It’s been the summer of bankrupt stocks. Traders have bid up the share prices of various struggling companies with extremely speculative trades, as the value of a bankrupt stock is usually minimal. And arguably no bankruptcy play has been stranger than Chesapeake Energy (OTCMKTS:CHKAQ).
In the case of Chesapeake stock, we have clear and hard evidence that the company is going to end up completely worthless with no redeeming stock value.
I know speculators don’t want to give up. However, in this case, there’s truly no reasonable bull case left, and traders should strongly consider taking whatever they can still get for their remaining holdings in Chesapeake
How Chesapeake Ended Up Bankruptcy
Our Matt McCall recently gave an excellent analysis of Chesapeake’s rise and fall. The company’s longtime leader, Aubrey McClendon, bet big and was a true pioneer in shale gas. Not only did he have good technical ideas, he was also a master at assembling land and lease packages and creating maximum value from these sorts of financial transactions.
He built a sprawling empire at Chesapeake. However, the company struggled to ever convert its financial maneuvering into consistent operating profitability. Particularly after McClendon’s untimely death, Chesapeake sunk farther and farther into debt as its properties simply couldn’t generate enough cash flow to service the company’s financial obligations.
The plunge in oil and gas prices from 2014 onward didn’t help matters. After a long fight with its suffocating debt load, Chesapeake succumbed to Chapter 11 bankruptcy earlier this year.
In his article, McCall shows why oil isn’t coming back quickly. You have the novel coronavirus itself, the second-order effects such as plunging gasoline demand, and also the overall glut of energy created by the fracking boom that McClendon himself helped launch.
No Recovery Is Coming for Chesapeake Stock
All those above factors ensure that it will take a long time for the oil and gas industry to recover. Unfortunately, by the time it does, Chesapeake’s current stock owners will be left with nothing. There’s no miracle coming here.
In fact, a government filing makes this clear. Chesapeake, in its restructuring support agreement, made it crystal clear that the common stock is effectively worthless. Chesapeake clarified exactly what will happen to each class of ownership once the agreement goes into effect.
Here’s the quote from the agreement concerning Chesapeake stock: “Each holder of an equity interest in Chesapeake would have such interest cancelled, released, and extinguished without any distribution.”
You see it right there. The stock will be cancelled and extinguished. There will be no distribution. That’s it – game over. Yes, Chesapeake is still trading for nearly $8 per share. But the stock will soon be worthless, it’s right there in writing.
Why isn’t the stock already at zero? Some folks don’t understand what’s about to happen. And also, some short sellers of the shares are repurchasing stock to close out their positions and take profits. Short-term trading in bankrupt securities can be volatile. In this case, however, there’s little question of where things will ultimately end up.
Chesapeake Stock Verdict
Hedge fund manager Scott Fearon, in his book Dead Companies Walking, explained that Americans are uniquely optimistic. And that carries through to investing. Even after it’s readily apparent that a company won’t make it, investors still cling to hope. He wrote:
“Failure terrifies people. They’ll do whatever they have to do to downplay it, wish it away, and just plain pretend it doesn’t exist. Most of the time, they’ll go on living in denial long after the truth of their predicament becomes obvious.”
Though he was speaking more generally, those words ring true for Chesapeake in particular. The company should be admired for taking bold bets and helping foster American energy independence.
However, ultimately, it borrowed too much money, and now the bill has come due. There’s no turnaround coming for Chesapeake’s current stockholders.
Yes, the company will likely reorganize. There will probably be new Chesapeake stock – and a new opportunity for the company’s employees. That’s the magic of the American bankruptcy process. Alas, that new equity will go to the owners of Chesapeake’s bonds; its current stock will be cancelled in the reorganization process.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.