When a stock drops 27% in the first few months of the year, investors are not going to be happy. When the drop is due to what many believe to be mismanagement, investors are going to be furious. So it was no surprise Monday that Southeastern Asset Management, which owns 13.6% of Chesapeake Energy (CHK), issued a letter to the board asking, among other things, that Chesapeake entertain any offers for the company. Southeastern recently changed its status in Chesapeake to activist, giving Southeastern the ability to discuss enhancing shareholder value in CHK with third parties. Announcements like this usually cause stocks to pop, as investors begin to bet on a sale. However, CHK ended down 1.5% on the day, receiving no pop at all from the news. So why did Southeastern's letter fail to rally the shares?
First of all, this was one of the nicest activist letters I have ever read, and I think that is the main reason the shares did not react. Southeastern owns 13.6% of the company, and their recommendations are that CHK's management stop doing analyst presentations, continue asset disposals and not spurn anyone who is interested in a takeover. That's it. There was no talk of nominating directors, no blasting the company's lack of oversight that allowed Mr. McClendon's hedge fund activities to go unreported, and no suggestions outside of what CHK is already doing. A more aggressive tone in the letter would have instilled more faith in investors that Southeastern means business. This passive letter seems to have left investors questioning how effective Southeastern can be.
Second, nothing in the letter adds a new plot to the CHK story. With the stock barely off a 52- week low, I think most people would agree that management should focus more on the day to day operations of the company, and less on Wall Street analysts. CHK has already detailed plans to dispose of assets, either through IPOs, joint ventures, or selling off oil and gas fields. So asking them to accelerate that process isn't anything new. As for entertaining takeover offers, any management has a fiduciary duty to consider all actions that would increase shareholder value, so asking CHK to at least listen is hardly a very demanding offer. Any company seriously interested in CHK could take its offer directly to shareholder if they were spurned by management, so I'm not sure this will bring a buyer forward.
What this letter does do, is signal that there is blood in the water at CHK. It's hard to ignore the fact that a company that controls 13.6% of CHK is disgruntled, and that has the possibility to bring in more activists, who have had better success in rattling the cages of boards. Carl Icahn has been active in this name before, and with the stock down considerably from where it was when Mr. Icahn exited his position in the stock, I would not be surprised if he is watching the situation closely.
Even with that in mind, CHK remains a company plagued in scandal, and that is going to depress the value of the shares going forward. I believe the best way to get the shares back above $20 would be to have Mr. McClendon removed from the board, as well as most of the other members who have overseen the company's decline. Even with a change at the top, this is a highly levered company, who produced a commodity whose price is at a generational low, with little relief in low prices coming until 2015 or 2016 when natural gas can be exported from North America.
Adding a management with a history of highly risky and borderline unethical behavior to the risks associated with CHK's underlying business makes me not want to touch this stock. That said, it's hard to deny that Southeastern's large stake and disgruntled position make the name ripe for some more volatility, and possible a bit of upside. However, the poor pricing environment for natural gas, and the massive debt load of CHK make me wonder if the smart money won't wait to see if they can get CHK at an even lower price.