Tuesday, August 28, 2012

Chesapeake Energy: A Problem like Aubrey – Part 3

Shareholders of Chesapeake Energy received an unwelcomed wake-up call on Wednesday, April 17, 2012.

Reuter's headline screamed "Exclusive: Chesapeake CEO took out $1.1 billion in unreported loans" - By Anna Driver and Brian Grow
 Aubrey McClendon, the CEO of Chesapeake Energy Corp, has borrowed as much as $1.1 billion over the last three years against his stake in thousands of company wells - a move that analysts, academics and attorneys who reviewed loan documents say raises the potential for conflicts of interest.

The loans, which haven't been previously detailed to shareholders, are used to fund McClendon's operating costs for an unusual corporate perk that offers him a chance to invest in a 2.5 percent interest in every well the company drills. McClendon in turn is using the 2.5 percent stakes as collateral on those same loans, documents filed in five states show.

The size and nature of the loans raise questions about whether McClendon's personal financial deals could compromise his fiduciary duty to Chesapeake investors, experts who reviewed the documents told Reuters.

Why do I suddenly hear a chorus of nuns?
Over the next few days as more information emerged and Chesapeake Energy attempted damage control, the market saw Chesapeake (CHK) shares hit a new 52-week low of $16.78  

The damage control from Chesapeake has been, well, a bit peculiar, and weak.  While the actual loan transactions and failure to disclose to the shareholders may be “legal”, it does bring up the issue of conflict of interest and makes one wonder what else is going on with McClendon.  

As Reuters dropped more shoes regarding Chesapeake Energy and Aubrey McClendon over the next few weeks, I kept hearing a chorus of nuns singing “How do you solve a problem like McClendon?”   Unlike Maria von Trapp, Aubrey doesn’t have a Mother Superior looking out for him, but he does have the Securities Exchange Commission (SEC) looking AT him.
Recent History of Chesapeake Energy
The day before the Reuters story made shareholder’s spine shudder Chesapeake Energy announced a public offering of its Oil Field Services.
The Wall Street Journal reports: (emphasis added)

Chesapeake Oilfield Services Inc. hopes to raise up to $862.5 million in an initial public offering of stock, according to a filing Monday with the Securities and Exchange Commission. The oilfield services company—which owns more than 100 drilling rigs, a hydraulic fracturing subsidiary, an oil field tool rental business and a fleet of trucks that ferry drilling rigs and other heavy equipment—will continue to primarily serve Chesapeake Energy, the filing said. Both companies are based in Oklahoma City, Okla.

Chesapeake Energy is the second largest natural gas producer in the U.S. and spent about $13.3 billion last year to drill and complete 1,662 wells, according to the filing. At year's end, Chesapeake Energy employed more than 130 drilling rigs, more than twice as many as its nearest competitor, Exxon Mobil Corp.

The filing didn't say how many shares Chesapeake Oilfield planned to sell in its IPO or in what range the company hoped to price them. It did say that underwriters Goldman Sachs Group Inc. G and Bank of America Merrill Lynch would have the option of selling up to $112.5 million worth of additional shares if demand warranted.

Chesapeake Energy has been attempting to raise cash and make its balance sheet more appealing by selling or spinning off assets. 

The previous week, Chesapeake Energy announced three oil and gas asset monetization transactions for proceeds of $2.6 Billion.

Marketwatch reports:   (emphasis added)

Chesapeake has completed the sale of preferred shares of a newly formed unrestricted, non-guarantor consolidated subsidiary, CHK Cleveland Tonkawa, L.L.C. (CHK C-T), and a 3.75% overriding royalty interest in the first 1,000 new net wells to be drilled on CHK C-T leasehold and certain wells contributed at closing for proceeds of $1.25 billion. The purchasing investment group was led by GSO Capital Partners LP, an affiliate of the Blackstone Group , and included TPG Capital, Magnetar Capital and EIG Global Energy Partners. CHK C-T owns approximately 245,000 net leasehold acres in the Cleveland and Tonkawa unconventional liquids-rich tight sand plays in Roger Mills and Ellis counties, Oklahoma. Chesapeake has retained all the common equity interests in CHK C-T.

In a risky play, Chesapeake Energy has gone “naked”:

"....removed most of its 2012 derivatives positions, leaving the company naked to big dips in natural-gas futures prices just as they were headed for a ten-year low.

Late last year, the company removed most of its gas and oil hedges for 2012 and 2013, according to documents and people familiar with the matter, believing that prices were at or near a bottom. " ~ CNBC, April 9, 2012

Definition of 'Naked Option':  A trading position where the seller of an option contract does not own any, or enough, of the underlying security to act as protection against adverse price movements. If the price of the underlying security moves against the trader, who does not already own the underlying security, he or she would be required to purchase the shares regardless of how high the price is. The potential for losses, then, can be unlimited, and as a result, brokers typically have specific rules regarding naked trading. Inexperienced traders, for example, would not be allowed to place this type of order.

In December 2011, Chesapeake Energy sold its Marcellus Shale gas gathering assets to Chesapeake Midstream Partners, LP, for $865 million.

Thick Skin?
The Two Sides of Aubrey, by Christopher Helman, a Forbes article in October 2011 describes McClendon as:

He's a hero: Chesapeake Energy may earn $2 billion this year and could solve our energy problems. He's a risk junkie: His aggressiveness could (and almost did kill) the company.

At a steak dinner with McClendon, Helmen remarked further:

"He co-owns the restaurant and had already picked the wine, which was decanted two hours ahead of time. Only the royal stuff: a 1989 Petrus, a 1989 Haut Brion and, conspicuously, a 1982 Lafite Rothschild. Easily ten grand worth of tipple."

Helman confesses to being critical of McClendon, "…called him everything from dangerous to overpaid and suggested that the company he built would fare better without him."

McClendon maintains "a key to success in any walk of life is having a short memory and a thick skin…"

His response to a March 2012 Rolling Stones article left me with the feeling his skin isn’t all that thick.  The day after the Rolling Stones article appeared on the internet, Chesapeake Energy released a 2,872 word rebuttal.  
Rolling Stone rebutted the rebuttal.   Chesapeake did not rebut the rebutted rebuttal.

Shell Games
Another story which should have sent red flares through the Chesapeake Energy shareholders morning newspaper was a December 2011 Reuters story By Joshua Schneyer and Brian Grow entitled Special Report: Energy giant hid behind shells in "land grab".  

The company issuing the rejections wasn't much of a business at all. It was a shell company - a paper-only firm with no real operations - called Northern Michigan Exploration LLC. 

(Emphasis added)  One jilted land owner, Eric Boyer-Lashuay, called to complain to the broker who had handled his lease. Northern, he recalls saying, is "a shell company ... a blank door with no one behind it."

Today, he puts it this way: "It was all a fake, all a scam."

Northern has voided hundreds of land deals, and was indeed a facade - a shell company created so that one of America's largest energy companies could conceal its role in the leasing spree, a Reuters investigation has found. Oklahoma-based Chesapeake Energy Corp., the nation's second-largest gas driller, was behind the entire operation.

Chesapeake had created one shell company that set up another, Northern Michigan Exploration. Next, Northern hired brokers who signed leases with residents such as Boyer-Lashuay. And those brokers were under strict orders not to divulge Chesapeake's role, records reviewed by Reuters show.

In fact, the effort in Michigan was directed from the very top - by Chesapeake's CEO, Aubrey McClendon. In corporate filings that Chesapeake made public earlier this year - nine months after McClendon's agents began signing Michigan land leases - McClendon is named as the chief executive officer of Northern, the shell company that voided hundreds of those leases.

How many other shell companies does Chesapeake have? 

On the last pages of Chesapeake Energy - POSASR-20110208, Exhibit-4 document, Jennifer M. Grigsby is listed as "Senior Vice President, Treasurer and Corporate Secretary of the Company and of the Subsidiaries listed below".

Northern Michigan Exploration LLC is on the list, as well as companies with exotic names such as Winter Moon Energy Company, L.L.C., Gothic Production, L.L.C. and Empress, L.L.C.   An internet search turned up no websites for these 4 companies.

Overseeing audits of Chesapeake is PricewaterhouseCoopers (PWC).  They received a little less than $3million to look at the books.  PWC were also auditors for Enron and American International Group, Inc. (AIG).  We know how well that worked out.

PWC's splash graphic on their website boasts "..Rethinking risk management for new market realities...".    Seems right up Chesapeake's alley.

Damage ControlChesapeake Energy tried to ease concerns by citing similar situation concerning Martha Stewart:

“Chesapeake says it didn’t have to say more and cites as legal justification a court ruling involving Martha Stewart.”

It wasn't long before ENRON and Chesapeake Energy would be spoken in the same breath.

Forbes | Christopher Helman | June 4, 2012

Secret hedge funds, off-balance-sheet financings, big perks for directors, sweetheart drilling deals and giant non-recourse loans for Chief Executive Aubrey McClendon — it all means that “crony capitalism has been alive and well,” says John Olson. “History seems to be repeating itself in just another way.”

Olson ought to know. He uncovered Enron. Back in the 1990s Olson, a veteran energy industry analyst, was a lonely voice in the wilderness; he was skeptical about Enron for a decade before its collapse. He became a target of Enron‘s Ken Lay, and lost his job at Merrill Lynch because he refused to go bullish on the company. He subsequently worked at Sander Morris Harris, ran a hedge fund, and now, at 69, handles investments for friends and family.

So what’s his take on Chesapeake? Olson quotes philosopher Fredrich Hegel, “The only thing we learn from history is that we don’t learn from history.”

Chesapeake Energy quickly circled the wagons and fired up the spin machine by retaining George Sard, the CEO of Sard Verbinnen.    Sard was described as a "spinmeister of the apocalypse" by Portfolio magazine in April 2009, because he has worked as a PR consultant for so many high-profile clients in moments of utter, humiliating public collapse."

Sard's clients have included the Madoff brothers (Ponzi scheme), Eliot Spitzer (prostitution), Martha Stewart (insider trading), former Lehman Brothers CEO Dick Fuld (Ponzi scheme), and AIG (Ponzi scheme). His firm was also on the scene during the Enron collapse -- JPMorgan hired him to beat back accusations that the bank was complicit in the Enron fraud (it eventually paid $135 million to settle SEC charges).

----Gee, those worked out really well, didn't they?
Sard describes itself as:  (Emphasis added)
Sard Verbinnen & Co (SVC) is a leading strategic corporate and financial communications firm. We provide communications counsel and services to clients including multinational corporations, smaller public and private companies, investment firms, financial and professional service firms, and high-profile individuals.

The firm’s highly experienced senior professionals provide sound, objective advice and execution support to clients across a broad spectrum of industries. Our work encompasses corporate positioning, media relations and investor relations, transaction communications, litigation support, crisis communications, and other special situations.

We are regularly cited as one of the top M&A and crisis communications advisors in North America

Who’s Sorry Now?
McClendon told investors he's "deeply sorry" that his personal finances have come under scrutiny as shares fell the most in three years.

"I'm deeply sorry for all of the distractions of the past two weeks," McClendon, co-founder of Oklahoma City-based Chesapeake, said on a conference call to discuss first-quarter results today. McClendon said the company may have to sell more assets than planned to cover a gap between cash flow and revenue if natural-gas prices remain depressed. These sales won't interfere with debt-reduction targets or plans to boost oil production, he said.

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