Chesapeake Energy Has 75% Upside Once CEO Leaves

| About: Chesapeake Energy (CHK)
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Chesapeake Energy Corporation (NYSE:CHK) is a U.S. energy company specializing in oil and gas. The company has a strong exposure to natural gas, making it the second-largest U.S. natural gas supplier. The company is focused on discovering and developing unconventional natural gas and oil fields onshore in the U.S. CHK competes with BP (NYSE:BP), Exxon Mobil (NYSE:XOM) , ConocoPhillips (NYSE:COP) and Anadarko (NYSE:APC). CHK has a market capitalization of $11.5 billion and sales of $12.4 billion. Operating margins have been a healthy 24.4% and net profit margin stood at 15.4%. So far so good.

Despite this basically attractive underlying profitability, the stock is in decline mainly as a result of its strong dependence on natural gas prices which have been in decline for some time. Investors fear the evaporation of cash flow as well as a margin squeeze from too ambitious growth expectations. As a result, CHK is looking for asset sales to honor its obligations. Now, investors certainly see asset sales at firesale prices as a huge red flag and it raises two questions: 1. Will the asset sales be enough to cover the bleeding and 2. How destructive is the sale to its growth and profitability prospects in the long run?

Both questions are certainly difficult to ascertain and it basically comes down to what trust investors have in management- which hasn't given much reason for credibility in the past. Now, I am a strong contrarian and I follow a rigid philosophy, but when it comes to insider transactions that can be characterized as self-dealing and the blatant ignorance of fundamental corporate governance, then I stay on the sidelines.

However, contrary to some of my fellow and respected posters at Seeking Alpha, I massively disagree with the CEO's behavior. In his capacity as CEO he has a fiduciary duty to protect shareholders and grow their wealth. What does it say about the character, the corporate governance of the company and the ethics of the key personnel, when the CEO takes those shareholder funds and buys a private stake in the very business he should work in on behalf of his shareholders? This is a blatant misunderstanding of incentive structures and conflicts of interest. It is not in the interest of shareholders to have management act as a competitor and use entrusted funds for their own selfish, self-dealing objectives. That guy is clearly a case for closer investigation.

For me, the whole thing depends on the CEO and the rest of management who either assisted in those transactions or failed at preventing conflicts of interest at the highest level to the detriment of shareholders whom they should serve. As soon as the CEO is replaced and the audit committee has thoroughly examined self-dealing issues, I am happy to consider an investment. As a contrarian, I still find the situation appealing: Fundamental business drivers (natural gas prices) have turned against the company, CHK is way over-leveraged and weak corporate governance make a great recipe for mispricings and give room for change. Under the assumption that management gets replaced and the self-dealing issues are examined and resolved, I am actually quite interested in going long.

Considering there will be change in the senior management level, I would initiate a buy rating on the stock based on a 2013 EPS estimate of $2.05 per share. Given the high basic underlying profitability of the company, a multiple of 15 would lead to a share price of around $30 marking about 75% upside potential once confidence issues are resolved.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CHK over the next 72 hours.