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Chesapeake Liabilities Deepen; Pickens Dumps Stock

Chesapeake Energy Corp. said in a regulatory filing Friday that it may have to delay some of the planned oil and natural gas asset sales this year, which could up be to $14 billion, because low natural gas prices may stretch its ability to comply with credit covenants.

In a Form 10-Q filing with the Securities and Exchange Commission (SEC), Chesapeake detailed some of the financial issues it is facing over the coming months.

Shareholders bolted Friday, with more than 76 million shares trading hands, versus a daily average of about 24 million. The stock lost 13.8% of its value in one day to end at $14.81 for the week.

Many long-time shareholders apparently said enough was enough following recent revelations, which include reports that the company has $1.4 billion in unreported liabilities from 10 volumetric production payments (VPP), with $300 million due this year. T. Boone Pickens, pro-gas advocate and personal friend of CEO Aubrey McClendon, also disclosed that his investment firm BP Capital has dumped all of its shares in the company.

In a revised proxy statement sent to shareholders on Friday the board promised to introduce performance-based awards as part of McClendon's pay package this year. The variable annual pay plan was approved by the board in December after more than 40% of the shareholders last year voted against Chesapeake's executive compensation plan and said McClendon's was "too high." In 2011 McClendon's compensation amounted to around $17.9 million, and the year before he took home about $21 million.

However, the statement came hours after The Wall Street Journal reported late Thursday that Chesapeake has about $1.4 billion of previously unreported liabilities over the next 10 years through its VPPs, which it called off balance sheet transactions. Most of the costs "will hit this year and next, at a time when the company needs to raise substantial cash to cover operating expenses and its move into the more lucrative oil business."

The Journal stated that it reviewed 10 VPP documents filed in county courthouses in four states, which it said showed Chesapeake's liability is "far larger than previously thought by investors and analysts, most of whose estimates were lower than $600 million." Based on the newspaper's calculations, the costs total $300 million in 2012, which Chesapeake confirmed, and $270 million in 2013. "Another roughly $800 million is expected between 2014 and 2022, the documents indicate."

Chesapeake has publicly disclosed that it gained $6.4 billion from the VPPs that were completed in onshore leaseholds, but it hasn't reported the costs associated with the contracts.

In a cover letter that accompanied the proxy statement, McClendon and lead independent director Pete Merrill, who also is CEO of National Oilwell Varco, acknowledged what shareholders and the rest of the investment community already know.

"As you know, the past month has been a challenging time for our company," wrote the duo. "The enormous scrutiny of Chesapeake has created distraction in the marketplace...We would like to take this opportunity to emphasize the board's continued commitment to serving the interests of our shareholders and improving corporate governance."

Pickens told CNBC during an interview in Las Vegas on Thursday that BP Capital's entire stake in Chesapeake, valued at about $13 billion -- or about 9% of BP Capital's equity -- has been sold. "I don't like the position he's in," Pickens said of McClendon. However, he said he "wouldn't count Aubrey out." Chesapeake's planned asset sales are wise and the company could be headed for better times, he told the network. McClendon "is a good friend" and "has done some innovative things."

Last Monday Southeastern Asset Management, which is the company's largest shareholder with 13.6 million shares, urged Chesapeake to consider selling the company (see Shale Daily, May 8).

Fitch Ratings earlier this month and Moody's Investors Service on Wednesday downgraded Chesapeake, in part because of the VPPs. Fitch Ratings scrutinized the company's "still aggressive capital spending program for 2012 in a very weak natural gas environment. The company's 2012 spending plans remain essentially unchanged in terms of magnitude and will create a large funding gap between cash flow from operations and capital spending and leasehold acquisitions, which is expected to be filled mostly from proceeds from asset sales and various monetizations."

Recent disclosures about McClendon's personal financing transactions to fund his participation in the Founder Well Participation Program "have raised conflict of interest questions and reflect poorly on Chesapeake's corporate governance," said Moody's Vice President Pete Speer. "These issues further confirm our existing views regarding the CEO's dominant role at Chesapeake and his strong influence on the company's risk appetite and growth objectives. This influence is reflected in the company's aggressive financial policies and complicated structure, which are incorporated into our ratings."

However, if an ongoing Securities and Exchange inquiry, shareholder litigation or the board of director's audit committee review of the CEO's personal financing transactions raise "additional issues or adversely effects the company's execution of its funding strategy then there could be negative ratings implications," said Speer. According to Moody's, Chesapeake's funding gap "could continue to rise" if natural gas prices continue to decline, which would lower earnings and increase its compliance risk with bank credit facility debt covenants in the second half of this year. So far this year, Moody's estimates that Chesapeake has raised close to $4 billion through a bond offering and planned monetization transactions.

Moody's views VPPs and recent subsidiary preferred stock transactions as debt, which therefore increased its debt as of March 31 to $23.6 billion from $19.2 billion at the beginning of the year. "Consequently, debt/proved developed reserves and debt/average daily production have increased to around $12.30/boe and $35,700/boe, respectively, at March 31." The ratings agency also is concerned that Chesapeake's leverage metrics "could remain elevated or continue to increase."

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