Chesapeake Energy Corp. (NYSE:CHK): Possible merger target?

• CHK-US’s relative size and current valuation make it a possible merger target within this peer group.

• CHK-US 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.

M&A Action

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.

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.