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Investors Declare War on Chesapeake Energy’s (CHK) CEO Aubrey McClendon

By: , dated June 8th, 2012

Over the past week, Chesapeake Energy’s (CHK: Charts, News) CEO Aubrey McClendon has loomed large in financial headlines, after leaked internal documents revealed that McClendon had misappropriated millions of dollars of company funds to personal investments and projects. Activist investor Carl Icahn, who owns a 7.6% stake in Chesapeake, has accused McClendon on spending excessively on excess businesses not related to its core competencies of oil and natural gas production, even as prices sharply dropped this year. The company is now under heavy pressure to replace nearly half of its board of directors to answer for its missteps.

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Internal documents reveal that McClendon used teams of Chesapeake employees to handle personal business affairs, as well as the company jet to ferry family and friends to holiday destinations. This “special unit” of employees, known as AKM Operations, was housed on Chesapeake’s corporate campus, with rotating employees designated with accounting and engineering responsibilities. McClendon also funded personal projects from company funds. In 2010, McClendon’s personal projects consumed $3 million of Chesapeake’s funds as well as 15,000 working hours from company employees. Another internal document, leaked to Reuters, revealed that company employees did an additional $3.2 million in work for McClendon alone, including repairing hailstone damage on his personal property. Another controversial project was a 31,000 square foot warehouse, which cost $3 million, to house McClendon’s personal wine collection within a mile of Chesapeake’s official campus. The lavish project was eventually halted due to financial difficulties in 2008.

McClendon also booked $2.25 million in company flights in 2010. On these flights he brought his family and friends to various international destinations, including his own vacation properties in Bermuda. Several of the company flights were even booked by friends of the family, without any McClendons on board.

In addition to McClendon’s liberal personal use of company funds, Carl Icahn has highlighted Chesapeake’s $300 million in Oklahoma City area real estate, which includes several shopping centers, a church, a grocery store and several houses. Icahn harshly criticized Chesapeake’s focus on these “non-core assets,” which further punish the company’s margins and bottom line in times of dropping commodity prices. Fadel Gheit, an analyst at Oppenheimer & Co., noted that its real estate subsidiary, Chesapeake Land Development, would have to be forcibly reined in. Creditsights Inc. analysts Brian Gibbons flatly stated, “They should not be involved in real estate development.” McClendon uses his own private investment firm, Arcadia Farm LLC, to invest heavily in real estate. However, Arcadia only holds a small slice of Chesapeake’s Oklahoma City real estate, at $24 million.

McClendon expressed that real estate development was one of his lifelong passions, and that he would have been a developer “in another life.” Chesapeake is also the landlord for the upscale restaurant Deep Fork Grill – a restaurant which McClendon owns a 49.7% share. This unusual arrangement, in which a CEO’s company rents out a property for his own personal investment needs, represents a conflict of interest to many shareholders.

Southeastern Asset Management, Chesapeake’s largest shareholder at 13.6%, also strongly urged the company to focus solely on oil and gas development and divest of all other assets, including real estate. Chesapeake, which is running low on cash, is finalizing a deal to sell the vast majority of its pipeline assets for $4 billion in cash – a deal the company’s major shareholders believe will further weaken the company’s core competencies.

Over the past twelve months, Chesapeake shares have slid nearly 40%. Declining oil and natural gas prices are expected to continue to weigh on the stock price. Shares are trading at 10.3 times forward earnings with a 5-year PEG ratio of 7.5. These fundamentals suggest sluggish to negative growth on the horizon. The stock pays a quarterly dividend of 9 cents per share.

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Leo Sun Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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