May 14, 2012
Chesapeake Energy Corp. Neutral
Walking a Tightrope: CHK Reiterates Spending, Asset Sale CHK
Plans, Confirms VPPs off the Table. We Remain Cautious. Price $14.81
We come away from the call slightly more negative on Chesapeake. We did not Exploration & Production
learn much, other than that an Eagle Ford Shale VPP (a $1 billion monetization Tim Rezvan, CFA
opportunity) has been deferred. Inflated spending, funded by debt (now) and asset (212) 338-4736
sale proceeds (later in '12), remain in place. We believe the company is walking a email@example.com
tightrope as it maintains spending amid a weakened cash flow outlook.
(Please refer to a report from earlier on May 14th, Liquidity Outlook Deteriorates. Company Data
Maintain Neutral Rating in Front of Business Update Call, Possible Icahn-Related 52-Week Range $14.49 - $35.75
Bounce, for a detailed review of the company) Market Capitalization (M) $9,836.5
Shares Outstanding (M) 664.2
Avg. Daily Vol. (000) 15,847.0
■ Revolver Opacity. The company did not disclose its credit facility balance as
of last Friday, despite repeated questions on today's call. The inference is clear
from management's comments that it was north of $3 billion. Friday's $3 billion
loan represents the second time this year the company has termed out a portion
of its revolver. It did so in February, when it paid down ~$1.3 billion.
■ Eagle Ford VPP Looks Like a No-Go. Other Assets Will Have to Feed the
Estimated $9.6 Billion Funding Gap. The company stated that it will postpone
a volumetric production payment (VPP) it estimated could have raised $1 billion
because it didn't want to give up the near-term cash flow. We believe this
explanation is, at best, misleading. We believe the investment community would
agree that the $1 billion in proceeds is critical to help bridge '12's funding gap
(estimated at $9.6 billion, not including debt paydown). It appears the deferral
is a product of restrictive covenant provisions. The company stated in its 10-Q
that "we may delay one or more of our currently planned asset monetizations,
or select other assets for monetization...to maintain our compliance (with
covenants)." As we stated in a note earlier today, any delay monetizing assets
could impair the company's ability to fund day-to-day operations. With an
estimated $13.8 billion funding gap in '12 and '13, all asset sales are crucial. Our
cash flow and asset sale estimates modeled a $927 million cash flow cushion
through y/e '13, but that included proceeds of $1 billion from the VPP. We
believe there are only so many "non-core" assets to be sold, and that the company
may be forced to sell attractive assets to meet its funding needs.
■ Debt Paydown In Conjunction with 25/25 Plan Appears Unlikely. With an
additional $3 billion of liquidity, insolvency fades as a short-term issue until
monetizations backfill the funding gap by 4Q12. However, we believe debt
financing may end up being a crucial funding vehicle for this year's capital
program. We also believe the stated debt reduction goal to $9.5 billion by year-
end '12 (from $13.1 billion as of March 31st) is unattainable, given the funding
gap and rigid management mindset on spending.
■ Reiterating Near-Term Positive Catalysts. We continue to believe a return to
$4/mcf natural gas is the most meaningful near-term catalyst. We also believe
strong headline prices in the Permian Basin (> $5B) or Mississippi Lime
(> $1.5B) could support shares.
Important Disclosures regarding Price Target Risks, Valuation Methodology, Regulation Analyst Certification,
Investment Banking, Ratings Definitions, and potential conflicts of interest begin on Page I of the Appendix Section.
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May 14, 2012
Chesapeake Energy Corp. (NYSE: CHK), engages in the acquisition, exploration, and development of properties for the production
of crude oil, natural gas liquids and natural gas. The company is one of the leading leaseholders in most of the largest U.S.
unconventional resource plays, including the Eagle Ford Shale, the Niobrara formation, the Utica Shale, the Haynesville Shale, the
Barnett Shale and the Williston Basin, among others. As of December 31, 2011, the company had over 18.8 Tcfe of proved reserves.
Chesapeake was founded in 1989 and is based in Oklahoma City, Oklahoma.
Regulation Analyst Certification:
I, Tim Rezvan, hereby certify the views expressed in this research report accurately reflect my personal views about the subject
security(ies) or issuer(s). I further certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific
recommendations or views expressed by me in this report.
Sterne, Agee & Leach, Inc. makes a market in the following subject company Chesapeake Energy Corp..
Sterne, Agee & Leach, Inc.'s research analysts receive compensation that is based upon various factors, including Sterne, Agee & Leach,
Inc.'s total revenues, a portion of which is generated by investment banking activities.
Sterne Agee & Leach, Inc. expects to receive or intends to seek compensation for investment banking services from the subject company
and/or companies in the next three months.
Price Target Risks & Related Risk Factors:
Investment risks associated with the achievement of the price target include, but are not limited to, a company's failure to achieve
Sterne, Agee & Leach, Inc., earnings and revenue estimates; unforeseen macroeconomic and/or industry events that adversely affect
demand for a company's products or services; product obsolescence; changes in investor sentiment regarding the specific company or
industry; intense and rapidly changing competitive pressures; the continuing development of industry standards; the company's ability
to recruit and retain competent personnel; and adverse market conditions. For a complete discussion of the risk factors that could
affect the market price of a company's shares, refer to the most recent Form 10-Q or 10-K that a company has filed with the Securities
Company Specific Risks:
We believe Chesapeake faces liquidity risk. The company needs to sell several billions of assets in 2012 to bridge a funding gap and
fund its capital program. Additional asset sales are likely in 2013. The company also faces commodity price risk. Over 75% of estimated
2012 production is natural gas, and the company has no hedges in place amid a weak natural gas price environment. The company also
faces capital market risk as it attempts to monetize its oilfield services assets.
Methodology for assigning ratings and target prices includes qualitative and quantitative factors including an assessment of industry
size, structure, business trends and overall attractiveness; management effectiveness; competition; visibility; financial condition; and
expected total return, among other factors. These factors are subject to change depending on overall economic conditions or industry
or company-specific occurrences. Sterne, Agee & Leach, Inc., analysts base valuations on a combination of forward looking earnings
multiples, price-to-revenue multiples, and enterprise-value-to-revenue ratios. Sterne, Agee & Leach, Inc., believes this accurately reflects
the strong absolute value of earnings, the strong earnings growth rate, the inherent profitability, and adjusted balance sheet factors.
Additional company-specific valuation methodology is available through Sterne, Agee & Leach, Inc.
Company Specific Valuation:
For the E&P names under coverage, we generally prefer to use EBITDA and Cash Flow multiples for valuation, with one eye on net
asset value (NAV) for proved reserves. While much of the Street uses "normalized" oil and gas prices, we prefer to use forecasted price
deck in our valuation analysis. Our biggest issue is that determining a "normalized" price is subjective, and, in our opinion, depends
on too many assumptions for accuracy. Our methodology for assessing ratings and target prices includes qualitative and quantitative
factors, and estimated cash flows, earnings, returns, valuation multiples and other metrics are compared to peers.
Definition of Investment Ratings:
BUY: We expect this stock to outperform the industry over the next 12 months.
NEUTRAL: We expect this stock to perform in line with the industry over the next 12 months.
Appendix Section, Page I
May 14, 2012
UNDERPERFORM: We expect this stock to underperform the industry over the next 12 months.
RESTRICTED: Restricted list requirements preclude comment.
IB Serv./ Past 12Mos.
Rating Category Count Percent Count Percent
Buy 228 49.67% 12 5.26%
Neutral 204 44.44% 6 2.94%
Underperform 27 5.88% 0 0.00%
ADDITIONAL INFORMATION AVAILABLE UPON REQUEST: Contact Robert Hoehn at 1-212-338-4731.
Opinions expressed are our present opinions only. This material is based upon information that we consider reliable, but we do not
represent that it is accurate or complete, and it should not be relied upon as such. Sterne, Agee & Leach, Inc., its affiliates, or one or
more of its officers, employees, or consultants may, at times, have long or short or options positions in the securities mentioned herein
and may act as principal or agent to buy or sell such securities.
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Appendix Section, Page II