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Chesapeake Ends on Slightly Positive Note -- Maybe

With six weeks of discouraging news trailing behind it, Chesapeake Energy Corp. managed to get away for the three-day Memorial Day weekend with things looking a tad brighter -- in some corners, perhaps. The stock price got a gentle nudge on the news that activist shareholder Carl Icahn is now one of the biggest shareholders, and some analysts now think that the stock price may have hit a bottom.

"We believe shares have hit a floor," said Sterne Agee's Timothy Rezvan of Chesapeake, whose shares had fallen to as low as $13 and change earlier this month. Chesapeake ended Friday trading at $15.79, which was up about 21 cents (1.35%) from the day before. Most of Chesapeake's $13 billion-plus debt load is unsecured by its massive onshore portfolio, which gives the company a lot of flexibility, he said.

"We believe Chesapeake has more flexibility to raise cash this year than many investors think. If asset sales do not proceed as planned, we believe Chesapeake could raise cash through secured debt, which would debunk the 'goose egg' theory for Chesapeake's equity this year."

However, the Sterne Agee analyst warned that even though this year's liquidity risks likely will be met, more challenges await Chesapeake around the corner because of uncertain -- and likely low -- natural gas prices. "We believe shares have bottomed but do not see significant upside in shares unless gas prices continue to recover to $4.00/Mcf or asset sale proceeds exceed expectations."

After the markets closed on Friday Icahn confirmed that his firm has purchased a 7.6% stake in Chesapeake, giving him more than 50 million shares in the company. By comparison, Southeastern Asset Management, which has taken a more active role in the company, is the largest shareholder with about 13.8% of the stock. However, Icahn wants more than just a bit of control. In the Securities and Exchange Commission filing, Icahn's firm also is demanding that Chesapeake replace four board members -- two with Icahn representatives and two with Southeastern representatives.

In late 2010 Icahn bought a 5.8% interest in Chesapeake, which he sold within a few months. BlackRock Institutional Trust Co., which already had 883,000 shares in Chesapeake at the end of March, also is said to have boosted its stake to four-five million shares.

Before Icahn's announced transaction was confirmed, analyst Antoine Gara of TheStreet noted that his previous entry into Chesapeake "was anything but activism" when he became for a short period the company's second largest shareholder (see NGI, Jan. 3, 2011). Icahn "was in and out without waging a proxy campaign.

"Chesapeake shares soared from the low $20s to as high as $35 after Icahn revealed his 5.8% stake in late 2010, and it's been straight down with Chesapeake shares since as the corporate governance situation worsened. If investors are looking to Icahn as a reason to consider a fast money, headline-driven catalyst for Chesapeake shares, it's a logical assumption that may not be helpful for long-term investors."

Chesapeake has several big assets on the market, including its huge Permian Basin portfolio, but on Thursday, it also listed half a million net acres in the Denver-Julesburg (DJ) Basin, which previously hadn't been on its to-do list. Gross acreage is estimated at more than 684,000 acres, net is around 504,000, according to Meager Energy Advisors, the listing agent. Net revenue interest is 80%. Preference for the sale is to be given to one bid for all five areas but separate bids also will be considered. The leaseholds could fetch up to $1 billion and help the company reach its capital commitment goals this year, according to Global Hunter Securities analyst Mike Kelly. Chesapeake doesn't have the "luxury" to do the kind of work that it would take to develop the properties, which are oil and gas-rich, he said.

That Chesapeake has put the DJ Basin portfolio up for sale is not entirely surprising. In conference calls to discuss 4Q2011 and 1Q2012 performance, CEO Aubrey McClendon and COO Steve Dixon expressed no enthusiasm about the leaseholds that are spread across portions of Colorado and Wyoming. In a conference call early this month Dixon admitted to analysts that in the Niobrara formation, Chesapeake "and others have struggled outside of the Greater Wattenberg Field to make this formation economic across a broader area."

McClendon in February told analysts that the DJ Basin "has not worked for us in the Niobrara" and the company had turned its focus to the Powder River Basin.

"I mean, on the DJ Basin, like with other companies, our results have been spotty. And today I don't think we're drilling anything in the DJ Basin in the Niobrara," the CEO said during a 4Q2011 conference call. He added, "I think for the DJ, I wouldn't say all is lost as you're outside of Greater Wattenberg, but there's going to be some other ideas. But we have certainly shifted our focus on the Niobrara play to the Powder River Basin."

Chesapeake's primary drilling target has been the Niobrara formation, but it also is drilling in the promising Codell, Greenhorn/Graneros, J Sands and Dakota Sands. The wells to date have been drilled to a depth of 5,500-9,000 feet. Estimated reserves from the Niobrara and the Greenhorn/Graneros formation were the same: 30 million boe/square mile, or more than 300,000 boe/well. The producer is operating 26 producing horizontal wells in the Niobrara, one producing Codell horizontal well, one producing Greenhorn well and one producing vertical J Sand well. The company also has a stake in 24 nonoperated wells, 15 of which are producing.

In early 2011 Chesapeake struck a $1.26 billion joint exploration agreement with China's Cnooc Ltd. to buy a one-third interest in Chesapeake's 800,000 net acres in the DJ and Powder River basins (see NGI, Feb. 7, 2011). According to Chesapeake, the sale announced on Thursday would not be affected by the Cnooc agreement.

Meanwhile, in a response filed by a group of shareholders to delay the annual meeting on June 8, Chesapeake claimed in a federal court filing in Oklahoma City Thursday that shareholders have plenty of information about McClendon's financial dealings and the meeting should not be delayed (Deborah G. Mallow IRA SEP Investment Plan v. McClendon, 12-cv-436, U.S. District Court, Western District of Oklahoma). Investors who are unhappy can't prove they will be "irreparably harmed" if the June 8 meeting goes forward, the filing stated. McClendon's loans aren't on the annual meeting agenda and the CEO's finances already have been disclosed in proxy filings, lawyers noted.

"The suggestion that shareholders have not been provided sufficient information cannot withstand even superficial scrutiny."

Last week had many of the same elements of recent previous weeks for Chesapeake, with a spat of criticism from big shareholder groups wary of corporate governance. Two shareholder proxy services, Egan-Jones Proxy Services and Institutional Shareholder Services (ISS), joined big shareholder groups in recommending against reelecting two directors to the board at the annual meeting in June.

Egan-Jones said Chesapeake had earned a corporate governance rating of "D+." The reviews centered on proposals that maximized shareholder value based on publicly available information, and noted the recent media attention that has swirled around CEO Aubrey McClendon's financial transactions with related parties to the corporation, financial commitments made by the corporation in which McClendon also has interests -- such as his 20% ownership of the Oklahoma Thunder National Basketball Association franchise -- and the elevated spending by the corporation in light of low gas prices.

Board members Richard K. Davidson, former CEO of Union Pacific Corp. and Oklahoma State University President V. Burns Hargis, who also are members of the audit committee, "appear qualified" but clients should "withhold" their votes to reelect them "due to egregiously weak board oversight," said Egan-Jones.

"The continuing directors serving on this board have repeatedly failed to respond to significant shareholder concerns and emerging best practices, demonstrating a lack of independent oversight," said ISS.

McClendon and lead independent director Pete Miller, who also is CEO of National Oilwell Varco, sent a letter to shareholders to address "certain issues" initially raised this month by John Liu, the City of New York's comptroller, who oversees the city's pension funds (see NGI, May 21). The funds urged shareholders to vote against two board members up for reelection because of corporate governance issues. McClendon and Miller called Richard K. Davidson and V. Burns Hargis "strong, highly qualified independent directors" who "warrant shareholder support."

Finally, there appeared to be some confusion on the company's message after a new 32-page investor presentation was posted early Tuesday only to be revised with one page deleted by that afternoon, with no explanation offered by the company. Chesapeake had claimed on the deleted page that it had "withstood an unprecedented negative media campaign" since mid April.

"During this time, an incredible 1.2 billion shares of stock has been traded, equal to 180% of our outstanding shares," Chesapeake stated in the original presentation. "While damaging in the short run to our reputation, these attacks have failed, and will continue to fail, to reduce the value of the company's assets and our long-term attractiveness to investors." Chesapeake's investor presentation went on. "At the end of the day, asset value and quality will win and today's shareholders will be well rewarded. Successful asset sales, ongoing transition to liquids and moving to an asset harvest strategy from an asset capture strategy will carry the day."

By the end of this year Chesapeake "will emerge with not only great assets, but also a good and steadily improving balance sheet and significant growth opportunities for years to come."

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