25% Gain Possible As Shorts Squeeze Chesapeake

| About: Chesapeake Energy (CHK)

Note: The section entitled “More troubles at the top” was corrected from the original version to accurately discuss McClendon’s personal finances. The section was originally titled “More troubles for CEO McClendon. The factually incorrect statements regarding CEO Aubrey McClendon finding a lawyer to combat the SEC about whether his $1.3 billion personal loans represented a conflict of interest or that the loans should have been announced to shareholders,and McClendon’s need to start courting banks to refinance his personal line of credit of $1.3 billion, which are partially secured by Chesapeake assets, have been deleted from this section.

Chesapeake (NYSE:CHK) has been in the news for the past month and at times the headlines have been frightening. First there is the falling price of natural gas, second the misconduct of the Board of Directors and CEO Aubrey McClendon, third the company's short fall on cash and fourth is the necessary sale of assets. It seemed the only good news was that of Carl Icahn buying a 7.5% stake in the company. But since the fall-out of all the bad news, there have been some bright spots forming for Chesapeake. At first glance it appears that Carl Icahn will get the changes he wants on the board and also the sale of assets to prop up the company in its operating cash short fall.

News on asset sale

Chesapeake is believed to have entered into a deal to sell its portion of Chesapeake Midstream Partners LP. to Global Infrastructure Partners for over $4 billion. Chesapeake Midstream Partners has over 3,700 miles of natural gas pipeline, with Chesapeake Energy owning an additional 1,950 miles of pipeline as well at the end of 2011. But one analyst, John Cusick of Wunderlich Securities, believes that Chesapeake Midstream is a reliable revenue stream and Chesapeake should try to hold on to the pipeline.

In a separate move, in May 2012, Chesapeake is said to have placed its 1.5 million acres of lease holdings in the Permian Basin located in Texas up for sale. Possible buyers for the Permian Basin area would include Anadarko (NYSE:APC) which already is a partner of Chesapeake in producing wells in the area and CEO Al Walker has been quoted as "looking seriously" at the Permian Basin sale. Chevron (NYSE:CVX) which is one of the largest producers in the Permian Basin since 1926, also has plans to build a new corporate office in the area and is beginning to hire more workers in the area. Chevron has the money to make this transaction easy for Chesapeake.

Occidental (NYSE:OXY) which is the largest producer in the Permian, is also believed to be shopping in the Permian too. Chesapeake also plans to divest in another 337,000 acres in Ohio with bids being due by July 11, 2012. Interested companies include Devon Energy (NYSE:DVN) which has recently found good success in the Utica area and it has plenty of room to grow operations in the Utica area. There are an additional 500,000 acres located in Colorado and Wyoming within the Denver-Julesburg Basin. Bids are due for the D.J. Basin in late June. Prospective buyers for the DJ Basin assets are Anadarko Petroleum and Marathon Oil (NYSE:MRO) and both companies continue to grow in the DJ Basin and each has looked at expanding. It appears that Anadarko Petroleum will buy one of these three or make it difficult for the leases to go cheap.

More troubles for CEO McClendon

A Reuters’ review of Chesapeake’s financials showed that McClendon counted family trips to Paris and Amsterdam, totaling $108,000 as a business expense. The report also showed that McClendon used company funds to finance a trip to Bermuda for nine of his wife’s friends in 2010. Chesapeake’s Board of Directors is currently looking into the ties between McClendon’s finances and Chesapeake.

Analysts are cautious with upgrades

In the past few days several analysts have come out and upgraded Chesapeake from a sell to hold based on the advancement of Mr. Icahn ideas of change at the company. But the upgrades have come with a cautious tone in the analysis. One upgrade came from Argus Research analyst Phil Weiss. Weiss thinks more corporate governance is needed but he likes the small steps of change that have been taking place since May 1, 2012.


Sure the news on Chesapeake was bad and the short sellers took a strangle hold on the stock and tried to suck the life out of the stock. Chesapeake Energy was under siege by short sellers based on all the news outlined above and shares short were at 67 million as of May 15, 2012. At this point shares short accounted for almost 15% of the total shares floated to investors. But the stock had stabilized around $15 per share for the last part of May, partly because of Mr. Icahn's newly acquired position.

Since early June, the stock has increased some 20%, trading around $17.67 per share currently. I think there is still plenty of upside for Chesapeake going forward and right now the stock could experience some nice gains until investors with shares short unwind their positions. I think the short sellers will need to cover more positions before the June 8, 2012 annual meeting because with Icahn pushing for changes, the short seller might need to run for cover. The stock could see a dramatic rally on high volume for several more weeks until the short sellers are through covering positions.

As more good news on Chesapeake's financial health improves, so will the stock. There is risk involved here but if you are a believer in Carl Icahn then your risk could turn to reward. An investor must also consider the price of natural gas and whether the price per unit will increase over the next six months. If growth returns to the world then Chesapeake might be a good stock for a buy and hold strategy too.

Overall, I believe an investor will be able to garner a nice return over the next few weeks of possibly 25% as suitors for Chesapeake's assets line up and bid. I am solely basing my opinion on short sellers covering their positions. I think the stock will top out around $23.

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

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