I am a Chesapeake Energy shareholder, and I'm happy to report that I am an increasingly optimistic Chesapeake Energy shareholder.
I became a Chesapeake Energy shareholder last fall at $25 per share because I am a big believer in the value of the assets that the company controls. My belief in the value of those assets is based on the repeated successful monetizations of pieces of those assets at prices that would imply that Chesapeake shares as a whole are dramatically undervalued.
Over the past month at these very depressed prices I've added significantly to my position.
A Very Depressed Share Price
Why are Chesapeake shares so depressed? I believe there are two big factors.
The first major reason for the depressed share price is the high level of debt that Chesapeake carries relative to its annual cash flow from operations. The plunge in natural gas prices this winter has exacerbated that problem by reducing cash flow and in doing so effectively increasing the level of leverage in the company.
The second major reason for the depressed share price is a distrust that investors have with the Chesapeake management team and its Board of Directors. This distrust has been created by controversial compensation and business dealings involving CEO Aubrey McClendon and a business plan that constantly changes.
I believe that the negative drag on the share price of Chesapeake from these two factors is starting to fade and will continue to diminish. That is why I have gone from being a disgruntled Chesapeake shareholder to an optimistic Chesapeake shareholder.
Good Things Happening
A big step was taken recently to greatly reduce concerns over Chesapeake's Board of Directors and management with this announcement from the company in response to demands from Carl Icahn:
OKLAHOMA CITY--(BUSINESS WIRE)--Jun. 4, 2012-- Chesapeake Energy Corporation (NYSE: CHK) today announced that following extensive discussions with its two largest shareholders, Southeastern Asset Management and Carl C. Icahn and his affiliated entities, who own, respectively, approximately 13.6% and 7.6% of the Company's common stock, Chesapeake has agreed to a plan to reconstitute its Board of Directors by adding four new independent directors to replace four existing independent directors who will resign from the Board upon the appointment of the new directors. Three of the new independent directors will be proposed by Southeastern and the fourth independent director will be Mr. Icahn or a person designated by Mr. Icahn, with Mr. Icahn making that determination prior to the reconstitution of the Board.
In addition, as previously announced, a fifth existing independent director is retiring at the 2012 Annual Meeting of Shareholders and will be replaced subsequently by a new independent Non-Executive Chairman through a selection process that is nearing completion. The new independent Non-Executive Chairman, who will have no previous substantive relationship with Chesapeake, will be confirmed by the reconstituted Board and will be acceptable to Southeastern and Mr. Icahn. Aubrey K. McClendon will relinquish the position of Chairman when the new Chairman is appointed and will continue as Chief Executive Officer and a director. Chesapeake will announce the new Board composition, including the independent Non-Executive Chairman, on or prior to June 22, 2012. The size of the Board will remain at nine directors.
That is truly great news for shareholders. The Board of Directors is going to have three representatives from a true long term shareholder in Southeastern Asset management, plus another from Icahn and a Non-Executive Chairman who will also require the approval of Southeastern and Icahn.
Shareholders rejoice! Our interests are now going to be front and centre instead of behind the interests of the Board of Directors and CEO.
The second concern which is high debt levels and available cash flow is also well on the way to being addressed. Last week Chesapeake announced that it had agreed to sell its Midstream assets for $4 billion. That is a big chunk of change even for Chesapeake.
And that monetization is hardly going to be the last one.
The next monetization is likely to be a Joint Venture involving Chesapeake's Mississippi Lime acreage where Chesapeake controls the largest single position in the industry with over 2 million net acres.
Chesapeake is the Largest Leaseholder in the Mississippi Lime
Chesapeake has completed a bunch of Joint Venture deals involving some of its other large unconventional oil and gas properties. The deals have typically involved Chesapeake selling 25% to 33% of its acreage in exchange for cash up front as well as the acquirer paying for a specified dollar amount of future drilling on the Joint Venture property.
According to page 3 of Chesapeake's most recent investor presentation the company believes that the Mississippi Lime acreage is worth $7,000 to $8,000 per acre. If you assume that Chesapeake sells 25% of its two million acres that would imply monetization proceeds of 500,000 x $7,500 = $3.75 billion.
As a shareholder my concern has been whether all of the negative press about Chesapeake might negatively impact the price it will receive in the Mississippi Lime monetization. I had a chance to run my concerns past Ruben Alba, Co-CEO of the private company PetroRiverUSA which is an emerging player in the Mississippi Lime.
Mr. Alba suggested that Chesapeake is in "all the right areas in the Mississippi Lime" and that he doesn't think that Chesapeake will have any trouble getting enough interest to receive attractive offers for the acreage.
I also asked Alba about his opinion on all of the recent attention focused on Chesapeake. Alba's response was interesting. While he had no comment on all of the negative attention and issues surrounding Chesapeake, he did say that "there would be no oil and gas business in the United States if it weren't for risk takers like McClendon".
Recent history offers another reason to be optimistic about Chesapeake's ability to complete a Joint Venture deal at attractive terms. Sandridge Energy has completed several such deals in the play which demonstrates that the industry has a healthy appetite for Mississippi Lime acreage. Page 6 of Sandridge's most recent presentation details the five monetizations completed for almost $2.5 billion.
Natural Gas Prices Still the Best Solution
I feel pretty confident that Chesapeake will be able to complete enough good deals to see it through its transition to a company with a much better balance between oil and liquids. What would really change Chesapeake's near future for the better is a rebound to natural gas prices, which would increase not only Chesapeake's cash flow but also the value of its natural gas properties which could create additional monetization opportunities.
When that rebound might happen though, I just don't know.
Disclosure: I am long CHK.
