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10 Things We Learned About Chesapeake Energy

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A Chesapeake investor explains his position in a company that lost 15% of its value in a week.

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Editor's Note: The following was posted in real time on our premium Buzz & Banter (click for a free trial).

MINYANVILLE ORIGINAL If you were short Chesapeake Energy (CHK) into its earnings release, may I humbly suggest you consider taking some off of the table? The stock traded 145 million shares on Wednesday compared to an average daily volume of just 20 million.

That said, if things remain as they are, I don't think the stock is done going down -- just experiencing some near-term choppiness. I covered approximately half of my short position into the close and will now look to sell calls against it at higher prices.

What did we learn on Wednesday?

1. We learned that Chesapeake really doesn't know how to hedge when it stated that it's hedged on "liquids" at an average of $103. It is hedging NGLs (natural gas liquids) with crude. Oil isn't the majority of its liquids production, so this is a poor hedge. This is proven through its own disclosure that it lost $194 million on liquids hedges.

2. Chesapeake's forecasting value for natural gas is well over $3. This means that its guidance is based on an average price for natural gas at $3+. It is off by about 30% right now.

3. Aubrey McClendon, the company's billionaire CEO and Chairman, stated on the call that if gas doesn't get back above $3 that the company will continue to have to sell assets.

4. Chesapeake wishes to reduce its debt level to about $9.5 billion, yet its free cash flow is a decidedly negative $12.36/share. For this task it has no cash. So, where is that cash coming from?

5. Any cash would come from asset sales. The company is planning on asset sales for 2012 at a minimum of $10 billion. This is a huge mistake to admit, in my opinion, because it tells potential buyers that it needs liquidity and gives those buyers a decided advantage in purchasing any of its millions of acres of leasehold in such gas shale plays as Permian Basin, MS Lime, and Eagle Ford properties.

6. Chesapeake is making a transition to a more crude-oil based business, but it hasn't been too successful thus far.

7. Chesapeake is reducing wet gas drill exposure by eight rigs to 115, but dry gas rigs will be cut to 12 from 50.

8. McClendon was running a $200 million hedge fund trading oil and gas. Conflict of interest, anyone?

9. Senator Bill Nelson has requested that the Department of Justice investigate McClendon and Chesapeake.

10. Multiple class-action lawsuits have been filed against McClendon and Chesapeake.

So, all in all, the earnings call was a debacle. Investor relations for the company was only taking calls from known "friendly" analysts. How do I know? Not one call about the hedge fund news, which broke before the call started.

I think McClendon's goose is cooked. The pressure on the board right now is enormous. I'm not sure when this will occur, but I can't imagine he will last too much longer. That said, he won't go down without a fight, either.

Considering today's action, should a CEO change occur now, I would seriously consider closing all of my short positions in Chesapeake. However one thing to consider is one of Chesapeake's largest shareholders – Southeastern Asset Management (with 27.4 million shares via Longleaf Partners). It has said it will take steps to "unlock value." We all know that can be code for selling the company. I don't believe anyone will take a full bite of Chesapeake as is. There is too much fear of the unknown – like potential off-balance sheet deals. That means selling the pieces, and Chesapeake is being touted as a value play on its assets. If it loses its assets, then what happens?

The other thing to consider is Carl Icahn's involvement in the firm. An activist investor, Icahn's not scared to tangle with management and he is there to make money from the nearly 6% stake he has in the company -- he doesn't really care if that's from a management change or asset sales. So, be careful with your position structure -- it could be the difference if the news changes and you (we) get caught leaning the wrong way.

Twitter: @axiosadvisors
Position in CHK

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