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No Let Up in Criticism of Chesapeake's McClendon
YOUNGSTOWN, Ohio – On the heels of a Reuters investigation that reported Chesapeake Energy Corp. CEO Aubrey McClendon borrowed $1.1 billion by using his stake in Chesapeake wells as collateral, a law firm known for class-action litigation is reviewing whether to sue Chesapeake on behalf of shareholders, and at least one analyst who follows the stock is calling for change at the top.
Meantime, Reuters is continuing its series of reports with more revelations about McClendon’s transactions and possible conflicts of interest. In a story published Monday (CLICK TO READ), the news service reports, “McClendon has employed another way to cash in on a perk unique to the company he runs: He sold his share of two large energy plays at the same time the company divested its interest.”
Two asset sales involved wells and acreage in Arkansas and Oklahoma, for which Chesapeake was paid $6.5 billion. The terms of McClendon’s transactions are not required to be publicly reported, Reuters said.
The law firm of Finkelstein Thompson LLP, Washington, D.C., announced Monday it’s asking Chesapeake shareholders to come forward to “[discuss] your rights.” The firm cited the highly critical Reuters stories that disclosed the existence of the loans and raised legal and ethical questions about McClendon’s fiduciary duty to investors.
Philip Weiss, an analyst at Argus Research, said in a note to investors that the questionable actions of McClendon, mixed with Chesapeake's sagging stock, aggressive accounting policies, and heavy debt load, led Argus to recommend that "the best thing for investors would be to replace the board and/or the CEO."
Chesapeake is the largest acreage holder in eastern Ohio among energy companies drilling in the liquids-rich Utica Shale. To date, the company has leased 1.35 million acres in the region.
Chesapeake, the second largest natural gas exploration company in the United States, has seen its stock tumble 19.6% year-to-date and 6.36% just in the last five days in the wake of the Reuters piece. Argus has placed a "sell" rating on Chesapeake's stock.
Weiss, one of Chesapeake's steady critics, wrote that the company's "near-term cash needs are growing, and that its spending levels are unsustainable and ill-advisably elevated."
Weiss said that while Chesapeake continues to generate cash through asset sales, the company also relies largely on financial engineering transactions to raise cash, which creates off-balance-sheet debt. Thus, "the company's weak balance sheet is not improving as much as management claims."
He also cited Chesapeake's earlier disclosure that not all of the company's acreage is producing, adding to more operational risk. And, Weiss noted that the company would also likely have to sell $3 billion to $4 billion in additional assets to meet spending targets next year.
Weiss also pointed out that his firm previously questioned Chesapeake's Founders Well Participation Program, the subject of the Reuters story.
The program, approved by Chesapeake's directors, allows McClendon to own up to 2.5% in wells the company has drilled. Over the last three years, McClendon has used his stake in Chesapeake wells as collateral to borrow at least $1.1 billion without disclosing the loans to shareholders.
On April 19, the Deborah G Mallow IRA SEP Investment Plan filed a lawsuit against McClendon and Chesapeake's board of directors and called for full disclosure to the shareholders of the loans and for the board to terminate the Founders Well program.
Chesapeake's general counsel, Henry Hood, said in a statement last week that the Founders Well program has been in place since the company was established, and was renewed by shareholders in 2005.
"The terms and the procedures for the program are clear and detailed in every proxy for all shareholders to see," Hood said. "Mr. McClendon's interests and Chesapeake's are completely aligned."
He also said that there are third-party interests that monitor Chesapeake's actions through well audits, government filings, reporting, hearings and participation in development plans.
"The suggestion of any conflict of interest in unfounded," Hood said.
Still, Weiss says lack of disclosure, while not against the law, "is pushing the envelope. Given Mr. McClendon's personal interest in CHK wells, it is reasonable to conclude that some decisions about company assets may be influenced in part by Mr. McClendon's personal interests. It would be best to eliminate such practices, as it would reduce the perception of impropriety."
According to the Argus Research analyst, just one other company – SandRidge Energy – used a similar program but ended two years after its implementation. SandRidge CEO Tom Ward co-founded Chesapeake with McClendon
Chesapeake's financial status is also greatly impacted by depressed natural gas prices, which have hit $2 per million cubic feet, Weiss said.
Although Weiss said that Chesapeake has a strong asset base, "we think that investors will keep the company in the penalty box without real change in its financial practices. Such change needs to start at the top."
BACKGROUND:
Chesapeake CEO Borrows $1.1B, Pledges Gas Wells
Chesapeake Refutes Report CEO's Loans Not Disclosed
Chesapeake Files Proxy in Response to CEO Loan Flap
Copyright 2012 The Business Journal, Youngstown, Ohio.