For six months I’ve been undecided on whether or not to take a significant position in Chesapeake Energy. Over that time Carl Icahn has been buying shares and it appears that his pace of buying has accelerated since the end of Q3 as he now owns 5.8% of the company.
For those interested in learning more about why Icahn believe Chesapeake is undervalued, here is a compilation of information I’ve gathered over the past several months:
July 11, 2010 – Valuation Using Recent Transactions
I've followed Chesapeake Energy for quite a few years. I've owned shares at times, I don't currently.
If I were bullish on natural gas, I would own a ton of it.
There is no disputing that CHK is an acreage acquiring machine. They or someone else find an emerging play, and there is no other company that can get out and lock down the land like these guys.
The recent Joint Venture agreements that CHK has entered into with some of the largest energy producers in the world give us a pretty easy way to value the company.
Here are the 4 major Joint Ventures:
1) Marcellus JV with Statoil - Statoil paid $3.375bil for 32.5% of CHK's Marcellus acreage. That implies that CHK's remaining acreage is worth $7bil.
2) Haynesville JV with PXP - PXP paid $3.2bil for 20% of CHK's Haynesville acreage. That implies that CHK's remaining acreage is worth $12.8bil.
3) Barnett JV with Total - Total paid $2.25bil for 25% of CHK's Barnett acreage. That implies that CHK's remaining acreage is worth $6.75bil.
4) Fayetteville JV with BP - BP paid $1.9bil for 25% of CHK's Fayetteville acreage. That implies that CHK's remaining acreage is worth $5.7bil.
Now add those up and it suggests CHK is still holding $32.25bil worth of property in these four areas.
Value of CHK remaining assets in these properties - $32.25bil
Less total debt of company - $11.6bil
Total Net asset value - $20.65bil
Fully diluted shares - 758mil
Value per share - $27.26
Current share price - $22.00
Note - So using a very objective measure (prices that profit motivated 3rd parties are willing to pay) we can conclude that the value of CHK's Marcellus/Haynesville/Barnett/Fayetteville properties less debt is considerably more than the current share price.
Now the kicker. These are only four of CHK's properties.
Consider:
1) The company had 15.8 tcfe of proved reserves as of March 31, 2010. Only 8tcfe of it related to the 4 properties discussed above.
2) The company controlled 13.9 million acres as of March 31, 2010. The four properties above represent 2.6 million acres of it.
If these four assets represent half of CHK's proved reserves and are worth $32bil. And we assume that the other half of the proved reserves are worth only half as much (properties likely don't have the same upside) that would still be $16bil. That is another $21 per share.
So if you are buying shares today you basically get to pay less than the BP/Statoil/Total/PXP companies did for the 4 big shale properties, and pay nothing for everything else that CHK has.
I'll cover this going forward. As I said, I don't currently own it mainly due to a lack of confidence in any improvement in natural gas prices.
July 13, 2010 – Aubrey Does Some Valuation Work for Investors
I had written earlier about Chesapeake and how the Joint Venture deals they had entered into provided evidence that the big 4 shale plays alone were worth more than the current stock price (meaning you were getting everything else for free).
I recently listened to the last quarterly conference call and CEO Aubrey laid out exactly what he believes CHK properties are worth.
1) Marcellus - $15 bil
2) Haynesville/Bossier - $15bil
3) Barnett - $7bil
4) Fayetteville - $5bil
5) Eagleford - $4bil
6) Conventional assets - $8bil
7) Midstream/Drilling Rigs - $6bil
8) Drilling carries - $3bil
9) 12 early stage oil plays - $5bil
Total assets $68bil
Less debt $12bil
Net assets $56bil
Total shares 758mil
Value per share $73.88
Share price $21
Aubrey is a salesman, that is to be sure. And you have to figure in some income taxes on these values as the acreage for most of it was acquired at prices that are fractions of what it is selling for now. But you can arrive at much of the values he lays out by looking at recent transactions.
I think it would be hard to argue that the net asset value of the company is not significantly higher than the current share price.
The problem is, what is going to force the stock market to recognize this if we don't get a nice run in natural gas prices ?
Aubrey lost most of the shares that he held in 2008 so he is not going to ever be motivated to sell the company and try and realize value for shareholders.
The plan management has is to reduce debt by about $3bil to achieve an investment grade rating. They believe this will help the market to focus on the asset value instead of worry about the debt. The problem is that we have heard this song and dance before from Aubrey and company and they did not follow through on it.
I'm going to keep watching. As I've mentioned before, if I thought an upturn in natural gas was coming this would be my first choice.
August 9, 2010 – Technology and Natural Gas Prices
I’ve been sucking my thumb considering making an investment in two natural gas producers who are actually quickly diversifying into a more balanced oil/gas production mix. The two companies I’m looking at are Chesapeake Energy and Sandridge Energy. What is holding me back is the future of natural gas prices. I’m bullish on oil long term, but I think the shale discoveries in the United States have likely changed the game for natural gas.
I’ve written about Chesapeake a couple of times:
http://www.gurufocus.com/news.php?id=101898
[www.gurufocus.com]
Today I read an interesting commentary from Oakmark that is fairly close to what I have been thinking. The main parts of their thoughts are below:
Energy and Disruptive Technologies
Those of you who have paid attention to our discussions concerning our energy investments over the years might remember that at one point we strongly favored domestic producers of natural gas, given what we saw as a favorable supply-demand dynamic with natural gas—the favored carbon fuel of the environmentally conscious. At the time we thought that a business that could develop and produce natural gas for under $4 per mmbtu and then could sell it at prices in excess of $7 per mmbtu was a good business. It was even better in those periods when a substantial amount of yearly production could and would be hedged for sale at prices in the range of $8 - $10 per mmbtu. In recent months, the dynamics of the natural gas marketplace have changed and we have reduced our exposure to gas considerably. Moreover, our other energy investments, primarily in Concho Resources, Cenovus, and Apache, have taken on a more oily mix. Because of these changes, we felt that a discussion of disruptive technology was in order.
Commodity prices are of course primarily affected by supply and demand issues. Commodities that are in short supply might have higher prices due to the increased costs of meeting environmental and safety standards, the continued deterioration in the size and grade of resource deposits, and the difficulty of accessing these deposits. Often, new technology can mitigate these upward price trends. For example, seismic imaging can help locate petroleum and mining deposits. Farmers employ genetically modified seeds and use larger GPS-equipped tractors. New chemicals and drilling techniques can extract more oil and gas from a well. The impacts on production costs might be incremental, but if the technology change is great enough, new technologies can lower production costs while increasing the supply of the commodity. We classify a technology as disruptive, then, when it significantly lowers the supply/demand equilibrium price while it simultaneously causes a surge in production capacity.
Offshore drilling was one of the first disruptive technologies in the petroleum market. Even though it started in the 1960s, the technology was not widely adopted until the late 1970s during the oil price shock. Initially, drilling occurred at depths less than 400 feet, and it moved quickly to the Gulf of Mexico, the North Sea, and other locations, resulting in increased oil production, even though demand increased only marginally. This geographic expansion was the result of the OPEC-producing countries cutting production by 40% from 1975 to 1985. Given an oversupply of the commodity, prices remained flat for two decades after the introduction of the disruptive technology. The end result of this price suppression, however, was a production peak, which led to substantial and sustainable real increases in the price of oil. We think that natural gas prices are now at a similar tipping point. Horizontal drilling techniques have been used in this country for more than twenty years. However, since 2003, new fracturing techniques for wells (especially in shale) have led to a 10x increase in horizontal drilling rigs. Horizontal drilled wells are now thought by some commentators to be responsible for more than 80% of incrementally produced natural gas in the U.S.
Over the past five years natural gas needed to trade at $6 - $7 per mmbtu to encourage new production of natural gas. Lower prices tended to cause a reduction in drilling and production to slow accordingly, resulting ultimately in a supply-demand imbalance that would increase prices until the demand was met again. In the past twelve months, prices have remained under $5 per mmbtu with the expectation that production would again be shut-in and drilling curtailed until pricing corrected back towards the $7 mmbtu range. The problem with these assumptions is that many companies have improved their horizontal drilling techniques to a point where they can earn attractive returns with gas at much lower prices than had been the case even a few years ago. As this technique becomes increasingly adopted by more companies, we are concerned that horizontal drilling will become a truly disruptive technology, resulting in lower price highs for natural gas. The prices at which producers will continue to expand production now appear to be in flux and drifting lower towards a new clearing price. Horizontally drilled wells may actually only generate negative cash flow when gas prices fall to $3 per mmbtu for the most efficient producers. Higher cost wells can be shut without ending oversupply because of the greater efficiency of horizontally drilled wells. Each horizontal rig can surge production by 5-10x the previous capability of vertically drilled wells. Thus, companies can adjust supply to meet demand in a much shorter time frame than the months historically required to correct imbalances. Thus, for the foreseeable future we expect natural gas prices to remain under $5.50 per mmbtu. Capacity should come off line as prices go below $3.50.
Regarding oil, we reach a different conclusion, given that both undersea and in previously explored areas on land, a substantial amount of new oil is being discovered as a result of improvements in technologies. Additionally, improvements in recovery as well as in drilling and production techniques are extracting more from existing wells than was originally thought possible. That said, OPEC continues to act as a constrictor of supply by being the swing producer, so that disruptive technologies requiring higher capital investment have not taken root as widely as with natural gas, given the global market for oil. What price is needed to bring on new production, and the sustainability of same, is a more complex question. By the same token, a new disruptive technology in either deep-water drilling techniques or for tar sands could substantially lower production costs and become a game changer.
So I guess I’m still left sucking my thumb. I find Chesapeake especially tempting as I think they are fairly compelling even at lower natural gas prices with a potential kicker from a rapid move they are making to liquids.
September 20, 2010 – LongLeaf Partners on Their CHK Position
I follow Longleaf Partners fairly closely. They run a pretty concentrated portfolio and therefore tend to know their positions well which provides for good starting points for further research. I am especially interested in Chesapeake Energy which is one of their three largest positions. I think Chesapeake has an incredible resource/asset base and will be a terrific bargain at the current stock price should natural gas prices improve. I read a Morningstar Interview today with Staley Cates and in it he touched on a few things.
Cates said that he is optimistic on the potential for stock price increases for two reasons 1) Stocks are cheap on an earnings yield basis, especially against bonds with Cates believing the earnings for the S&P 500 would be $80 this year 2) Investors are very fearful, with everyone focused on macro items and not on micro..in other words yes there are things to be concerned with but this is already well reflected in stock prices
Cates had an interesting comment on how he and his analysts avoid commitment bias and stay fresh with stocks they have owned for a long period. The key is that all analysts are required to invest all of their money in Longleaf funds, so everyone working at the fund has a vested interest in maximizing performance and all holdings will be scrutinized all of the time.
On energy investing Cates noted that they don’t feel like they need to be in or out of the sector and that they don’t care at all about sector weighting. He said he thinks Chesapeake has the best natural gas assets through the shale plays that they got into early and into inexpensively. He believes that they are the best at what they do which I take to mean finding new large resource plays and locking up acreage quickly.
Cates mentioned that CHK is their most controversial holding mainly due to the pay package of CEO Aubrey McClendon. His assessment of Aubrey is actually quite similar to mine, which is that he has done an incredible job of investing $3 billion into various shale plays from which he has already received $12 billion in cash/drilling carries from partners and still retains 75% of the assets. But while he found these incredible assets for CHK he was incredibly stupid with his personal assets borrowing against CHK stock and getting hit with a margin call.
Also a very interesting answer was given as to which of his current holdings would still be in the portfolio in five years. The company Cates provided was Cemex, which has had its short term issues. Cates referred to it as a company with a 10% earnings yield at a time when everything has been going wrong. With time he believes there is considerable upside in both earnings and the stock price.
As to why Longleaf has such little exposures to financials he gave the common answer that it is very hard if not impossible to understand the assets of a bank which makes them an easy pass.
I would suggest that if you don’t know Chesapeake it is worth doing some research on. I’ve written about it before a couple of times and think it could have huge upside if there is an increase in natural gas prices:
Chesapeake value per share as explained by its CEO:
http://www.gurufocus.com/news.php?id=100055
At current prices you pay nothing for CHK’s move towards oil:
http://www.gurufocus.com/news.php?id=101898
October 15, 2010 – Two Ways To Win Investing in CHK
I don’t think I’ve ever been so undecided about a company as I am with Chesapeake Energy (CHK). My analysis tells me that it is likely a very undervalued opportunity. My memory tells me to stay away.
Yesterday I listened to the Chesapeake investor day presentations. And as usual I came away impressed with the enormous amount of acreage that the company holds.
As I wrote earlier, it is also impossible to ignore the values that they are establishing for this acreage as they sell of 25% to 33% interests in various properties.
http://www.gurufocus.com/news.php?id=109134
All of these transactions give us an arm’s length, profit motivated buyer price for these properties. And when you add them all together, you get to a share price that is not 20% higher than where CHK is today, but rather multiples of where it is today.
The CHK CEO has laid it out for us in the previous conference call and it is hard to argue with as virtually all of it is verifiable through transactions:
1) Marcellus - $15 bil
2) Haynesville/Bossier - $15bil
3) Barnett - $7bil
4) Fayetteville - $5bil
5) Eagleford - $4bil
6) Conventional assets - $8bil
7) Midstream/Drilling Rigs - $6bil
8) Drilling carries - $3bil
9) 12 early stage oil plays - $5bil
Total assets $68bil
Less debt $12bil
Net assets $56bil
Total shares 758mil
Value per share $73.88
Share price $22
Bloomberg also provided the following recap of what was said at this week’s investor day:
“ Saying Chesapeake Energy will continue to lease land cheaply in obscure
shale oil plays and sell minority stakes to joint-venture partners, CEO
Aubrey McClendon told investment analysts Wednesday that his company will
become one of the five biggest oil producers in the US very soon.
"My guess is that no one in this room believes we will become a top five
oil producer," McClendon quipped, noting that 20 years ago no one would
have predicted that the Oklahoma City-based firm would be among the
nation's top natural gas producers.
McClendon told a lunchtime audience of analysts at the company's
headquarters that Chesapeake has already leased 10 billion to 15 billion
barrels of potential reserves in shale oil plays and will use the same
leasing and financing techniques it used to unlock huge volumes of
natural gas in shale formations.
"We're going to take what we learned in gas to unconventional oil,"
McClendon said, But unlike gas, where "we clearly proved we could overrun
the market, we can't affect the price of oil."
He told analysts to expect a new joint venture early next year involving
Chesapeake's Niobrara shale oil position in Wyoming and Colorado, with a
second partnership by the middle of the year in a shale oil play the
company won't identify.
McClendon said Chesapeake holds 1 million acres of shale oil leasehold in
that and other "mystery" plays, as well as more than five identified
shale oil plays stretching from South Texas' Eagle Ford north through the
Permian and Anadarko basins into the Rocky Mountains.
While Chesapeake has launched a plan to have 25% of its production
volumes in the form of oil and liquids by 2015, the company hasn't
forgotten gas. Saying its breakeven price for drilling in the Marcellus
Shale is $2.45/Mcf, Chesapeake GeoScience Manager John Sharp said the
Marcellus is poised for explosive growth this year and next.
Chesapeake is also pushing projects aimed at creating new markets for the
gas that's swamping the North American market, Senior Vice President for
Natural Gas Projects Mike Stice told analysts.
The closest to fruition, Stice said, is the effort to get developers to
build liquefaction capabilities into their idling liquefied natural gas
terminals along the Texas Gulf Coast. "Every operator on the Gulf Coast
has a liquefaction plan," he said. "In the near term, if you get the
right political wave, you can do it really quickly."
Stice said Chesapeake is leery of making direct investments in
construction of the first liquefaction terminals in the continental US,
but it is willing to support those efforts by signing long-term gas
supply contracts, probably tied at first to Henry Hub index prices and
then ultimately to LNG pricing within the Atlantic Basin.
Stice said Chesapeake was "in very serious discussions" with regulators
and has signed a memorandum of understanding with terminal developer and
operator Cheniere Energy of Houston.
A second effort is centered around gas-to-liquids technology, Stice said.
While he thinks it will take a technological breakthrough on the same
scale as what shale gas has done for US gas, plus another five years, to
get GTL operations up and running, eventually "GTL will be a reality in
the US."
So why do I resist making this a core investment holding ? Aubrey and his 2008 margin call. I’m sure you are familiar with it. The CEO borrowed in huge amounts to buy company stock in the years leading up to the meltdown of the stock market meltdown in 2008. He lost virtually all of his holdings.
I promised myself after seeing that I would not invest in a company where the head man manages the risk in his own personal portfolio so recklessly.
But yet, here I am. Still following the company. Still conflicted.
I think CHK is clearly undervalued. I also believe that there are two ways that an investor could win really big by investing in the company at these prices.
1) Natural gas prices move up – CHK is THE natural gas company of this century. If prices go up to $6 plus again this investment is a homerun.
2) Aubrey’s talk of moving quickly to oil pans out. They were victims of their own success in locking up natural gas shale properties (they flooded the market with product). That won’t happen with oil.
I’m starting to feel that you could win big if either of the above happen. But also that even if they don’t the CHK share price likely isn’t to go down much from here as their production keeps growing 15% year after year after year which will effectively deleverage the company.
When you start feeling that there is upside of multiples and little downside it might be time to really consider an investment.
November 9, 2010 – Atlas Deal Confirms CHK Value
I’m still here sitting on my hands. Looking at Chesapeake almost daily. Looking at the prices being paid for acreage in the regions where CHK is almost always the number 1 or number 2 acreage holder. Doing the math on these transactions and trying to determine what that means for the value of CHK’s assets. And always shaking my head about how the total is always at least 3 times the current stock price.
Am I being disciplined by not buying, or am I just being stupid ?
And today more evidence that what Chesapeake owns is worth much more than the stock market is giving them credit for. Today Chevron (CVX) announced that it is buying Atlas Energy (ATLS) in a deal worth $4.3 billion.
Chevron explained the reason for the deal as follows:
“Atlas “has one of the premier acreage positions in the prolific Marcellus,” George L. Kirkland, Chevron vice chairman, said in a statement. “The high quality resource, competitive cost structure in the Marcellus, strong growth potential of the asset base and its proximity to premier natural gas markets make this targeted acquisition a compelling investment for Chevron.””
Atlas reported more than 1 trillion cubic feet of natural gas reserves at the end of last year and controls 622,000 acres in the Marcellus Shale, according to its website. The company reported today that daily output for the third quarter rose 18 percent from a year earlier to the equivalent of 118.3 million cubic feet.
And the metrics on the deal work out to about $9,000 an acre for the Marcellus holdings.
Which leaves me asking myself “How many times do I have to see profit motivated companies in this industry verify the value CHK’s acreage holdings before I believe it and take a significant position ?”
You will note above that Atlas just sold its acreage for $9,000 per acre.
Consider what CHK is currently holding:
Shale Gas
Marcellus – 1,620,000 acres
Haynesville – 525,000 acres
Barnett – 215,000 acres
Fayetteville – 440,000 acres
Bossier – 200,000 acres
Unconventional Oil/Liquids
Anadarko Basin – 1,015,000 acres
Eagle Ford – 625,000 acres
Permian Basin – 680,000 acres
Powder River and the DJ – 800,000 acres
If you add them all up and apply prices from recent transactions that are publicly available you get to a share price of over $70 per share vs $23 today. The transactions are happening every month, and it is getting hard to dispute the values of these properties today. And if they can get these deals done at $4 natural gas prices, what would they be worth if natural gas every improved ?
The argument that I always hear is that these shale gas plays are not as economical as the companies producing from them make them out to be. That argument is getting very hard to swallow given the sheer number of intelligent companies are paying the currently prices for these assets. Chevron, Statoil, BP, Exxon, Total, Reliance, CNOOC and others are all looking at these properties and believe that they are making good investments.
Realistically, are all of these companies that incompetent that they are making deals that are not going to be profitable for them ? Seems far fetched doesn’t it ?
So what has held me out of Chesapeake ? Two things. One is that I prefer exposure to oil given that I believe $70 plus oil prices are here to stay. The second is the bad taste in my mouth from watching Chesapeake’s Board of Directors hand CEO Aubrey a $50 million cheque in order to basically get him back on his feet after he lost all of his CHK holdings through margin calls.
I am starting to get the feeling that I will be kicking myself for not loading up on CHK at these prices. I also can’t help but wonder why someone doesn’t attempt a hostile takeover of the company at these prices. There is no large shareholder standing in the way from what I can tell.
I encourage you to have a look at CHK’s investor presentation and then do some due diligence of your own to verify the prices being paid for the acres where CHK has huge land holdings. Here is the link.
[www.chk.com]
November 12, 2010 – Q3 Conference Call Notes
I’ve been writing pretty regularly about Chesapeake Energy. I’ve been circling it for months as I think it is likely VERY undervalued at current prices and has a couple of options for even further upside. Those options being a large move to oil and the possibility of an improvement in natural gas prices.
http://valueinvestorcanada.blogspot.com/search/label/CHK
The share price is currently about $22 with a fair valuation likely more than double that (see prior articles for some valuation details). I believe what we have here is a discount related to the CEO and his 2008 margin call and just general distaste for natural gas.
On Aggressive Oil/Liquids Growth Plans
We are currently producing more than 55,000 barrels of liquids per day and have our sights set on exceeding 150,000 barrels per day by year end 2012 and 250,000 barrels per day by year end 2015. We think that will make us a top five producer of liquids in the U.S. by the end of 2005.
Our latest JV, the CNOOC deal in the Eagle Ford, is expected to close in the near future. And our data room is open for the Niobrara Shale JV, in which we own 800,000 net acres, evenly split between the Powder River and D-J Basins. We expect to also sell a 33% working interest in this play at what we believe will be an attractive price both to us and to our future partner.
We believe the recoverable resource under our 800,000 net acres is an unrisked approximate 4.6 billion barrels of oil, representing potentially $400 billion of future undiscounted revenue. This is a reminder that the size of the plays that we have chased and have captured is quite remarkable.
Some of you may be wondering what's next in our liquids plays. I can tell you that we have several new plays under evaluation or development, including an almost 100,000-acre new position in the Williston Basin and a 1 million-acre position in another play that will probably be ready for disclosure in the JV data room in the first half of 2011. We believe there will be worldwide interest in this next big play of ours.
On Building a Top 10 Natural Gas Producer Inside CHK Every Year
Next, I'd like to highlight our exceptionally low finding cost during the first nine months of the year. We added, on a gross basis, 4.0 Tcfe of proved reserves at a drilling and completion cost of only $0.97 per Mcfe. Basically, we are building a top 10 U.S. natural gas producer every year inside our company, an incredible achievement we believe.
And not only are we good at finding gas cheaply at the $0.97 per Mcfe level, we are also good at selling it for much more. To date this year, we have received well north of $3 per Mcfe when we have sold properties through VPPs. It's always good to buy low and sell high, and that's what we try to do around here, whether it's leasehold or proved reserves.
Well Hedged for 2011 and Huge Benefit From Partner Drilling Carry
Finally, I'd like to point out that our realized cash hedging gains since 2001 now reached almost $6 billion. In addition, we have hedged approximately 80% of our anticipated gas production in the first half of 2011 with swaps at an average strike price of $6.35 per Mcf and approximately 43% in the second half of 2011, the swaps at an average strike price of $6.61 per Mcf. If today's 2011 strip holds true, we should record another $1.5 billion in hedging gains in 2011.
That $1.5 billion, along with an expected $2 billion in drilling carried in 2011, will provide Chesapeake with $3.5 billion in cash from two important competitive advantages and what most expect will be a tough industry environment in 2011. We also expect to generate more than $1.5 billion in cash and $1.5 billion in additional drilling carries from two new JVs that we should close in 2011. So that's a total of $6.5 billion in competitive advantages before we even consider the expected $3.5 billion in operating cash flow we should generate in 2011 without any hedges.
The Market Doesn’t Appreciate The Impact of Shifting From Natural Gas to Oil
If you're on our website or go to it at some point, note Slide 17, which is a projected CapEx budget over the next, well, I guess, three years going out to 2012. And in 2010, we'll spend 31% of our money on liquids CapEx, 2011 that should be 45%. And by 2012, we'll be spending almost 2/3 of our capital on liquids plays. So I suspect that people really don't appreciate that impact when we start replacing $3 and $4 Mcf with $13 and $14 Mcf. On a similar cost basis, you really see a huge move in per-unit value creation, and that will drive some numbers in 2012 and beyond and I think most people are not currently not modeling for. So that will remain a focus of the company. Of course, if gas prices, for some reason, were to come back at higher levels, we can always pick our gas drilling back up. But at this point, our goal is to go from 90% natural gas CapEx in 2009 to go to 35% gas CapEx in 2012.
On Deleveraging the Company Through Production Increases
Joseph Allman - JP Morgan Chase & Co
Aubrey, on the same topic, do you still plan to reduce debt and become investment grade? Or have other priorities risen to the top?
Aubrey McClendon
That's still the plan, Joe. When we look out by year end 2012, we think we'll be a 22 to 24 Tcfe company. That's almost 4 billion barrels of oil. By that time, we shouldn't have more than $10 billion of debt. So is $0.40 in Mcfe or $2.50 per barrel debt, are those investment-grade stats by year end 2012? Absolutely. Looking at our book cap today, I guess, guys what's our debt? 42%. Our debt's 42%. If you just look at the earnings capability of the company over the next few years, we will be earning close to $2 billion a year. You'll see that percentage continue to drop. So we absolutely think we're there. And our goal is to drop absolute levels of debt, which we've stated as our goal. But certainly, on a relative basis, as we increase our reserves by 2 1/2, 3, 3 1/2 Bcf per year or Tcf per year, rather, you will see that drop very dramatically on a relative basis for sure.
On Recently Increasing Production Guidance
You bet. Good question, Steve. Let's talk about, first of all, the change in production guidance. For 2010, we did previously have just a spot number for our oil production at 19 million barrels. We went ahead and added a range there of 18 million to 19 million, and that really reflects some ethane rejection that occurred that took our NGL barrels down. We haven't properly accounted for that in our models and now are doing a better job of that. And then also some pickup delays related to some Midstream activity. So we'll see where we come out there, but we felt like it was prudent to put a range in rather than just a spot number of 19 million barrels. And then in 2012, I think Nick mentioned this, but just greater clarity on some of our plays, particularly the Eagle Ford, and I think I might have mentioned the Niobrara as well. So that's been able to give us that clarity. What's that mean with regard to our thoughts about gas prices? I mean, I think we just have to live with today's reality, which is the projection for gas prices going forward and comparing that to the curve would make anybody with a choice of drilling an oil well or drilling a gas well be inclined to drill an oil well. And so that's what we're doing. And then three years ago or so, we were a single-product company focused only on natural gas. We didn't really think we could find oil in any meaningful quantities. We didn't want to go out and buy it. But all that's changed in the last three years, and we have figured out a way to find liquids. And so we're going to back down our gas drilling over time. And again, as I mentioned before, we'll be down to a third of our drilling in 2012 will be gas compared to 90% last year. If gas prices rebound and the country says we need more gas, we can absolutely respond to that very quickly. But right now, the focus is on oil, because it's 3x or 4x more profitable to look for it than it is natural gas.
My Comments
I’ve been following this company since at least 2006. They are a reserve and production growth machine. Really, the only problem they have had is that they and others have been too successful in increasing natural gas supplies for the United States.
I think this is probably a decent investment if natural gas ranges between $4 and $6 for the next few years. There is potential for a multi-bagger return here if either 1) natural gas moves up into a higher range of $6 to $8 2) Aubrey isn’t blowing smoke about the size of the unconventional oil prize he is amassing.
Given what they did with unconventional natural gas reserves, I’m not sure why I shouldn’t believe that they can do something impress of on the oil/liquids side.
I currently have a very small position. If I get any chance under $20 I will be buying aggressively, and I may do so at these prices as well. Right now I’m just trying to be patient and make sure I’m 100% committed to this investment.
December 16, 2010 – Time For a Hostile Takeover
I’ve read both of Boone Pickens biographical books. I liked the first one better as it detailed his efforts through Mesa Petroleum to takeover much larger oil companies Unocal, Phillips Petroleum and Gulf Oil. To be honest I’m not terribly enamored with Pickens as an investor as I think his aggressive approach could just as easily left him bankrupt as it made him rich. But I certainly do have a soft spot for his efforts to take advantage of assets undervalued by the stock market and poorly exploited by entrenched management.
Thinking of Pickens and hostile takeovers led me to thinking about Chesapeake Energy.
Clearly the assets that Chesapeake holds are in high demand. They have so far sold pieces of five different resource plays to five different companies. They also have indicated that they have two more joint ventures coming in 2011. One for the Niobrara Shale and the second for a yet to be named play. Here are the transactions so far:
Haynesville JV with PXP – Sold 20% of the acreage for $3.16 billion or $30,000 per undeveloped acre (note that this one was completed at the top of the natural gas market in early 2008)
Fayetteville JV with BP – Sold 25% of the acreage for $1.9 billion or $12,300 per undeveloped acre
Marcellus JV with STO – Sold 32.5% of the acreage for $3.37 billion or $5,700 per undeveloped acre (note that this transaction was completed in Nov 2008 when it was virtually impossible to complete a deal)
Barnett JV with TOT – Sold 25% of the acreage for $2.25 billion or $15,700 per undeveloped acre
Eagle Ford JV with CEO – Sold 33.3% of the acreage for $2.16 billion or $10,800 per undeveloped acre
And it isn’t just Chesapeake selling pieces of these plays to the big boys. XTO sold the entire company to Exxon, Shell paid almost $5 billion for East Resources, India’s Reliance Industries bought into Pioneer’s Eagle Ford play…..etc, etc, etc.
My point is that there is big demand for the assets that Chesapeake has assembled and the prices being paid are pretty attractive to the companies like Chesapeake that are selling.
However, while Chesapeake and others can sell of pieces of these properties at very nice prices the stock market values these assets much differently. I’ve looked at what the implied value per share of Chesapeake is using its asset sales to indicate what each of its properties is worth. It breaks down as follows:
1) Marcellus (sold 33% for $3.37bil) – Implied value of that retained is $6.75bil
2) Haynesville/Bossier (sold 20% for $3.16bil) – Implied value of that retained is $12.64bil
3) Barnett (sold 25% for $2.25bil) – Implied value of that retained is $6.75bil
4) Fayetteville (sold 25% for $1.9bil) – Implied value of that retained is $5.7bil
5) Eagle Ford (sold 33% for $2.16bil) – Implied value of that retained $4.32bil
Total value of retained interest in shale plays is $36 billion
To that value we also need to add Chesapeake’s other assets:
6) Conventional assets - $8bil (PV10 value)
7) Midstream/Drilling Rigs - $6bil
8) Drilling carries - $4bil
9) 12 early stage oil plays - $5bil
The value of the retained interest in the share plays plus these other assets equals $59bil
Less debt $12bil
Net assets $47bil
Total shares 758mil
Value per share $62
Share price $22
I don’t for a second think that I’ve got value of the assets calculated exactly correctly at $62 per share. But I do think that it is very obvious based on the values being paid by profit motivated buyers that there is a huge difference between the price that Chesapeake is entering JV transactions at and what the stock market is valuing the sum of the parts at.
I also think that I have greatly understated the value of the acreage in liquids rich plays that Chesapeake has put together over the past 3 years. According to their most recent presentation they have 3 million acres in such plays, they just a piece of the Eagle Ford for $10,800 per developed acre, so it is quite likely that the $4 billion I have pegged in for valuing these is very low.
Now let’s take the next step here.
First, we have virtually every large E&P company scrambling to invest dollars in these shale plays that the independents have locked down. These assets are clearly something the large E&Ps want and we can see the prices they are willing to pay.
Second, we have a company in Chesapeake that retains large acreage positions in virtually every hot play other than the Bakken that the large E&Ps are interested in. However, the share price of Chesapeake values these shale assets at a fraction of what the large companies are willing to pay.
Put the two together and what do you have in Chesapeake ? A collection of all of the assets that everyone wants at a price much lower than what everyone is willing to pay.
A major oil company could pay a pretty hefty premium to the current share price of Chesapeake and still get these assets at a sizable discount to what virtually every company in the industry is willing to pay for them in arm’s length transactions.
Somebody should step up and take this company out. Maybe good old T Boone has one more exciting play left in him.
For those interested in learning more about why Icahn believe Chesapeake is undervalued, here is a compilation of information I’ve gathered over the past several months:
July 11, 2010 – Valuation Using Recent Transactions
I've followed Chesapeake Energy for quite a few years. I've owned shares at times, I don't currently.
If I were bullish on natural gas, I would own a ton of it.
There is no disputing that CHK is an acreage acquiring machine. They or someone else find an emerging play, and there is no other company that can get out and lock down the land like these guys.
The recent Joint Venture agreements that CHK has entered into with some of the largest energy producers in the world give us a pretty easy way to value the company.
Here are the 4 major Joint Ventures:
1) Marcellus JV with Statoil - Statoil paid $3.375bil for 32.5% of CHK's Marcellus acreage. That implies that CHK's remaining acreage is worth $7bil.
2) Haynesville JV with PXP - PXP paid $3.2bil for 20% of CHK's Haynesville acreage. That implies that CHK's remaining acreage is worth $12.8bil.
3) Barnett JV with Total - Total paid $2.25bil for 25% of CHK's Barnett acreage. That implies that CHK's remaining acreage is worth $6.75bil.
4) Fayetteville JV with BP - BP paid $1.9bil for 25% of CHK's Fayetteville acreage. That implies that CHK's remaining acreage is worth $5.7bil.
Now add those up and it suggests CHK is still holding $32.25bil worth of property in these four areas.
Value of CHK remaining assets in these properties - $32.25bil
Less total debt of company - $11.6bil
Total Net asset value - $20.65bil
Fully diluted shares - 758mil
Value per share - $27.26
Current share price - $22.00
Note - So using a very objective measure (prices that profit motivated 3rd parties are willing to pay) we can conclude that the value of CHK's Marcellus/Haynesville/Barnett/Fayetteville properties less debt is considerably more than the current share price.
Now the kicker. These are only four of CHK's properties.
Consider:
1) The company had 15.8 tcfe of proved reserves as of March 31, 2010. Only 8tcfe of it related to the 4 properties discussed above.
2) The company controlled 13.9 million acres as of March 31, 2010. The four properties above represent 2.6 million acres of it.
If these four assets represent half of CHK's proved reserves and are worth $32bil. And we assume that the other half of the proved reserves are worth only half as much (properties likely don't have the same upside) that would still be $16bil. That is another $21 per share.
So if you are buying shares today you basically get to pay less than the BP/Statoil/Total/PXP companies did for the 4 big shale properties, and pay nothing for everything else that CHK has.
I'll cover this going forward. As I said, I don't currently own it mainly due to a lack of confidence in any improvement in natural gas prices.
July 13, 2010 – Aubrey Does Some Valuation Work for Investors
I had written earlier about Chesapeake and how the Joint Venture deals they had entered into provided evidence that the big 4 shale plays alone were worth more than the current stock price (meaning you were getting everything else for free).
I recently listened to the last quarterly conference call and CEO Aubrey laid out exactly what he believes CHK properties are worth.
1) Marcellus - $15 bil
2) Haynesville/Bossier - $15bil
3) Barnett - $7bil
4) Fayetteville - $5bil
5) Eagleford - $4bil
6) Conventional assets - $8bil
7) Midstream/Drilling Rigs - $6bil
8) Drilling carries - $3bil
9) 12 early stage oil plays - $5bil
Total assets $68bil
Less debt $12bil
Net assets $56bil
Total shares 758mil
Value per share $73.88
Share price $21
Aubrey is a salesman, that is to be sure. And you have to figure in some income taxes on these values as the acreage for most of it was acquired at prices that are fractions of what it is selling for now. But you can arrive at much of the values he lays out by looking at recent transactions.
I think it would be hard to argue that the net asset value of the company is not significantly higher than the current share price.
The problem is, what is going to force the stock market to recognize this if we don't get a nice run in natural gas prices ?
Aubrey lost most of the shares that he held in 2008 so he is not going to ever be motivated to sell the company and try and realize value for shareholders.
The plan management has is to reduce debt by about $3bil to achieve an investment grade rating. They believe this will help the market to focus on the asset value instead of worry about the debt. The problem is that we have heard this song and dance before from Aubrey and company and they did not follow through on it.
I'm going to keep watching. As I've mentioned before, if I thought an upturn in natural gas was coming this would be my first choice.
August 9, 2010 – Technology and Natural Gas Prices
I’ve been sucking my thumb considering making an investment in two natural gas producers who are actually quickly diversifying into a more balanced oil/gas production mix. The two companies I’m looking at are Chesapeake Energy and Sandridge Energy. What is holding me back is the future of natural gas prices. I’m bullish on oil long term, but I think the shale discoveries in the United States have likely changed the game for natural gas.
I’ve written about Chesapeake a couple of times:
http://www.gurufocus.com/news.php?id=101898
[www.gurufocus.com]
Today I read an interesting commentary from Oakmark that is fairly close to what I have been thinking. The main parts of their thoughts are below:
Energy and Disruptive Technologies
Those of you who have paid attention to our discussions concerning our energy investments over the years might remember that at one point we strongly favored domestic producers of natural gas, given what we saw as a favorable supply-demand dynamic with natural gas—the favored carbon fuel of the environmentally conscious. At the time we thought that a business that could develop and produce natural gas for under $4 per mmbtu and then could sell it at prices in excess of $7 per mmbtu was a good business. It was even better in those periods when a substantial amount of yearly production could and would be hedged for sale at prices in the range of $8 - $10 per mmbtu. In recent months, the dynamics of the natural gas marketplace have changed and we have reduced our exposure to gas considerably. Moreover, our other energy investments, primarily in Concho Resources, Cenovus, and Apache, have taken on a more oily mix. Because of these changes, we felt that a discussion of disruptive technology was in order.
Commodity prices are of course primarily affected by supply and demand issues. Commodities that are in short supply might have higher prices due to the increased costs of meeting environmental and safety standards, the continued deterioration in the size and grade of resource deposits, and the difficulty of accessing these deposits. Often, new technology can mitigate these upward price trends. For example, seismic imaging can help locate petroleum and mining deposits. Farmers employ genetically modified seeds and use larger GPS-equipped tractors. New chemicals and drilling techniques can extract more oil and gas from a well. The impacts on production costs might be incremental, but if the technology change is great enough, new technologies can lower production costs while increasing the supply of the commodity. We classify a technology as disruptive, then, when it significantly lowers the supply/demand equilibrium price while it simultaneously causes a surge in production capacity.
Offshore drilling was one of the first disruptive technologies in the petroleum market. Even though it started in the 1960s, the technology was not widely adopted until the late 1970s during the oil price shock. Initially, drilling occurred at depths less than 400 feet, and it moved quickly to the Gulf of Mexico, the North Sea, and other locations, resulting in increased oil production, even though demand increased only marginally. This geographic expansion was the result of the OPEC-producing countries cutting production by 40% from 1975 to 1985. Given an oversupply of the commodity, prices remained flat for two decades after the introduction of the disruptive technology. The end result of this price suppression, however, was a production peak, which led to substantial and sustainable real increases in the price of oil. We think that natural gas prices are now at a similar tipping point. Horizontal drilling techniques have been used in this country for more than twenty years. However, since 2003, new fracturing techniques for wells (especially in shale) have led to a 10x increase in horizontal drilling rigs. Horizontal drilled wells are now thought by some commentators to be responsible for more than 80% of incrementally produced natural gas in the U.S.
Over the past five years natural gas needed to trade at $6 - $7 per mmbtu to encourage new production of natural gas. Lower prices tended to cause a reduction in drilling and production to slow accordingly, resulting ultimately in a supply-demand imbalance that would increase prices until the demand was met again. In the past twelve months, prices have remained under $5 per mmbtu with the expectation that production would again be shut-in and drilling curtailed until pricing corrected back towards the $7 mmbtu range. The problem with these assumptions is that many companies have improved their horizontal drilling techniques to a point where they can earn attractive returns with gas at much lower prices than had been the case even a few years ago. As this technique becomes increasingly adopted by more companies, we are concerned that horizontal drilling will become a truly disruptive technology, resulting in lower price highs for natural gas. The prices at which producers will continue to expand production now appear to be in flux and drifting lower towards a new clearing price. Horizontally drilled wells may actually only generate negative cash flow when gas prices fall to $3 per mmbtu for the most efficient producers. Higher cost wells can be shut without ending oversupply because of the greater efficiency of horizontally drilled wells. Each horizontal rig can surge production by 5-10x the previous capability of vertically drilled wells. Thus, companies can adjust supply to meet demand in a much shorter time frame than the months historically required to correct imbalances. Thus, for the foreseeable future we expect natural gas prices to remain under $5.50 per mmbtu. Capacity should come off line as prices go below $3.50.
Regarding oil, we reach a different conclusion, given that both undersea and in previously explored areas on land, a substantial amount of new oil is being discovered as a result of improvements in technologies. Additionally, improvements in recovery as well as in drilling and production techniques are extracting more from existing wells than was originally thought possible. That said, OPEC continues to act as a constrictor of supply by being the swing producer, so that disruptive technologies requiring higher capital investment have not taken root as widely as with natural gas, given the global market for oil. What price is needed to bring on new production, and the sustainability of same, is a more complex question. By the same token, a new disruptive technology in either deep-water drilling techniques or for tar sands could substantially lower production costs and become a game changer.
So I guess I’m still left sucking my thumb. I find Chesapeake especially tempting as I think they are fairly compelling even at lower natural gas prices with a potential kicker from a rapid move they are making to liquids.
September 20, 2010 – LongLeaf Partners on Their CHK Position
I follow Longleaf Partners fairly closely. They run a pretty concentrated portfolio and therefore tend to know their positions well which provides for good starting points for further research. I am especially interested in Chesapeake Energy which is one of their three largest positions. I think Chesapeake has an incredible resource/asset base and will be a terrific bargain at the current stock price should natural gas prices improve. I read a Morningstar Interview today with Staley Cates and in it he touched on a few things.
Cates said that he is optimistic on the potential for stock price increases for two reasons 1) Stocks are cheap on an earnings yield basis, especially against bonds with Cates believing the earnings for the S&P 500 would be $80 this year 2) Investors are very fearful, with everyone focused on macro items and not on micro..in other words yes there are things to be concerned with but this is already well reflected in stock prices
Cates had an interesting comment on how he and his analysts avoid commitment bias and stay fresh with stocks they have owned for a long period. The key is that all analysts are required to invest all of their money in Longleaf funds, so everyone working at the fund has a vested interest in maximizing performance and all holdings will be scrutinized all of the time.
On energy investing Cates noted that they don’t feel like they need to be in or out of the sector and that they don’t care at all about sector weighting. He said he thinks Chesapeake has the best natural gas assets through the shale plays that they got into early and into inexpensively. He believes that they are the best at what they do which I take to mean finding new large resource plays and locking up acreage quickly.
Cates mentioned that CHK is their most controversial holding mainly due to the pay package of CEO Aubrey McClendon. His assessment of Aubrey is actually quite similar to mine, which is that he has done an incredible job of investing $3 billion into various shale plays from which he has already received $12 billion in cash/drilling carries from partners and still retains 75% of the assets. But while he found these incredible assets for CHK he was incredibly stupid with his personal assets borrowing against CHK stock and getting hit with a margin call.
Also a very interesting answer was given as to which of his current holdings would still be in the portfolio in five years. The company Cates provided was Cemex, which has had its short term issues. Cates referred to it as a company with a 10% earnings yield at a time when everything has been going wrong. With time he believes there is considerable upside in both earnings and the stock price.
As to why Longleaf has such little exposures to financials he gave the common answer that it is very hard if not impossible to understand the assets of a bank which makes them an easy pass.
I would suggest that if you don’t know Chesapeake it is worth doing some research on. I’ve written about it before a couple of times and think it could have huge upside if there is an increase in natural gas prices:
Chesapeake value per share as explained by its CEO:
http://www.gurufocus.com/news.php?id=100055
At current prices you pay nothing for CHK’s move towards oil:
http://www.gurufocus.com/news.php?id=101898
October 15, 2010 – Two Ways To Win Investing in CHK
I don’t think I’ve ever been so undecided about a company as I am with Chesapeake Energy (CHK). My analysis tells me that it is likely a very undervalued opportunity. My memory tells me to stay away.
Yesterday I listened to the Chesapeake investor day presentations. And as usual I came away impressed with the enormous amount of acreage that the company holds.
As I wrote earlier, it is also impossible to ignore the values that they are establishing for this acreage as they sell of 25% to 33% interests in various properties.
http://www.gurufocus.com/news.php?id=109134
All of these transactions give us an arm’s length, profit motivated buyer price for these properties. And when you add them all together, you get to a share price that is not 20% higher than where CHK is today, but rather multiples of where it is today.
The CHK CEO has laid it out for us in the previous conference call and it is hard to argue with as virtually all of it is verifiable through transactions:
1) Marcellus - $15 bil
2) Haynesville/Bossier - $15bil
3) Barnett - $7bil
4) Fayetteville - $5bil
5) Eagleford - $4bil
6) Conventional assets - $8bil
7) Midstream/Drilling Rigs - $6bil
8) Drilling carries - $3bil
9) 12 early stage oil plays - $5bil
Total assets $68bil
Less debt $12bil
Net assets $56bil
Total shares 758mil
Value per share $73.88
Share price $22
Bloomberg also provided the following recap of what was said at this week’s investor day:
“ Saying Chesapeake Energy will continue to lease land cheaply in obscure
shale oil plays and sell minority stakes to joint-venture partners, CEO
Aubrey McClendon told investment analysts Wednesday that his company will
become one of the five biggest oil producers in the US very soon.
"My guess is that no one in this room believes we will become a top five
oil producer," McClendon quipped, noting that 20 years ago no one would
have predicted that the Oklahoma City-based firm would be among the
nation's top natural gas producers.
McClendon told a lunchtime audience of analysts at the company's
headquarters that Chesapeake has already leased 10 billion to 15 billion
barrels of potential reserves in shale oil plays and will use the same
leasing and financing techniques it used to unlock huge volumes of
natural gas in shale formations.
"We're going to take what we learned in gas to unconventional oil,"
McClendon said, But unlike gas, where "we clearly proved we could overrun
the market, we can't affect the price of oil."
He told analysts to expect a new joint venture early next year involving
Chesapeake's Niobrara shale oil position in Wyoming and Colorado, with a
second partnership by the middle of the year in a shale oil play the
company won't identify.
McClendon said Chesapeake holds 1 million acres of shale oil leasehold in
that and other "mystery" plays, as well as more than five identified
shale oil plays stretching from South Texas' Eagle Ford north through the
Permian and Anadarko basins into the Rocky Mountains.
While Chesapeake has launched a plan to have 25% of its production
volumes in the form of oil and liquids by 2015, the company hasn't
forgotten gas. Saying its breakeven price for drilling in the Marcellus
Shale is $2.45/Mcf, Chesapeake GeoScience Manager John Sharp said the
Marcellus is poised for explosive growth this year and next.
Chesapeake is also pushing projects aimed at creating new markets for the
gas that's swamping the North American market, Senior Vice President for
Natural Gas Projects Mike Stice told analysts.
The closest to fruition, Stice said, is the effort to get developers to
build liquefaction capabilities into their idling liquefied natural gas
terminals along the Texas Gulf Coast. "Every operator on the Gulf Coast
has a liquefaction plan," he said. "In the near term, if you get the
right political wave, you can do it really quickly."
Stice said Chesapeake is leery of making direct investments in
construction of the first liquefaction terminals in the continental US,
but it is willing to support those efforts by signing long-term gas
supply contracts, probably tied at first to Henry Hub index prices and
then ultimately to LNG pricing within the Atlantic Basin.
Stice said Chesapeake was "in very serious discussions" with regulators
and has signed a memorandum of understanding with terminal developer and
operator Cheniere Energy of Houston.
A second effort is centered around gas-to-liquids technology, Stice said.
While he thinks it will take a technological breakthrough on the same
scale as what shale gas has done for US gas, plus another five years, to
get GTL operations up and running, eventually "GTL will be a reality in
the US."
So why do I resist making this a core investment holding ? Aubrey and his 2008 margin call. I’m sure you are familiar with it. The CEO borrowed in huge amounts to buy company stock in the years leading up to the meltdown of the stock market meltdown in 2008. He lost virtually all of his holdings.
I promised myself after seeing that I would not invest in a company where the head man manages the risk in his own personal portfolio so recklessly.
But yet, here I am. Still following the company. Still conflicted.
I think CHK is clearly undervalued. I also believe that there are two ways that an investor could win really big by investing in the company at these prices.
1) Natural gas prices move up – CHK is THE natural gas company of this century. If prices go up to $6 plus again this investment is a homerun.
2) Aubrey’s talk of moving quickly to oil pans out. They were victims of their own success in locking up natural gas shale properties (they flooded the market with product). That won’t happen with oil.
I’m starting to feel that you could win big if either of the above happen. But also that even if they don’t the CHK share price likely isn’t to go down much from here as their production keeps growing 15% year after year after year which will effectively deleverage the company.
When you start feeling that there is upside of multiples and little downside it might be time to really consider an investment.
November 9, 2010 – Atlas Deal Confirms CHK Value
I’m still here sitting on my hands. Looking at Chesapeake almost daily. Looking at the prices being paid for acreage in the regions where CHK is almost always the number 1 or number 2 acreage holder. Doing the math on these transactions and trying to determine what that means for the value of CHK’s assets. And always shaking my head about how the total is always at least 3 times the current stock price.
Am I being disciplined by not buying, or am I just being stupid ?
And today more evidence that what Chesapeake owns is worth much more than the stock market is giving them credit for. Today Chevron (CVX) announced that it is buying Atlas Energy (ATLS) in a deal worth $4.3 billion.
Chevron explained the reason for the deal as follows:
“Atlas “has one of the premier acreage positions in the prolific Marcellus,” George L. Kirkland, Chevron vice chairman, said in a statement. “The high quality resource, competitive cost structure in the Marcellus, strong growth potential of the asset base and its proximity to premier natural gas markets make this targeted acquisition a compelling investment for Chevron.””
Atlas reported more than 1 trillion cubic feet of natural gas reserves at the end of last year and controls 622,000 acres in the Marcellus Shale, according to its website. The company reported today that daily output for the third quarter rose 18 percent from a year earlier to the equivalent of 118.3 million cubic feet.
And the metrics on the deal work out to about $9,000 an acre for the Marcellus holdings.
Which leaves me asking myself “How many times do I have to see profit motivated companies in this industry verify the value CHK’s acreage holdings before I believe it and take a significant position ?”
You will note above that Atlas just sold its acreage for $9,000 per acre.
Consider what CHK is currently holding:
Shale Gas
Marcellus – 1,620,000 acres
Haynesville – 525,000 acres
Barnett – 215,000 acres
Fayetteville – 440,000 acres
Bossier – 200,000 acres
Unconventional Oil/Liquids
Anadarko Basin – 1,015,000 acres
Eagle Ford – 625,000 acres
Permian Basin – 680,000 acres
Powder River and the DJ – 800,000 acres
If you add them all up and apply prices from recent transactions that are publicly available you get to a share price of over $70 per share vs $23 today. The transactions are happening every month, and it is getting hard to dispute the values of these properties today. And if they can get these deals done at $4 natural gas prices, what would they be worth if natural gas every improved ?
The argument that I always hear is that these shale gas plays are not as economical as the companies producing from them make them out to be. That argument is getting very hard to swallow given the sheer number of intelligent companies are paying the currently prices for these assets. Chevron, Statoil, BP, Exxon, Total, Reliance, CNOOC and others are all looking at these properties and believe that they are making good investments.
Realistically, are all of these companies that incompetent that they are making deals that are not going to be profitable for them ? Seems far fetched doesn’t it ?
So what has held me out of Chesapeake ? Two things. One is that I prefer exposure to oil given that I believe $70 plus oil prices are here to stay. The second is the bad taste in my mouth from watching Chesapeake’s Board of Directors hand CEO Aubrey a $50 million cheque in order to basically get him back on his feet after he lost all of his CHK holdings through margin calls.
I am starting to get the feeling that I will be kicking myself for not loading up on CHK at these prices. I also can’t help but wonder why someone doesn’t attempt a hostile takeover of the company at these prices. There is no large shareholder standing in the way from what I can tell.
I encourage you to have a look at CHK’s investor presentation and then do some due diligence of your own to verify the prices being paid for the acres where CHK has huge land holdings. Here is the link.
[www.chk.com]
November 12, 2010 – Q3 Conference Call Notes
I’ve been writing pretty regularly about Chesapeake Energy. I’ve been circling it for months as I think it is likely VERY undervalued at current prices and has a couple of options for even further upside. Those options being a large move to oil and the possibility of an improvement in natural gas prices.
http://valueinvestorcanada.blogspot.com/search/label/CHK
The share price is currently about $22 with a fair valuation likely more than double that (see prior articles for some valuation details). I believe what we have here is a discount related to the CEO and his 2008 margin call and just general distaste for natural gas.
On Aggressive Oil/Liquids Growth Plans
We are currently producing more than 55,000 barrels of liquids per day and have our sights set on exceeding 150,000 barrels per day by year end 2012 and 250,000 barrels per day by year end 2015. We think that will make us a top five producer of liquids in the U.S. by the end of 2005.
Our latest JV, the CNOOC deal in the Eagle Ford, is expected to close in the near future. And our data room is open for the Niobrara Shale JV, in which we own 800,000 net acres, evenly split between the Powder River and D-J Basins. We expect to also sell a 33% working interest in this play at what we believe will be an attractive price both to us and to our future partner.
We believe the recoverable resource under our 800,000 net acres is an unrisked approximate 4.6 billion barrels of oil, representing potentially $400 billion of future undiscounted revenue. This is a reminder that the size of the plays that we have chased and have captured is quite remarkable.
Some of you may be wondering what's next in our liquids plays. I can tell you that we have several new plays under evaluation or development, including an almost 100,000-acre new position in the Williston Basin and a 1 million-acre position in another play that will probably be ready for disclosure in the JV data room in the first half of 2011. We believe there will be worldwide interest in this next big play of ours.
On Building a Top 10 Natural Gas Producer Inside CHK Every Year
Next, I'd like to highlight our exceptionally low finding cost during the first nine months of the year. We added, on a gross basis, 4.0 Tcfe of proved reserves at a drilling and completion cost of only $0.97 per Mcfe. Basically, we are building a top 10 U.S. natural gas producer every year inside our company, an incredible achievement we believe.
And not only are we good at finding gas cheaply at the $0.97 per Mcfe level, we are also good at selling it for much more. To date this year, we have received well north of $3 per Mcfe when we have sold properties through VPPs. It's always good to buy low and sell high, and that's what we try to do around here, whether it's leasehold or proved reserves.
Well Hedged for 2011 and Huge Benefit From Partner Drilling Carry
Finally, I'd like to point out that our realized cash hedging gains since 2001 now reached almost $6 billion. In addition, we have hedged approximately 80% of our anticipated gas production in the first half of 2011 with swaps at an average strike price of $6.35 per Mcf and approximately 43% in the second half of 2011, the swaps at an average strike price of $6.61 per Mcf. If today's 2011 strip holds true, we should record another $1.5 billion in hedging gains in 2011.
That $1.5 billion, along with an expected $2 billion in drilling carried in 2011, will provide Chesapeake with $3.5 billion in cash from two important competitive advantages and what most expect will be a tough industry environment in 2011. We also expect to generate more than $1.5 billion in cash and $1.5 billion in additional drilling carries from two new JVs that we should close in 2011. So that's a total of $6.5 billion in competitive advantages before we even consider the expected $3.5 billion in operating cash flow we should generate in 2011 without any hedges.
The Market Doesn’t Appreciate The Impact of Shifting From Natural Gas to Oil
If you're on our website or go to it at some point, note Slide 17, which is a projected CapEx budget over the next, well, I guess, three years going out to 2012. And in 2010, we'll spend 31% of our money on liquids CapEx, 2011 that should be 45%. And by 2012, we'll be spending almost 2/3 of our capital on liquids plays. So I suspect that people really don't appreciate that impact when we start replacing $3 and $4 Mcf with $13 and $14 Mcf. On a similar cost basis, you really see a huge move in per-unit value creation, and that will drive some numbers in 2012 and beyond and I think most people are not currently not modeling for. So that will remain a focus of the company. Of course, if gas prices, for some reason, were to come back at higher levels, we can always pick our gas drilling back up. But at this point, our goal is to go from 90% natural gas CapEx in 2009 to go to 35% gas CapEx in 2012.
On Deleveraging the Company Through Production Increases
Joseph Allman - JP Morgan Chase & Co
Aubrey, on the same topic, do you still plan to reduce debt and become investment grade? Or have other priorities risen to the top?
Aubrey McClendon
That's still the plan, Joe. When we look out by year end 2012, we think we'll be a 22 to 24 Tcfe company. That's almost 4 billion barrels of oil. By that time, we shouldn't have more than $10 billion of debt. So is $0.40 in Mcfe or $2.50 per barrel debt, are those investment-grade stats by year end 2012? Absolutely. Looking at our book cap today, I guess, guys what's our debt? 42%. Our debt's 42%. If you just look at the earnings capability of the company over the next few years, we will be earning close to $2 billion a year. You'll see that percentage continue to drop. So we absolutely think we're there. And our goal is to drop absolute levels of debt, which we've stated as our goal. But certainly, on a relative basis, as we increase our reserves by 2 1/2, 3, 3 1/2 Bcf per year or Tcf per year, rather, you will see that drop very dramatically on a relative basis for sure.
On Recently Increasing Production Guidance
You bet. Good question, Steve. Let's talk about, first of all, the change in production guidance. For 2010, we did previously have just a spot number for our oil production at 19 million barrels. We went ahead and added a range there of 18 million to 19 million, and that really reflects some ethane rejection that occurred that took our NGL barrels down. We haven't properly accounted for that in our models and now are doing a better job of that. And then also some pickup delays related to some Midstream activity. So we'll see where we come out there, but we felt like it was prudent to put a range in rather than just a spot number of 19 million barrels. And then in 2012, I think Nick mentioned this, but just greater clarity on some of our plays, particularly the Eagle Ford, and I think I might have mentioned the Niobrara as well. So that's been able to give us that clarity. What's that mean with regard to our thoughts about gas prices? I mean, I think we just have to live with today's reality, which is the projection for gas prices going forward and comparing that to the curve would make anybody with a choice of drilling an oil well or drilling a gas well be inclined to drill an oil well. And so that's what we're doing. And then three years ago or so, we were a single-product company focused only on natural gas. We didn't really think we could find oil in any meaningful quantities. We didn't want to go out and buy it. But all that's changed in the last three years, and we have figured out a way to find liquids. And so we're going to back down our gas drilling over time. And again, as I mentioned before, we'll be down to a third of our drilling in 2012 will be gas compared to 90% last year. If gas prices rebound and the country says we need more gas, we can absolutely respond to that very quickly. But right now, the focus is on oil, because it's 3x or 4x more profitable to look for it than it is natural gas.
My Comments
I’ve been following this company since at least 2006. They are a reserve and production growth machine. Really, the only problem they have had is that they and others have been too successful in increasing natural gas supplies for the United States.
I think this is probably a decent investment if natural gas ranges between $4 and $6 for the next few years. There is potential for a multi-bagger return here if either 1) natural gas moves up into a higher range of $6 to $8 2) Aubrey isn’t blowing smoke about the size of the unconventional oil prize he is amassing.
Given what they did with unconventional natural gas reserves, I’m not sure why I shouldn’t believe that they can do something impress of on the oil/liquids side.
I currently have a very small position. If I get any chance under $20 I will be buying aggressively, and I may do so at these prices as well. Right now I’m just trying to be patient and make sure I’m 100% committed to this investment.
December 16, 2010 – Time For a Hostile Takeover
I’ve read both of Boone Pickens biographical books. I liked the first one better as it detailed his efforts through Mesa Petroleum to takeover much larger oil companies Unocal, Phillips Petroleum and Gulf Oil. To be honest I’m not terribly enamored with Pickens as an investor as I think his aggressive approach could just as easily left him bankrupt as it made him rich. But I certainly do have a soft spot for his efforts to take advantage of assets undervalued by the stock market and poorly exploited by entrenched management.
Thinking of Pickens and hostile takeovers led me to thinking about Chesapeake Energy.
Clearly the assets that Chesapeake holds are in high demand. They have so far sold pieces of five different resource plays to five different companies. They also have indicated that they have two more joint ventures coming in 2011. One for the Niobrara Shale and the second for a yet to be named play. Here are the transactions so far:
Haynesville JV with PXP – Sold 20% of the acreage for $3.16 billion or $30,000 per undeveloped acre (note that this one was completed at the top of the natural gas market in early 2008)
Fayetteville JV with BP – Sold 25% of the acreage for $1.9 billion or $12,300 per undeveloped acre
Marcellus JV with STO – Sold 32.5% of the acreage for $3.37 billion or $5,700 per undeveloped acre (note that this transaction was completed in Nov 2008 when it was virtually impossible to complete a deal)
Barnett JV with TOT – Sold 25% of the acreage for $2.25 billion or $15,700 per undeveloped acre
Eagle Ford JV with CEO – Sold 33.3% of the acreage for $2.16 billion or $10,800 per undeveloped acre
And it isn’t just Chesapeake selling pieces of these plays to the big boys. XTO sold the entire company to Exxon, Shell paid almost $5 billion for East Resources, India’s Reliance Industries bought into Pioneer’s Eagle Ford play…..etc, etc, etc.
My point is that there is big demand for the assets that Chesapeake has assembled and the prices being paid are pretty attractive to the companies like Chesapeake that are selling.
However, while Chesapeake and others can sell of pieces of these properties at very nice prices the stock market values these assets much differently. I’ve looked at what the implied value per share of Chesapeake is using its asset sales to indicate what each of its properties is worth. It breaks down as follows:
1) Marcellus (sold 33% for $3.37bil) – Implied value of that retained is $6.75bil
2) Haynesville/Bossier (sold 20% for $3.16bil) – Implied value of that retained is $12.64bil
3) Barnett (sold 25% for $2.25bil) – Implied value of that retained is $6.75bil
4) Fayetteville (sold 25% for $1.9bil) – Implied value of that retained is $5.7bil
5) Eagle Ford (sold 33% for $2.16bil) – Implied value of that retained $4.32bil
Total value of retained interest in shale plays is $36 billion
To that value we also need to add Chesapeake’s other assets:
6) Conventional assets - $8bil (PV10 value)
7) Midstream/Drilling Rigs - $6bil
8) Drilling carries - $4bil
9) 12 early stage oil plays - $5bil
The value of the retained interest in the share plays plus these other assets equals $59bil
Less debt $12bil
Net assets $47bil
Total shares 758mil
Value per share $62
Share price $22
I don’t for a second think that I’ve got value of the assets calculated exactly correctly at $62 per share. But I do think that it is very obvious based on the values being paid by profit motivated buyers that there is a huge difference between the price that Chesapeake is entering JV transactions at and what the stock market is valuing the sum of the parts at.
I also think that I have greatly understated the value of the acreage in liquids rich plays that Chesapeake has put together over the past 3 years. According to their most recent presentation they have 3 million acres in such plays, they just a piece of the Eagle Ford for $10,800 per developed acre, so it is quite likely that the $4 billion I have pegged in for valuing these is very low.
Now let’s take the next step here.
First, we have virtually every large E&P company scrambling to invest dollars in these shale plays that the independents have locked down. These assets are clearly something the large E&Ps want and we can see the prices they are willing to pay.
Second, we have a company in Chesapeake that retains large acreage positions in virtually every hot play other than the Bakken that the large E&Ps are interested in. However, the share price of Chesapeake values these shale assets at a fraction of what the large companies are willing to pay.
Put the two together and what do you have in Chesapeake ? A collection of all of the assets that everyone wants at a price much lower than what everyone is willing to pay.
A major oil company could pay a pretty hefty premium to the current share price of Chesapeake and still get these assets at a sizable discount to what virtually every company in the industry is willing to pay for them in arm’s length transactions.
Somebody should step up and take this company out. Maybe good old T Boone has one more exciting play left in him.
