What happened

Shares of Chesapeake Energy (OTC:CHKA.Q) are skyrocketing today, up by more than 37% as of 10:30 a.m. EDT, following news that the oil and gas specialist adopted a poison pill to shield its "net operating loss carryforwards" (NOLs) from a potential acquirer.  

So what

Chesapeake Energy's board of directors has adopted a shareholder rights plan, also known as a poison pill, to protect the availability of its NOLs. The company had racked up about $7.6 billion of NOLs as of the end of last year that it could use to offset future federal income taxes. These NOLs are the result of years of losses, as Chesapeake has struggled to turn a profit due to mismanagement and commodity price volatility.  

Two oil pumps with a bright sun in the background.

Image source: Getty Images.

NOLs are potentially valuable to a would-be acquirer because it could use them to offset its future tax liability. Chesapeake, however, has taken a step to protect this value by adopting a shareholder rights plan. Under this poison pill, Chesapeake's ability to use these NOLs would be significantly limited if it experienced an ownership change. That would happen if investors holding 5% of its stock increased their ownership by more than 50% over a rolling three-year period. In this case, if an investor or group acquires 4.9% or more of Chesapeake's outstanding stock, the rest of the company's investors would be able to purchase shares at a 50% discount. That would dilute the holdings of the 5% investor, making it harder for them to wrestle control of the company for its NOLs.  

Now what

Speculators see the adoption of a poison pill as an indication that an investor (such as a hedge fund) might want to take control of Chesapeake. That seems highly unlikely given the energy company's massive $9 billion debt. This leverage has put so much financial strain on Chesapeake that it seems destined to file for bankruptcy in the coming months. The most likely outcome of that event would be the complete wipeout of the company's existing shareholders. That high probability of a worthless stock is why investors should steer clear of Chesapeake.

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