[Editor's note: A version of this story appears in the December 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

Oh, say it ain’t so. Chesapeake Energy Corp., buried deep in a 10-Q SEC filing on page 30 in early November, subtly raised a caution flag of “substantial doubt about our ability to continue as a going concern” if low commodity prices persist. The hint of the once-proud natural gas giant defaulting and potentially being sucked into a swirling vortex of bankruptcy prompted ana­lysts to shout “Sell!” and investors to rapidly jump ship.

The company’s already battered stock price plummeted 57% over the course of a week, settling well below $1 per share for the first time since the last century.

Everybody, it seems, loves to cheer for Chesapeake. It’s a storied tale of a mighty champion that fell on hard times due to un­foreseen forces mixed with self-inflicted largesse, yet with the hope for an epic, over­coming-all-odds comeback leading to a mag­nificent triumph.

Only we await the triumphant ending.

It has been six and a half years now since new management took over the listing ship, burdened with a massive $16 billion debt load and a reputation for spending before looking. Over that course, CEO Doug Lawler has trimmed the sails with asset sales and op­erational efficiencies, tirelessly piloting the balance sheet out of dangerous seas.

Yet some $9.7 billion of debt remains, a 3.6x debt-to-EBITDA leverage ratio. The Oklaho­ma City company, though, has received no updraft from commodity prices at this crucial juncture in which to bail away at the debt fast­er, leaving it still heavily burdened.

Chesapeake’s conundrum is twofold. First, it needs to create cash flow ASAP despite commodity prices to drain the debt. To do so, in its third-quarter report, it announced it would slash 2020 capex by 30%. All well and good, but the lower activity naturally results in fewer rigs running and less wells drilled. And resulting less production means less EBITDA.

And thus the conundrum.

The going-concern specter is not so much about liquidity but rather the likelihood of triggering a credit facility covenant some­time late next year. As of Sept. 30, the cov­enant states the company must be at or be­low a 5.5x debt-to-EBITDA ratio. It is, at about 3.6x per analysts. But beginning with fourth-quarter 2019, that covenant metric begins stepping down by 25 basis points every quarter until it reaches a 4x ratio first-quarter 2021.

The catch: If Chesapeake slows down capex to pay down absolute debt, the pay down is slower than the declining covenant pace. Ergo the problem.

“Given the impact from falling production and the impact on EBITDA, we see TTM leverage approaching 5x by year-end 2020,” wrote Raymond James analyst John Freeman Nov. 5. Of course, that would trip the cove­nant, leading to unsavory things such as fore­closure on collateral and cross-default with other loans.

And Chesapeake seems unconcerned with that. When asked about that little point of remaining a going concern in the confer­ence call, Chesapeake CFO Nick Dell’Osso waved it off.

“We could go out and seek a waiver at any time from our bank group,” he assured mat­ter-of-factly. “But at the moment we continue to be focused on the strategic levers that re­sult in permanent debt reduction.”

Asset sales are one of those levers, and a big one would drop that debt metric rapidly. Following the third-quarter report, Reuters reported Chesapeake is in discussions with the Jerry Jones majority-owned Comstock Resources Inc. to sell its discovery Haynes­ville Shale assets in the neighborhood of $1 billion. If so, problem averted—for now.

Chesapeake seems somewhat perturbed at the reaction to the going-concern mention. It’s all an overreaction, is the unspoken mes­sage. The banks will acquiesce.

In a follow-up press release after 16% eq­uity owner NGP dumped all its shares, Law­ler assures that the plan in place is working just fine. Be patient. Have faith.

“We have substantial liquidity with no significant near-term maturities,” he said, addressing the fear factor. “We continue to pursue strategic levers to reduce debt, includ­ing asset sales, capital markets transactions and focus on cost discipline. Additionally, we are de-risking our cash flows through our hedging program and remain confident in our long-term liquidity.”

Confident, he said, that the company will be able to pay its notes.

The day following Chesapeake’s third-quarter call, and as the stock was freefalling, Lawler backed his boast with cash, buying the dip with 50,000 shares at 91 cents. His total stake tops 5 million shares. Other exec­utives raised their ante as well.

RayJay’s Freeman said Chesapeake faces “a tough road ahead as it works to right-size the balance sheet.”

But it looks as if Lawler and crew are bank­ing on being a going concern next year and for years to come. Maybe we’ll see a trium­phant ending after all.

Comments