Icahn Right, but Chesapeake Wrong
NEW YORK (TheStreet) -- Carl Icahn revealed on Monday that he had increased his stake in Chesapeake (CHK) - Get Report to more than 5.8%. This caused a fast $2 rise in the shares of the stock, benefiting Icahn's stake alone to the tune of more than $70 million.
Although Icahn's investment in Chesapeake may ultimately turn out to be right, Chesapeake still remains, in my view, the wrong way to profit from natural gas, a sector where I could hardly be more bullish for 2011 and where
Devon
(DVN) - Get Report
and
Cimarex
(XEC) - Get Report
remain my recommendations. Icahn's move should embolden investors to increase their stakes in natural gas -- just not with the company that Icahn has chosen.
#1 Natural Gas Stock
Icahn could not have picked a more typical candidate for his investing style than with Chesapeake. He described his own metric as buying companies "when no one else wants them." In Chesapeake, he couldn't find a more appropriate target. The number two producer of domestic natural gas has flatly underperformed the sector for the past year, trailing Devon by close to 20% as well as
Anadarko Petroleum
(APC) - Get Report
by a similar margin, despite Anadarko's Gulf of Mexico exposure that pummeled shares this summer. For the last five years, the picture is even bleaker, as Chesapeake has underperformed Devon by almost 40% and Anadarko by more than 60%.
These are stunningly bad results and are readily traceable to the business plan executed by Chesapeake CEO Aubrey McClendon. Chesapeake now has a long history of aggressive acquisition of acreage for exuberant new exploration and production, increasing its debt position with the quick expansions. As wells turn in uneven performance as the commodity has sagged, the company has been forced to sell assets or find large multinational integrated oil partners for some of the more prime drilling prospects, as it did in 2008 with its 32.5% sale of its Marcellus shale assets to Norwegian giant
Statoil
(STO)
.
In addition, Chesapeake has a very aggressive natural gas trading operation, hedging its production in varying percentages, by some accounts, as far forward as 2015. This virtually guarantees both a limited protection and profit from a falling natural gas price, but more importantly, an almost completely capped upside profit potential from a rising price, should we see one in the next two years. Katy Kelly of
CNBC
has gone so far to call Chesapeake a "hedge fund."
For a natural gas market that has seen huge spikes in 2003, 2004, 2005 and as recently as 2008, this is an incredibly limiting overhang on what is historically a very volatile and fabulously profitable commodity, when it runs. Chesapeake shares, in fact, participated tremendously during these spikes, moving from single digits at the start of the decade to trade more than $60 in 2008. That kind of potential, it seems, is off the table.
This is a perfect scenario for a raider like Icahn, ready to increase his activism, steal a couple of board seats and turn around the behavior of Chesapeake and its CEO. I don't see a likely takeover or buyout, as few have the resources to swallow up the $16.5 billion company, although that would be the best result for shareholders. Without a sale, the turnaround plan that Icahn has so clearly in mind will take lots of time -- two or more years at least to see a reasonable unwinding of swap positions and a restructuring of the balance sheet. It still might be worth a punt if just the announcement of the Icahn stake hadn't pumped shares up more than 8% overnight, removing a large slug of the possible profit from a strategic buy of shares.
Instead, point your guns at a target that will generate instant and solid results should natural gas explode in 2011, which I am expecting. With the steady increases in LNG plants and terminals, and a continued (if undeserved) environmental pushback on the development of shale plays, natural gas is poised to give us a spike of the type we saw in 2003, 2004, 2005 or 2008. Even a "moderate" move to $7/MMbtu, which is my target, will generate handsome increases in my favorite natural gas plays: Devon and Cimarex.
Devon has concentrated in onshore natural gas, increasing its exposure to the high margin liquids while divesting itself of offshore gulf assets right before the
BP
(BP) - Get Report
blowout this summer. It is a company that has proven itself both lucky and good. And Cimarex is engaged in the undervalued Permian basin with a superior leadership team. Both of these require no restructuring to take advantage of an improving commodity price and remain better choices for the average investor.
Carl Icahn is right -- natural gas is the place to be. But for most investors, his choice of Chesapeake is wrong. Find your way into others in the sector.
At the time of publication, Dicker owned DEV and XEC.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.