As of June 29, 2020, Chesapeake Energy has filed for Chapter 11 Bankruptcy. The current common stock has been suspended and will be delisted. What does it mean for the current stakeholders? First, we need to discuss the missed interest payment. A hint that bankruptcy was in the cards was set in motion on June 15th when Chesapeake skipped an interest payment on a bond issue.
The company has been utilizing financial engineering for the last 8-9 years to try to solve their financial problems. Now, in fairness to the current management team, they did a good job of reducing the debt load that had been inherited. That remained true until the Wild Horse acquisition. The purchase was made in order to give Chesapeake more exposure to oil as the company is very heavily exposed to natural gas. At the time of the Chapter 11 filing, Chesapeake had approximately 9 billion dollars in debt. About 7 billion dollars of the debt will be wiped clean. Equity holders are largely wiped out. However, there will be a 600 million dollar rights offering after Chesapeake emerges from bankruptcy.
At one point before the announcement, there was a rush of people purchasing Chesapeake’s plunging stock. Why is this? Take a look at similar behavior from investors who purchased Hertz stock. After Hertz announced their bankruptcy in May of this year, many investors made a gamble by purchasing the company’s common stock. That historically has not been a successful investment strategy. Why? When a company files for bankruptcy, it affects the shareholders of common stock primarily by rendering the equity worthless in most cases and wiping out the common shareholders investment. The holder of the debt instruments typically end up with newly issued equity in the company in exchange of forgiving the debt in what is typically called a debt for equity swap.
Debt for Equity Swap
- In Chesapeake’s case after emerging from bankruptcy, they will end up with a de-leveraged balance sheet. This will give the company an opportunity to begin to create value again from the excellent assets they hold in their portfolio.
- The main point to remember for any investor who invests in the equity or debt of a company is this: if there is a bankruptcy filing and a subsequent debt for equity swap, the equity of the common shareholders typically gets wiped out. A debt/equity swap is a transaction in which the obligations or debts of a company or individual are exchanged for something of value, equity; and the balance sheet is cleansed. In the case of a publicly traded company, this generally entails an exchange of bond value for newly issued stock.
The Bottom Line
In the environment that we are experiencing since the COVID-19 pandemic began, every investor should do their own due diligence and examine a respective company’s balance sheet and cash flow statements at a minimum before investing. Caveat Emptor.
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