Chesapeake's Well is Running Dry

There are some things you simply can't do when running a company. CEO’s far and wide are trembling at the thought of putting pay packages up for vote to shareholders and investigations by the board into “personal misconduct.” Others like Aubrey McClendon do things like this gaffe from 2008.


Ever confident, McClendon doubled down: His personal balance sheet resembled Chesapeake's as he borrowed against his existing holdings to buy another 750,000 shares in that offering. Lousy timing: By October, as the economy imploded, with energy prices falling in lockstep, Chesapeake's stock price halved, and McClendon was hit with margin calls. As 30 million of his shares (more than 90% of his holdings) were liquidated, Chesapeake's share price halved yet again, down to $11. (A class action alleges the company didn't clarify the risks posed by McClendon's margin loans.) As his fortune vaporized, McClendon didn't flinch. "I never saw him blink," says Michael Stice, CEO of Chesapeake's pipeline company. "He was a rock."

As if getting called out of a company that you built from the ground up wasn’t enough, it seems that for many years he kept going back to the well for more.


The program, called the Founders Well Participation Program, came under assault from shareholders when it was discovered that CEO Aubrey McClendon used his shares in thousands of wells as collateral and leveraged more than $1 billion in personal loans.

As a clarification, McClendon was allowed to invest alongside his company in new well projects. He was allowed a 2.5% stake in these drilled wells. His argument for this was unlike many CEO’s he has skin in the game and a vested interest in his company doing well. Bear in mind, until recently he was both chairman of the board and CEO.

If that wasn't enough, it turns out that good 'ol Aubrey was also running a 'secret' 200 million dollar hedgefund on the side which traded in commodities. Although my initial reaction is to say this can't possibly be a good thing, I have read the reuters report about it and it doesn't seem like the end of the world. However, with corporate malfeasance in the forefront of people's minds I doubt this will go untouched.

What do you think of the current state of corporate governance and what can be done to avoid examples such as this? Although he built the company from the ground up, should Chairman and CEO be mutually exclusive roles within a company? Should Chesapeake shareholders be alarmed?

 

He's not a bad guy. I met his daughter a few weeks ago (she's hot and works at GSAM btw), but overall my only opinion about this was that I just felt bad back in '08 when he had to like sell his entire fortune. I have nothing against CEOs that are heavily invested in their own companies- and McClendon is almost all in in Chesapeake energy.

Reality hits you hard, bro...
 
Best Response
MMBinNC:
He's not a bad guy. I met his daughter a few weeks ago (she's hot and works at GSAM btw), but overall my only opinion about this was that I just felt bad back in '08 when he had to like sell his entire fortune. I have nothing against CEOs that are heavily invested in their own companies- and McClendon is almost all in in Chesapeake energy.

I totally disagree with you. Yes back in 2008, Cramer was going balls nuts on Aubrey having a stake in the actual wells and land rights, this is common and was something he was praised for. But now with the reuters having your own VPP agreement (not a company, an individual) is unheard of. The way I view it is Aubrey basically is cashing in restricted stock options, he borrowed against his stake in the company. He is basically getting $$$ in the present in the hope the stock recovers in 5 years at higher gas prices. You might as well overpay the guy to have the stock lose 50% in a year, basically the same.

 
marcellus_wallace:
MMBinNC:
He's not a bad guy. I met his daughter a few weeks ago (she's hot and works at GSAM btw), but overall my only opinion about this was that I just felt bad back in '08 when he had to like sell his entire fortune. I have nothing against CEOs that are heavily invested in their own companies- and McClendon is almost all in in Chesapeake energy.

I totally disagree with you. Yes back in 2008, Cramer was going balls nuts on Aubrey having a stake in the actual wells and land rights, this is common and was something he was praised for. But now with the reuters having your own VPP agreement (not a company, an individual) is unheard of. The way I view it is Aubrey basically is cashing in restricted stock options, he borrowed against his stake in the company. He is basically getting $$$ in the present in the hope the stock recovers in 5 years at higher gas prices. You might as well overpay the guy to have the stock lose 50% in a year, basically the same.

The loans are the only part that looks bad to me in this. And the question of whether it is truly something illegal probably has to do with the nature of the way his stake in the wells was set up and a variety of other things. I view the wells and land more akin to restricted stock rather than restricted stock options. You may be say...hey what's the difference? Well, options could amount to nothing in the future. You can in fact take loans out against the value of your restricted stock portfolio. I don't think he did anything illegal by what I read. This isn't a Bernie Ebbards deal, no matter how much OWS would LOVE for a business scandal right now. Do I think it looks bad for McClendon? Yea. But I definitely don't think he did anything illegal from what I currently know.

Reality hits you hard, bro...
 

The company will bounce back. They still have the most impressive energy asset portfolio in nat gas and liquid plays among any of the E&P names. The thing that worries me is they may have to continue to sell those assets to support operations if nat gas doesn't get back above 3 mmbtu in the next 8-12.

Here's the thing. If you can't spot the sucker in the first half hour at the table, you are the sucker.
 

So, a Fortune 500 CEO, his company's interior decorator, the head of a PE firm that invests alongside the company, and the manager of a hedge fund that trades the commodity the company produces all walk into a bar.

Bartender says: "Your usual, Mr. McClendon?"

It looks like a terrible idea to give him interest in wells versus just giving him a big option or restricted stock grant. Options are easier to understand/price. Plus, the well program clearly takes up more time and attention: he has to actually finance the drilling, and presumably has to deal with extra paperwork every time a project gets sold. You could make Lloyd Blankfein buy 2.5% of every trade Goldman makes. You could make Jeff Bezos put up 2.5% of the cost of every Amazon server, and earn back 2.5% of every AWS payment. But that would be retarded: there are some really cool financial instruments that create that kind of exposure but tamp down the conflicts of interest. I call them "GS" and "AMZN," and you should check 'em out.

Plus, let's not forget the subtle conflicts of interest: if Chessy spends $2 million on research/negotiation to make an extra $1 million in gross profit, that's a bad deal for shareholders. But for someone who owns 2.5% of that gross profit, it's a good deal: McClendon has an incentive to accept higher corporate overhead in exchange for higher revenue, even if the overhead isn't the best way to help the company. And of course there's the obvious conflict of interest when his personal cash flow needs can be satisfied by having the company sell assets.

Basically, this is the stupidest fucking thing in the universe. I'm not going to do any research, but I'd bet even money that it was a compensation standard that made sense in about 1952, based on some oil depletion tax loophole that got closed in 1953.

The hedge fund is just shit icing on the shitcake of a situation. He could manage that portfolio in-house. He could pay himself far better than 2 and 20.

The most annoying part is that Aubrey is clearly a talented bro. If he unwound all of his side interests and Chessy's board just gave him options on 5% of the company, I'd probably buy some. But the guy clearly can't resist the urge to complicate things.

 
freemarketeer:
http://www.reuters.com/article/2012/05/03/us-chesapeake-mcclendon-hedge…

Guy is a tool bag.

Shit seems shady, but is this illegal is the question. Look at the trading operations of BP or Shell. They basically engage in front-running, hold proprietary, non-public information, and obviously hold IMMENSE sway over their respective products.

Is it unfair? Yes. Is it illegal...probably not. It doesn't say that he utilized market manipulation- they alleged it, but did not prove anything. Hell, when BP got fined for market manipulation they were fined what...like $200k?

Reality hits you hard, bro...
 

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