Being an outside investor is hard. Any time the shares of a publicly traded company you own start underperforming its peer group you wonder if there isn’t something going on that you don’t know. You are just an outsider and perhaps other people have better information than you do?
If the stock price really starts acting strangely you might even get tempted to sell at exactly the wrong time. That is why you really need to be able to have confidence in the management team who are inside the company running it for you.
For a long time I’ve followed Chesapeake Energy (CHK). And for a long time I’ve had a hard time having confidence in management. Three big reasons:
- CEO Aubrey McClendon lost virtually his entire ownership stake in Chesapeake during the 2008 market collapse because of margin calls
- Later in 2008 after McClendon lost these shares Chesapeake bought $12 million of antique maps from him
- Also in 2008 after he lost his shares McClendon was awarded a $75 million bonus from Chesapeake
Like many people I didn’t really want to own a company run by a guy who took that much risk with his personal finances. Why wouldn’t he have similarly bad judgement running the company? The map sale is just awful really. What does an energy producer need a map collection for? And the bonus was especially egregious given the timing of it in the midst of what looked for a time to be the start of a depression.
But Aubrey and his crew have won me over. They have done it by repeatedly assembling hugely valuable acreage positions in unconventional resource plays, telling me what they were worth and then executing joint venture transactions that fully backed up their claims.
What these joint ventures have also done is create a huge amount of value for shareholders and made it easy to see that Chesapeake is dramatically undervalued.
The Joint Ventures
There have been five joint ventures executed by Chesapeake in total.
1) Haynesville Joint Venture with Plains Exploration (PXP) – The timing on this one was extremely fortunate occurring as natural gas prices were over $10 immediately before the world fell apart in June 2008. Chesapeake sold 20% of its Haynesville acreage to Plains for $3.16 billion. That implied that the acreage retained by Chesapeake was worth $13.2 billion.
2) Marcellus Joint Venture with Statoil (STO) – At a time when deals couldn’t get done, Chesapeake got a deal done. In November 2008 Statoil paid $2.1 billion for a 32.5% interest in Chesapeake’s Marcellus shale acreage. The implied value of the retained acreage for Chesapeake was $7 billion. The price received certainly reflected the market conditions of November 2008, but at the time Chesapeake needed to strengthen its financial position.
3) Barnett Shale Joint Venture with Total (TOT) – It is almost like Chesapeake is trying to learn new languages, this time teaming up with a French company. For $2.25 billion Total got a 25% interest in Chesapeake’s Barnett shale properties, which implied that the retained value was $6.8 billion.
4) Eagle Ford Joint Venture with CNOOC (CEO) – Chesapeake put its Eagle Ford acreage position together with blinding speed in 2010. In November 2010 CNOOC bought a 33% interest in the land for $2.2 billion implying that Chesapeake retained a land position worth $4.4 billion.
5) Niobrara Joint Venture with CNOOC – Same partner, different property. This time the Niobrara where CNOOC purchased a 33% interest for $1.3 billion implying that the retained value is $2.6 billion to Chesapeake.
Add all of those together and the implied retained value for Chesapeake is $34 billion. That is useful information to have when you know that the enterprise value is $30 billion and you also know that Chesapeake has another $15 billion of proved and probable reserves, and joint ventures coming on the Utica shale (estimated to be worth $15 billion plus), the Mississippi lime and the Williston Basin.
The Value Creation
The joint ventures are extremely useful for help in figuring out what the value of Chesapeake’s assets might be. But what is really impressive is the value creation that they show.
Consider the following which relates to the various joint venture properties:
- Cost of Acquiring the Acreage - $16.6 billion
- Proceed from the Joint Ventures - $19.9 billion
Chesapeake has more than recovered all of the cash spent acquiring the acreage in these joint ventures AND retains ownership of 66% to 80% of each of the properties which were shown above to have a value of roughly $34 billion.
For a long time Chesapeake was criticized for constantly spending billions on land when investors thought that the company should be strengthening its balance sheet. But when you basically pay nothing on a net basis and receive properties that are worth $34 billion in an undeveloped state why would you not?
Chesapeake was given up for dead in late 2008 because the market couldn’t see where the company would get financing from to develop its huge inventory. There are quite a few companies being priced today like this despite having asset values that are multiples of their current share prices.
Investors want to be buying when uncertainty prevails and assets are discounted and selling when the future seems clear. Of course the million dollar question is being able to differentiate between uncertainty and risk.
Disclosure: I am long CHK.
