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One Number Chesapeake Needs to Call

Courtesy of Benzinga.

In the classic “Wall Street,” the first one, Michael Douglas’ Gordon Gekko told the shareholders of the fictional Teldar Paper “I am not a destroyer of companies. I am liberator of them!” These days, Chesapeake Energy (NYSE: CHK) investors might feel as though they’re stuck with a destroyer of their company, CEO Aubrey McClendon.

And that’s odd considering it was McClendon that built Oklahoma-based Chesapeake from the ground up, in his own maverick image, to become the second-largest U.S. natural producer trailing only Exxon Mobil (NYSE: XOM). Giving credit where credit is due, shares of Chesapeake are up almost 1,200% since the early 1990s, but has anyone really held the stock that long?

Who is actually willing to fess up to having owned the stock around $70 in 2008 and also willing to admit he or she owns it today at less than $18? Owning Exxon Mobil or Chevron (NYSE: CVX) for 15-20 years, while not everyone’s favorite investment strategy, is plausible as those companies are well-run, prodigious dividend raisers. Chesapeake, not so much.

While the Chesapeake board was busy buying maps from McClendon among other dubious financial pursuits, the dividend was being increased by mere pennies. The most recent dividend increase was 1.3 cents per share. That’s not the kind of dividend growth that will keep most smart investors involved in a stock for multiple decades.

The dividend, or lack thereof, is only a small slice of the toxic pie that is now Chesapeake. Those not living under a rock by now that McClendon borrowed as much as $1.1 billion over the last three years against his holdings in thousands of Chesapeake wells without telling shareholders about it. The first analysts and investors heard of the gambit was when Reuters broke the story in April.

The loans allowed McClendon to take a 2.5% stake in every well the company drills. As Reuters reported, potential conflict arises because McClendon’s collateral on the loans is his 2.5% interest in the wells. McClendon and the board which he wielded so much power over until recently said there was no conflict of interest.

Now, we’re not going to be so bold as to say Chesapeake is the next Enron. But with these shenanigans, one might be apt to ask did McClendon attend the Andrew Fastow School of Accounting?

Out here in the real world, Chesapeake is now a “story stock” and the story isn’t good. Amid natural gas prices that until very recently had been languishing below $2 per thousand cubic feet, shares of Chesapeake had slumped more than 43% in the past year. At the end of 2011, Chesapeake had long-term debt of $10.3 billion.

Today, Fitch Ratings lowered its outlook on Chesapeake to negative from stable. The company has confirmed an informal inquiry by the fine folks at the Securities and Exchange Commission. In other words, it’s hard to be long this stock for anything more than a day or two.

Some folks have argued a bullish case for Chesapeake on the basis of attractive assets, which the company does have, and some have come forth with a compelling technical case for the shares.

Unfortunately, Chesapeake may prove to be an example of where fundamentals, such as the stock looking cheap and the company’s lush Utica Shale acreage, are overlooked as long as McClendon is the captain of the ship. Technicals? Well, does it seem plausible in this moment that Chesapeake is going to gain roughly 33% and head to $24? No, it doesn’t unless…

…McClendon makes the one phone call he so desperately needs to make to liberate Chesapeake of his chicanery and create something resembling value for long-term shareholders. That’s right, the falling knife that is Chesapeake must sell itself.

The list of potential acquirers is short. Exxon is a foolhardy bet because the company is already the largest U.S. natural gas producer and analysts and investors want more oil and less gas from the largest U.S. oil company. Chevron has stood by and watched its rivals grapple with falling natural gas prices so there’s no reason for the company to boost its gas presence right now, especially with the likes of Chesapeake.

We could go on and on. Royal Dutch Shell (NYSE: RDS-A) has plenty of natural gas assets. BP (NYSE: BP) needs to be selling assets to raise cash, not spending cash on a company that has cash problems. A Chinese oil major could easily afford Chesapeake, but there is the risk that Uncle Sam would not sign-off on the deal.

All that means McClendon has one number to dial and hopefully Chesapeake can afford the international charges. He needs to ring BHP Billiton (NYSE: BHP) and CEO Marius Kloppers.

BHP has bought billions in Chesapeake assets in the past, $4.75 billion in February 2011 to be precise. Kloppers also moved on Petrohawk Energy for $12.1 billion. These deals reiterate the fact that while many think of BHP as a mining company, it’s the seventh-largest independent oil company in the world. At the end of 2011 BHP had $12.3 billion in cash flow and the balance sheet and strong credit to make plenty of deals.

McClendon needs to make the call and do so soon. It might be the only phone call that salvages his reputation.


For more Benzinga, visit Benzinga Professional Service, Value Investor, and Stocks Under $5.


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