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Chesapeake: The 'Ides Of August' And The Death Of The Junior Cap Structure


Chesapeake is out this morning with an announcement that it has executed its 1.5L (it's long-awaited "One and One-Half Lien").

The 1.5L is, of course, senior to the entire Chesapeake cap structure - junior ONLY to the First Lien Credit Facility.

This isn't good for any (now) junior cap structure vehicle (this includes the now junior Second Lien) - especially the equity class.

Chesapeake continues to move towards a prepackaged bankruptcy; optimizing its cap structure with follow on tender offers of junior debt will help.

The "Ides of August" are upon us.

Chesapeake Energy (NYSE:CHK) has announced a series of financial engineering transactions that will restructure its capital structure as well as realign seniority of its capital structure; both are hugely important developments and both have hugely important long-term implications. However, I believe both should be extremely alarming to the junior cap structure in that now - post-financial engineering: Chesapeake is fully encumbered, Chesapeake has no additional collateral to package in any follow-on financial engineering transactions, Chesapeake likely will not deleverage as a result of its announced financial engineering, and Chesapeake no longer has "seniority" to use as a currency in swaps/exchanges. Put simply, for better or worse, Chesapeake "is what it is" until death do it and its investors part. I'll explain.

On the Road to Restructuring?...

It's important to note that nothing Chesapeake is doing is unexpected. The destressing program currently being deployed is the only logical destressing program the E&P could have deployed. This program - using equity in swaps transactions [even if it meant issuing equity in "par plus" transactions (inclusive of interest accrued-and-owed plus swap transaction premiums on the bonds being swapped with equity)], issuing a 1.5 Lien (a lien immediately-junior to the First Lien Credit Facility but immediately-senior to all other cap structure vehicles - including the now primed Second Lien), and trying to minimize contractual obligations [e.g. non-GAAP debt, supremely negative capital productivity engagements (via asset divestitures), etc.] through whatever means possible - is the only program that would allow Chesapeake to maintain a model that could potentially be sustainable longer-term but also one that's optimized for a prepackaged bankruptcy should the enterprise ultimately need to in-court restructure. This is how I knew Chesapeake would take the steps it has in the order that it has (from a May 12, 2016 publication):

Chesapeake has some of the finest financial and legal minds in the world working its case; and these are minds that know the reality of the current commodity environment, the realities of the overwhelming mathematics facing the E&P, and the realities of the efficiencies/productivity of bankruptcy (especially those minds from Kirkland & Ellis). The good news about this reality - that Chesapeake has such fine financial and legal minds on the case - is that we (the investing public) can assume logical, rational, and timely decision making from Chesapeake. We can also narrow...