Chesapeake Energy Corp. (NYSE: CHK) CEO Aubrey McClendon is a gambler. He gambles with his personal finances and he gambles with the faith and fortunes of his company’s shareholders.
In 2008, when the financial crisis was at its apex, McClendon was forced to sell more than 90% of his Chesapeake shares over a period of just a few days to meet margin loan calls. Chesapeake shares plunged more than 40% that week and ended the year down about 60%.
To help McClendon out of hock, the Chesapeake board came through with a $110 million compensation package – one in which the board agreed to buy McClendon’s collection of 19th century maps for $12 million. (McClendon was forced to buy back the maps last year for $12 million plus 2.28% interest as part of a shareholder settlement.)
Shareholders who thought McClendon had learned his lesson were disappointed last week, when Reuters revealed that the \ McClendon has been borrowing against personal stakes in thousands of company-operated wells to pay his part of drilling costs. Furthermore, he’s used those same wells as collateral for additional loans.
McClendon took roughly $1.1 billion in personal loans against his stakes in Chesapeake wells, according to Reuters.
Chesapeake has defended McClendon’s actions as perfectly legal and part of the Founder Well Participation Program that was approved by shareholders in 1993. The program lets the CEO take up to a 2.5% stake in any Chesapeake wells as long as as he pays a proportionate share of the drilling costs on those wells.
However, since McClendon couldn’t cover the operating costs of his investments, he turned to private equity firm, EIG Global Partners. EIG has acquired the rights to all of McClendon’s well stakes for 2009 and 2010. And it set up a new special purpose vehicle to control his 2011 and 2012 well shares.
EIG is set to receive 100% of the cash flow from McClendon’s stakes in those projects until the firm gets all of its money back – plus a 13% return. It also will receive 42% of McClendon’s share of the wells’ profits in perpetuity.
Those terms probably stung McClendon, but he’ll be in even more pain if the wells he invested in don’t end up being as profitable as he anticipated.
It’s worth noting that McClendon has lost more than $600 million on the well program in the past three years: $116.1 million in 2009, $141.9 million in 2010 and $315.3 million in 2011.
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Chesapeake holds first liens on its wells, so the company is protected from losing any of its assets even if McClendon were to default.
Still, the loans were previously undisclosed to shareholders and clearly compromise McClendon’s credibility and fiduciary duty to Chesapeake.
Now, McClendon and several Chesapeake directors are the targets of another shareholder lawsuit, with many investors calling for their resignations. And the company’s stock has plunged 27% in little more than a month. In fact, Chesapeake stock is now down 75% from its 2008 peak.
Those aren’t the only negative effects brought on by McClendon’s propensity for risk-taking, either. The CEO’s determination to add to his personal cache of oil stakes before he’s found the money to drill them is a microcosm of what Chesapeake has become.
Chesapeake has outspent its cash flow in 19 of the past 21 years. As a result, the company has a debt burden of nearly $10 billion. McClendon insists that Chesapeake will be able to erase that gap by selling $17 billion of assets by the end of 2013. But now, with natural gas prices at the lowest they’ve been in a decade, many analysts and investors question whether the company’s assets are really worth as much as he claims.
Chesapeake said on Thursday that it would not extend the Founder Well Participation Program beyond 2015. But it will take more than that to win back shareholder confidence. Unless tomorrow’s earnings report delivers a big upside surprise, McClendon has to go.
Until then, investors would be wise to steer clear of Chesapeake, because the next time McClendon overreaches there may not be someone there to buy his antique maps.
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