Why Corporate Balance Sheets Just Don't Matter In The New ZIRP Normal
By now everyone knows that Chesapeake is a slow motion trainwreck: whether it is internal management issues, which eventually will culminate with the long overdue termination of the company's head (something the company had much control over and could avoid, but didn't, and should result in the sacking of the entire board for gross negligence), or plunging gas prices (something it had far less control over, but could have hedged properly, yet didn't), what is absolutely certain is that the firm's cash flow just isn't what it used to be. In fact, according to some, it is quite, quite negative. What, however, people do not know is that under ZIRP, when every basis point of debt return over 0% is praised, and an epic scramble ensues among hedge for any yielding paper no matter how worthless, the balance sheets of companies just do not matter. In other words, for companies that have massive leverage, high interest rates, negative cash flow, which all were corporate death knells as recently as 2008, the capitalization structure is completely irrelevant. We said this a month ago when we cautioned, precisely about Chesapeake, that "to all those scrambling to short the company: beware. CHK has a history of being able to fund itself with HY bonds and other unsecured debt come hell or high water. If and when the stock tanks, the short interest will surge on expectations of a funding shortfall. Alas, courtesy of the Fed's malevolent capital misallocation enabling, we are more than confident that the firm will be able to issue as much HY debt (unsustainably at 10%+, but that is irrelevant for the short-term) as it needs, crushing all short theses. What this means, simply, is that anyone who believes traditional fundamental analysis will and should work in the CHK case is likely to get burned." Sure enough, we were again proven right: Chesapeake just announced, following today's epic drubbing, that it is refinancing its secured debt facility (with its numerous restrictive covenants) with $3 billion in brand new Libor+7.00% unsecured paper (courtesy of Goldman and Jefferies). In doing so, CHK just got at least a one year reprieve.
The full just released PR:
Chesapeake Energy Corporation Enhances Financial Flexibility with $3.0 Billion Unsecured Loan to Be Repaid from 2012 Asset Sales
Chesapeake Energy Corporation (NYSE:CHK - News) today announced it has entered into a $3.0 billion unsecured loan from Goldman Sachs Bank USA and affiliates of Jefferies Group, Inc. The net proceeds of the loan, after payment of customary fees and original issue discount (if any), will be utilized to repay borrowings under the company’s existing corporate revolving credit facility.
The new facility, which ranks pari passu to Chesapeake’s outstanding senior notes, matures on December 2, 2017 and may be repaid at any time this year without penalty at par value and carries an initial variable annual interest rate through December 31, 2012 of LIBOR plus 7.0%, which is currently 8.5%, given the 1.5% LIBOR floor in the loan agreement. During the remainder of the year, Chesapeake plans to complete asset sales totaling $9.0-$11.5 billion and intends to use a portion of the proceeds from these asset sales to repay the loan. Chesapeake has received strong interest from prospective buyers of its Permian Basin asset sales process and its Mississippi Lime joint venture process, and the company expects to complete these two transactions in the 2012 third quarter.
Aubrey K. McClendon, Chairman and Chief Executive Officer, said, “This short-term loan from Goldman and Jefferies provides us with significant additional financial flexibility as we execute our asset sales during the remainder of 2012.
As previously announced, Chesapeake’s business strategy is evolving in 2012 from the unconventional resource play identification and leasehold capture strategy of the past seven years to a strategy now focused exclusively on developing the 10 core plays in which we have built a #1 or #2 position and on continuing our transition from natural gas to liquids, reducing capital expenditures and paying down long-term debt. We believe Chesapeake has built the nation’s best collection of E&P assets, and we are 100% committed to delivering on the very substantial growth and value embedded in these assets for our shareholders through a relentless focus on developing our 10 core plays.”
Reading between the lines, what just happened, is that the Fed, due to its policy of destroying the cost of capital as an indicator of corporate health, forced lenders to agree to less protections in exchange for preserving a comparable cash interest stream from Chesapeake. What it also did, is allow CHK to engage in even more stupid behavior as the elimination of secured creditors as a class, means the company will no longer have to preserve EBITDA and Free Cash Flow over a certain level, nor will it have to engage in prudent hedging.
The end result of course is that CHK will merely do more of the same kind of stupidity that dragged its stock down to 1 year lows today, but not before another vicious snapback as shorts expecting a prompt burial, will be forced to cover. In the meantime, the firm will engage in even more equity destroying behavior, until one day it no longer can refi its debt (maybe they can get some pointers from Europe on how to deplete the collateral value of their assets in record time). But that will happen after some time: first it will refi all its HY bonds with in kind bonds having a longer maturity but higher interest, until little by little the entire estate if bled dry of all asset value and is paid out in the form of interest expense to the firm's creditors.
It also means that since the firm will preserve its inefficient production profile, much more natgas than equilibrium will be pumped out of the ground, pressuring the overall natgas price lower, for longer, than in a normal world, free of ZIRP... and of Bernanke.
Then, when the CHK bankruptcy finally does come, it will be straight to Chapter 7, do not pass 11, full blown liquidation, and zero recoveries for anyone as there will be absolutely no salvageable asset value left in this shell of a companies that was just "Greeced" for the benefit of its creditors. Finally, do not be surprised to see Goldman and Jefferies refi the firm's entire balance sheet - all that means is that the two investment banks are progressively stealing more and more value from equity, until one day, inevitable, they are also the DIP lenders.
Thank you Fed.