GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

forbes.com: "Chesapeake Energy: CEO McClendon Serves Himself First"

April 18, 2012 | About:

forbes.com

Chesapeake Energy: CEO McClendon Serves Himself First

Does anyone else find this disturbing?

http://www.forbes.com/sites/francinemckenna/2012/04/18/chesapeake-energy-ceo-mcclendon-serves-himself-first/?partner=yahootix



Edit: Disclosure, I own a small interest in CHK through a mutual fund
  • CEO Buys, CFO Buys: Stocks that are bought by their CEO/CFOs.
  • Insider Cluster Buys: Stocks that multiple company officers and directors have bought.
  • Double Buys:: Companies that both Gurus and Insiders are buying
  • Triple Buys: Companies that both Gurus and Insiders are buying, and Company is buying back.

» Take a Free Trial of Premium Membership


Rating: 4.3/5 (4 votes)

Comments

jameshou
Jameshou premium member - 2 years ago
Yes, very... any insights?
LwC
LwC - 2 years ago
I guess I could offer a few observations FWIW, if not insights, with the caveat that I don't follow CHK and therefore my remarks are off the top of my head.

1. If the Reuters report has its facts straight, then IMO it's fair to assume that there has been a pattern of self dealing that goes back years. Since any self dealing that involves just millions or even tens of millions of dollars might be considered "immaterial" in a company the size of CHK, and therefore not disclosed or discovered by auditors, there is the potential for lots more to be uncovered in any investigation of past activities.

2. The current disclosures appear to involve something called a "Founder Well Participation Program" that entitles McClendon to participate as a partner in CHK's exploration program. Presumably it was intended that McClendon participate with his own money, not Company money, but in effect by loaning him the money secured by the wells he received the benefit of successful results without assuming the risk of unsuccessful results.

3. As a thought experiment, consider that if the drilling activities resulted in a 3 or 4 times return on invested capital, then the $1 billion of company money invested on McClendon's behalf might generate $2-3 billion in profits for him after paying back principal and interest. Since this would in effect be a benefit provided to him by the Company and therefore might be viewed as part of his compensation package IMO it raises at least two legitimate questions: when did the shareholders have the opportunity to vote on such a huge pay package; and how is it that management and the board decided that disclosure was not necessary? After all that was Company (and Shareholder) money that generated or will generate those profits which otherwise would have gone to the Company and the Shareholders.

4. It's my understanding that McClendon began his oil patch career as a landman and promoter. It appears that he runs CHK as if it is a private company, not a publicly owned company; and IMO he is still acting as a promoter rather than as the CEO of a publicly owned company to which he owes a fiduciary duty to the shareholders.

LwC
LwC - 2 years ago
Argus Research oil analyst thinks Chesapeake CEO and/or BOD should be replaced:

http://finance.yahoo.com/news/chesapeakes-ceo-replaced-argus-132557311.html

I don't like to make predictions because I am so often wrong, but I've decided to make an exception and predict that this is going to get worse for McClendon before it gets better for Chesapeake. One reason I think that is because the Chesapeake spokespeople are being so adamant that there's nothing wrong, but IMO they can spin this in a positive light only until some real light reveals the depth of the self dealing that I believe has been going on for years.

AlbertaSunwapta
AlbertaSunwapta - 2 years ago
Yeah, over the years my biggest and most dramatic losses have come about by buying between, a substantial drop on a negative accounting disclosure, and the subsequent collapse as the market realized that the accountants in collusion with their management were really quite adept at make a business with poor economics look anything but.
LwC
LwC - 2 years ago
This is one of the best articles about it that I've read so far:

"How Chesapeake Energy went from darling to dud"

By Cyrus Sanati

April 25

http://finance.fortune.cnn.com/2012/04/25/chesapeake-energy-collapse/?source=yahoo_quote



"Chesapeake Energy sold itself as a premier energy exploration and production firm, but it seemed to function more like a Wall Street hedge fund. Now the house of cards is collapsing."


AlbertaSunwapta
AlbertaSunwapta - 2 years ago
^ Interesting. Thanks for posting.

So as huge natural gas companies like CHK struggle when their hedging ends, I expect that there will be distress sales of assets. Buyers will then be able to produce and sell at even lower prices in the race to the bottom. That's great for natural gas consumers but not for most producers.

Who would be a buyer of CHK's assets should it come to that?
batbeer2
Batbeer2 premium member - 2 years ago
Ehm..... I don't want to spoil the party here but I couldn't resist. I just picked up a few shares.

1) McClendon borrowed some money from EIG Global Energy Partners. Not from CHK. Of course that is a boring fact omitted from this and most other threads discussing the matter. McClendon used the cash to buy small stakes in the same wells CHK was buying. He used the assets as collateral. If you think that's bad or should be illegal, then the US is in serious trouble. There's a few trillion dollars out there backed by the homes of law-abiding Americans. CHK itself was borrowing from EIG too. On the same terms. The CEO personally buying the same assets on the same terms as the company is a good thing no ? Apparently, the Internet community says no.

Now if McClendon had been SELLING these assets to CHK or buying ahead of the company, that would be another matter. In any case, it's not like CHK could have legally disclosed what McClendon was privately doing even if they had wanted to. This is utter nonsense and it has caused the stock to drop like a stone !

2) CHK hedged their production since 2006... all the way down. They were criticized for this. Prices would go up tenfold. The spread with oil was just too big. That spread just HAD to close. As it turns out, the hedges were worth many billions. Now, they've taken off the hedges. Again, they are being criticized. You see, everyone expects the price of gas to go all the way to zero.

In short, I believe the thesis is still valid.


- EDIT -

One more thing.... the CEO of Sandridge (Ward) did exactly the same thing. He ended up selling his stakes in Sandridge's wells TO SANDRIDGE in 2008. At a profit. Ward co-founded Chesapeake and now runs Sandridge.
LwC
LwC - 2 years ago
Hi batbeer2,

IMO if there's any party that's being spoiled it's the party that McClendon has been enjoying with the apparent self dealing.

Anyway as to your assertions, I propose that while you might be right that McClendon's activities are completely innocent the problem is that we can't know that yet because of the lack of disclosure about what was going on. I've seen the references to EIG in the news reports and in fact that was reported in a couple of the reports that I have referred to above, so I don't know why you wrote that "that is a boring fact omitted from this and most other threads discussing the matter". The problem IMO is that it's not clear at to what role EIG has played and, maybe more importantly, when EIG played that role. I don't know if McClendon's activities were illegal or unethical, but it sure does smell. You seem to be jumping to the conclusion that critics are wrong, but IMO it's still too early to tell one way or the other until there is much more disclosure.

You have asserted that McClendon did not borrow from CHK, but how do you know that? What if that's just positive spin in an attempt to deflect attention. For example, what if McClendon purchased his interest in the wells with loans from Chesapeake as has been asserted in many reports, but then entered into deals with EIG to pay back some of those loans? The issue would still be that McClendon received a huge financial benefit from the company and it wasn't disclosed. If it wasn't disclosed, why not? Maybe it was completely innocent and they didn't think it needed to be disclosed; or maybe they knew they were on thin ice and therefore didn't disclose because they didn't want under the light of day. Wouldn't be the first time bad actors have attempted to cover up their activities.

I don't agree that McClendon bought "small stakes"; after all there doesn't seem to be any dispute that the activities involved more than $1billion and IMO that is not small stakes. Also, as the Fortune article pointed out, the potential for conflicts of interest is rife when both CHK and McClendon acting personally are doing business with EIG.

You acknowledge that if McClendon were selling assets to CHK or buying ahead of the company you would have a different opinion. Of course we don't know (yet) whether or not that was happening, and that may very well have been happening. You assume that it wasn't while others assume that it was. Regardless, I have not seen any report in which CHK has asserted that McClendon didn't borrow any money from CHK to drill those wells. Have you? To the contrary in its Form 8 report last week CHK appears to acknowledge that he did borrow but it left the amounts involved blank, presumably left to be filled in later. I guess that they don't know the actual amounts involved and that they are busy trying to figure it out.

IMO the Fortune article author wasn't criticizing CHK for taking off the hedges. IMO he was simply pointing out that without those hedges going forward to shelter the company's production from low gas prices, the prospects for profits for the near to medium term is not very good and also that it will weigh heavily on CHK's ability to meet debt service requirements and to continue to grow its production (both oil and gas). He also pointed out that there is a huge amount of off balance sheet debt in the form of the VPPs. Well we've seen before what happens when those types of hens come home to roost.

You may not agree but considering the size of McClendon's non Chesapeake business activities, IMO it's fair to wonder just when he had time to manage both Chesapeake and his personal oil & gas business; after all a company with over $1billion of assets and thousands of wells is a full time job for most people and that's just his personal holdings. Certainly his job as CEO of CHK is full time job itself. Might it not be a conflict of interest just to allocate his time between the two?

You may be right that reactions to this news is overblown, but in most previous examples of this kind of activity (eg. Enron, Worldcom, Tyco) it hasn't turned out very well for the companies or the individuals involved.

Good luck with your CHK investment.

And BTW IMO it's interesting that you bring up Ward who has been a long time partner and associate of McClendon. Maybe it's not coincidence that they both have indulged in similar activities. There's that old saying about how birds of a feather flock together.

batbeer2
Batbeer2 premium member - 2 years ago
Hi LwC,

This is not Enron or Worldcom. Tyco.... maybe.

I propose that while you might be right that McClendon's activities are completely innocent the problem is that we can't know that yet because of the lack of disclosure about what was going on.

The board came out and said:

1) They believe there wasn't anything they should have disclosed beyond what they had disclosed.

2) The plan was designed to align the interest of the CEO with the company.

If you don't believe that's true, then you believe the board is dumb or rotten.

Come on !

I find it hard to believe Lou Simpson, a guy trusted by Charles Munger for decades to manage the portfolio of Wesco, is a crook. But yeah.... I can't know that.

Assuming he is a a crook, he was smart enough to keep it a secret from Buffett for decades.

There's that old saying about how birds of a feather flock together.

But hey... even if I'm wrong on this and it's rotten to the core, wel, it will be blown out of the water any day now. They'll all be replaced. Meanwhile, the fair market value of the assets is clearly many multiples of the enterprise value of the business.

Invert, what would you be willing to pay for the future proceeds (if any) of the current litigation. Is that more or less than the decline in CHK's market cap ?

Mason Hawkins, as a major shareholder, came out with an open letter to the board of directors after the Olympus debacle. If memory serves, he did that within days of the news. Hawkins now remains silent. Why ?
batbeer2
Batbeer2 premium member - 2 years ago
>> 3. As a thought experiment, consider that if the drilling activities resulted in a 3 or 4 times return on invested capital, then the $1 billion of company money invested on McClendon's behalf might generate $2-3 billion in profits for him after paying back principal and interest. Since this would in effect be a benefit provided to him by the Company and therefore might be viewed as part of his compensation package IMO it raises at least two legitimate questions: when did the shareholders have the opportunity to vote on such a huge pay package; and how is it that management and the board decided that disclosure was not necessary? After all that was Company (and Shareholder) money that generated or will generate those profits which otherwise would have gone to the Company and the Shareholders.

As it is, there is absolutely no evidence Chesapeake was lending McClendon money. In fact, we know who was lending him the money and it was not Chesapeake.

So I ask: What on earth should shareholders have been voting on ?

LwC
LwC - 2 years ago
I was referring to Enron and Worldcom as to lack of disclosure and the off balance sheet items as well as their now known unethical and criminal actions. I stated above that I don't know if this situation rises to that level, or better yet if it sinks to that level.

As for the CHK board, well they are not necessarily independent (it's widely believed by many observers that many BODs are too cozy with management, and IMO hardly anybody would argue that the CHK board is not packed by McClendon's cronies) and certainly they may feel compelled to defend their actions, or lack thereof. I certainly don't think they're dumb, but maybe compromised? As for Lou Simpson, well I guess there's a reason he isn't at BRK anymore, and I don't know whether his prior actions amount to being crooked, but unethical might apply. I don't see Munger defending his actions. As Munger and Buffett are fond of saying, it takes only a minute to undermine a lifetime of good reputation (or however they put it). I'm just not impressed that Simpson was invited to the CHK board when there are certainly many qualified individuals who are not potentially challenged ethically. Maybe it says something about the nature of the CHK board that they invited Simpson to the party instead of one of those others. Anyway apparently much of this occurred before Simpson joined the board so, so what?

IMO both of your points about the board's public response to the news are not convincing. I addressed the question of disclosure above. As for the idea that the well participation program was meant to align the interest of the CEO with the company, well as I wrote above that might be the case if he actually used his own money, but that is the question isn't it? Did he use his own money, or did he use company money? Even if that was the intention, maybe it didn't work out that way; maybe the opportunity for self dealing was just too inviting to pass up. And anyway why aren't his salary, perks and share ownership enough to align this interest with the company's interest? Isn't that the case at most every other public company? Well IMO this thing just doesn't smell right.

The question of FMV of the assets is an interesting one that IMO can't be estimated without the full disclosure that appears to be lacking. Regardless of the FMV of the assets, if they are so heavily burdened that they can't generate the free cash flow to keep the company in business, or to realize enough cash after sale to pay the burdens and keep the company in business, well so what? IMO the author of the Fortune article raised some interesting questions about that. We'll see how it plays out.

It just so happens that the small interest I own of CHK that I referred to above is through Mason Hawkins' fund, and frankly I have wondered why he has continued to hold CHK. I confess that I bought into Hawkins' fund when it opened to new investors a few years ago and I'm not impressed. My initial small investment, which was intended as an initial position in preparation to building a larger position, is so far my only investment in his fund. It is worth less than I paid.

Thanks for your response

BTW I just read your last response wherein you state again that there is no evidence that CHK was lending McClendon money. I previously referred you to CHK's SEC filing last week in which they pretty clearly stated that they had, but left the amount blank. Did you look it up before you commented?

And you wrote: "So I ask: What on earth should shareholders have been voting on ?"

Well first off I think you took that statement of mine out of context. I think I stated pretty clearly that IF CHK loaned the money for McClendon to drill his share of the wells and therefore it amounted to a cost free benefit to him, and a big one at that, THEN maybe the shareholders should have been able to vote on what was in effect a huge benefit package. Frankly I don't know why you would choose to obfuscate that idea.

batbeer2
Batbeer2 premium member - 2 years ago
Hi LwC,

Here's the Q&A with Reuters.

Two undisputed facts:

1) Ever since Chesapeake was founded, McClendon has agreed to personally fund 2.5% of the cost of every single Chesapeake well. In return he gets the rights to 2.5% of the profit. Shareholders reaffirmed this scheme in 2005.

2) Recently, McClendon was able to sell a portion of his rights for $1.1 B. Shareholders were not informed or consulted.

The $1.1 B breaks down this way: In June 2009, McClendon forked over some rights to Union Bank, a California lender for $225 million in cash. In December 2010, he got $375 million from TCW Asset Management, a private equity firm. In January 2012, McClendon got $500 million from EIG Global Energy Partners in return for some rights.

On these two facts, I base my opinion that what we have here is just another data point confirming the fair market value of Chesapeake's assets.
LwC
LwC - 2 years ago
Well batbeer, I guess we've about beat this one to death. I'm confident that both of us will find more grist as new info becomes public. Meanwhile I'll add this to the fire:

http://www.marketwatch.com/story/cracking-the-chesapeake-piggy-bank-2012-04-26?siteid=yhoof2

"Despite the outrage over this and other fiduciary entitlements bestowed on McClendon, blame for this kind of wanton behavior could also be fixed on an spineless board, lazy shareholders, lax auditors and overworked regulators. Any one of these groups could have called out McClendon years ago. None did.

What we’re left with is another classic example of why CEOs should not be chairmen of their own companies, especially when they can lord the title “founder” over the rest of the boardroom. If McClendon wanted to run a personal fiefdom, he should never have taken the company public. If shareholders wanted an independent board to keep senior executives in line, they should have kept McClendon out of the boardroom. Having no one to tell him how to behave, he behaved badly."

I especially like the part about McClendon keeping the company private if he wanted to run the company as his personal fiefdom, a sentiment which I agree with.

Good luck.

batbeer2
Batbeer2 premium member - 2 years ago
Yup.... time will tell.

To be clear, I have never been to the US. I have never spoken to anyone that worked for Chesapeake. If I have an axe to grind, it's because I am a consumer of natgas. The price I pay is about $30 per 1000 cubic feet. In the US, you pay somewhat less. Meanwhile, I literally live on top of the stuff. If you don't like McClendon in the US, please send him over here !

From the article you linked to:

>> One of those generous little pats included a plan approved by the board of directors in 2005 called the Founders Well Participation Plan, or FWPP. The plan gives McClendon a personal stake of up to 2.5% in every production well the company drills. Of course, convincing the board he truly deserved this was probably made easy by the fact that he chairs that same board.

There are at least two lies in there:

1) The plan wasn't approved by the board, it was put to the vote. Shareholders voted.

2) The plan doesn't give McClendon a 2.5% stake. McClendon is obliged to personally fund 2.5% of the cost of every well drilled. In return he gets a right to 2.5% of the profits of that well.
batbeer2
Batbeer2 premium member - 2 years ago
Mason Hawkins, yesterday, had this to say:

"Sell-side conferences, media interviews with no hope of a fair hearing, and meetings all over the U.S. with groups who may have only a casual interest but don't mind hearing the 'story' use valuable amounts of top management's time with no apparent benefit and plenty of misinterpretation detriment," the letter said. "Trading volumes highlight that CHK stock has far too many renters and not enough owners."
LwC
LwC - 1 year ago
Batbeer,

I don't know if you still have your CHK position, but I thought you might find this interesting if you don't already know it:

"Retired ConocoPhillips CEO Archie Dunham, brought in by Chesapeake Energy to undo the mess made by CEO Aubrey McClendon and restore confidence in the oil and gas driller, is putting his money where his mouth is as non-executive chairman of Chesapeake."

http://www.thestreet.com/story/11710522/1/chesapeake-energy-chairman-puts-money-where-mouth-is.html?puc=yahoo&cm_ven=YAHOO

If I remember correctly you bought below the current market price, so you're in a gain position. Congrats.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK