A decade ago, Chesapeake was a $37.5 billion company led by the energetic Aubrey McClendon, an outspoken advocate for the gas industry. Chesapeake became the second-largest U.S producer of the fuel. But in 2016, McClendon was indicted by a federal grand jury on charges of conspiring to rig bids for the purchase of oil and gas leases. A day later, he was dead after his car collided with a highway overpass.
On Tuesday, Chesapeake’s market value was $2.6 billion. The company was brought there by years of low gas prices, the result of an industry that has been the victim of its own success in cracking open shale-rock formations for access to additional supplies.
Chesapeake has spent the years since McClendon’s death selling assets, cutting jobs and trying to produce more oil in an effort to chip away at a mountain of debt. Its notice Tuesday comes as shale producers struggle to prove to investors they can produce positive cash flow, not just grow at any cost.
When times were good, Chesapeake’s campus was home to an army of construction cranes as McClendon, a graduate of Duke University, sought the look of a leafy private university for the company’s headquarters. It had the accouterments of a country club, with an multistory health center featuring two massage therapists on staff, a large daycare facility, a soccer field and running track.
McClendon at one point had amassed about $400 million of real estate in the Oklahoma City area, including at least two shopping centers, a church and a grocery store. He invested in local restaurants and plastered the Chesapeake name on the arena housing the Oklahoma City Thunder basketball team, which he partly owned. All of that drew fire from investors, who said the company should focus more on oil and gas while selling non-core assets.
The going-concern warning signals that Chief Executive Officer Doug Lawler’s six-year campaign to rescue Chesapeake from the billions of dollars in debts amassed by McClendon may be on the verge of failure. Lawler, who was hand-picked for the job by activist investor Carl Icahn, long sought to convert the gas giant into an oil company, to no avail.
If oil and gas prices remain low, the company may not be able to comply with its leverage ratio covenant during the next year, “which raises substantial doubt about our ability to continue as a going concern,” Chesapeake said Tuesday in a quarterly filing. The warning comes less than a year after Lawler orchestrated the $1.9 billion takeover of shale explorer WildHorse Resource Development Corp.
Shares fell as much as much as 17%, the most in more than three years. Chesapeake’s 8% coupon notes due 2025 are among the most actively traded securities in the high yield market, according to Trace. The bond’s price dropped by over $4, the largest price drop on record for the security. Chesapeake’s 8% coupon notes due 2027 also plunged to their lowest price ever.
The shale boom has sent gas prices tumbling to less than $3 per million British thermal units from an all-time high near $16 in 2005. Terminals originally designed to import the fuel have been converted to export plants as the supply surge overwhelms domestic demand, leaving producers to seek international markets for their output.
Chesapeake executives tried to assuage some fears on a third-quarter conference call. The producer continues to look at opportunities to improve its balance sheet, including asset sales, deleveraging acquisitions and capital funding options, they said.
“We could go out and seek a waiver at any time from our bank group, but at the moment we continue to be focused on the strategic levers that result in permanent debt reduction,” Chief Financial Officer Nick Dell’Osso Jr. said.
Chesapeake’s borrowings totaled $9.73 billion as of Sept. 30, up from $8.17 billion at the end of last year.
“With massive debt, leverage is not going down every quarter you continue to outspend,” Neal Dingmann, an analyst at SunTrust Robinson Humphrey Inc., said by phone. “What is leverage going to look like next year and how are you going to address it internally or externally? That’s the story.”
Though Chesapeake plans to reduce spending by almost a third next year as it seeks to generate free cash flow, its third-quarter capital expenditures rose 16% from a year earlier as it completed more wells. The producer is standing by its budget guidance for full-year 2019.
Chesapeake has already taken some steps to cut debt. In September, the company announced a $588 million debt-for-equity swap. In an earnings statement earlier Tuesday, Chesapeake said it had restructured gas gathering and crude transportation contracts in South Texas and the Brazos Valley to improve future returns.
“They need to walk people through how they plan to get free cash flow,” Sameer Panjwani, an analyst at Tudor, Pickering, Holt & Co., said by phone. “A big part of it could be asset sales. They’ve talked about it before on a high level, but how far along are they in some of these processes?”