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Chesapeake Energy Can't Get the Chinese to Overpay for Every Acre

For one, the Permian is the size of some states, at 250 miles by 300 miles. The Permian is also a 100-year old drilling region where not all wells are producing equally or on the same life cycle -- it's essentially a legacy of the Texas vertical drilling boom of a century ago that has found new life in the age of horizontal, hydraulic fracturing.

Also, Chesapeake still holds roughly 470,000 net undeveloped acres in the Midland section of the Permian that can still be sold, and at an average of $3,000 per acre, for example, that would bridge a significant part of the gap in the expected deal pricing.

RBC estimates that the Shell acreage was sold at sub-$3,000 and the Chevron acreage around $3,000. Either way, it's a "blunt" valuation instrument that does seem low compared with other Permian deals ranging from $5,000 per acre to as much as $10,000 per acre. Even if RBC Capital Markets analyst Scott Hanold thinks the "blunt" approach got too much market attention on Wednesday, he said even if the market had a perfect formula for assessing the deal, it would probably seem "light" on price.

That's no surprise given the position of weakness that everyone should have known Chesapeake was negotiating from. It's not simply the cash crunch but the specific short-term loan from Goldman Sachs and Jefferies provided earlier this year when Chesapeake was facing market fears it was in a "death spiral," a loan it now needs to use the deal proceeds to pay off.

Chesapeake may still get the NOC premium with the Mississippian Lime joint venture, and the Sinopec chatter may yet be right if it is Chesapeake's JV partner. Though Chesapeake has also floated the possibility that Mississippian assets could be sold outright.

Chesapeake also had the problem of defining value for assets within its larger publicly traded business. Selling shale boom drilling businesses outright to mining giant BHP Billiton (BHP), as Petrohawk did, or to Statoil (STO), as in the case of Brigham Exploration, is a type of foreign buyer that won't raise the political rhetoric to a decibel level. It's also selling a publicly traded company where the premium is transparent being tied to existing stock value, rather than assets within a far-flung land drilling regime like Chesapeake's.

When McClendon initially presented the Permian sales plan, he said, "I think the returns from our projects in the Permian are first-rate, and I think that is why you see so much industry interest in the Permian, and frankly why you see so much investor interest. Just looking at the valuation of some companies that are pure Permian basin players, we are tempted to spin out our Permian asset and just make it a separate company. But at the end of the day, it is probably best for our overall goals this year to work the JV approach and also to work the 100% approach as well."

Chesapeake's ace-in-the-hole is that it can always sell something. If it got into its current mess by buying too much on leverage, it can always sell when push comes to shove as it has had to do in 2012. But you can't get the Chinese to pay up for every acre when the "national interest" trumps your need to raise cash. The best, or at least most aggressive buyers, don't even have a seat at the table when the "100% approach" is required.

Chesapeake said it went with the 100% approach because it wants out of the Permian for good, as it focuses on basins where it has No. 1 or No. 2 positions. So the Permian may be the exception to the rule in terms of the "big premium" shale M&A story pumped by bankers and supported by foreign state-run oil companies.

Hopefully for the sake of Chesapeake shareholders, the company won't put itself in the position again where it has to sell, rather than JV, any assets in those No. 1 or No. 2 positions that run across land masses as big as some Eastern seaboard states and run into the billions of dollars of acreage value, which immediately limits the number of potential buyers. If it does, the same "a little light" of expectations reaction can be expected from the market, and there's nothing Sinopec, or Chesapeake, can do about it. So let's hope Aubrey learned his lesson this time. The Chesapeake CEO has had a history of needing to learn the same lesson too many times in the past.

--By Eric Rosenbaum

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