Chesapeake Energy's New Liquids Play Worth as Much as Entire Current Share Price

| About: Chesapeake Energy (CHK)
Chesapeake Energy (NYSE:CHK) is a bit of a sore spot for me. For the better part of six months last year, I looked and looked at the company while it traded in the $21 to $23 range and considered making a major investment. I run a pretty concentrated portfolio, so by "major investment" I mean at least a 10% position. I honestly felt like the company was worth at least $60, and that meant that I could have overvalued the company by 100% and still been buying with a margin of safety.
Long story short: I only bought a few shares and then watched them run well north of $30 by early 2011. I missed out on a 50% gain and I’m still not sure why.
My disappointment with myself for not owning Chesapeake continues to get worse, as the company just announced that it's built a huge position in a new resource play that could be worth as much as the entire market cap of the company.

Having achieved successful results from recent drilling activities in eastern Ohio, Chesapeake is announcing the discovery of a major new liquids-rich play in the Utica Shale. Based on its proprietary geoscientific, petrophysical and engineering research during the past two years and the results of six horizontal and nine vertical wells it has drilled, Chesapeake believes that its industry-leading 1.25 million net leasehold acres in the Utica Shale play could be worth $15-20 billion in increased value to the company. Chesapeake’s dataset on the Utica Shale includes approximately 2,000 well logs, full-suite petrophysical data on approximately 200 wells, 3,200 feet of proprietary core samples from nine wells and production results from three wells. As a result of its analysis, the company believes the Utica Shale will be characterized by a western oil phase, a central wet gas phase and an eastern dry gas phase and is likely most analogous, but economically superior to, the Eagle Ford Shale in South Texas.

Chesapeake is currently drilling in the Utica Shale with five operated rigs to further evaluate and develop its leasehold and anticipates increasing its rig count to eight by the end of 2011 and reaching at least a range of 16-20 rigs by year-end 2012. Also, the company believes that its leasehold position in the Utica Shale will support a drilling effort of at least 40 rigs by year-end 2014. Chesapeake is currently conducting a competitive process to monetize a portion of its Utica Shale leasehold position, which will be through an industry joint venture process or through a number of other monetization alternatives. The company anticipates completing a Utica Shale transaction in the 2011 fourth quarter.

Chesapeake indicates above that they think the new liquids rich Utica play could be worth up to $20 billion. With roughly 750 million shares outstanding, that would be $26 per share in value. The current share price is $34. I have to say that it isn’t very often that a company announces ownership of a previously undisclosed asset that is worth almost as much as the entire market capitalization of the company.

You should of course always take information that comes directly from a company with a grain of salt. And normally something this significant would have me really skeptical. But here is the thing with Chesapeake: I’ve been following it for a long time and every time it tells me that a property is worth a certain dollar amount, it subsequently proves it by monetizing a portion of it.
But the market is for some reason slow to grasp what these repeated monetizations show the various properties are worth. Chesapeake has done it five times already, monetizing portions of the following properties:
  • Haynesville 20% to Plains Exploration (NYSE:PXP) for $3.1 billion
  • Marcellus 32.5% to Statoil (NYSE:STO) for $3.4 billion
  • Barnett 25% to Total (NYSE:TOT) for $2.25 billion
  • Eagle Ford 33% to CNOOC (NYSE:CEO) for $2.2 billion
  • Niobrara 33% to CNOOC for $1.3 billion
Every one of these properties was monetized for what Chesapeake had suggested it was worth. That is five for five, so how can you not believe that the new property is likely worth the $20 billion it suggests? Even if it is only worth $10 billion, it is still $13 of value on a $34 stock.
It will be interesting to see how the stock market reacts to learning about this new play. If the past is any indication, the market doesn’t seem to like to reward these unconventional producers for the value of their acreage, preferring instead to wait until the production actually comes out of the ground.
Personally I’d love to see Chesapeake sell off hard one more time so that I can get that big position that I should have had last year. This company has assets that are the envy of the entire industry and has an inventory of drilling that is going to result in steady production growth for many, many years.
The truth is that even if the stock rises 10% tomorrow, I should likely be buying, because even at $40 these shares are a bargain.
Disclosure: I am long CHK.

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