Chesapeake a Special Situation
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When "Mr. Wall Street" Carl Icahn does something, people get curious. His endeavor into Chesapeake Energy (NYSE: CHK) is no different. In particular, people wondered what impact Icahn would have on a board of directors who seemed to let its CEO and now former Chairman Aubrey McClendon run roughshod.
In the not too distant past there were mutual fund managers, two of whom I know, who would not invest in Chesapeake because they feared the potential for funny financials with McClendon as the dual CEO and Chairman, and his tight-knit board.
Their fear was not without some merit. As Footnoted.com mapped out, McClendon has had some interesting compensation and other arrangements with the company. The appearance seemed like smoke to some, which was enough to keep them away for fear of fire.
Icahn's entry into a 7.5% stake of Chesapeake was clearly predicated on his view that as a holder of massive oil and gas acreage, the company had significant unrecognized value. In not untypical fashion, Icahn has moved to remove McClendon as Chairman, and has seen him replaced with former ConocoPhillips (NYSE: COP) chair Archie Dunham as a step towards unlocking that value.
Today, with Icahn having a seat on the board to agitate as an activist, several other seats changed at his urging and another big activist investor in Southeastern Asset Management also placing board seats, the company seems to be righting the ship in the eyes of investors. Though McClendon retains the CEO role, Southeastern just doubled down on its bet in Chesapeake which likely shows quite a bit of confidence in the company.
Combining with the scent of smoke at Chesapeake was also the precipitous plunge in natural gas prices. As one of the largest natural gas producers in America, Chesapeake suffered significant loss of earnings in recent years to the point of having an approximately $22 billion debt shortfall on the horizon.
Even prior to the activist investors though, Chesapeake was changing its business model to better reflect the realities of low natural gas prices relative to oil and natural gas liquids.
As of the most recent quarterly filing by Chesapeake, the company has managed to nearly triple oil production from last year, while cutting dry natural gas production by over 60%. This has the dual effect of raising the company's margins on oil vs gas, as well as, reducing natural gas supply in the system. Chesapeake's impact on natural gas is hard to track, but such a large cut in supply is sure to have influenced the price rise in natural gas this year.
With several more asset sales planned, Chesapeake seems on pace to plug their funding hole. Bond rates for the company have fallen by about a quarter point in the past few months with the current round of asset sales, including its stake in Midstream Partners LP.
Going forward, if you trust in the new activist managers and McClendon to steer the company well, the assets of the company are significant. According to Chesapeake, it is "the second-largest producer of natural gas, a Top 15 producer of oil and natural gas liquids and the most active driller of new wells in the U.S."
I have twice sold cash-secured puts on Chesapeake collecting a nice pessimism premium. I had been hoping to catch entry at a slightly lower price, however, it appears I may just have to buck up and buy shares in the company as confidence in leadership develops. Chesapeake's share price has already climbed over 40% from it's 2012 low to over $19 per share, though is not near its post financial-crisis highs in the low $30s per share.
Kirk and clients of Bluemound Asset Management, LLC own no positions in any company mentioned. Neither Kirk nor Bluemound clients plan any transactions in the next 3 trading days in the mentioned company's securities. Opinions subject to change at any time without notice. Follow Kirk on Twitter @GALPinvesting, GALP is Growth At Low Prices, for new columns, important financial news and weekly stock picks. 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.