Going From Bad to Downright Dreadful at Chesapeake

To say that 2012 has been a year Chesapeake Energy (NYSE: CHK  ) shareholders would like to forget is a vast understatement. For those just catching up, let's review:

  • Natural gas -- which accounted for more than half of the company's revenue in 2011 -- hit multiyear lows due to supply gluts.
  • The stock's price is down more than 22% year to date.
  • It was reported that CEO Aubrey McClendon was leveraged to the hilt to participate in a company perk that put his interests at odds with shareholders'.
  • McClendon and SandRidge Energy (NYSE: SD  ) CEO Tom Ward ran a hedge fund when Ward still worked at Chesapeake that took up a great deal of their time and energy. The fund's existence raised questions of trading on insider information.

Today, a special report released by Reuters -- "The Lavish and Leveraged Life of Aubrey McClendon" -- is adding even more fuel to the fire.

A few details
The report, which Reuters put together after conducting several interviews and reviewing both public filings and internal documents, reveals just how over-the-top the company's chief executive can go.

First, there is AKM Operations, a small division of the company employing six full-time workers. Their main task: managing several business aspects of McClendon's personal life. Though regulatory filings make reference to the existence of such a group, its true scope was never made clear to shareholders. In 2010, this group worked over 15,000 hours and cost the company $3 million. It appears, however, that McClendon reimbursed the company for the bulk of the expenses.

Where that money is coming from, on the other hand, is another question. According to the report: "Although McClendon's net worth is pegged by Forbes at $1.1 billion, he has mortgaged much of what he owns: the restaurants, the wine, the boats, the homes, proceeds from three accounts at Goldman Sachs, his stake in private companies and his stake in thousands of Chesapeake wells."

McClendon owns a 19% stake in the Oklahoma City Thunder -- who qualified for the NBA finals just last night -- and even that holding isn't exempt from leverage. Twice he has taken out loans on future earnings from the Thunder -- loans which were previously undisclosed.

Just as damaging, McClendon has been using his clout to set up sweetheart deals for his personal businesses and friends. He owns an interest in several restaurants, some of which occupy land owned by Chesapeake subsidiaries. And the company plane has been used extensively for personal use -- including a trip to Bermuda in 2010 for nine female friends of Mrs. McClendon, but no family members on board.

Though such trips are legal under SEC rules and company policy, they seem to represent just one of several pieces of evidence pointing to a much larger problem at Chesapeake. The report nails the scope of the problem when it states, "Beyond the mixing of personal and professional, another theme emerges from interviews and records: McClendon's seemingly insatiable desire to own more and more -- of everything."

How did we get here?
When you are playing with your own money, you can pretty much do what you want and not too many questions will be asked. But once you're playing with other people's money -- whether it be taxpayers' or shareholders' -- there are different rules to play by.

You'd never guess from the company's behavior, though, that Chesapeake was a publicly held company. McClendon has been able to get away with his lavish and leveraged lifestyle because the officers who are supposed to be providing a check to his decisions largely consist of his friends. Only recently has the board decided to strip McClendon of his chairmanship and oust four directors, replacing them with four independent directors who can keep an eye out for abuses of shareholder interests.

In the end, McClendon's friends -- even the ones who acknowledge his odd behavior -- think the media is misreporting him as a man with a silver spoon who wants things the easy way. "The implication is that he pulled the lever on the slot machine in life and ding-ding, got lucky -- and nothing could be further from the truth," says Chesapeake senior vice president Thomas S Price, Jr. They cite a man who works long hours and cares deeply about his native Oklahoma.

While that may be true, McClendon's fatal flaw probably stems from a deeper problem relayed by Vanguard founder John Bogle in his book Enough.

The title comes from a conversation between Kurt Vonnegut and Joseph Heller -- author of the best-selling Catch-22. The pair is attending a party hosted by a multi-billionaire hedge fund manager. Midway through the party, Vonnegut points out that the host has likely made more money in one day than Heller ever made on his famous book.

"Yes," Heller responds, "but I've got something he'll never have: enough."

This, it seems, is a lesson McClendon sorely needs to learn.

Fool contributor Brian Stoffel does not own shares in any of the companies mentioned. You can follow him on Twitter, where he goes by TMFStoffel.

The Motley Fool owns shares of Chesapeake Energy. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (7) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 07, 2012, at 1:08 PM, TMFDarwood11 wrote:

    The only good news in this article is the fact that I don't own any CHK.

    This is another example of what happens when a CEO runs as company as if it were his personal fiefdom.

    Where was the board of directors????

  • Report this Comment On June 07, 2012, at 1:28 PM, TMFCheesehead wrote:

    They were largely his friends and associates, though that is changing soon.

    Brian Stoffel

  • Report this Comment On June 07, 2012, at 2:09 PM, Sharpe427 wrote:

    Just another sad tale of an incompetent BoD. But, remember that BoD's are usually elected, and by a group of stakeholders that are also asleep at the wheel but ready, willing, and able to scream fraud when things go south. Any investor that fails in his OWN due diligence is asking to get a smack down.

  • Report this Comment On June 07, 2012, at 2:40 PM, FoolishJayhawk wrote:

    A great article and really the story of many in the corporate world.

    It all just comes down to hubris. Mr. McClendon is addicted to leverage and growth at any cost. I'm not certain he has come to terms with this fact, but I hope someone close to him has come to this realization and helps him understand this. He's certainly a shrewd businessman to have made CHK what it is from $50K not too long ago, but in his brilliance has turned to complacency.

    I hope recent events will straighten him up for the sake of CHK shareholders, Oklahoma City (where he has done a lot of positive things), and - perhaps most importantly - his family.

  • Report this Comment On June 07, 2012, at 4:14 PM, rebozo2 wrote:

    This fellow reminds me of Dennis Koslowski, former head of Tyco (which morphed into Covidien) who freely spent company money on a foreign party for his wife and luxury items for himself. He traded his presumed ethics for a room in the Graybar Inn where this McClendon fellow may follow. Shareholders deserve better than this kind of 'entitled' behaviour. He should be made an example of in the strongest terms. A good executive may merit high rewards, but crosses the line when dipping into the cookie jar; it shows an ignoring of ethics and law - a sad Superman complex perhaps.

  • Report this Comment On June 07, 2012, at 9:47 PM, Jaycee5353 wrote:

    So from an investment view would CHK be worth a look at down 25%. Buy when others are fearful?

    Will four new directors and bad publicity keep his hand out of a good cookie jar?

  • Report this Comment On June 08, 2012, at 11:40 AM, IdaAg wrote:

    I'm not sure even with the 25% drop that Chesapeake is a good value right now. If you look there have been many gas companies that have lost 15-20% in the last couple of months. So I'm seeing only an extra 5-10% drop in Chesapeake, not enough to make me run out and buy the stock.

    Gas prices are not going to rise anytime soon, there is a still a glut of supply on the market, prices won't rise until the country can make a fundamental shift to using more natural gas, as fuel for cars, more power plants, etc... But all that takes years, so you have some time to wait before prices will start to rise. Also, Chesapeake is selling off many assets right now, some are so be careful in your evaluation of future incomes.

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