It's Time to Get Out of Chesapeake

I write about all things energy, but in the last week, only one question has filled my inbox from readers: What am I doing about Chesapeake (CHK), a recommended speculative holding of mine. I won't bury the lede here: I am looking to convert out of the common shares into the preferred for myself, but as a recommendation, I am abandoning the stock and recommending a sale.

Let's look a little more closely at this move and explain it. When I recommended Chesapeake, I did so with the caveat that it was a speculative play and therefore carried higher risk, with the price proviso that if shares got down to around $5, I suspected something was happening inside the company that I didn't know about and it was necessarily bad. When buying shares around $7, we saw a quick rally toward $9, where I did sell a few shares, but not nearly enough -- and I still have significant holdings with at least so far insignificant losses.

Let's update where we are now.

Talk about a Fed rate raise in December has caused a fairly widespread collapse in the corporate bond market, but with the most speculative and highest-yielding corporates, this effect has been much worse. There is no doubt that Chesapeake bonds are clearly on the riskiest end of the high-yield ladder, and these bonds were summarily killed late last week. Does this reflect an especially worse turn of the debt position of the company compared to others in the high-risk pool? Most likely not, but with credit default swaps now indicating a greater-than-50% risk of default, it's a move I simply can't ignore.

More to the downside, there has been a less-than-wholesome Connecticut firm that shall remain nameless that has been taking a short scare run at the stock since September. This firm, for some unfathomable reason, has the continuing confidence of Barrons (another less-than-stellar player) and between the two has managed to generate some serious short interest in the shares -- every down day is viewed as an opportunity to hammer shares far more than they deserve.

Hey, look, I've been in this game a long time and this is also part of the game: If you've got the guns, you fire them. Right now, with the bond weakness and CDS blowout, the short sellers' leverage is difficult to fight -- you can bet they'll push shares lower than $5 if oil breaks down below $40, even for a few days. If natural gas somehow again approaches $2/mcf, it'll be even worse.

There are some remaining plus sides to staying long the common. CEO Doug Lawler has recently purchased 50,000 shares, for example. But that $300,000 commitment from the CEO is not much to go on and, truth be told, I've never been a big believer in insider buying as an incentive for investment. Finally, there is still Carl C. Icahn in the mix. It is hard to believe the master trader will merely watch while his nearly 10% stake in the company fritters away. Even if Icahn is looking to reduce his holdings, his modus operandi is to start some rumor of the company being in play with suitors surrounding it, or of a proxy fight to change board composition or both, all designed to boost shares to help him dump them. You could "depend" on trader Carl to pull something and wait, but I can't recommend that either.

I know that throughout this column I've talked about "trading" and "market" aspects of Chesapeake shares and less about the fundamentals of cash flow, debt load, asset sales and capex adjustments. For the record, I still see Chesapeake as a survivor of the oil and gas bust, which from the start I believed still has at least another eight months to run. I don't believe Chesapeake will be one of the firms to go bust -- but the bond market is not so sure anymore.

It is for that fundamental reason that I will take a tax loss on my common shares in December, but swap the equity into the preferred shares -- where you can still collect a dividend while being higher up on the totem pole should the company be ultimately forced into restructuring.

But as for the original recommendation I made, I'm finished. It's time to sell Chesapeake common shares and wait for another opportunity.  

At the time of publication, Dicker was long CHK, although positions may change at any time.