Is Chesapeake the Next Enron?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Are you as sick as I am after reading the latest headline on Chesapeake Energy (NYSE: CHK)? If you missed it, embattled CEO Aubrey McClendon is at it again, this time for potential abuse of the corporate jet among other things. According to reports, McClendon cost the company well over $100,000 for flights made with his family to Amsterdam and Paris. Other reports call into question the relationship between the Oklahoma City Thunder NBA team in which he owns a 19% stake and the naming rights deal for their arena which total $36 million. Was McClendon too busy enriching himself to the point that he’s left Chesapeake on the precipice?
While one could wonder how he managed to spend six figures flying to cities I’ve flown to for one tenth of the cost, the real issue is the leverage he’s employed both personally and professionally. As gas prices remain depressed and oil prices come off their highs thanks to concerns across the sea, you begin to wonder if Chesapeake’s $10 billion in debt will begin to drown a company that seems to barely keep its head above water even in the good times. Chesapeake as the number two natural gas producer has a lot of assets that are either for sale or could be sold to meet upcoming cash requirements. The real concern comes to play if commodity prices don’t improve to the point where they can become a viable going concern.
While it should be quite obvious, but if the saying is buy low and sell high and prices are now low then now is not the time to be selling assets to raise cash. Yet, that’s exactly what they are doing. The most recent asset to be put on the market is their stake in Chesapeake Midstream Partners LP (NYSE: CHKM). According to reports, they are looking to obtain about $4 billion for the unit as well as other pipeline interests. Last year they IPO’d Chesapeake Granite Wash Trust (NYSE: CHKR) and they are looking to sell off other assets to raise cash. Finally, they’ve signed several joint venture agreements with the likes of CNOOC (NYSE: CEO) and Total SA (NYSE: TOT) in recent years where they have traded stakes in large acreage positions for cash. The real question is if Chesapeake has just become an asset flipper instead a long term producer. There will come a point where assets cannot be flipped and liquidity and potentially solvency becomes an issue.
The real problem with Chesapeake is that when you drill down below the surface of the company it gets real scary, real fast. In one report it’s mentioned that the real leverage is closer to $24.5 billion when you include volumetric production payments, off-balance sheet amounts, preferred stock and the company’s working capital deficit. They also run the risk of needing to write down huge amounts of reserves if prices stay where they are. The big concern given what we are learning about the dealings of McClendon is that not every shoe might have dropped yet. What we don’t know about the company could turn out to be far worse. While I’m not saying they are the next Enron, you can’t help but notice the similarities.
In a fascinating article on Fool.com, “Should You Join Chesapeake’s Circus” the author details the $200 million dollar hedge fund ran by McClendon and now SandRidge Energy (NYSE: SD) CEO Tom Ward as well as the $12 million McClendon was paid for his antique map collection and maybe most disturbing of all, Chesapeake Land Development which amassed a $300 million real estate portfolio and among the holdings was some retail stores a grocery store and a church! As details emerge as to who owned what, it’s been pretty clear that Chesapeake’s shareholders were on the hook for the bill, whether it was in no interest loans or with assets serving as collateral for loans. It will be an interesting story to watch from afar to see just how far McClendon went in building his own empire. While low natural gas prices are mostly to blame in the current price of the stock, McClendon’s antics could potentially cost shareholders whatever value is left in the shares if more off balance sheet deals are discovered.
If you are looking for an energy company to buy today, I recommend investors should take a look at Linn Energy (NASDAQ: LINE). The company has a great balance between gas and liquids, are well hedged into the future, and employ prudent leverage. Think Chesapeake is a buy? Sound off in the comment box below.
latimerburned owns shares of Linn Energy, LLC. 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. Motley Fool newsletter services recommend Total SA. (ADR). 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.