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Implications of XOM/XTO Deal For Natural Gas & Chesapeake Energy

December 15, 2009
Saj Karsan

Davy Bui

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The first big deal in the energy E&P space was announced yesterday as Exxon Mobil struck an agreement to buy XTO Energy. While I do not have a vested interest in either party, this deal has some implications for the energy markets and our largest position, Chesapeake Energy (CHK).

Exxon’s move into the US natural gas market can only be seen as a vote of confidence in onshore shale gas, despite the current, prolonged price slump. This action dovetails with what Chesapeake’s CEO, Aubrey McClendon, has been pounding the table on for the last few months: that gas producers will bifurcate into two groups: conventional, high-cost producers or shale-based, low-cost producers. Exxon Mobil seems to agree with McClendon and is looking to position XTO Energy as a separate unit inside Exxon to explore shale gas opportunities.

Exxon’s stellar reputation as best-in-class in costs and operations also implies the US natural gas market has a bright and very profitable future. What it does not imply is that XTO is pulling a Blackstone — selling out at the “top” of the market — as this Wall Street Journal article suggests. In fact, this article is downright laughable as it makes no mention of the fact that XTO’s founder and chairman, Bob Simpson, is retiring (maybe a big reason for selling out) or that the company insisted on an all-stock buy-out (hardly a logical move if you were pulling a fast one over on the buyer). Furthermore, this quote from the article, “If the Exxon deal prompts other large, integrated oil and gas companies to enter the shale-gas industry…” shows this writer and/or the analyst he is quoting is out to lunch. Other integrateds have already entered the shale-gas space as evidenced by the multi-billion dollar joint venture partnerships Chesapeake struck with BP in the Fayetteville Shale and Statoil in the Marcellus.

As for implications specific to our position in Chesapeake, the Exxon/XTO tie-up confirms my thesis that CHK’s margin of safety is backstopped by its value as an acquisition target, if all else fails. Yesterday’s deal also bodes well for Chesapeake’s efforts to find a joint venture partner in the Barnett Shale, where the company has an enviable position. However, the company’s high debt load and financial engineering (JV’s, VPPs, etc.) may make CHK less desirable in the M&A tango.

If so, I am more than content to collect 9% annual yields (based on my cost) on my CHK preferred stake while watching the company successfully exploit an increasingly valuable resource.

Davy Bui

http://enlightened-american.com/

About the author:

Davy Bui
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.

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