Why We Agree With Icahn On Chesapeake Energy

| About: Chesapeake Energy (CHK)
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The Event: I would not sell Chesapeake: Carl Icahn

Carl Icahn, during an interview given to CNBC yesterday (July 3, 2012), said that the natural gas giant, Chesapeake Energy Corp (NYSE:CHK), is a "very undervalued company".

Icahn has a Chief Executive Officer on the prices of natural gas, and says, "I think natural gas, in the next few years, will go quite a bit higher, and Chesapeake will be there to take advantage of it."

He further stated, "I would not sell Chesapeake. I would be against selling this stock."

While speaking about the Chief Executive Officer (CEO) of Chesapeake, he said, "Aubrey (McClendon) is a very bright guy and he's put a lot of great assets together."

When asked about the funding gap faced by the company, he said, "I think they'll definitely meet [their cash gap] if they're able to cut costs and sell their assets."

Icahn sees an interesting similarity between Chesapeake's current situation and that of ImClone Systems (IMCL), in facing a corporate governance failure, but whose assets were still prized. Icahn took over ImClone in 2006 and sold it to Eli Lilly (NYSE:LLY) two years later.

With regards to the changes in the board and Chief Executive Officer, he said, "There's a new board, I put on a director. I can tell you, the shareholders control the company now."


Chesapeake Energy Corporation is the second largest natural gas producer in the U.S. The company has witnessed tremendous growth over the past few years due to the natural gas shale boom in the U.S., but this has come at the price of the company mounting a very high leverage.

Natural gas prices have a taken a plunge over the past few years, which has hurt the profitability of the company, and created a cash funding gap since the aggressive capital expenditure cannot be fulfilled with just the internally generated cash flows. This requires that the company undergo cost cutting, while also liquidating some of its less profitable assets, and shift from gas to liquids-and-oil plays.

In April, it was revealed that the then chairman and CEO, Aubrey McClendon (now only CEO), had enjoyed perks and compensations, and had pursued certain business strategies to his own benefit, and the detriment of the company, which was a failure of the corporate governance in place at the company.

By the end of May, Carl Icahn declared that he had acquired a 7.6% stake in CHK and called for a change in the board representation. The board was reconstituted in June, and Carl Icahn got one representative on the board, Southeastern Management got three board representatives, while Archie Dunham (Ex Chairman ConocoPhillips - COP) had been appointed as the Independent Non-executive Chairman of the board.

Qineqt's View

As highlighted in our report titled Is Chesapeake Energy A Turnaround Story? , we expressed our bullish stance on the company, and expressed that the company was a high risk investment; a reversal in gas prices (our bullish opinions expressed in subsequent reports such as How To Play A Rebound In Natural Gas Prices and Will Natural Gas Prices Rebound?) would benefit the company significantly, provided that it is able to liquidate assets and reduce costs to meet its funding gap. We have witnessed a recovery in gas prices ever since, and believe that if natural gas prices continue on their trajectory path, it will be beneficial not only for Chesapeake Energy Corporation, but also other producers of natural gas in the U.S like Apache (NYSE:APA), Devon Energy (NYSE:DVN) and Range resources (NYSE:RRC).

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