IB Net Payout Yields Model

The Alpha Wildcatter

Forbes has a fascinating story about Chesapeake Energy CEO Aubrey McClendon. His risk taking has made Chesapeake Energy (CHK) into the 2nd biggest producer of natural gas in the US and the largest land owner in the prolific shale plays in the US.

Unfortunately his level of risk taking has made investors shy away from the stock. Reading the detailed Forbes article makes a normal investors head spin. All the joint ventures, hedging, VPPs, and oil services make it very complex for an investor to understand the risks involved in an investment which will likely depress the stock in the future.

As skeptics point out, this all sounds eerily close to Enron though probably not fair. CHK is just the opposite in that it is actually hedging and selling production it owns. Building up land positions in shale areas and selling a portion for a profit is very smart. Sure beats the majors sitting around and missing the opportunity completely.

What actually scares me is that McClendon appears a lot more like WorldCom's Bernie Ebbers. Always wheeling and dealing whether within the business or outside via farmland, wine, or art. As a WorldCom employee that lived through the rise and fall of Bernie, the similarities are stark. The ultimate similarity was the willingness to take huge risk of buying the companies stock with borrowed money. Both seem to think the business can grow forever that they don't know when to stop. Why would anyone take such risks as a billionaire is beyond me?

McClendon has become so successful that he is forcing natural gas prices too depressed levels in the US. Sure it will spur demand, but at what price and when? CHK has all these leases to drill now and demand might be years away. Has CHK just pushed up acreage prices while pushing down nat gas prices? If it finds another nat gas shale play should it pounce on the opportunity or just keep it quiet hoping to buy cheaper later. After all, it isn't likely that gas pries rise until 2013 or 2014.

Whats so great about the Marcellus Shale at $3.5 nat gas? It can't be shipped to foreign markets to collect much higher prices and nat gas apparently is abundant now. The liquid plays like the Eagle Ford shale and potentially the Utica shale hold immense value now. CHK should've kept all the Eagle Ford assets and avoid a partner in the Utica shale as oil prices are likely to stay high for a long time as the global demand for oil increases.

Read the article for now. The stock on the other hand needs more research. CHK is a fascinating story on value creation, but the riskiness of the assets are concerning. Ultimately the success of McClendon might be his undoing as demand might never grow with the supply creation. This is a potentially bad situation for a risk taker being ahead of the market.

Disclosure: No position mentioned. Please review the disclaimer page for more details.


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