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The Globe and Mail

Chesapeake can't bank on Midstream to buy its assets

Chesapeake Energy's problems are compounding. The troubled gas giant hopes to raise at least $10-billion (U.S.) this year from asset sales to cover its mounting debt. But its woes make it harder to tap one of its favourite sources – Chesapeake Midstream Partners, the $4-billion master limited partnership (MLP) it controls. Governance and cash flow concerns about the parent may limit Midstream's ability to pay up for more Chesapeake goodies.

Last year its offspring paid Chesapeake $600-million in cash and $279-million in equity units for a bunch of assets. In theory, Midstream looks in a good position to continue to help. As an MLP, it pays out to investors essentially all the free cash flow it generates from gathering and treating gas. That means it doesn't need to pay corporate income tax, which attracts yield-hungry investors and allows Midstream to pay good prices for assets. And with debt at less than three times operating cash flow it is less leveraged than rival MLPs, which trade closer to four.

But Midstream's cozy relationship with Chesapeake has become a cause for concern. Chesapeake holds a 50 per cent stake in the MLP's general partner, so has effective control. Midstream depends on its parent for 75 per cent of its business. And Aubrey McClendon, Chesapeake's chief executive, sits on Midstream's board.

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News that Mr. McClendon was running Chesapeake and a hedge fund at the same time rightly raises concerns among Midstream's other investors about conflicts of interest. S&P recently downgraded the MLP to BB and placed it on negative watch, which increases borrowing costs. Skittish investors sent its market value down 11 per cent in April, making it harder and more expensive to raise equity. And if Chesapeake's cash-flow problems lead to it producing less gas, that could affect Midstream's revenue.

Finally, if investors and credit agencies are worried about how intertwined the two firms are, it surely reduces the appeal of deepening their ties. As a 46 per cent owner of the limited partner interests, Chesapeake will still receive its quarterly distributions, currently worth around $25-million. But the more desperate Chesapeake's need for cash, the less it may be able to rely on its faithful partner.

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