So much has been written about Chesapeake Energy Corp (NYSE: CHK) and the struggles it faces. Many of the challenges have been blamed on Aubrey McClendon, the founder of the company. But I would like to ask this question. Is he the cause or just a scapegoat by perception? Is Chesapeake a victim of the poor economic conditions, scrambling to stay alive or is it his fault?
What if Mr. McClendon did no Wrong?
It is no secret that Aubrey K. McClendon has relinquished the position of Chairman, remaining as CEO and President of the company. Nor can it be denied that Mr. McClendon has done an amazing job with the company he started form nothing to guide it to where it has gone. Let's make the assumption that he did nothing wrong (an assumption for discussion). Please bear with me on this so you can follow my logic. Unfortunately the drop in natural gas prices to a 10 year low had a huge affect upon Chesapeake. And with that, people naturally took a closer look at the company. This is where perception kicks in for the company.
Mr. McClendon's $800 million in private loans obtained from his personal stake company wells are thought to have conflicted with his "professional" duties. Even if no harm was done, the perception of wrong doing is easily construed when so many investors are worried while the stock price drops and money to operate continues to evaporate. He was criticized by investors for obscuring the line between private transactions and his corporate duties. The "perception" of impropriety because of the maverick way he chose to do business is haunting him. Mind you, I am not saying he actually did anything wrong. And I am not saying that he had a 100% commitment to the company in all he did, but the way he did things may have been a bit too maverick for the size of the company and in the post-Enron atmosphere we live in. The damage was done because of the global economic events and people scrutinized the company a bit closer, not liking the way Mr. McClendon did business.
It Doesn't Take "Wrong Doing" to make it look like "Wrong Doing"
The "perception" of wrong doing can become a great fertilizer for cultivating other "probable wrong doings. Case in point-the Ohio state pension fund for CHK realized losses and right away the Ohio Attorney General suspected a direct link to Chesapeake operations. It was stated that the AG wanted to make sure that Mr. McClendon was not defrauding investors for personal gain. I wish to point out that this news is strictly subjective and no proof exists of any fraudulent practice concerning the pension funds that I am aware. It is the "power of perception" that can drive news. In an era when the "Enron Saga" is still in the memory of investors, you can bet that watch dog groups are going to be suspicious of any activity that looks questionable or not. The Ohio Citizen's Action group expressed concern that unchecked activity by Chesapeake could lead to another Enron experience for Ohio pension fund holders. No legal accusations have been made but the "perception" of wrong doing might as well be written in stone. It has a strong negative affect upon the image of the business as a whole.
A More "Corporate Looking" Board
So a shake up takes place on the board level as the two largest shareholders, Southeastern Asset Management (13.9%) and Carl Icahn (7.6%) have their directors appointed to the board (3 and 1 respectively). Mr. McClendon relinquished his chairmanship but retains his place as CEO and President.
Archie Dunham, a seasoned leader in the industry with no previous ties to Chesapeake is brought in as the new chairman. He has the experience as former Chairman of ConocoPhillips (COP) and former Chief Executive Officer of Conoco. An Oklahoma native (important for image here) is no neophyte when it comes to managing cash flow challenges. Dunham steered ConocoPhillips through two boom-and-bust cycles in the oil market. And now he is handed the task of righting a business with a huge shortfall and given the task of what one writer called:
"…curbing the CEO's penchant for costly expansions into uncharted oil and gas fields while overseeing corporate belt-tightening under a mandate from Chesapeake's biggest investors."
But is this truth, or is it just perception? Was Mr. McClendon responsible for the company's present demise or is it a victim of the global economy and his maverick way of doing business just makes a great scapegoat? I am not condoning the way he did business at the level the company operated at. I am trying to point out the economic conditions and how perception plays a huge role in why things are the way they are.
Left Selling Assets
Selling assets to pay off debt and operate is the focus of the day! Personally I think the reality show of McClendon's management style is irrelevant compared to the assets the company is now working with. The company must sell $7 billion in assets in 2012 to sidestep any credit downgrading or breach of debt covenants according to Moody's Investors Service. It does have an agreement to sell its pipeline assets for $4 billion which puts it right on track. Also planning to sell its drilling acreage in Texas' Permian Basin oil fields, McClendon said he expects the Permian Basin assets to fetch at least $5 billion.
I am sure in a smaller private company, the cross over between private and business happens all the time. But publicly traded companies in a post-Enron environment are going to have a harder time allowing something like this to take place, especially when harder times come for the business.
- Was it right that accountants, engineers and supervisors handled about $3 million of personal work for McClendon in 2010? Probably not.
- A controller once helped coordinate the repair of a McClendon house that was damaged by hailstones. Should he be doing this on company time? No.
- Chesapeake logs show, nine female friends of McClendon's wife flew to Bermuda in 2010 without any McClendons aboard at a cost of $23,000. Was a reimbursement given-I don't know.
His personal interests have been well intertwined with the public corporation he started. There is much more to the story but I am wondering if any is what bought Chesapeake to its knees. I don't think so. The mixing is done and never should have occurred on a publicly traded company like this. I am sure it is done all the time in the private sector, but publicly-it was waiting to be discovered and disapproved of.
Chesapeake Energy is where it is today because of the cellar prices of natural gas, not Mr. McClendon's personal use of business expenses. I am not condoning his leadership style but I am also not going to put the straight blame on him. But the perception he unwittingly created for himself in the public eye sure makes him the easy and likely target for its fall from grace!
So what do Investors do Now?
Presently we know that cash flow is an issue as well as paying off debt because of the low natural gas prices. Since the company has been leveraged, I would give two pieces of advice for long term investors:
First, if you really believe in the company still and want to invest, understand that the rewards may be high one day as natural gas prices are still around (provided they make it as a business) but the risk is high right now. So invest knowing the risk level. I do not think it is wrong to say they are in a great struggle.
Secondly, if you want to be more frugal, put the company on a watch list and wait until we see a turn around in the natural gas prices. Sure you may lose out on some profit in the short term but if the company does not make it you won't lose everything in the long run.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.