Today we assess if Chesapeake Energy Corporation (NYSE:CHK) could be a likely merger target or an acquirer within its peer group. The peer set we use for our analysis comprises: Anadarko Petroleum Corporation (NYSE:APC), EOG Resources, Inc. (NYSE:EOG), Apache Corporation (NYSE:APA), Devon Energy Corporation (NYSE:DVN), Williams Companies, Inc. (NYSE:WMB), Noble Energy, Inc. (NYSE:NBL), Hess Corp. (NYSE:HES) and EQT Corporation (NYSE:EQT).
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- Chesapeake Energy Corporation (NYSE:CHK)’s relative size and current valuation make it a possible merger target within this peer group.
- Chesapeake Energy Corporation (NYSE:CHK) could achieve growth through acquisitions as it is big enough (by book value) and has only a modest level of goodwill on its balance sheet, but its valuation is not high enough to make acquisitions within this peer group easy.
- Downward pressure on CHK-US’s dividends due to relatively weak operating results, low interest coverage and a weak cash cushion (for the dividend) is offset by the medium dividend quality, which does not indicate the need to change dividend policy in the short-term.
- While the company’s share price is sufficiently below its 52-week high (currently about 35% below) it does not have a positive free cash flow, which suggests that a share buyback at this time may not be prudent.
Company numbers are TTM (trailing twelve months) or latest available. Share price data is previous day’s close unless otherwise stated.This report does not predict dividend or equity actions but highlights corporate actions that are supported by fundamental company performance and corporate finance principles.
Why merge or acquire?
Companies typically acquire to realize economies of scale, scope, gain customers, bundle complementary products, or gain vertical integration. From an investor’s perspective, these business reasons fall into natural screening categories that include: (a) buying companies to boost growth expectations; (b) buying to realize cost synergies; and (c) buying earnings through acquisitions that increase EPS.
Potential targets would typically be smaller than their peers though sometimes targets can be marginally larger than the acquirer. As a result, when identifying a company as a target, we check for a book value that is up to 80% more than the peer median. In addition, we also filter for a cheap valuation relative to peers (i.e. price to book is less than the peer median) and a share price that is trading sufficiently (i.e. at least 20%) below its 52-week high.
|M&A Target Conditions||CHK-US||Comparable||Pass/Fail|
|Book value||<=||1.8 x Peer median||12,265.0||23,452.6||Pass|
|% below 52-week high share price||>=||20%||34.8||20||Pass|
|Price to book (P/B)||<=||1.2 x Peer median*||0.9||2.2||Pass|
|* We use a 20% tolerance (0.8-1.2x) around the median.|
Typically, acquirers are larger than their peers though, as mentioned above, targets can sometimes be marginally larger than the acquirer. To identify a company as an acquirer, we look for a book value that is around or more than the peer median and for growth expectations (measured by its price to earnings or P/E) that are lower than peer median. In addition, we consider whether the company has the capacity to add intangible assets (like goodwill) and whether its valuation (measured by its price to book or P/B) is attractive relative to its peers.
|M&A Acquirer Conditions||CHK-US||Comparable||Pass/Fail|
|Book value||>=||0.8 x Peer median||12,265.0||10,423.4||Pass|
|Price to earnings (P/E)||<=||1.2 x Peer median*||N/A||41.7||N/A|
|Net tangible assets to equity||>=||25%||99.8||25||Pass|
|Price to book (P/B)||>=||0.8 x Peer median*||0.9||1.5||Fail|
|* We use a 20% tolerance (0.8-1.2x) around the median.|Relative size and current market value make CHK-US a possible merger target within this peer group.
With a book value of USD12,265 million, CHK-US could be acquired by others within this peer group. It may also be a possible target now because its share price is reasonably off its 52-week high and not so high in relation to book (P/B is lower than peers) that it would deter an acquirer.
CHK-US’s relative valuation (P/B) is not high enough to suggest acquisitions in this peer group.
CHK-US could achieve growth through acquisitions as it is big enough (by book value) and has room for more goodwill on its balance sheet. Acquisitions in this peer group would be more likely if its relative valuation (P/B) was higher.
Dividend cut, increase or initiate?
Is the company likely to buy back shares?
Chesapeake Energy Corp. explores, develops and produces oil and natural gas properties. Its principal activities include discovering and developing unconventional natural gas and oil fields onshore in the U.S. The company has also vertically integrated its operations and owns substantial marketing, midstream and oilfield services businesses directly and indirectly through its subsidiaries Chesapeake Energy Marketing, Inc., Chesapeake Midstream Development LP, Chesapeake Oilfield Services LLC, and Chesapeake Midstream Partners LP. Chesapeake Energy operates its business though the following segments: Exploration and Production; Natural Gas and Oil Marketing; Gathering and Compression; and Oilfield Services. The Exploration and Production segment is responsible for finding and producing natural gas and oil. The Marketing, Gathering and Compression segment is responsible for marketing, gathering and compression of natural gas and oil primarily from Chesapeake-operated wells. The Oilfield Services segment is responsible for contract drilling, oilfield trucking, oilfield rental, pressure pumping and other oilfield services operations for both Chesapeake-operated wells and wells operated by third parties. The company was founded by Aubrey K. McClendon and Tom L. Ward on May 18, 1989 and is headquartered in Oklahoma City, OK.
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