Thursday, May 19, 2011

An Inflation-Agnostic Trade: Chesapeake (CHK) Preferred Stock (CHKDG)

Sometimes when I mention natural gas, it is simply as a thought experiment: why buy silver if there are other commodities that would do better under almost any conceivable scenario?

I am not buying NG futures, but I have a clever idea that I think is even better. Chesapeake Energy (CHK) is the 2nd largest producer of natural gas in the US. I have seen a variety of sum-of-the-parts analyses of CHK that suggest the real value is twice as high as the current share price. Wall Street hates the company and the CEO Aubrey McClendon.

It has a convertible preferred stock (CHKDG) with a 4.6% yield that can optionally be converted into CHK stock at $44.

Chesapeake Energy Corp., 4.50% Cumulative Convertible Preferred Stock, liquidation preference $100 per share, not redeemable at the issuer's option at any time, and with no stated maturity. Distributions of 4.50% ($4.50) per annum paid quarterly... The preferred shares are convertible any time at the holder's option into an initial 2.2639 common shares of CHK, an initial conversion price of $44.172 per common share (now 2.2727 at $43.9998) . On or after 9/15/2010, if the price of the common stock exceeds 130% of the conversion price for 20 of any 30 consecutive trading days, the company may, at their option, force the preferred shares to be converted into common shares at the then prevailing conversion price. In regards to payment of dividends and upon liquidation, the preferred shares rank equally with other preferreds and senior to the common shares of the company. 
I consider it "inflation agnostic"; if NG prices stay the same, we get a nice yield, and if NG prices increase we would get the benefit of a higher CHK share price.


John Risner said...

This is one of those ideas with the potential to be a value trap. CEO Audbrey McClendon has amply demonstrated, through his sale of his personal map collection to the company, through his forced margin sales, through is wasting of corp assets to sponsor the OK Thunder, and in many other ways that he sees Aubrey McClendon as the number one priority of Chesapeake, with common and pfd shareholders somewhere down the list.
It will make sense at some point, but my sense is you are early. Risk does not justify reward yet.

CP said...

Thanks for your thoughts. You may be right, although my impression is that quite a bit of negativity about AM is priced in already.

Incidentally, this trade is not CHK-specific. There are a number of other O&G producers with convertible preferreds that give a free option on hyperinflation.

They are pretty illiquid, but email me at ctx_coverage @ and I can discuss.