Pony Up, Cowboy: Chesapeake's Cash (And Management) Problem

| About: Chesapeake Energy (CHK)

There's no other way to say it: Chesapeake (NYSE:CHK) has major problems. The sort of problems that won't go away even if natural gas prices go up. I see two problems with Chesapeake in particular, and these problems are severe enough that potential investors should approach Chesapeake only with extreme caution.

The Cash Problem

Chesapeake is facing a $22 billion cash shortfall. Much of that comes from overextensions: the company entered into 600,000 leases for 9 million acres, which will take 30 years to drill. Such leverage and capital expenditures looked great on paper when natural gas prices were rising, but now that they've hit rock bottom, the only thing flowing is red ink.

In an effort to mitigate that gigantic shortfall, Chesapeake is selling assets to raise money: for example, they're selling interests in Chesapeake Midstream Partners LP (CHKM) for $2 billion. This obviously leaves a significant shortfall. As reported by Businessweek:

In the past six weeks, the second-largest U.S. natural-gas explorer shrank pay packages, eliminated perks, agreed to remake its board, and obtained a $4 billion loan to cope with tumbling gas prices and a looming cash shortfall. Still, (CEO Aubrey) McClendon is $7.4 billion shy of the asset sales he said are needed during the next six months to cover drilling costs and begin to repay ballooning debt.

Aubrey McClendon is the key here. The man responsible for building Chesapeake is also the man responsible for nearly destroying it.

The Aubrey McClendon Problem

Where do I even begin? McClendon took out over $800 million in loans to buy personal stakes in company-operated wells. I think my fellow Seeking Alpha contributor Shaun Connell said it best last month when he called Aubrey McClendon a:

cowboy who's being investigated by the SEC, the IRS, and sued for unnecessarily brash financial moves.

Another great soundbite comes from Christopher Helman, who did a bio on Aubrey McClendon for Forbes and called him:

the most reckless (oil man), the alpha wildcatter with an off-the-charts risk tolerance. It proved nearly fatal in 2008, when extreme leverage, aggressive financing and plunging oil and gas prices combined to crush Chesapeake shares by 80%

Not satisfied with leveraging his company, McClendon also ran his own hedge fund on the side. Even leaving aside questions about conflicts of interest, the hedge fund management undoubtedly interfered with McClendon's running of Chesapeake. As stated by a trader involved with the hedge fund:

(McClendon) engaged in "near daily" communications and "exhaustive" calls to help direct the fund's trading

After all that, it should be no surprise that 80% of shareholders voted no on executive compensation.

Conclusion: Stay Away from Chesapeake

Is it possible that Chesapeake could resurrect itself into the proud giant it once was? Yes, it's entirely possible. But unless you're a die-hard contrarian, you're probably better off going with another company if you want to invest in the oil and gas industry. For example, you could invest in Exxon Mobil (NYSE:XOM) or Conoco Phillips (NYSE:COP), which have much stronger financials and CEOs who aren't incredibly reckless.

For what it's worth, T. Boone Pickens -- a "good friend" of Aubrey McClendon's -- prefers Continental Resources (NYSE:CLR) and Pioneer Natural Resources (NYSE:PXD) over Chesapeake.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.