Chesapeake: A Lucrative Buy At $18

Jun.19.12 | About: Chesapeake Energy (CHK)

Chesapeake (NYSE:CHK) stockholders have not had a particularly good time, with the company constantly in the news for all the wrong reasons. The icing on the cake was a special report from Reuters on the company's CEO-entitled Special Report: The lavish and leveraged life of Aubrey McClendon. The report was put together after several interviews and the examination of many documents and is a damning expose of how far over the top McClendon has gone in his running of the company. Some of the highlights from the report are briefly described below.

AKM Operations is a small division of the company employing six full-time workers, but their main job is to manage several aspects of McClendon's personal business and personal life. The regulatory filings of the company disclose the existence of this division, but shareholders have been unaware of the details. In 2010, this group worked over 15,000 hours at a cost to the company of over $3 million; it does appear that the bulk of these expenses were reimbursed to the company by McClendon.

At Will Rogers World Airport, Chesapeake has a fleet of leased company planes used to transport company personnel to oil and gas fields that has been used to transport the McClendon family to holiday destinations. One such trip to Amsterdam and Paris cost $108,000 but was counted as a business expense. The logs also show that, on another trip, nine female friends of Mrs McClendon went to Bermuda at a cost of $23,000.

The trips are legal under the company policy and SEC regulation, but do raise disturbing questions about corporate governance. In another case of mixing his personal interests with the interests of Chesapeake, McClendon owns 19% of the Oklahoma City NBA franchise, the Oklahoma City Thunder. Chesapeake has an annual sponsorship deal with the team worth $36 million and pays a further $4 million annually for the stadium to be branded as Chesapeake Energy Arena. What was previously not disclosed was that the proceeds from the team had been mortgaged as collateral for bank loans.

At a shareholders meeting just a few days ago, shareholders demonstrated that they were fed up the antics of McClendon and the Chesapeake board of directors. Directors V. Burns Hargis and Richard K. Davidson received just 26% and 27% of votes and will be among four board members who will be replaced. Shareholders also voted to reincorporate the company in Delaware where laws are far friendlier to shareholders than Oklahoma. This was one of the biggest ever protests at a stockholders general meeting in the United States.

In addition, executive compensation packages, which are among the most generous in the industry, were shot down with only 20% of the votes in favor though it should be noted that the vote is not binding on the company. All this took place despite the promises of the company to strip McClendon of his chairmanship and appointing four new faces to the board. With a fifth director retiring, shareholders will control five out of nine directors. This means that independent directors will now have a majority on the board and then you can expect to see some degree of control over McClendon's shenanigans.

All this should not mask the fact that McClendon is an outstanding oil and gas executive who has built the company into one of the largest shale gas producers in the United States with an outstanding collection of assets. Carl Icahn's arrival on the scene with a $785 million acquisition of a 7.6% stake in Chesapeake is good news because Icahn has an excellent reputation for enhancing value for all shareholders wherever he takes a stake.

McClendon has also moved decisively to accumulate cash to finance exploration and cut down debt. Chesapeake has also announced an asset sale, which includes its midstream unit Chesapeake Midstream Partners LP (CHKM), which will fetch about $4 billion. It has also put over 300,000 acres of its Utica-Point Pleasant acreage and this should fetch another $4 billion or so.

This entire mess may well put Chesapeake into play as a possible acquisition and I believe that major companies who would be interested in acquiring this major natural gas producer will include Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and Shell (NYSE:RDS.A). After all, gas prices are at a 10-year low and the valuation of Chesapeake could make it attractive for the long term. This would be a cheap way of boosting reserves and this may well be a once-in-a-lifetime opportunity.

Personally, I tend to agree with the bullish view that a new style of management could do wonders for the company. McClendon could continue to be a valuable asset provided the new board of directors can put a leash on him and force him to behave more responsibly. A recovery in the natural gas market prices can also do wonders for the bottom line.

I would consider Chesapeake to be an irresistible buy at this point in time. In addition to the acquisition possibilities and the changed board of directors, the fundamentals themselves are compelling. With a price to book ratio of 0.7 and a price-earnings ratio in the region of 7, you can hardly go wrong on an investment on which I see plenty of upside and very little downside. Even if you are currently reluctant to invest, hold on to your existing positions in the stock and wait for the price appreciation.

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