Friday, January 7, 2011

Chesapeake's Austerity Strategy?

Yesterday, Chesapeake Energy released its preliminary 2010 operating results and 2011-12 strategic and financial plan.  I'll spare you the numbers, but I found two interesting takeaways.

First, Chesapeake has now hedged approximately 96% of its expected 2011 natural gas production at the average price of $5.84/Mcf.  For 2012, the company has hedged approximately 17% of its expected natural gas production at an average price of $6.19/Mcf.  Not bad prices considering the market uncertainty and general malaise of the natural gas commodity market.  Interestingly, the company has only hedged 5% of its 2011 and 1% of its 2012 expected oil production.  They are on board with T. Boone Pickens in expecting oil to rise above $120/barrel.

Second, the company announced a new strategic and financial plan called the "25/25 Plan."  Chesapeake will reduce its long-term debt by 25% and cut its production growth rate to 25% (from a planned 30-40%).  How?  First, the company will continue to monetize its assets.  These deals will reduce net production going forward and bring in up-front cash to pay debt.  To the relief of shareholders, Chesapeake says it will not issue any common or preferred stock to achieve the objective.  Second, the company will cut back on leasehold spending.

The new strategy is not altogether new since the company has pioneered (and depended heavily on) creative asset monetization transactions to bring in cash.  The difference here is a promise of self-control - not likely a European government austerity plan - but less spending on new leases.  As I read it, the Next Big Play will not see a mad rush of friendly-faced Chesapeake landmen flooding country roads and county courthouses.

But it truth, limiting speculative leasing is a big divergence from the company's strategy.  The leasehold spending fuels the asset monetization machine.  But it also requires more cash flow than the company generates through operations.  Chesapeake is a true growth stock because of this strategy.

If there is a New Big Play in, say, Michigan or Ohio, I'd love to be a fly on the wall in Oklahoma City watching CEO Aubrey McClendon not try to lease it up.

What happens after two years?  I can't help but thinking of the Broadway musical "Barnum" about legendary circus promoter P.T. Barnum.  In the play, when Mr. Barnum decided to change careers and enter politics, the lament in one song went, "No bunting in the streets/You’ll talk of budget cuts and ballot sheets/Statistics day and night/Running black and white."  That lyric has stuck with me since childhood, and it speaks to me of people (and companies, I suppose) that diverge from their nature.  (I'll avoid the scorpion and the frog story.)

I can't help but wonder if Carl Icahn is whispering in CEO Aubrey McClendon's ear, maybe twisting Aubrey's arm behind his back, telling him to cut the lease spending.  That's the only angle I see for Icahn to make money on his investment since no company is better than Chesapeake at monetizing assets and a traditional share buy-back is not really feasible when the company has been issuing preferred stock to sovereign wealth funds like handing out candy at Halloween.  But is that the best move for the company long-term since Chesapeake has built its business on the aggressive leasing strategy?

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