Chesapeake Energy shares have been on a wild ride in the past week, as management's use of “ substantial doubt in our ability to continue as a going concern” language in the company’s 3Q2019 10-Q filing made the shorts salivate with hopes of impending bankruptcy for the energy giant. As I mentioned in my prior Forbes column on SoftBank, private equity investors tend to be the worst public market investors. True to form, long-time Chesapeake backer private equity firm Natural Gas Partners disclosed Tuesday that it had distributed to its investors its entire stake in Chesapeake, 310.8 million shares or 15.9% of the amount outstanding. Of course, NGP’s investors could have chosen to hold those shares, but in Tuesday’s trading, with 176 shares of Chesapeake traded, three times the normal volume, and the shares hitting an all-time low of $0.64 per share, it certainly felt as if a mass sell-off was occurring.
EAST RUTHERFORD, NEW JERSEY - NOVEMBER 04: Dallas Cowboys Owner, President and General Manager ... [+]
I was buying Chesapeake with both hands for my investment vehicle, Excelsior Capital Partners, in Tuesday’s trading, and adding uncovered shares to an existing position that was hedged with deep-in-the-money calls.
As I woke up Wednesday morning, I discovered an unlikely ally in the form of Comstock Resources and its Chairman, Jerry Jones. Mr. Jones is most famous for his ownership of the NFL’s Dallas Cowboys, but Comstock has grown rapidly by buying up natural gas producing assets, especially in the Haynesville Shale play in Northeast Texas and Arkansas. Reuters reported this morning that Chesapeake management and Comstock have agreed to the outline of a deal that would transfer Chesapeake’s assets in the Haynesville to Comstock for a reported valuation of $1 billion.
No sentient investor could believe that Chesapeake’s current ratio of a $1.4 billion equity market capitalization to $9.7 billion in debt is a healthy one, so perhaps any deal is a good deal. In this case, unlike some of the trades the Cowboys have made in recent years, I believe a deal between Chesapeake and Comstock, if one is consummated, would be a true win-win.
Chesapeake CEO Doug Lawler is transitioning his company away from natural gas and toward black oil. This is a reflection of the depression in natural gas prices, which is now entering its sixth year. Natural gas prices haven’t traded above $4.00/mmcf for any extended period since November 2014, and today’s Henry Hub natgas futures price of $2.58/mmcf reflects “more of the same,” as the price hasn’t been above $3.00/mmcf since January. Oil prices, in contrast, have held steady in the range between $50.00/barrel and $60.00/barrel, and today’s WTI futures price of $57.25, while not the stuff of wildcatters’ dreams, is one at which Chesapeake’s oil assets in Colorado's Powder River Basin and South Texas’ Eagle Ford Shale offer attractive returns. Even after the closing of Chesapeake's $4 billion purchase of Eagle Ford producer WildHorse Resources in February, Chesapeake’s production mix still sits at a very “gassy” 74%/26% natgas/oil. Clearly Chesapeake management would like to lower that disparity.
Chesapeake management barely mentioned its Haynesville Shale asset in last week's earnings conference call. Lawler did note that Chesapeake had released the single rig it had running in the Haynesville, so for the fourth quarter and 2020, Chesapeake’s Haynesville assets would see no incremental spending. The asset produces solid cash flow—Chesapeake management quantified it at $150 million per year—but without further drilling, the value would decline quickly, as natural gas wells tend to have steeper decline in production from initial levels than oil wells do.
So, that’s where Jerry Jones comes in. He has stated many times his belief in the attractiveness of the Haynesville Shale, even at current commodity prices. To generate attractive returns at the current natgas price of $2.58/mmcf requires massive size and economies of scale and, obviously, Chesapeake’s highly-leveraged balance sheet prohibits them from investing adequately in their Haynesville assets.
So, Jerry can add those cubic feet of gas to Comstock’s portfolio—already increased by Comstock’s $2.2 billion purchase of Haynesville player Covey Park in July—and further, as oilmen would say, “scale the play.” Chesapeake could use the proceeds from a transaction to pay down debt, which the equity market is telling them they need to do imminently and urgently.
It’s a win, win. Both Comstock shares, which, although volatile, are trading at the same level they held on Thanksgiving 2018 and Chesapeake shares, which have fallen nearly 80% in that same period, are rising today. A successful completion of a transaction with Comstock wouldn’t represent a Super Bowl victory for Chesapeake shareholders or my firm just yet, but would be a solid step in the journey toward sustainability as a public company.
