Seventy Seven Spinoff Could Have Chesapeake's Investors Gushing

NEW YORK (TheStreet) - Chesapeake Energy  (CHK) plans to spin off its oilfield services business, and this could be a boon for investors.

Spinning off this business allows Chesapeake to unload around $1 billion in debt and raise cash. Moreover, since Chesapeake won't retain any interest in the unit after the spinoff, it will not be responsible for its capital expenditure.

The unit will be converted into a new company called Seventy Seven Energy, which is currently valued at between $2.5 billion and $7 billion. It will be listed at the New York Stock Exchange under "SSE."

Chesapeake's oilfield services unit, which has reported double-digit revenue growth, will have the fifth-largest land-based rig fleets in the United States, with operations in the leading shale plays including Eagle Ford, Utica, Permian Basin and Marcellus.

Chesapeake's shares have risen by 21.5% in the last 12 months and currently trade around $25. The company has outperformed the S&P 500, which has risen by 19.6% in the corresponding period.

Chesapeake's decision is in line with the company's broader objectives to cut costs, reduce debt and increase the value of its assets.

Last year, Chesapeake reported a 14% increase in revenue from oilfield services unit to $2.2 billion, most of which came from hydraulic fracturing and drilling businesses. The unit, however, swung to a loss of $19.7 million from a profit of $69.6 million in 2012 on the back of pricing pressure and higher operating costs.

In drilling, hydraulic fracturing and oilfield rental businesses, Chesapeake's oilfield services arm operated through its wholly owned subsidiaries Nomac Drilling, Performance Technologies and Great Plains Oilfield Rental, respectively.

On average, over the last three years the natural gas giant's contribution to the unit's revenue has been 92.7%. The spinoff, however, will give Seventy Seven an opportunity to diversify its customer base to other exploration and production companies.

The spinoff allows Chesapeake to simplify its structure while unloading around $1 billion debt. According to Chesapeake's official filing, the total long-term debt of its oilfield services unit stands at $1 billion.

Chesapeake carries a lot of debt. By the end of 2013, Chesapeake's total debt, excluding unrestricted cash, dropped slightly to $12.05 billion from $12.33 billion a year ago. On the other hand, the company's cash reserves increased to $873 million by the end of 2013 from $287 million in the prior year.

Chesapeake has been selling its assets to shore up its balance sheet. So far this year, Chesapeake has received $209 million from the sale of its interest in Chaparral Energy and will receive an additional $150 million from asset sales held in the prior years. Overall, the company has forecast that it will receive $1 billion from divestitures in 2014. This will help the company in filling its $1 billion funding gap.

The spinoff will also help Chesapeake in its capital expense reduction drive once the oilfield services unit starts operating as a separate and independent company.

For the current year, Chesapeake will spend between $5.2 billion and $5.6 billion as capital expenditures, more than 90% of which will flow towards exploration and production projects. The current capital expenditure shows a significant decline from $6.7 billion in 2013 and $13.4 billion in 2012.

In these tough times, the spinoff could also support Chesapeake's balance sheet if it results in an inflow of cash. On the other hand, an outright sale of the unit could cause a massive cash infusion of more than $2 billion.

According to Jefferies, Seventy Seven will be valued at $2.5 billion. This would imply the company is valued at 1.13 times its trailing sales. The three biggest oilfield services firms, Schlumberger (SLB), Halliburton (HAL) and Baker Hughes (BHI) are valued at an average of 1.87 times their trailing sales. At this multiple, Seventy Seven could be valued at $4.12 billion.

On the other hand, in 2011, Chesapeake's co-founder and former head Aubrey McClendon valued the unit at between $5 billion and $7 billion.

Once the oilfield services unit is spun off, Chesapeake shareholders will receive a single share of Seventy Seven for an unspecified number of Chesapeake's shares.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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