When we look back on 2020, one of the year’s defining features will be the unprecedented interest in the stocks of bankrupted companies. Normally, when a company goes bust, its stock price goes to almost zero immediately and that’s that. This year, however, traders have stuck with firms in bankruptcy far longer than normal. Chesapeake Energy (OTCMKTS:CHKAQ) stock is one example of that trend.
Chesapeake filed for bankruptcy back in June of this year, ending its long struggle to restructure as much as $10 billion of debt by less dramatic means. However, the one-two punch of plunging oil prices and the novel coronavirus was too much for the embattled firm to withstand.
Chesapeake Energy Stock Is Heading to Zero
Normally, it’s a bit hyperbolic when analysts claims that a stock is worthless. Chesapeake Energy is one of the exceptions to the rule, however. It’s entirely clear how this story is going to end.
In fact, InvestorPlace columnist Mark Hake explained in detail just what’s going to happen to the company. To summarize, 76% of Chesapeake’s reorganized stock will go to the primary noteholders, with two other groups of debtholders receiving 12% each.
Add it up, and that’s 100% of Chesapeake’s future shares accounted for already. So what happens to people holding the firm’s current common stock? As you can guess, their fate will not be good. As Chesapeake put it bluntly when describing its proposed debt restructuring:
“Equity Holders. Each holder of an equity interest in Chesapeake, including our common and preferred stock, would have such interest canceled, released, and extinguished without any distribution.”
Since then, the bankruptcy plan has advanced largely as expected, with only a slight delay. A judge should confirm the reorganization plan on Dec. 15, Assuming that happens, the common stock should be canceled shortly thereafter.
So Why Is Chesapeake Still Trading for Nearly $2?
You might be wondering why Chesapeake’s shares are still trading for more than a few cents, given their inevitable fate.
There are two likely reasons for that. For one, there’s a sunk-cost bias. That is, some people who own Chesapeake Energy stock still want to dream that it can recover, so they won’t ever sell it.
However, the adage, “It’s not a loss until you sell” is illogical. In reality, it’s better to recoup part of one’s capital rather than losing all of it.
Secondly, it’s extremely difficult to bet against Chesapeake Energy stock. Normally, short sellers will take advantage of overvalued stocks by betting against them.
If the price is too high, short sellers can provide balance. In this case, however, there are hardly any shares available to short, and what is available is exorbitantly expensive.
As of this writing, one major brokerage is charging a fee of 117%per year — or nearly 10% per month! — to bet against Chesapeake Energy. Thus, even though the stock has farther to fall, it’s not easy to short it.
On the flip side of that equation, people who lend their shares to short sellers can receive part of the 117% per-year fee. Some traders may be looking to buy Chesapeake Energy stock and lend it out at that huge interest rate, hoping that they will be able to sell it at a decent price before the stock is inevitably canceled.
While that approach can be lucrative, it’s also an extremely risky strategy. In general, most people should avoid buying stocks merely to lend them out. And it’s definitely better to stay away from names like Chesapeake which will become defunct soon.
The Bottom Line
Many investment decisions are complicated. Both bulls and bears can have great points, and it’s tough to make a decision. Chesapeake Energy stock is not one of those cases. In fact, it’s clear that investors should get rid of the firm’s shares while they still have value.
Within the next few months at the latest, Chesapeake’s stock will be cancelled. There’s no coming back from that. With the name heading to zero in the near-term, there’s no reason to waste any more capital or energy on this name.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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.