Going in to Chesapeake's (NYSE:CHK) Annual Shareholders Meeting, CEO Aubrey McClendon and the Board of Directors certainly knew that they were heading in to a fight for survival. By the close of the meeting, Chesapeake shareholders made it astonishingly clear that McClendon and the board lost the battle, and 97% of shareholders voted for a proposal to require a majority of shareholder votes for board member election.
Following the shareholder votes against board directors V. Burns Hargis and Richard K. Davidson, both men offered to resign. The offers will be reviewed by the remaining board members, who can choose to reject or accept the resignations. It is unclear whether Chesapeake's remaining board members will negotiate with Carl Icahn and Southeastern Asset Management to replace these two in part with the four shareholder-appointed new board members agreed to earlier this month, or whether six of the current board will be forced out. Southeastern indicated that it would support Hargis remaining on board only until the ongoing review of McClendon's financial dealings related to the Founders Well Participation Program (FWPP) are completed, adding that it wants to see the review concluded within "weeks, not months." In any event, Chesapeake's entire board will be up for re-election in 2013.
The long term incentive plan suggested by Chesapeake's board did pass with 86% of votes cast. From this, I think that executives at Chesapeake are looking at a significant cut in pay by this time next year, as even if they do manage to turn Chesapeake around it will be years before the benefits of these changes trickle in to the incentive plan, particularly since the proposed annual incentive plan that could have compensated for this received just 31% shareholder support. By comparison, shareholders of Exxon Mobil (NYSE:XOM) voted for a proposed executive compensation package at that particular firm, noteworthy given Exxon Mobil's legal battles and poor public perception on its environmental track record. This makes it clear that Chesapeake's combination of steadily falling returns and depleted image are setting it up for failure.
Asset Sales Moving Slowly
Chesapeake's situation is dire. Its string of announcements regarding assets it is holding out for sale over the past few months are garnering little public interest, so on June 8 Chesapeake announced that it will be selling its pipeline interests to Global Infrastructure Partners in a deal valued at just over $4 billion. $2 billion of this represents the purchase price for Chesapeake pipeline specialist and subsidiary Chesapeake Midstream Partners LP (CHKM), and a further $2 billion will be raised by transferring its internal pipeline development unit and some of its conduits to Chesapeake Midstream prior to the deal's close.
In appraising the deal, Timothy W.N. Guinness, founder of Guinness Asset Management Ltd, noted that "it's highly sensible for [Chesapeake] to be selling assets to tide themselves over any short-term price squeeze," a statement most analysts would probably support. However, in Chesapeake's case the squeeze is not short term.
One of the major pressures on Chesapeake is the low U.S. natural gas price environment, which is making it difficult for Chesapeake to realize a profit on production from leaseholds across the country. Supermajor BP (NYSE:BP) is predicting through its marketing subsidiary ProGas that NYMEX and Chicago natural gas prices will remain low throughout 2012. Anadarko (NYSE:APC) is not predicting a return to gas prices between $4 and $6 per btu until at least 2014, and as a result Anadarko is "dialing back U.S. onshore dry gas activity" according to Board Chairman and CEO Jim Hackett. These predictions make it unlikely that Chesapeake will be able to hold off further asset sales, and also eliminates the likelihood of Anadarko purchasing Chesapeake's natural gas assets despite its position as a leader in this market.
As it waits for natural gas prices to rebalance, the cash shortfall for Chesapeake is widening, with Alembic Global Advisors recently raising the shortfall estimate for the company to $22 billion by 2014 - or roughly twice Chesapeake's current market cap, which is standing at $11.5 billion.
Chesapeake hopes to make up part of its funding shortfall by selling some of its leaseholds in the Utica shale, the newest play that Chesapeake is marketing from its core assets. J.P. Morgan analyst Joseph Allman is predicting Chesapeake will receive far less than what it paid for these assets, netting around $500 an acre, far less than the $1,500 an acre it paid on average. I agree with this assessment for several reasons. Chesapeake is clearly a company in trouble, which lessens its bargaining power to such a degree that its asking prices on these properties are almost ridiculously optimistic. Additionally, though Chesapeake's properties in the Utica shale are overall better developed than other of its assets, such as those in the Niobrara, the leaseholds it is offering for sale are likely to be un- or under-developed, and in many cases unproved. As there are many other leaseholds to be had in the Utica with better well data, Chesapeake may see an uphill battle proving the worth of its offerings.
Finally, many players who would be interested in Chesapeake's piecemeal leases are doing exactly what Chesapeake failed to do, focusing on oil acquisitions rather than gas. Cabot Oil & Gas (NYSE:COG), for example, has positions on the Utica, but is driving towards oil with recent successes on the Marmaton play. Cabot is now extracting substantially more oil out of Marmaton with the completion of several new wells that are averaging between 740 and 1,279 barrels of oil per day. Moreover, Cabot reports that the top-performing well cost just $3.8 million to drill and complete, compared to an average cost of $5 to $6 million on the Utica.
Shares in Chesapeake are up 23% from one month ago, currently trading around $17. I attribute this boost more to Carl Icahn's recent involvement with the firm than any material changes in Chesapeake's current outlook. With a price to book of 0.9 and a forward price to earnings of 9.3 Chesapeake is trading cheap. However, I think that the Chesapeake Board's final appraisal of McClendon's FWPP mortgages and related financial dealings, which should be released by the end of summer, could introduce a more appealing buy.
It is my prediction that the release of the FWPP details will move Chesapeake down, and if the misdealing is severe enough it could be the final push needed to remove McClendon from his position as CEO. I believe that action, more than any other potential asset sale or decision on behalf of Chesapeake's management team, would take a weight off of Chesapeake's stock and send it up.
From this, I would be looking for an entry point around $15 in the coming months, with a hold until mid-fall. By the time winter approaches it will be clear whether Chesapeake will be able to make its asset sales work, or whether it will be seeking a buyer in whole. At this point, with leaseholds in nearly every single one of its plays on the market, Chesapeake is probably making the same predictions itself.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.