Summary

• CHK equity is attractive—trades at a 1-1.5x discount to other public gas operators despite having a better acreage position, more inventory, and generally better drilling than the comps. It also throws off a significant amount of cash (nearly 20% LFCF yield in 2022) and has committed to returning 50%+ to shareholders—for now in the form of a quarterly variable dividend.

• Warrants trade at a ~40% implied vol, vs. long-dated options of other gas names closer to 60%. They have embedded dividend protection and give investors better risk-reward than the equity. The class C warrants are the most interesting—while they are quite in-the-money, they are the highest strike and therefore have the most convexity

• As the gap vs. comps closes, there is 40% upside to the equity and 78% to the class C warrants

Background

Chesapeake (CHK) is an E&P with acreage positions across the Marcellus, Haynesville, Eagle Ford, Brazos Valley, and Powder River Basin. The company had historically been a decent operator / driller that was burdened by above-market MVCs and excessive leverage. CHK was forced into bankruptcy following the commodity + broader market crash in early 2020. After a 7-8 month bankruptcy, the company emerged with a cleaned up capital structure, very little leverage, and almost no firm transport contracts / MVCs. 

Vine Acquisition

In early August, CHK announced the acquisition of Vine Energy – a post-reorg pure-play gas E&P in the Haynesville. CHK paid $2.2bn total (~3.5x EBITDA) in a zero-premium deal for Vine. While Blackstone owns 70% of Vine, they have a 60-day lockup on their shares following the closing of the deal and will own <10% of the pro forma company following the closing of the merger. Chesapeake picked up 370 locations in the Haynesville, which they claim have a 50%+ IRR at $2.50 gas. I think ~1/3 of these are high-quality Haynesville locations (PV-10 breakevens in low-$2s range) and ~2/3 of them are middle Bossier, which could be really attractive but is an interval that is still being delineated.

Acreage

• Marcellus: CHK has about 12 years of high-quality (~$2 PV-10 breakeven) inventory in the Marcellus. This doesn’t include additional upside from the upper Marcellus (where Cabot and CHK have both drilled some very economic wells) or from “Tier 2” acreage that CHK has, just north of the core Marcellus, where CHK has also drilled some very economic wells. While the quality of the rock / reservoir is maybe second only to Cabot, CHK has historically drilled its wells with much wider spacing and less intense completions than Cabot. As a result, it’s not facing the same parent-child / pressure issues that are currently plaguing Cabot – CHK’s recent child wells are actually performing in line with Cabot’s recent parents and are not seeing the same level of degradation

• Haynesville: Standalone CHK had about 10-12 years of high-quality Haynesville inventory (~$2.25 PV-10 breakeven). While the Vine acquisition added inventory, CHK is also ramping up its drilling pace from 3 rigs to 6 in the Haynesville. The pro forma company has 7-8 years of high-quality Haynesville inventory and another 3-4 years of Middle Bossier inventory, which is still being delineated but we have seen some decent but variable wells

• Eagle Ford: CHK has 7-8 years of Eagle Ford inventory (high-$40s PV-10 breakeven on WTI) at the 2022 drilling pace. They are adding rigs back here next year, which makes sense given (1) their inventory is very economic with oil at current levels and (2) they have an MVC in this region

• Brazos Valley: CHK has 20-25 years of inventory here if they drill at a 1-rig pace (low $50s PV-10 breakeven on WTI). This is the old Wildhorse acreage, which they overpaid for when they acquired it but has still seen some pretty good wells.

• Powder River Basin: This is CHK’s worst acreage. I think they have 5-7 years of inventory here (low-$60s PV-10 breakeven on WTI) at a 1-rig pace. They are drilling ~8 wells here next year for leasehold purposes.

Warrants

• Three classes of warrants were issued as part of the bankruptcy

• Warrants trade at a ~40% implied vol. Long-dated options of most other Appalachia gas peers trade at ~60% IV

• Class C warrants are the highest strike ($35.708) and have the most convexity

Valuation

At year-end (pro forma for Vine), CHK should have ~$1.1bn of net debt and ~$8.1bn of market cap