A new CEO. A new board of directors. Carl Icahn's praises. Things are certainly looking better for Chesapeake (CHK) after a very rocky month. In this article, I will examine Chesapeake's current position and explain why I think we are starting to see signs the company is finally turning the corner. I will also discuss potential buyers and the company's future outlook. Here are my findings.
New Chairman, Board Bring Potential for New Direction
Chesapeake recently named Archie Dunham its new Chairman of the Board to replace McClendon, who formerly held the title of Chairman as well as his title as CEO. Dunham previously navigated Conoco through its merger with Phillips Petroleum and resulting public offering as ConocoPhillips (COP), remaining as chairman of the new company until 2014. Chesapeake also named four new independent directors, hopefully giving the Board a new direction as well as a new face. However, the independence of some of the directors is open to question. I think the appointment of Archie Dunham as CEO is a big positive step for Chesapeake.
Bob G. Alexander, a new director named by institutional investor Southeastern Asset Management, and supported by Carl Icahn, participated in a major business deal with Sandridge Energy (SD) CEO Tom Ward, a close friend and mentor of McClendon, as recently as 2006. Alexander also attended the same college as Dunham, and serves on the Board of CVR Energy (CVI) along with another of the newly minted Chesapeake directors, Vincent Intrieri. Icahn is also a member of the CVR board. I think any votes that these two directors pass can implicitly be assumed to have the blessing of Icahn.
Icahn indicated to the media last week that he and other institutional investors "believe that Chesapeake is now heading in the right direction," which is understandable since Icahn can feel confident about his influence on the board selections. Icahn's experience in navigating company turnarounds paired with Dunham's same experience are still a bright spot for Chesapeake, but the web of relationships between these new directors means that while they may be mostly independent from Chesapeake, they are far from independent from one another.
Sinopec Emerging as Likely Permian Buyer
According to McClendon, Chesapeake "will become a completely different company to invest in" after $13 billion in asset sales planned over the next two years, which the company hopes will allow it to fund a looming cash shortfall and focus on its most valuable (read: oil-heavy) plays. In theory, selling off its gas producing assets would give it the cash and resources it needs to focus more heavily on its oil producing assets, but in Chesapeake's case I anticipate that most of this cash will need to be spent instead on repaying its complicated loans, not developing the production it so badly needs.
One of the few companies known to be interested in Chesapeake is Sinopec SNP, parent company of Sinopec Shanghai Petrochemical Company Limited ADR (SHI). Sinopec SNP recently unveiled a $2.5 billion joint venture with Chesapeake's competitor Devon Energy (DVN). Sinopec is currently dependent on downstream activities for most of its revenue, but its joint venture with Devon as well as an uptick in mergers and acquisitions worldwide show a company transitioning to upstream. With 25 billion RMB cash on hand (about $4 billion) at the close of 2011 Sinopec has a comfortable cash margin to make further acquisitions, though I think that it would be looking for a U.S.-based partner in any deal with Chesapeake.
One indicator that Chesapeake is serious about selling its assets is the speed of recent settlements. Its assets in Pennsylvania are among those on the auction block, and in order to make sure that its offerings are as unencumbered as possible the company recently settled arbitration from families in Terry Township claiming well contamination for $1.6 million. Chesapeake will take ownership of the land owned by these families as part of the settlement, but details on the acreage are not yet available. I think that Chesapeake's willingness to settle a suit that it had a good chance of winning in court is a good sign; though it can ill afford to siphon off cash, it is an indication that the company is beginning to realize the seriousness of its situation and is taking measures to streamline its divestitures.
At least a few of Chesapeake's top executives are bullish on the stock, with Chief Operating Officer Steven C. Dixon and Senior Vice President, Treasurer, and Secretary Jennifer M. Grigsby both exercising options in the last week. Certain of the Board's new members are also bullish, with one remarking after appointment that Chesapeake's growth prospects are too good to put it up for sale in the near term - an idea with which many watching Chesapeake, including myself, disagree. Given its funding shortfalls and focus on plays where it owns a deal of acreage but not much production compared to competitors, it is hard to anticipate Chesapeake having enough cash for meaningful development any sooner than a five year horizon. In the meantime, the company would have to deal with continued depression in natural gas markets and low liquids production against competitors with much better weight in infrastructure and development.
So, is Chesapeake turning the corner? While we are starting to see positive signs, I am still rooting for a takeover for Chesapeake, which is currently trading around $17. At a price to book of 0.8 the value is there, although the recent announcement of Encana's investigation into the Reuters antitrust accusations could quickly change this. The initial Reuters report points to alleged collusion between Chesapeake and Encana over keeping land prices for oil and gas fields in Michigan artificially low.
I think another entry point close to the value seen at the beginning of this month, at $16 per share, and a price to book of 0.7, is possible within a very short time.