by Daniel Putnam | May 2, 2012 11:54 am
The onion that is Aubrey McClendon’s tenure as Chesapeake Energy’s (NYSE:CHK) CEO is getting peeled back one nasty layer at a time. Two weeks after Reuters broke the story about McClendon’s personal investments in the company’s wells, the news agency has uncovered another story that may have even larger implications for the natural gas giant. Reuters’ investigation today revealed that McClendon helped run a $200 billion commodity hedge fund on the side.
While the distraction posed by such a venture is bad enough, here’s the worst aspect of this news: The fund traded in natural gas. Whether or not anything nefarious occurred, at the very least this opens the door for speculation about front-running, the use of insider information and other activities sure to draw the attention of the Securities & Exchange Commission.
At the very least, it’s another example of the company engaging in practices that are a clear conflict of interest. Shouldn’t common sense dictate that McClendon’s side ventures would destroy Chesapeake’s stock price (down another 13% today), especially if the media is allowed to reveal them in a piecemeal fashion? Be it ignorance, apathy or a total lack of appreciation for the basics of crisis management, the underlying thinking that underpins these governance practices should frighten shareholders.
Coming as it does on the heels of Reuters’ story about McClendon’s interest in Chesapeake’s wells, this latest piece of news casts another shadow over the stock. As well it should: Clearly, this is a management team that just doesn’t get it.
Chesapeake tried to soothe investors by ending the program that enabled McClendon to invest in — and borrow against — Chesapeake properties. There’s just one problem: The program isn’t scheduled to end immediately, or even in 2013, but instead in 2014. That’s two more years that McClendon has to use Chesapeake as his personal ATM.
Chalk this up as another piece of evidence that the company doesn’t have shareholders’ best interests at heart.
And that’s not all. After the bell on Tuesday, the company reported first-quarter EPS of 18 cents, far below the consensus expectation of 28 cents. Revenues also came in light, at $2.42 billion versus expectations of $2.71 billion. CHK shares opened Wednesday down over 9% before slipping another three percentage points during the course of the management conference call.
All of this raises the question of whether it’s now worth taking a swing from the long side with Chesapeake. The company is an industry leader with rising production growth, its valuation is attractive and it’s taking steps to pay down its huge debt load.
Still, anyone who tries to make a bet from the long side on CHK is taking on tremendous headline risk — something that isn’t necessary with other industry players such as Southwestern Energy (NYSE:SWN) or Cabot Oil & Gas (NYSE:COG). Simply put, there’s no reason to play a recovery in natural gas with CHK — and all of the baggage that comes with it — when better options are out there.
That said, this is no time to short the stock, either. While it’s too glib to say “all the bad news has been factored into the price” given the potential for more negative headlines, Chesapeake — with a short interest near 10% — is vulnerable to a short squeeze that could chop up investors who try to bet against it. Also, takeover chatter isn’t out of the question at this point.
The bottom line: For the time being, Chesapeake remains a stock to avoid for all but the most sophisticated day traders. For the rest of us, the lesson is clear: Once a company displays poor corporate governance practices — as Chesapeake did by bailing McClendon out of financial trouble in 2008 and 2009 — it’s only a matter of time before more bad news will follow.
As of this writing Daniel Putnam doesn’t own any securities mentioned here.
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