Some Thoughts On Carl Icahn Selling Chesapeake

| About: Chesapeake Energy (CHK)

Summary

Shares of Chesapeake fell in after-hours trading after Carl Icahn reported that he slashed his stake in the company by more than half.

After owning shares in the business for years, this may come as a big surprise for investors.

Certainly, Mr. Market does not like the move, and there could be undisclosed reasons regarding the sale.

But Icahn's explanation of selling for tax-planning purposes does make a lot of sense and, if true, investors shouldn't worry too much.

For long-oriented investors, there are ways to protect oneself while waiting for evidence of Icahn's true intentions.

Though I don't buy into shares of a business because somebody else did, I do recognize the appeal of having a major investor like Carl Icahn invested in a company that I also own shares in. Such has been the case for some time for investors in Chesapeake Energy Corp. (NYSE:CHK), a company that Icahn recently owned as much as 9.4% of right before selling his stock and sending shares another leg lower. What does this mean for investors in the entity moving forward, and should you follow suit?

A look at Chesapeake over time

Without any doubt, shares of Chesapeake have been among the best performing of all energy companies so far this year since bottoming at $1.50 apiece. Today, shares of the company (prior to Icahn's announcement and after a daily decline of 7.35%) closed at $6.81, which represents an increase of 354% compared to their 52-week low, and at one point, shares could be sold for as much as $9.55 over the past year, 537% above their 52-week low.

Of course, Chesapeake's extreme moves have come about as a result of a volatile oil market and the firm's exposure to it. For instance, investors who bought in near the multi-year high of nearly $30 per share in mid-2014 have taken a heck of a beating as oil prices have plummeted, and despite a partial recovery in the price of energy and despite management making some interesting moves that have been aimed toward extending debt maturities and lowering the probability of a cash crunch over the next few years, shares have yet to recover to a point where many investors would like to see them.

Being the investor he is, however, Carl Icahn recognized what appeared to be an attractive prospect, but did so even before the oil crisis began, buying up a piece of the business in 2011, and began hounding the business about mismanagement. Despite the downturn, he continued to hold 73 million shares of the business, representing around 9.4% of the enterprise, until just recently when he sold over half his stake, decreasing ownership to 4.55% of the business with 35.3 million shares today.

What to make of this

One fear among market participants is that Icahn, someone who has far more knowledge regarding the business than outsiders, may be souring to the company for some reason. One possibility is that he could be displeased about management's recent debt tactic (though I see this as unlikely), whereby it exchanged lower interest debt that's due to be paid back as early as 2017 for debt with an interest rate of around 9% (it's a floating-rate security based on LIBOR [subject to a 1% floor] plus 7.5% so it can fluctuate).

Another possibility is that Icahn fears what could happen in the oil market. Despite indications from OPEC members that a deal to stabilize the oil markets is likely imminent, changes in supply and demand figures provided by the EIA (Energy Information Administration), IEA (International Energy Agency) and OPEC suggest the market's bullish case is less appealing than it was even a month earlier. Add to this the fact that there has been talk about (though also problems implementing) production increases from Nigeria and Libya, and the mood, even though I believe it is unwarranted, has turned more negative than positive regarding oil.

These are just two possibilities regarding Icahn's sale, and it is possible that, in his mind, one or both of these fears could warrant a sale. Having said that, the single largest (and perhaps only) reason for the divestiture regarding Chesapeake seems to be that Icahn wants to take the loss for tax purposes. As stated on his website, "we believe that over the last few years Doug Lawler and his team have done an admirable job, especially in light of the circumstances. We reduced our position to recognize a capital loss for tax planning purposes". Sometime over the next several weeks, we should find out how true this is, because if Icahn does like the business and does not fear potential downside, then he would be wise to buy back in after the 30-day wash sale rule expires (assuming shares don't become too expensive in that time frame).

Takeaway

While it is possible that Icahn is selling Chesapeake for fundamental reasons, the reason he's giving is that it is for tax planning purposes. For investors who are worried that there's more to the sale than meets the eye, an option is to sell, but if you bought into Chesapeake and don't believe the firm's value has changed for the worse, then you could hold the shares and wait for to see if Icahn buys back in (he almost certainly will, if he believes the value is still there and if the price doesn't rise meaningfully), or you could hold while buying put options to protect yourself while waiting for a possible move by Icahn back into the shares.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CHK over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.