Chesapeake’s Rise a Bet on Icahn
Tim is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If today’s price movement is any indication Chesapeake Energy (NYSE: CHK) shareholders are betting on billionaire investor Carl Icahn to save the beleaguered one-time industry bellwether. It’s no secret Carl plays hard ball, which is exactly what owners of Chesapeake need right now. But don’t buy the hyped momentum or the reputation.
Why not bet on Mr. Icahn you ask? After all he has a long history of stepping in, demanding CEO’s and Board’s maximize shareholder value - not from a philanthropic sense by any means - and he’s been fairly successful on many occasions. That’s why the guy's a billionaire. But the problems with Chesapeake go well beyond CEO Aubrey McClendon’s management snafu’s that have come to light of late – well beyond.
It was mid-February when the first article regarding Chesapeake’s financial – not the management improprieties mind you – issues were raised on this forum. And that’s what prospective investors should be focused on right now, not Aubrey’s “situation” or even Carl’s swapping out of five members of the Board (after the mandatory retirement of Charles Maxwell) leading up to what is sure to be one interesting shareholder’s meeting on the 8th of June. Is a change in oversight needed? Of course, but that shouldn’t be the impetus for betting on Chesapeake – except for the momentum investor looking for a quick in-and-out perhaps.
Why? Because the company’s precarious situation won't be fixed with a change at the top – the problems run deep and have been building for some time. The list of financial concerns is long and getting longer as oil prices plunge, and that’s on top of what were already beaten down natural gas prices. Chesapeake’s – in other words Aubrey’s – bet on oil is biting the company where it hurts. Can’t really blame him in the sense that the recent 25% drop in crude prices surprised a lot of people. But even with last week’s oil drilling jackpot at the company’s Thurman well, there are simply too many other factors working against a full-blown Chesapeake comeback.
The Real Concerns
There are a few significant financial concerns for the company – none of which will be addressed by swapping out Board members or the inclusion of Carl Icahn’s influence. The biggest two haven’t changed for years – cash flow and debt. Aubrey used debt to expand the company’s portfolio like it was going out of style. Today Chesapeake has accounts payable that outweigh accounts receivable, they’re sitting on just shy of $440 million in cash with a long-term debt load of just over $13 billion. The numbers have changed a bit but the concept has remained the same for years – Chesapeake doesn’t have the cash flow to warrant the continued increase in debt load on top of the company's other operating expenses.
The answer? Selling assets – lots of assets – just as we discussed in the original article months ago. In February the objective was to raise about $10 - $12 billion in cash from various transactions and reduce debt to around $9 billion by the end of this year. Now the goal has become much more aggressive in that Aubrey has put $20.5 billion on the block - nearly half the company’s $45.5 billion total assets.
The industry as a whole is just a tough place to be – too many negative factors impacting the sector in the short to mid-term. Linn Energy (NASDAQ: LINE) – a $7+ billion competitor - will at least provide yield hungry investors with an 8.25% dividend and a long, consistent payment history. Linn also generates solid return on equity results that rank at or near the top of the industry. Cimarex Energy (NYSE: XEC) continues to grow assets – even while the debt load creeps up. But $572 million in debt for a $4.4 billion company with positive – albeit shrinking – cash flow makes a lot more sense for investors betting on the long-term.
For now? Don’t be fooled by the day’s rise – that’s a bet on Carl and a new Chesapeake Board as much as the good news from the Thurman well. There are way too many fundamental problems with Chesapeake– just as there has been for some time now – for anyone but the most aggressive of momentum and/or daytrading aficionados.
timbrugger 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.