Based on the earnings estimates from 35 Wall Street analysts, Chesapeake Energy (NYSE: CHK ) currently trades at just 8.3 times its expected 2013 earnings. Now that's a mouthwatering valuation.
And yet I still wouldn't touch Chesapeake's stock with a 10-foot pole. The reason is simple: CEO Aubrey McClendon.
In my past coverage of McClendon and his various shenanigans, there have been some readers concerned that views like mine are focusing on the wrong things and are, in themselves, more harmful to Chesapeake shareholders. As one reader put it:
As we've seen the past three years, more damage has been done by novice and institutional investors who trade on news headlines as opposed to the actual fundamentals of the companies they buy and sell. ... Thank God for the Capitalist pigs and the greedy "cockroaches" that make millions heading these companies! The people who've exhibited "corporate greed" have helped the "little" investor like me...
To that point, I should be clear: My views on McClendon aren't driven by a simple distaste for CEOs making a lot of money. There are plenty of CEOs that are paid more than McClendon -- Ralph Lauren's (NYSE: RL ) eponym CEO had total 2011 compensation that was 66% higher than McClendon's, and the ever-handsomely-paid Larry Ellison of Oracle (Nasdaq: ORCL ) had total 2011 comp of nearly $80 million. While I may not agree with those lofty packages, I don't think investors should be as concerned about those companies.
The difference is this: In McClendon's case, it's not just an overly healthy pay package. It's the side deals that are lauded as aligning the CEO with shareholders when they do anything but. It's the intertwining of McClendon's personal finances and the company's. And, most of all, it's the CEO's approach to his own finances -- if he's employing heavy leverage, taking big gambles, and flirting with disaster when it comes to his own balance sheet, shareholders have every reason to be concerned that he's bringing that same "go big or go home" mentality to the business that they've invested their hard-earned money in.
And as details continue to emerge on the inner workings of Chesapeake, the more this worrisome picture emerges. In yet another special report on the company released yesterday, Reuters continued its yeoman's work unraveling Chesapeake, detailing the fact that the operations of the company are at least as much about clever financing arrangements as they are about natural gas:
The financial-engineering strategy began as a way for CEO Aubrey McClendon to expand the company. Now, Chesapeake has become so reliant on deals like Glenn Pool that more such transactions may be necessary just to tread water.
Today, the Oklahoma City company is taking in more money from bankers, other investors and its own financial bets than it is from its oil and gas. ... Chesapeake is expanding so fast that it takes in much less revenue from its oil and gas than it spends, leaving it stretched.
The Wall Street Journal chipped in as well, providing detail on one of the company's key financing methods, volumetric production payments: "Struggling Chesapeake Energy Corp. has saddled itself with about $1.4 billion of previously unreported liabilities over the next decade through off-balance-sheet financial deals. Most of this liability occurs this year and next year, at a time when Chesapeake is scrambling to raise cash to cover its operating costs and move into the more lucrative oil business."
Stock market history is littered with the sun-bleached bones of companies that, instead of focusing on running a sound business that efficiently produces products that customers want to buy, wrap themselves up in complex financing arrangements and creative deals with Wall Street. And considering what we have heard at this point, it's well worth wondering what we still haven't heard.
Whether Chesapeake falls victim to its own creativity is yet to be seen, but the details that are emerging not only about the company's CEO, but also how the natural gas giant has been built, should be deeply concerning to any current shareholder or potential investor. And it's worth pointing out that the former group only includes the company's management to a relatively de minimus extent -- as of recent filings, management and the board of directors collectively owned less than 1% of the company.
So yes, based on some traditional valuation metrics Chesapeake Energy absolutely looks like a bargain. But with lots of question marks swirling over how this company is being run, there are many places that I'd rather put my investment dollars.
Keep track of how Chesapeake Energy performers as the events unfold, add them to your watchlist now.