Chesapeake Red Flags Continue To Shake Stock
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Chesapeake Energy (NYSE: CHK) is a questionable investment. There are a number of red flags to dissuade investors and shareholders from keeping this asset in their portfolio. Even aggressive investors are greatly dependent on hope or faith when betting on this American E&P. Chesapeake Energy has been inundated in million dollar lawsuits, federal investigations, and questionable management and corporate governance regarding superfluous payments. Chesapeake Energy has high liabilities, and they are increasing with time. Its business model can also be questioned in terms of long-term sustainability. This E&P could be headed for bankruptcy, another significant change in management, or a possible acquisition based on its lopsided operations.
Chesapeake Energy is currently appealing a court decision that awarded family-owned Peak Energy a sum of $19.7 million for breach of contract for not buying agreed upon land leases that Chesapeake had signed letters of intent for. Chesapeake Energy is also facing claims adding up to $100 million for similar breaches with lease holders in Texas. These are only two of hundreds of cases filed against Chesapeake in Texas, Michigan and Pennsylvania. The plaintiffs in these cases claim that Chesapeake Energy backed out of land lease agreements in various states once it had liquidity problems and saw that the natural gas prices began to drop drastically. Chesapeake is currently pushing landowners in Ohio to revise their land lease agreements. Aside from these court cases, Chesapeake is being investigated for collusion with Encana (NYSE: ECA) by the U.S Department of Justice and the state of Michigan. This stems from a report in Reuters that uncovered documents from 2010 that indicated Chesapeake Energy and Encana exchanged information and acted accordingly to lower and undercut the price for land leases in Michigan prior to transaction agreements.
These types of stories are only a continuation of the scandals that have surrounded Chesapeake Energy and its CEO. There have already been reports of lucrative spending and the CEO hedging his own personal fortune in hedge funds against Chesapeake Energy's interests. A judge has consolidated 13 plaintiffs' claims from Oklahoma against Chesapeake for a lack of fiduciary responsibility regarding these matters. These scandals led to his ousting as Chairman, but he still remains CEO. Well-known activist, Carl Icahn, invested over seven percent interest in Chesapeake and was integral in establishing new independent board members. Archie Dunham, former Chairman of ConocoPhillips (COP) was named Chairman for Chesapeake; there were also four additional independent board members added. However, all these board members, including the new Chairman, have a personal history and past working relationships with each other, with Carl Icahn, or with current CEO Aubrey McClendon. This creates some misgivings about the true independence and new direction in which this board will take Chesapeake. Currently, around 12 percent of mid-level employers are currently wondering if they will receive their single-trigger lump sum amounting to over $100 million for this change in the board.
Chesapeake is the second largest natural gas producer in the U.S. The problem is, unlike most of the other E&P's, its assets are largely lopsided in natural gas assets. Its aggressive pursuit of land led to high liabilities, and the drop in natural gas prices put it in a hard position to recover from. It's only way to sustain until prices rebound is to divest some of its larger assets in order to cover its current debt obligations. It's also important to note that a large catalyst behind the drop in natural gas prices was the proliferation in shale technology that led to an abundant domestic supply of natural gas. It's not necessarily likely that natural gas prices will revert to previous levels. In conjunction, the validity of Chesapeake's estimates of proven reserves has recently been called into question by an independent research firm. It's also noteworthy that Chesapeake is too thin on capital to make the effective transition to oil assets while being tied up in debt. Successful E&P's like Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX) have done well because they keep diversified portfolios with minimal exposure. Exxon is looking to boost production in its more profitable areas while scaling back on unpromising areas. Similarly, Chevron has been focusing its efforts on natural gas production in Australia.
Chesapeake does have a plan to reduce its debt by 25 percent while increasing its growth production by 25 percent over the next two years. Aside from that, it has an increasing amount of liabilities and is inundated in a natural gas market that is showing minimal recovery at this point. In conjunction with the quasi-new management and current investigations and litigation issues, this is a shaky investment at best. I believe this is an asset for aggressive investors. Debt and a potential acquisition are the most likely long-term outcomes for Chesapeake at this point in time.
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