Chesapeake- Why Insiders Are Buying Now
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Beset by falling natural gas prices and more controversies than any one company should claim, Chesapeake Energy (NYSE: CHK) recently indicated that it will be reducing its force of landmen from 1,300 to 650 by the end of this year. Chesapeake already cut 225 contracted landmen in June, and since many shale players are used to following Chesapeake's lead into hot new plays, this reduction may signal an acquisitions lull across the industry.
Given the low natural gas prices and the supply of potential drill sites, it seems likely that the U.S. oil and gas industry is in for a calm period, one which is perhaps overdue. However, I do not think that Chesapeake will have much opportunity to enjoy the calm, since its mounting problems require immediate and substantial action to keep the company viable.
Ongoing Litigation, Investigations
Chesapeake plans to file an appeal to overturn a $19.7 million judgment against it in a breach of contract suit brought in Texas. The judgment was awarded to Peak Energy, which alleged that Chesapeake agreed in 2008 to purchase thousands of acres of Peak's Haynesville shale holdings, and then backed out as natural gas prices plummeted. Chesapeake is claiming that the deal was not binding as there was no final agreement, and that Peak did not offer to tender the total acreage agreed on in the original discussions as it did not have the land rights it claimed. While $19.7 million is just a drop in Chesapeake's leaking bucket, similar litigation is pending in Texas, Michigan, and Pennsylvania, all of which could add up to substantial damages.
As usual, Chesapeake CEO Aubrey McClendon's actions are stacking against the company, this time in the form of emails McClendon sent to staff at the height of the 2008 stock market upheavals. In one e-mail, apparently sent just days after Chesapeake pulled out of its deal with Peak, McClendon indicated "what was a fair price 90 days ago for a lease is now overpriced by a factor of at least 2x, given the dramatic worsening of the natural gas and financial markets." As many companies learned between 2008 and 2012, these kinds of e-mails can, and will, come back to bite, and it is exactly damaging e-mails like these that can cause a defense against litigation to succeed or fail.
One can only guess at the e-mails that will become public in the coming months as Chesapeake and McClendon are investigated by multiple other federal and state entities. A report recently released by Reuters indicating the possibility Chesapeake cooperated with rival Encana (NYSE: ECA) to artificially lower the value of resource leases in Michigan is prompting an official investigation by the U.S. Justice Department. Michigan's Department of Resources and the Michigan Attorney General are also investigating the two companies for antitrust and other violations. For its part, Encana announced it will be undertaking its own internal investigation on the charges. The fines against Chesapeake here could be substantial, and as these investigations mount the positive news and improved investor confidence garnered by last month's board changes are being quickly overwritten. This further delays any meaningful rebound in Chesapeake's stock.
Land that Chesapeake previously prized is slipping out of the company's grasp in New York as well, as the New York Attorney General ruled last month that Chesapeake will be required to allow other oil and gas companies to bid on 4,400 of its non-drilled leases in that state. Chesapeake did not drill the leases pending a ruling from the state on the practice of fracking, but did not renegotiate terms with landowners as required.
To make matters worse, Chesapeake could be facing unneeded headwinds in the Marcellus, as a recent study indicates that the unique geology of the Marcellus formation could allow brine, and therefore fracking fluid, to move more freely across the shale than previously estimated, contaminating drinking water supplies. Chris Tucker of the Energy in Depth coalition pointed out that the study had no way of determining how long it took the brine to move into the drinking water tested, and Terry Engelder, a Penn State University geologist, made public his private peer review of the paper in which he suggested that the study appeared to be "science-based advocacy" - that is, tainted with bias.
Nevertheless, drillers, including Chesapeake, suffer from the bad publicity brought about by such studies, which can also increase the cost of leases as private landowners become reluctant to sell or renew. Increased land costs are not in Chesapeake's budget as it tries to sell what were previously critical plays to hold on to the assets that will get it through the next three years.
Outlook
According to its most recent investor presentation, Chesapeake has the "second best liquids production growth story" in the U.S., as it grew production from 30,000 barrels per day at the close of 2009 to 114,000 barrels per day at the beginning of 2012. While liquids growth is a positive, what matters here is how much liquids it has overall, and in comparison to the rest of the industry (and its own pressing cash needs), 114,000 barrels per day is not going to dig Chesapeake out of its trench. By comparison, Occidental Petroleum (NYSE: OXY) is producing 244,000 barrels of oil per day in the U.S. alone, whereas Apache (NYSE: APA) is producing 125,928 barrels of oil per day in the U.S., a total of 141,510 barrels counting its Canadian operations.
Chesapeake is currently trading around $20 per share, which gives it a price to book of 1 and a forward price to earnings of 8.8. The stock is stabilizing somewhat now that Carl Icahn is on board, but Icahn can do little about the problems Chesapeake caused for itself with its past actions. What he can do is help guide the company forward, which many investors are hoping he will be able to do - possibly without Aubrey McClendon at the controls, since the more revelations are made public the more complicit with poor corporate governance McClendon appears.
Icahn's current strategy seems to be to cut costs as far as possible. If Icahn is successful, the current price of $20 will look like a bargain a year from now, since Chesapeake should track higher once investor confidence is restored. Insiders at Chesapeake are snapping up shares, as board member Merrill Anthony Miller purchased 27,700 shares at $18 on June 27 and new board member Robert Bradley Martin purchased 20,000 shares at $17.75 on June 28.
Interestingly enough, insiders at SandRidge Energy (NYSE: SD) are also feeling acquisitive, since insider purchases of SandRidge stock are also on the rise. It appears that the leadership teams supporting SandRidge CEO Tom Ward are just as confident in their company as Chesapeake's leadership remains in their own. Even with its problems, Chesapeake could be an opportunity for the long-term, though I like the more nimble SandRidge on a shorter horizon.
jordobivona has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
