Icahn’s Chesapeake Intervention Faces $22 Billion Hurdle
Carl Icahn’s makeover of Chesapeake Energy Corp. (CHK)’s board may be too late to shield the U.S. natural- gas producer from a gathering storm of wrong-way bets on energy demand, plunging oil prices and corporate-governance failures.
Chairman and Chief Executive Officer Aubrey McClendon’s management of the company he co-founded 23 years ago will come under new oversight after Chesapeake said yesterday it will replace four of the eight non-executive directors along with naming a new independent chairman. Icahn said he’ll now push to curb spending after earlier criticizing the CEO and directors for “irresponsible actions” that led Chesapeake “to the edge of the proverbial cliff.”
The overhaul of Chesapeake’s board follows a plunge in gas prices to a 10-year low and revelations that McClendon had intertwined his personal business with that of the company’s key financiers. The CEO’s strategic shift from gas toward more profitable oil production may falter after crude prices had their biggest monthly decline since 2008.
Bringing in new directors doesn’t address “concern on cash flow in 2013, especially after you had a $24-a-barrel pullback in crude prices,” Tim Rezvan, a New York-based analyst for Sterne Agee & Leach Inc. who rates the shares “neutral,” said yesterday in a telephone interview. “That’s the latest bomb to drop: First you had gas prices, then the personal conflict-of- interest story and now you’ve got a 25 percent pullback” in crude prices since March 1.
Chesapeake had lost almost half its market value in the past year as a glut of North American gas collapsed prices to the lowest since 2002 and McClendon’s personal finances came under scrutiny by the U.S. Securities & Exchange Commission, the Internal Revenue Service and the board he has led since the company’s inception. The shares rose 2.9 percent to $17 at the close today in New York.
Four new independent directors will be named by Chesapeake’s two largest shareholders, Southeastern Asset Management Inc. and Icahn, by June 22, the company said in a statement yesterday. Icahn spurred the overhaul by acquiring a 7.6 percent stake to rein in McClendon, whose decision-making the 76-year-old billionaire blamed for a cash crunch that drove the share price to the lowest since 2009.
McClendon has been under a cloud since a series of media reports in March and April about personal loans he obtained using minority stakes in company-owned wells that he’d been allowed to gather for his private portfolio. The company announced May 1 that he will step down as chairman when a replacement is chosen.
With a fifth director, Charles Maxwell, having reached the mandatory retirement age of 80, Icahn and Southeastern together will control at least five of the nine seats. Louis Simpson, a former Warren Buffett protégé who joined the board at Southeastern’s request last year, won’t be among those to resign, the company said yesterday.
The annual shareholders’ meeting scheduled for June 8 will proceed as planned, said Michael Kehs, vice president of strategic affairs and public relations.
“It’s positive from a governance standpoint because Aubrey’s ability to just run the company as he sees fit takes a blow,” said Philip Weiss, a New York-based analyst for Argus Research who was the second-best performer among analysts following the company during the past year, based on buy, sell and hold recommendations. However, “the company’s issues with debt, liquidity, cash flow and low commodity prices aren’t going to go away just because they’re changing the board.”
Chesapeake outspent cash flow in 19 of the past 21 years while amassing a portfolio of oil and gas fields that cover an area half the size of New York state. In turn, the company’s debt load swelled to $12.6 billion as of March 31, which exceeds those of companies two and three times Chesapeake’s market value, such as EOG Resources Inc. (EOG) and Anadarko Petroleum Corp., according to data compiled by Bloomberg.
Chesapeake reported an unexpected $71 million first-quarter loss on May 1 and warned it may run out of cash next year if it fails to reach its divestiture goals. McClendon is auctioning $20.5 billion in oilfields and other assets this year and next. James Sullivan, an analyst with Alembic Global Advisors, has estimated the company’s 2012-13 cash-flow shortfall will exceed $22 billion.
Icahn said in a regulatory filing yesterday that he wants new directors and McClendon to focus on limiting spending, selling assets and perhaps selling the entire company if the price is right.
“This is obviously a huge, long-term, important development,” Jeffrey Bronchick, who oversees about 306,000 Chesapeake shares as part of a $355 million portfolio at Cove Street Capital, said in a telephone interview. “Fixing this issue was a pre-condition to addressing the leverage issue in an adult and forthright manner.”
McClendon aggravated the impact of falling gas prices on the company’s profits in late 2011 by exiting commodity hedges that would have secured higher prices for the company’s output, Moody’s Investors Service said on May 31. The CEO incorrectly anticipated that colder weather was imminent in the northern U.S. that would lift the price of the furnace fuel.
“Obviously, we are not happy with that decision,” McClendon said during a May 2 conference call with analysts and investors. “If we had to do it all over again and with the hindsight of winter, we would have obviously done something different.”
McClendon’s plan to rescue Chesapeake from swooning gas prices involves boosting oil and gas liquids to 26 percent of the company’s output next year from 16 percent in 2011. Under that scenario, oil and gas liquids would account for 55 percent of Chesapeake’s 2013 revenue, according to a May 22 presentation published on the company’s website.
The company’s 2012 and 2013 cash flow estimates hinge on an assumption that U.S. crude futures will average $100 a barrel, according to the presentation. With the futures trading around $84 a barrel, about 24 percent below this year’s peak of $110.55 reached in March, that plan may be in jeopardy, Sterne Agee’s Rezvan said.
Oil prices, which have fallen amid weakening economic outlooks in China, the U.S. and Europe, also may hinder McClendon’s efforts to find buyers for crude assets such as Chesapeake’s holdings in the Permian Basin of west Texas, Moody’s analysts led by Peter Speer said in last week’s report.
Lower oil prices may leave potential buyers with less cash available to use on acquisitions, as well as making oilfields less attractive from an earnings standpoint. McClendon said in a March interview in Oklahoma City that he’s counting on the Permian assets to raise at least $5 billion.
“Further declines in crude prices could reduce the number of bidders for Chesapeake’s assets and lower their sale prices,” Speer’s team wrote.
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