Aubrey McClendon’s announced retirement from Chesapeake Energy Corp., the company he helped to found and then grow into an unconventional natural gas behemoth, may end one point of controversy for the debt-ridden operator, but it won’t solve many of the financial problems ahead, pundits said last week.
The self professed industry cheerleader, only 53, who co-founded the Oklahoma City-based operator 24 years ago, announced his retirement from the company effective April 1, effectively ending his relationship with a company that helped to forge a path into creating value from shale and tight gas resources across the country.
The termination agreement, which allows McClendon to remain until a successor is named, was reached with the board of directors, according to Chairman Archie W. Dunham. The reconfigured board, brought about by shareholder protests that ousted McClendon allies last spring, is part of sweeping takeover of the company that led to hiring Dunham, the former chief of ConocoPhillips, last June (see NGI, June 25, 2012).
“Over the past 24 years, Aubrey McClendon has created one of the most valuable and innovative companies in the energy industry,” Dunham said. “Under Aubrey’s strong leadership, Chesapeake has built an unmatched portfolio of natural gas and oil assets in creating one of the world’s leading energy companies. He has been a pioneer in the development of unconventional resources, and he has also been a leader in the effort to make the United States energy independent.
“However, as the company moves toward more fully developing the value of its outstanding assets, Chesapeake is at an important transition in its history and Aubrey and the board of directors have agreed that the time has come for the company to select a new leader. The board will be working collaboratively with Aubrey to make a smooth transition to Chesapeake’s next chief executive officer.”
Dunham assured employees in an email last week that the company was not for sale. McClendon, in a separate letter to the workforce that he built, said his departure centered on some differences with the board of directors.
“By now you all should have received the press release announcing that the board and I have mutually agreed to my resignation as CEO as of April 1,” he said. “Although this is due to certain philosophical differences that exist between the board and me, the separation will be amicable and smooth. I have the utmost confidence in you and the company’s future and I will always treasure the time we have spent together building Chesapeake into the unique and dynamic company that it is today.”
The search for a new CEO is said to be well underway, with the board considering internal candidates, as well as a possible heavyweight from outside. A successor may be named before McClendon’s April departure, a company source told NGI.
McClendon, a geologist by trade, founded Chesapeake with Tom Ward, who now runs SandRidge Energy Inc. (which also has come under scrutiny). Under McClendon’s watch, Chesapeake grew to become the largest natural gas producer in the United States, a position only lost when ExxonMobil Corp. bought XTO Energy Inc. in 2009.
McClendon recognized the value in shale gas early, and through a string of acquisitions and property development, financed in part by joint ventures (JV) with foreign firms, amassed a giant reserve holding. NGI first reported on an acquisition by McClendon’s Chesapeake in 1998 when he paid $88 million for properties in British Columbia and the Anadarko Basin (see NGI, Jan. 19, 1998). A spree in spending led Chesapeake just seven months later to explore strategic alternatives — because of low oil prices (see NGI, July 13, 1998).
The strategic alternatives turned from selling the company to upending company strategies to gas exploration. However, the shale gas boom, which McClendon often took credit for, drove down prices to the point that the risky gas-driven strategy began to misfire. Burdened by debt, Chesapeake was unable to make the switch as quickly as others to oil- and liquids-based properties, and the company’s revenue and cash flow deteriorated at about the same time the world financial crisis hit in 2008.
In addition to the leasehold spending frenzy that Chesapeake undertook, the flamboyant leader’s tenure also has been marked by controversy on a personal level. Faced himself with mounting debt tied to his huge exposure in Chesapeake, McClendon in 2008 was forced to sell nearly all of his 33 million shares to meet margin loan calls (see NGI, Oct. 13, 2008). The CEO’s “profligate spending” long has long been questioned by analysts, including forays into buying a big stake in the National Basketball Association’s Oklahoma Thunder, which moved to the city from Seattle with some coaxing by McClendon (see NGI, Dec. 6, 2010). Predatory investors began to buy stock, including Carl Icahn (see NGI, Jan. 10, 2011).
Last year, following the drip, drip, drip that led to a downpour questioning the company’s financial picture and McClendon’s overreach, the handwriting appeared to be written on the wall (see NGI, April 23, 2012; March 12, 2012). The Securities and Exchange Commission, as well as the Internal Revenue Service, began to investigate the CEO and the company (see NGI, May 7, 2012).
Some of McClendon’s financial dealings include the company’s long-time Founder Well Participation Program (FWPP), which was publicly acknowledged for years by the company, of which the CEO was the sole participant. The FWPP, which will remain in place until 2014, has given McClendon the contractual right to receive a 2.5% stake in every well the company had drilled since 1993. The board said last Tuesday it would release information about McClendon’s financing arrangements, and other matters, between him, entities in the FWPP, “and any third party that has had or may have a relationship with the company in any capacity,” when the 4Q2012 and year-end earnings are released by Feb. 21.
“The board’s extensive review to date has not revealed improper conduct by Mr. McClendon,” the board stated. “The board and Mr. McClendon’s decision to commence a search for a new leader is not related to the board’s pending review of his financing arrangements and other matters.”
McClendon, who oversaw all facets of the company’s operations until last May, now earns close to $1 million in base salary; his compensation in 2011 totaled $18 million, and in 2010 he was awarded a compensation package worth $21 million. Because his departure would be with “no cause,” he is eligible to receive an annual base salary of $975,000 and a bonus of $1.95 million over the remaining four years of his employment contract, a company filing stated. He earlier this year said he would not take a bonus for 2012 (see NGI, Jan. 14). In addition, McClendon holds close to 1.5 million shares of stock, which depending on market conditions could be around $20/share.
Shareholders and analysts overall seemed to view the news as positive. When the market closed Tuesday, ahead of the announcement of McClendon’s retirement, Chesapeake was trading at $18.97/share. However, after the retirement news broke around 5 p.m. ET Tuesday, the share price climbed in after-hours trading. On Wednesday Chesapeake finished out the day at $20.11, up $1.14, or 6.01% from Tuesday’s close. More than 72 million shares traded hands on the day, versus average volume over the past three months of about 13.5 million a day. On Friday Chesapeake shares closed at $20.33.
GHS Research analysts, who met with McClendon in 4Q2012, said his departure caught them by surprise. They had come away thinking a difference of philosophies between the embattled CEO and the new board were more in line than at opposite ends. “In fact we were told that everything positive that could come from tighter corporate discipline at Chesapeake would in fact emerge,” analysts said.
With McClendon’s departure, Chesapeake’s asset sales are expected to accelerate beyond $17-19 billion for 2012/2013 because the board “likely” will favor pulling the present value of Chesapeake’s 15.1 million undeveloped leasehold acreage forward, said the GHS team. There is “value” for a major that might want to make a move as well because Chesapeake has massive leaseholds that it still hasn’t developed in the Utica, Marcellus and Eagle Ford shales, as well as the Mississippian Lime and Powder River/Denver Julesburg Basin. Some of those assets already are up for sale.
“We think that a major with lower cost of capital versus Chesapeake can quickly get to a starting point of $30/share of value fairly easy,” GHS noted. What may hinder buyers, however, is Chesapeake’s “intimidating” capital structure, which includes seven JVs, close to $13 billion in long-term debt, $3 billion in preferred equity and around $2.4 billion in noncontrolling interests.
BMO Capital Markets analyst Dan McSpirit said Chesapeake faces a lot of problems that basically have nothing to do with McClendon’s departure. “What remains is a company struggling with its balance sheet…What remains is a stock that’s a leveraged proxy for natural gas, highlighted by production naked to strip pricing.”
Chesapeake’s shares were trading at seven times BMO’s 2013 gross earnings estimate, said McSpirit. “This compares with a group median closer to six times. Not cheap, in our view. Our NAV [net asset value] analysis yields $24. An NAV of $15 results after excluding the value of the still-uncertain Utica Shale and the economically challenged dry gas operations targeting the Barnett Shale and Haynesville Shale plays. We see greater uncertainty. We see greater downside.”
Tudor, Pickering, Holt & Co. (TPH) analysts feel much the same. “In our view, the idea of change is brighter than reality and CHK still faces a steep climb,” analysts said. “Absent a big move in gas prices, we think fixing the balance sheet will require more divesting of core assets with CHK likely sacrificing growth to get a peer average valuation of 5.4 times…in 2015. Chesapeake remains relatively expensive on multiples…and we firmly believe the company is not for sale.”
One “most discussed question” for TPH’s team is, “what if CHK targeted a transformational divestment (think Marcellus) and pursued a shrink to grow strategy? Our view is that such an action, combined with other assets marked for monetization, improves the balance sheet near-term. However, the company struggles to maintain activity while preserving reasonable long-term leverage…Gas price leverage is still key to reevaluation…”
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