Chesapeake Energy clipped by corporate conflict

McClendon's latest financial gaffe has CHK on the 'avoid' list.

By InvestorPlace Apr 19, 2012 10:44AM

By Daniel Putnam


Just when it seemed that matters couldn't get any worse for natural gas stocks, now corporate governance issues are coming into play.


On Wednesday morning, Reuters reported that Chesapeake Energy (CHK) CEO Aubrey McClendon had borrowed $1.1 billion against his investments in the company's wells over the past three years. McClendon can make personal investments of up to 2.5% of the value of each of Chesapeake's wells, and according to Reuters, he used these as collateral to take out the loans. The company that issued the loans also finances CHK.


The most problematic aspect of this is not just the potential conflict of interest it raises, but the fact that the company did not disclose the loans. Further, it hid under the letter of the law to say that the company had no legal responsibility to disclose these transactions. Maybe not, but the market has spoken nonetheless: Chesapeake shares fell more than 10% at mid-day before rebounding.


But the fundamental question remains: If there was nothing wrong about the transaction, why bury it in the footnotes? And why not have the foresight to understand that better disclosure would have prevented the stock from being vulnerable to this sort of revelation?


This marks another milestone in what's turning out to be a bad year for the company. Prior to this news, Chesapeake shares already were down 13.5% year-to-date and 43.7% from their 52-week high. Chesapeake still has some positives going for it: The stock now has a forward price-to-earnings ratio of 6, the 8.5% short interest provides some fuel for a rally once this wave of selling abates, and it is frequently mentioned as a takeover candidate (although not as attractive of a candidate after Wednesday's news). Also, the stock has fallen to 0.9 times book value in the wake of the Reuters story.


On the other hand, the company also has $10.5 billion of net debt, close to its current market cap of about $11 billion -- not an enviable position given the weakness in natural gas. In addition, the cash shortfall has forced the company to sell off assets and issue $2 billion of preferred stock. The possibility of shareholder lawsuits and SEC involvement are now additional question marks that have been added into the equation.


Put it all together, and Chesapeake is a stock to avoid even for short-term bottom-fishers. The company has a history of questionable activities that hurt shareholders, including a special bonus to bail McClendon out of a 2008 margin call, as well as the incredible purchase of McClendon's rare map collection to help alleviate his personal financial trouble. The company once again is back in the headlines for the wrong reasons -- a recipe for trading at a discount to the rest of the energy sector as long as the current management remains at the helm.


Is Chesapeake a long-term value here based on its underlying assets? Perhaps. But poor corporate governance also is a long-term problem -- and, most important for traders, one that will prevent CHK from being the most effective way to play an eventual rebound in natural gas.


For now, natural gas bulls would be better served by looking at the multitude of better-managed companies in the sector.


Until natural gas comes back up for air, there's a number of sectors benefiting from $2 natural gas.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.


Related Articles



Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.


StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

125 rated 1
264 rated 2
485 rated 3
679 rated 4
640 rated 5
617 rated 6
632 rated 7
493 rated 8
276 rated 9
153 rated 10

Top Picks

TAT&T Inc9



Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.