S&P Drops Chesapeake’s Credit Rating

Ratings agency Standard & Poor’s this morning lowered the corporate credit rating of Chesapeake Energy Corp. (NYSE: CHK) from ‘BB’ to ‘BB-’, and put the company on negative credit watch. Two Chesapeake subsidiaries, Chesapeake Midstream Partners L.P. (NYSE: CHKM) and Chesapeake Oilfield Operating LLC, were given the same rating as the parent company.

The S&P analyst noted:

The downgrade reflects mounting turmoil stemming from revelations that underscore shortcomings in Chesapeake’s corporate governance practices, covenant concerns, and the likelihood Chesapeake will face an even wider gap between its operating cash flow and planned capital expenditures than we had previously anticipated.

S&P calculates that Chesapeake’s negative free cash flow for the period 2012-2013 at over $16 billion. The company’s aggressive capital spending program is the culprit, but Chesapeake has no choice but to drill more and hope that natural gas prices rise. Otherwise the company’s leases could expire, leaving Chesapeake without anything of value to sell.

The potential value of Chesapeake’s assets is what apparently drew activist investor Carl Icahn back into the company’s shares yesterday. Icahn owned 5.8% of Chesapeake as recently as 2010, and made a nice profit without having to threaten Chesapeake with mayhem. This time may turn out differently.

The California Public Employees Retirement System (CalPERS) yesterday sent a letter to Chesapeake shareholders urging support for two proposals that will be considered at the company’s shareholder June 8th meeting. The first eliminates the company’s supermajority voting on bylaw and incorporation proposals, and the second seeks a direct shareholder nominating process for election to the company’s somnolent — and well-compensated — board of directors.

Shares in Chesapeake rose as high as $16.42 yesterday on the news about Icahn, but have fallen more than -4% this morning, to $14.88 in a 52-week range of $14.49-$35.75.

Paul Ausick