Is Chesapeake Ready to Return to Prime Time?

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We Americans tend to possess a trait that more often than not is admirable. That is, we typically forgive transgressors when it appears they're at least headed toward getting their act together. That appears to be the order of the day at Chesapeake Energy (NYSE: CHK  ) , and it may just be appropriate, given the market's more than 30% drubbing of the company's shares in the past year.

A pair of questionable approaches
The transgressions at the company -- the second-largest natural gas producer in the U.S. behind only ExxonMobil (NYSE: XOM  ) -- essentially come in two parts. The more egregious of the pair, from my perspective, was an array of shenanigans by the company's flamboyant co-founder and CEO, Aubrey McClendon. As you likely recall, these included taking down well over $1 billion in personal loans from EIG Global Energy Partners, a firm that was simultaneously arranging financings for Chesapeake itself.

And then there was the disclosure that McClendon and Tom Ward, Chesapeake's other co-founder and now CEO of SandRidge Energy (NYSE: SD  ) , had operated a $200 million hedge fund between 2004 and 2008, when they were in a position to gain special insight from their Chesapeake posts. Furthermore, there was the 2008 award of a $75 million "well cost and incentive award" to McClendon by his compliant board, following the CEO's need to dump most of his Chesapeake holdings to meet a $552 million margin call.

I could go on, and perhaps I should, because McClendon surprisingly (and somewhat disconcertingly) is still CEO of the company. However, his generous minions on the board of directors have generally been shunted aside, following the arrival on the scene by investor Carl Icahn, in concert with muscle-flexing by Southeastern Asset Management, the holder of 13.6% of Chesapeake's outstanding shares. The new -- and hopefully more independent -- board is now being headed by a new nonexecutive chairman, Archie Dunham, whose background, which once included the same role at ConocoPhillips (NYSE: COP  ) , speaks well for his ability to quickly get his arms around Chesapeake's milieu.

A mighty big garage sale
The other questionable approach at Chesapeake is probably easier to fix. In recent years, the company has tended to operate under a groaning balance sheet that has resulted largely from its shopping sprees to acquire vast amounts of acreage in many of the nation's primary unconventional plays, most of them gas-prone. At the same time, the costs of its drilling efforts have long exceeded the wherewithal in its pocketbook.

Now, either because of enhanced wisdom that arrived with its new board, or through the heavy hand of reality, the company intends to ultimately jettison a minimum of $13 billion of its assets, up from an earlier prediction of $11.5 billion. The clear objective is to trim the company's current $14.3 billion in long-term debt to about $9.5 billion. At the same time, the effort to alter Chesapeake's reserves and production from primarily natural gas to larger amounts of oil and liquids continues apace.

It appears that the next of the company's asset sales will involve a portion of its 1.5 million acres in the Permian Basin of southwest Texas and southeast New Mexico. For-sale signs have been hung out over four tracts in the basin -- one of the oldest U.S. producing areas -- and three of the four are already sporting "sale pending" additions. It's generally anticipated that the three parcels will garner about $5 billion for the company, which, along with another $2 billion from other prior sales, likely will result in approximately $7 billion being added to its coffers during the third quarter.

Scoring with an Eagle
None of this is to indicate that Chesapeake has lost its noteworthy capability as an operator and discoverer of major U.S. unconventional hydrocarbons plays. Regarding the prolific Eagle Ford of south Texas, for instance, Steven Dixon, the company's chief operating officer, said on the post-release call that the play is "attracting 28% of our capital in 2012 and 33% in 2013. Second quarter net production from Eagle Ford was 36,300 BOE per day, which is a 58% increase over the first quarter and 615% year-over-year."

Dixon also noted: "During the quarter we connected 121 wells, or nearly one-third of our 337 total producing wells in Eagle Ford. Importantly, at June 30 we had 220 wells at various stages of completion or pipeline connection."

The Foolish bottom line
The question then becomes whether Fools should unleash buy orders for a Chesapeake that is both under new oversight and is undergoing significant repairs. This would be my recommended approach: I'd create a basket of shares of both Chesapeake and EOG Resources (NYSE: EOG  ) , which, as I told Fools earlier this week, isn't necessitating the transformation from largely natural gas to increased oil output. Furthermore, EOG is also active in North Dakota's oil-prone Bakken play, the one that Chesapeake missed.

Nevertheless, a renovated Chesapeake offers an opportunity to regain ground from its 2012 market drubbing. At the very least, I'd immediately add both Chesapeake and EOG Resources to My Watchlist.

Fool contributor David Lee Smith doesn't own shares in any of the companies named in the article. The Motley Fool owns shares of Chesapeake Energy and ExxonMobil. 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 (4) | Recommend This Article (3)

Comments from our Foolish Readers

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  • Report this Comment On August 09, 2012, at 2:56 PM, HectorLemans wrote:

    Wasn't there several articles on here about Chesapeake several months ago slamming their incompetence as their stock price headed south? And now that it's rallied almost 50%, you've decided they might be worth a look? That sounds like a good way to sell low and buy high to me.

  • Report this Comment On August 09, 2012, at 7:09 PM, TMFJebbo wrote:

    Just because a stock price has rebounded 50% off its low does NOT mean that it is fully valued. Aubrey McClendon is a sleazy character without a doubt. If you are a Buffet-style investor you will stay away because he is definitely not the type of manager who would run a company under BRK. But as counter intuitive as it may be, Aubrey may be one of the best things CHK has going for it. His flamboyant notoriety has helped keep the stock price low in spite of the company's huge asset base. NG is currently rebounding off a decade-long low, If you want to buy low and sell high now is the time to buy. Some analysts rate this stock at a $50 value. If you are the least bit interested in any type of energy play I think it would be foolish to not take out at least a small position in CHK.

    From their latest 10Q:

    "When we have completed our asset sales, we anticipate Chesapeake will still retain core positions in 10 plays, which we believe will be 10 of the 15 best plays in the country. In each of those 10 plays, Chesapeake will be either the number one or number two producer. We are not aware of another company that will be number one or number two in more than three of these 15 best plays."

  • Report this Comment On August 09, 2012, at 7:31 PM, NOTvuffett wrote:

    I have the misfortune of owning some CHK. McClendon has run this company into the ground,

  • Report this Comment On August 10, 2012, at 9:06 AM, TMFJebbo wrote:

    I would agree that McClendon has run the PRICE of this company's stock into the ground, but not the company itself. I first invested at over $26 a share and sold most of that for tax reasons last year. When it got below $15 it was too tempting not to get back in. But too I am still on the losing end of the deal with this investment.

    We have all heard the stories....the company buying the maps, the fast food outlets on company property that are owned by Aubrey, the hedge fund, the wife's friends flying on the corporate jet, etc...I urge you to attach a dollar value to each one of these items, select something on the high side, and then subtract that from what would be a reasonable market cap if anyone else was running the company. These events get alot of press, I'm sure they are fun to write about, but MATERIALLY they aren't damaging to CHK. But they have kept the price of the stock down.

    We have a new blood on the board. The famous active investor Carl Ichan is one of them. We rebounding off a low in NatGas pricing. There are plenty of means to make debt payments. To me this all points to a margin of safety and is a good buy signal.

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