Seeking Alpha
Hedge fund manager, energy, value, special situations
Profile| Send Message|
( followers)  

Is Chesapeake (NYSE:CHK) the next Enron? Or has it been unfairly impugned by aggressive short sellers and news media? Should you buy the stock for the rally when they sell assets, short it to benefit from the next shoe to drop or sell calls or puts to generate income?

Much ink has been spilled by intelligent analysts arguing these points and making such recommendations.

It is apparent there is or will be opportunity to make (or lose) meaningfully from the recent news. But I am doing none of those things. I have successfully identified and shorted frauds before and profited from their inevitable stock price crashes. I have bought into valuable stressed companies and benefited from their stock price rises. And I've sold puts when implied volatility has spiked. Chesapeake's situation seems sufficiently complicated that the risk/reward on a usual play doesn't seem compelling.

However, there is a tangential trade that seems to have much of the potential upside with less of the hair associated with picking sides in the Chesapeake solvency debate. We know that Chesapeake has been aggressively monetizing assets recently, and that the company has accelerated that process in the past couple weeks as the spotlight has shone increasingly bright.

One small holding by Chesapeake on its balance sheet is a ~10% position in a small cap publicly traded company called Gastar Exploration (NYSEMKT:GST). Gastar is a rapidly growing Marcellus shale oil and gas producer, and also has exposure to the emerging EagleBine play in East Texas and another stealth oil play with compelling economics. Gastar stock has underperformed the small cap E&P group over the past year due to its exposure to natural gas prices, but is increasing its liquids exposure and is exclusively drilling high rate of return liquids-rich wells, and has sufficient liquidity for its capital program.

Something very unusual happened to Gastar stock recently. Gastar had a positive earnings report, showing higher than expected production and continued success exploiting its core liquids-rich Marcellus acreage position. In the following two days, the stock imploded, down almost 20%. I spoke with two of the investment bank research analysts who have covered Gastar stock for years and they agreed that it was a very unusual market response to a positive report.

One theory emerged from conversations with those analysts and with other investors in the stock. It appears that Chesapeake may have been aggressively selling its 10% position in Gastar stock, motivated by a need to raise cash to meet its various creditor obligations. ~$15 million in cash is worth much more to Chesapeake right now than 10% ownership of Gastar, despite Gastar potentially having an intrinsic value substantially greater than that, due to Chesapeake's stressed liquidity situation.

Rather than having to bet on whether Chesapeake is solvent or not, the most compelling opportunity may be to benefit from what appears to be Chesapeake's forced sale of Gastar stock, and investors can bet that forced selling of Gastar stock will come to an end.

While we don't know for sure (yet) that Chesapeake was the aggressive seller of Gastar stock, we do know that Gastar is solvent, that it is rapidly growing, trading at a big discount to analyst price targets, and is delivering on projected production growth rates. And we know that the stock is now 20% cheaper than it was previous to its earnings report last week. So perhaps the way to play the recent news about Chesapeake is to leave Chesapeake stock alone and buy Gastar for the 25% bounce back to the price before earnings, and possibly a lot higher.

Source: Gastar Exploration: Taking Unconventional Profits From Chesapeake