Aubrey McClendon is certainly audacious. The co-founder,
chairman and chief executive officer of
Chesapeake Energy (
always swings for the fences. Trouble is, he has swung and missed
more often than not. But hope springs eternal, and he's taking big
swings once again. And that's why McClendon and Chesapeake Energy
are either loved or hated, depending on who you talk to.
There's Gas in Them Thar Shales
After seeing the natural gas market soar and fall throughout much
of the last two decades, McClendon started to see a perfect storm
brewing a few years ago, one that temporarily made him a
billionaire. In 2008, natural gas prices were soaring and
geologists were starting to see that the United States was sitting
on the "Saudi Arabia of natural gas" under deep rock formations
known as shales.
With more and more power plants expected to switch from coal to
natural gas during the next decade, and a seemingly unlimited
bounty of gas underground, Chesapeake borrowed millions in order to
buy up and exploit vast untapped gas fields. And McClendon had no
trouble finding fans on Wall Street. Shares doubled from the summer
of 2007 to 2008, peaking at $69.
for natural gas seemed unstoppable. The energy source rose from
under $2 per thousand cubic feet (
) throughout much of the 1990s, shooting past $5 in 2003 on its way
to the $8 mark in 2008.
And then reality set in. The global economy cooled, natural gas
prices plunged below $4, and Chesapeake suddenly found itself awash
shot up from $7.4 billion at the end of 2006 to $13.2 billion at
the end of 2008. Annual interest payments soon ballooned to $800
million. Just four months later, in November 2008, shares had lost
80% of their value.
McClendon was left with no choice but to sell off assets, take on
equity partners, and sharply cut spending on the development of new
wells. [As an example of a recent asset sale, Chesapeake sold off
25% of its Texas-based Barnett shale fields for $2.25 billion to
in January of this year]. Although he has pulled the company back
from the brink, investors still have very strong feelings about
this high-risk/high-reward approach.
On the one hand, if natural gas prices weaken, that debt load could
again start to bite, implying further asset sales. To beat back
those concerns, Chesapeake announced in May that it plans to raise
$5 billion in fresh equity in order to repay up to $3.5 billion in
debt and increase investment in new oil fields (as the company
reduces its dependence on natural gas shales).
But Cheseapeake is still primarily a natural gas play, with more
than two-thirds of its revenue still expected to come from natural
gas. And bulls correctly note that rising natural gas prices
would turn this stock into one of the best performers in the
industry. That's because Chesapeake is still sitting on some of the
most promising yet low-cost gas fields in North America.
Specifically, Chesapeake is most active in two shale formations,
known as Marcellus (in the Northern end of the Appalachian
Mountains) and Haynesville (located in Louisiana and East Texas).
And it has moved more quickly to tap those fields than rivals such
Anadarko Petroleum (
Devon Energy (
. Those two firms have been seen as tortoises to Chesapeake's hare,
which has not been a bad thing in light of the swift plunge in gas
price, from as noted above, $8 per MCF to around $4.25 per MCF
Where Chesapeake's shares end up in a few years depends on where
gas prices go, but also on McClendon's never-ending re-jiggering of
the company's assets. He's convinced he knows when to sell certain
gas fields at their peak of value, while snapping up undervalued
fields on the cheap. In a late 2009 conference call with investors,
management said that "it sees acquiring and selling acreage as a
based on the company's ability and technical expertise in
delineating emerging resource plays," according to a Goldman Sachs
report. In effect, the company thinks that other industry players
lack Chesapeake's savvy, when they really lack Chesapeake's moxie.
Action to Take -->
Depends on where you think gas prices are headed. Shares are
reasonably priced at about 4.5 times projected 2010 earnings before
interest, tax, depreciation and amortization (EBITDA) of $5.2
billion, on an
basis. Where gas prices go in the next few years will tell us a lot
about whether EBITDA can approach $7 billion by 2012 or 2013, or
whether it will slump down toward $3 billion. Analysts tend to
think that these gas plays are worth about six times forward
EBITDA. So the math is pretty straightforward. If EBITDA can
approach $7 billion on higher energy prices, then the target
enterprise value would be $42 million, implying a
of around $30 billion, more than double the current value of $13.75
Then again, if falling gas prices push EBITDA back down to $3
billion, and you exclude the company's current $12 billion debt
load , then the company would be worth less than $5 billion, or
less than half the current value. Unless gas prices barely budge,
which is unlikely for this volatile
, then shares of Chesapeake are either
or undervalued by half.
-- David Sterman
David Sterman has worked as an investment analyst for nearly two
decades. He started his career in equity research at Smith Barney,
culminating in a position as Senior Analyst covering European
banks. David has also served as Director of Research at Individual
Investor and has made numerous media appearances over the years,
primarily on CNBC and Bloomberg TV. David has a master's degree in
management from Georgia Tech. Read More...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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