Tuesday, May 22, 2012

Contributor Writes in About Latest Chesapeake Article in Forbes ($CHK)

The guy at Forbes who writes the Chesapeake articles is Christopher Helman and this is his latest masterpiece. It looks like he was an English major at Berkeley with a graduate journalism degree from Columbia. So, getting his hands dirty with BTUs must be second nature. A contributor writes in with a rebuttal:

"The entire premise of this exercise is completely flawed. Slide 26 of CHK's most recent presentation does not value the company's "core assets" and leave no value for the unproved resources, as Helman implies. Instead, the entire purpose of the slide is to show the insanely low (and currently negative price) that the market is valuing the unproved resources at. To say that CHK's unproved resources are worthless with their dominant shale position is either purposefully negligent or downright stupid.

"Risked Unproved Resources" (the total recoverable resource modified downward significantly by some risk factor to account for uncertainty) are very difficult to value because the breakeven cost of producing these resources has to be taken into account. At $0.25 per Mcf of risked unproved resources this asset would be worth $28 billion or $36.47 per fully diluted CHK share. There is no correct value to put on this type of uncertain resource, but $0.25 is a decent rule of thumb. The whole purpose of this slide was that CHK wanted to point out that an investor is currently paying negative $6 billion, or negative $0.05 per Mcf for this resource.

Shale has changed the industry and the way it is valued. Historically one could conservatively value an oil and gas field on its proved reserves only, and ignore the probable or possible resource in order to be conservative. This was because it might not exist and it would be expensive and time consuming to shoot seismic and drill to try to find out what other resources there might be. All of the known reserves where including in either proved developed producing (PDP) or proved undeveloped (PUD). This is no longer the case, as there are known reserves in the shale, with a known cost of extraction, that are not included in PDP or PUD due to the accounting rules.

E&P's can book PUD's on offsetting wells (if you drill one well on each side of an 8 well pad, you can book the reserves for the two offsetting wells on either side that you haven't drilled yet, because geology they will be the same). The limit to this is that you cannot book reserves for anything you aren't planning on drilling in the next five years - so "reserves" are dictated by the level of activity in the field rather than geological reality. The result of these rules is that PDP and PUD no longer encompass the known economic resource in a play and companies, wall street, and private equity are now willing to pay huge sums for what reserve accounting calls "risked unproved resources" but an intelligent industry observer calls "tier 1 shale acreage". If the breakeven cost in the Marcellus shale is $2.75 per Mcf, and the natural gas strip has gas priced at $3.75 next year, you can quickly understand why someone would pay $0.25 per Mcf or more for "risked unproved resources" that they know they can produce at a $1.00 gross profit (and a larger gross profit in the outer years).

Back to Helman's valuation: he suggests cutting the value of CHK's proved reserves by 25% to account for potential reserve write-downs. This is a ridiculous assertion, and one that would not be made by any analyst. The majority of Chesapeake's assets are in unproved shale resources - this is the reason BHP paid $4.75 billion for their Fayetteville shale which only had a billion in proved reserves. Removing the primary asset and then giving a 25% haircut to the PV10 of their remaining assets is ludicrous. If Helman were valuing Google, would he assume zero for goodwill, intellectual property, and their competitive position? Would he then give their net cash, property, plant and facilities a 25% haircut?

Helman next increases Chesapeake's liabilities by 25% to account for "potential surprises concerning the off-balance sheet VPPs etc." The only potential liabilities associated with the "off balance sheet" VPPs - which are off-balance sheet in the sense that they have been sold and removed from the balance sheet like any other asset that is sold - is essentially a warranty to true-up the production in these specific wells if they underperform. Chesapeake's liability to replace production in the unlikely event that these wells underperform is limited to the production Chesapeake retained in these specific wells, not to any of the company's other wells. It is basically a limited warranty of a few hundred million dollars that is very unlikely to be claimed - for this Helman adds $5 billion in addition liabilities to his "valuation".

After this stellar and well-reasoned "analysis", Helman goes on to say that CHK will likely trigger a default if they breach the Debt/EBITDA ceiling of 4X on their revolver. He does not note that CHK completely replaced their revolver with a $4 billion 5-year unsecured syndicated loan making this a moot point. More importantly, Chesapeake will almost certainly get a temporary waiver of this covenant - which they are unlikely to breach in the first place. Helman thinks they will breach this covenant (in a facility they aren't using) based on observation that gas prices are "$3.20 a year from now". This article was written today, and May 2013 natural gas futures are trading for $3.50 . . . but what is $0.30 per Mcf among friends?

Helman's coup de grace is his insightful conclusion that the company needs to "sell something, anything, as soon as possible". I'm sure he would be most pleased and comforted to see page 20 of the presentation, where CHK details the $9-11.5 billion in monetizations underway that CHK expects to conclude within the next 4-5 months. I'm not sure if they have ever given out an honorary CFA without someone first sitting for the exams, but I nominate Helman for this very timely and astute valuation exercise."
It's pretty heartening to see that one of the vocal CHK critics can't get the basic facts right and doesn't seem to know what he is looking at.


Taylor Conant said...

Good job sniffing out his background. Think this chimp is doing his own calculations, or are they being spoon-fed to him?

Reading his article is like reading one of these pop finance lit books written by a starry-eyed magazine writers who is in awe of the rock star status of their hedge fund titan subjects. You can tell the writer just randomly regurgitated facts and figures given to them by their source/interviewee without any real personal capability of interpreting or making sense of that which they were handed. They toss in a few finance jargon words and phrases they've picked up hanging around trading pits and Wall St watering holes from early on in their career when they were doing all the shit grunt work-- and they hope to god they pass as knowledgeable about their industry and no one notices they aren't.

It usually works because the typical bestseller reader these days is a mouthbreathing moron who has no better idea than the author of what the hell is going on in the story. They're only reading to see the double and triple digit returns on trades, the 9-figure bonuses and compensation and other eye-popping statistics that either cause them to salivate wildly imaging what it must be like to be a god, or to go into a blind rage at the injustice of economic inequality in this country (for those friends on the Left).

You can usually tell how clueless the writer is by the number of times they mention interest rates and central bank policy in close proximity to wild swings in the market and the resultant success or failure of their cherished hedgie heroes:

0 mentions - certifiable dolt
1-2 mentions - they remember someone at the CFR once mumbling about counter-cyclical monetary policy
3-5 mentions - they have a sneaking suspicion bubbles aren't an accident, but have no idea where they come from
1:1 ratio - you're dealing with someone well-versed in ABCT (note: this person does not currently exist in the world of financial journalism)

CP said...

They are his own calculations, sadly. Some of the stuff was just too dumb to be anyone else's.