Kimmeridge Exec: Chesapeake-Southwestern is Gas Sector’s ‘Most Logical Combination’

Activist investment firm Kimmeridge, a major Chesapeake Energy investor, wants to see a deal with Southwestern Energy come together.

Kimmeridge Energy Management owns 2.9 million shares, or approximately 2%, of Chesapeake Energy Corp.’s shares, Kimmeridge Managing Partner Mark Viviano told Hart Energy.

Kimmeridge has taken an active role in pushing Oklahoma City-based Chesapeake to pivot into a pure-play natural gas company focused on the Marcellus and Haynesville shale basins.

Last year, the firm privately lobbied Chesapeake to sell off and monetize its oily assets in the Eagle Ford Shale. Compared to the E&P’s top-tier acreage footprint in the Marcellus and Haynesville, Kimmeridge analysis found Chesapeake’s oily assets in South Texas unable to compete for development capital, Viviano said.

“If you step back and look at our investment thesis on Chesapeake, it was always through the lens of a two-step process: first, you monetize the oil assets,” Viviano said. “Then, you use those proceeds to consolidate within the Haynesville and the Marcellus in order to build operational scale and investor relevancy through greater size.”

Chesapeake ended up selling off its Eagle Ford assets and exiting South Texas earlier this year, generating proceeds of over $3.5 billion across three separate deals with SilverBow Resources, INEOS Energy and WildFire Energy.

Now, rumors are swirling that Chesapeake could acquire Houston-based gas producer Southwestern Energy Co. in a transaction valued at around $11 billion, including debt.

It’s a blockbuster shale gas deal that Kimmeridge would support.

“I’m excited about this because this is the deal we always wanted,” Viviano said.

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‘The most logical combination’

Analysts and investors, like Kimmeridge, generally think a transaction between Chesapeake and Southwestern makes sense.

“We really do view Chesapeake and Southwestern as the most logical combination in the sector today, given the operational overlap, the materiality of synergies and the opportunity for a valuation re-rating,” Viviano said.

One of the top reasons is scale. Kimmeridge’s view is there are too many public E&P companies in the market today relative to the degree of investor interest in the sector, leading to depressed valuations.

In the early days of the shale revolution, being a small, nimble E&P had its advantages. Today, shale production has entered mass manufacturing mode, where tried-and-true development processes are applied in basins across the Lower 48.

Being a bigger player matters a lot more when negotiating on services pricing, lowering overhead costs, gaining operating efficiencies and accessing investment-grade debt.

Combined, Chesapeake and Southwestern would have a production of around 8 Bcfe/d—putting it ahead of the nation’s current largest gas producer, EQT Corp., according to analysis by Truist Securities.

The combined company would also be the only publicly traded gas E&P with producing assets in both the Marcellus and Haynesville shale basins. Having blockier acreage positions would enable a combined player to drill longer laterals and save on drilling expenses.

“As much as we all appreciate the role of blocking up acreage through consolidation for longer laterals, it should have the greatest impact in the Haynesville—just because you’re starting with the highest well costs and the biggest benefit from drilling longer laterals,” Viviano said.

Combining Chesapeake and Southwestern would also create a gas company in a prime position to capitalize on growing global demand for LNG.

Both companies already sell a significant amount of their gas production into the Gulf Coast market. Earlier this year, Chesapeake signed a 15-year LNG supply agreement with Gunvor Group to supply Haynesville gas for liquefaction.

“I believe that a company with a leading position in the Haynesville, in close proximity to LNG infrastructure, is going to be uniquely positioned to capitalize on that long-term opportunity for greater connectivity to the global gas market,” Viviano said.

Gas demand to fuel U.S. LNG exports is forecasted to grow by 17.4 Bcf/d between 2023 and 2030, according to East Daley Analytics data. Total peak LNG export capacity in 2022 was about 13.9 Bcf/d, Energy Information Administration (EIA) figures show.

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What’s your price?

Given the myriad of different operational efficiencies and synergies that could materialize should the two companies combine, Kimmeridge thinks a deal could happen—but only for the right price.

Chesapeake acquiring Southwestern for a roughly $11 billion purchase price, or about $7 per share of Southwestern stock, would imply little to no premium takeout compared to recent closing prices for SWN shares.

Analysts said they wouldn’t be surprised to see a final price closer to between $7.50 and $8 per share of SWN stock.

“I do think it’ll happen as long as Southwestern’s board’s willing to accept a modest premium,” Viviano said.

Kimmeridge thinks a “modest premium” of between 10% to 15% would make sense for an acquisition, given the difference in size between Chesapeake (which has a market capitalization of around $12 billion) and Southwestern ($8 billion).

The oil and gas M&A market has seen a flurry of activity in 2023—especially in the Permian Basin, where E&Ps have been consolidating premium drilling inventory.

The clearest example of this trend is Exxon Mobil’s behemoth acquisition of Pioneer Natural Resources in an all-stock transaction valued at nearly $60 billion, excluding debt.

Devon Energy Corp. reportedly held preliminary conversations with Marathon Oil Corp. about a potential combination, according to Bloomberg.

Permian Basin deals have centered around oil-producing assets, but extreme volatility in natural gas prices has chilled the M&A market for gas-weighted deals.

Henry Hub natural gas prices are expected to average $2.61 in 2023—down nearly 60% from an average of $6.42 last year, according to the EIA’s latest forecast.

This summer, a consortium of family office investment groups took ownership of Wyoming-focused gas producer PureWest Energy in a $1.84 billion cash deal.

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