Icahn Wins Chesapeake Energy Board Battle

Chesapeake Energy board story updated to reflect analyst comments, additional data and closing share prices

NEW YORK ( TheStreet) -- Chesapeake Energy ( CHK) has settled a campaign raised by activist investor Carl Icahn to give shareholders of the struggling oil and gas company four board seats. It's a significant win for Icahn, but Chesapeake Energy still faces a crucial task of selling billions in oil and gas assets amid slumping commodity prices to meet a projected a second half cash shortfall.

The company said that following "extensive discussions" with its two largest shareholders, Southeastern Asset Management and Icahn, it has agreed to add four new independent directors to replace four existing independent directors who will resign from Chesapeake's board. Three of the new independent directors will be proposed by Southeastern and the fourth will be proposed by Icahn.

In his recent letter to Chesapeake after revealing a stake in the company, Icahn asked for the right to appoint two board members and for two board seats to be given to Southeastern.

Chesapeake is continuing its search for a non-executive chairman -- who will also serve as a fifth independent director, after co-founder and CEO Aubrey McClendon agreed to relinquish his chairman role earlier this year amid concerns of potential conflicts in his stewardship of the company. In a Monday statement, Chesapeake Energy said that the new board composition will be announced by June 22, and reaffirmed that McClendon will remain the company's CEO.

For Carl Icahn, who announced a 7.6% share stake in Chesapeake in late May, the move is a quick answer to his activist calls for more independence on the company's board as it works to sell assets to meet a near $10 billion funding gap in 2012, amid decade-low natural gas prices.

In a scathing May letter to Chesapeake's board of directors, Icahn called for the nomination of four shareholder appointed directors as a first cause of action to improve the struggling gas giant's waning finances and share prices.

" The stock price suffers because of the enormous risk associated with an ever changing business strategy, enormous capital funding gap, poor governance, and unchecked risk taking," Icahn wrote in late May letter to Chesapeake's board, adding, " What is important is that this pernicious funding gap, which we believe this board has created, must be filled."

Chesapeake Energy did not say which board members will resign in a press release. The board includes former U.S. senator Don Nickles, Frank Keating -- who has headed national banking and insurance industry lobbies, as well as served in the House of Representatives and several Republican White House administrations, and Pete Miller, the CEO of National Oilwell Varco.

For Chesapeake's annual meeting scheduled for June 8, several large pension funds had already submitted proposals for shareholder representation on the board, and the New York City comptroller had specifically asked for the removal of Oklahoma State University President Burns Hargis and former Union Pacific Corp. Chairman Richard K. Davidson as directors.

Louis Simpson, a former Berkshire Hathaway investment manager who joined the board in 2010, was singled out by Icahn in his letter as the only board member who should remain. Chesapeake Energy also said it would look to gain an exemption from an Oklahoma law that requires staggered corporate boards so that its entire board will go to a shareholder vote in 2013.

Monday's settlement appears to have cooled Icahn's ire at the company's managerial issues. "We appreciate the Board's willingness to listen to shareholders and to respond appropriately. Under Aubrey's leadership, Chesapeake has assembled great assets and I am confident I can help the Company create significant shareholder value from these assets," said Icahn in a press release.

"We believe the independent directors will push for a more conservative capital plan and aggressive asset monetization. Additionally, we believe the reconstituted board would be more amenable to a potential takeover," said Canacord Genuity analyst John Gerdes in a Monday note to clients.

In May, Icahn noted in his letter that his activist stance has led to an increase in market value of approximately $55 billion for shareholders at over a dozen companies in recent years. "We would like the opportunity to do the same at Chesapeake," wrote Icahn, who like Chesapeake CEO McClendon says that the company's assets are worth far more than current market prices.

In Monday trading, Chesapeake shares rose over 6% to $16.52. Still, the company's shares are off over 25% in 2012 and 45% in the last 12 months respectively, amid concerns about its finances and CEO McClendon's 2.5% personal investment in almost all of the wells that the company's drilled over the years. The rally on Monday also came directly on the heels of a 6% sell-off in Chesapeake shares last Friday, a day on which shares began trading at $16.52, the same price shares closed at on Monday.

Aside from shuffling board seats to add independent investor input into Chesapeake's management decision making, Icahn will have plenty of work cut out for him to turn a profit on his near $800 million investment in the company, which UBS analysts calculated were made at a price of $15.76.

Underlying the tough talk about a board shakeup, it's important for investors to remember that a shoring up of the balance sheet through sales asset sales is the key focus for the oil and gas company in 2012. With or without Icahn, asset sales are the make or break issue as the company tries to bridge a funding gap while tilting its energy portfolio longer-term toward oil amid decade low natural gas prices.

Moody's calculates the company needs to sell $7 billion in assets to avoid a ratings downgrade and breach of its debt covenants. "Even $7 billion in asset sales could place Chesapeake's covenant compliance for its revolving credit facility in some doubt, and the company would still face a significant funding gap in 2013," wrote Moody's analyst Peter Speer on May 31.

As Icahn talks up board change, Chesapeake Energy is separately putting new oil and gas assets up for sale to meet its funding needs. In late May, Chesapeake Energy listed 57,000 acres for sale in the Woodbine shale play of East Texas, according to a prospectus from energy asset M&A boutique Meagher Energy Advisors, said its president Matthew Meagher. Last week, Chesapeake listed a prospectus for 503,863 of net acres for sale in the DJ Basin of the Niobrara shale of Colorado and Wyoming.

Icahn argued that shareholder representation could help instill discipline and a more singular focus on asset sales.

" For year-end debt to not exceed $12bn (4x $3.0bn), then asset monetizations must reach at least $5.0bn," noted Citigroup analyst Robert Morris in a May note to clients. "Without any asset sales, CHK would be non-compliant with its revolving bank credit facility at year end unless spending was cut sharply." Chesapeake expects to cover much of its funding gap through the sale of its Permian assets and a joint venture in the Mississippian Lime, while maintaining its debt covenants -- it recently shelved a planned $1 billion Eagle Ford transaction.

One Wall Street analyst who, like McClendon and Icahn think Chesapeake's asset value is far higher than its current share price, didn't view Icahn's stake or activist call as cause for an upgrade. "Our hold rating is a function of a nearer term outlook that significantly exposes shareholders to market & commodity risk, however the prospect for real strategic change does bear watching," wrote Deutsche Bank analyst Stephen Richardson in a late May note to clients. He estimates Chesapeake Energy's assets are worth $35 a share with oil at $95 a barrel and gas trading at $4.50.

Oil fell to its lowest price in 2012 last Friday, below $83, while natural gas is hovering around the $2.40 mark after dropping below $2 earlier this year.

For more on Carl Icahn, see his investment portfolio. For more on energy stocks, see the energy stocks bought and sold by hedge funds in the latest quarter.

See 5 ways Chesapeake Energy can be saved from itself for more on how it can initiate a share turnaround.

-- Written by Antoine Gara in New York

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