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Icahn Takes 7.6% Stake in Chesapeake, Wants Four Board Members Out

Until the bell rang on Friday, things appeared to be looking up for Chesapeake Energy Corp.'s management team. Its decision to sell a half million acres in the Denver-Julesburg (DJ) Basin, which previously hadn't been on the company's list of publicly disclosed assets to sell, had been praised, with analysts noting that it might fetch up to $1 billion and help the company reach its capital commitment goals this year.

However, just as vacationers were packing up their bags for the beach, activist investor Carl Icahn's investment firm confirmed rumors that it now holds a 7.6% stake in Chesapeake, giving it more than 50 million shares -- and making it one of the largest shareholders in the company. And Icahn has some business with management: he wants four board members gone, to be replaced with two of his representatives and two representatives of Southeastern Asset Management, which with 13.8% of the stock is Chesapeake's largest shareholder.

Icahn previously held a 5.8% stake in Chesapeake in late 2010 but sold it 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.

Ahead of the news, Chesapeake finished up 21 cents (1.35%) on Friday to end the week at $15.79.

"We believe shares have hit a floor," said Sterne Agee's Timothy Rezvan. Most of Chesapeake's $13 billion-plus debt load is unsecured by its portfolio, which gives the company 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 said even if this year's liquidity risks are met, more challenges await Chesapeake 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," said Rezvan.

Ahead of Icahn's filing, analyst Antoine Gara of TheStreet had said on Friday that shareholders shouldn't put too much into Icahn's purchase because his previous stake had been "anything but activism" (see Daily GPI, Dec. 22, 2010). Icahn "was in and out without waging a proxy campaign." Those days may be over.

Chesapeake's $9.5-11 billion in asset sales, which now include the DJ Basin assets, may be a good sign, according to Global Hunter Securities analyst Mike Kelly, who said the portfolio, sold in parts or as a whole, could fetch up to $1 billion. 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.

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. "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 is marketing five leaseholds with gross acreage estimated at more than 684,000 acres; net acreage totals about 504,000 acres, 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.

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 Daily GPI, Feb. 1, 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 said. McClendon's loans aren't on the annual meeting agenda, and the CEO's finances already have been disclosed in proxy filings, lawyers said.

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

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