Earlier in 2016, investors were pricing in significant bankruptcy risk across Chesapeake (CHK, Financial)’s capital structure. At the time, we believed Chesapeake’s liquidity risks were manageable given the company’s ability to sell assets representing a small percentage of its future production in exchange for cash, making up a meaningful percentage of the company’s enterprise value. We felt that Chesapeake’s bonds at the time had a similar upside to the stock and had the added benefit of higher seniority in the capital structure, so we swapped the preponderance of our Chesapeake equity position into the company’s fixed income securities. On average over the months in which we executed this trade, we sold CHK stock for approximately $4 per share and bought bonds trading for $48.
Commodity prices rose during the quarter, while Chesapeake sold assets for cash without substantially reducing its current EBITDA. We believe that the liquidity profile of the company is now considerably improved. Today the bonds are trading for $85 while the stock is at $4.28, and the relative attractiveness of Chesapeake bonds to its stock has noticeably narrowed. We are very impressed with how well Chesapeake’s management team and board of directors have navigated this challenging commodity price environment, and we remain positive about the long-term prospects for this company.
From Bill Nygren (Trades, Portfolio)'s Oakmark Select Fund second quarter 2016 commentary.
