved undeveloped component (64%)," Fitch said. "While Fitch does have concerns regarding the high multiple paid for the proved reserves and the low amount of proved developed producing reserves acquired, the transactions will do little to change the overall risk profile of Chesapeake.

"The ratings are supported by the size and quality of Chesapeake's reserves, the company's strong operations and its conservative funding strategy employed to finance the growth in recent years," the ratings agency said.

About 65% of Chesapeake's reserves are in the Midcontinent, with 14% in the Barnett Shale, 11% in the Permian Basin and 10% in the Gulf Coast. The company's total debt after completion of the proposed debt offering will be about $3.7 billion, providing debt of $0.68/Mcfe, which is relatively high compared to its peers, Fitch said.

The ratings agency also noted that more than half of Chesapeake's reserve growth in the past three years has come through acquisitions. The new purchases follow several other recent deals, including the $325 million purchase of Tulsa-based BRG Petroleum Corp. (223 Bcfe of proved reserves and 227 Bcfe of probable and possible reserves) late last year, and a $292 million acquisition of Barnett Shale properties from Dallas-based Hallwood Energy Corp. (135 Bcfe of proved reserves and 145 Bcfe of probable and possible reserves).

"Notably, it has funded these acquisitions in a relatively balanced manner through internally generated cash flow as well as equity and debt issuances," Fitch said. It has raised about $1.7 billion of equity (common and preferred stock) while issuing $1.7 billion of debt in the last three years.

Chesapeake's reserves replacement over the last three years was more than 400% and its organic replacement during the same period exceeded 200%, demonstrating the company's ability to grow through the drill bit.

"While the latest acquisitions are higher than Chesapeake's three-year average finding, development and acquisition costs of $1.66/Mcfe, the low lifting costs associated with those properties partially offset Fitch's concern," the agency said. Its stable rating outlook is based on several factors, including Chesapeake's continued conservative funding strategy for future acquisitions, a relatively unchanged risk profile with regards to its reserves and stable lifting and finding costs. Positive rating actions are limited by the company's relatively high debt-to-reserve ratios.

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