Chesapeake's Largest Shareholder Says Company's "Leadership Controversy is Now Moot"

A letter from Mason Hawkins, CEO and chairman of Southeastern Asset Management, to Chesapeake shareholders shows that they feel the controversy surrounding Chesapeake's leadership, Aubrey McClendon in particular, is not an issue going forward.  Southeastern is Chesapeake's largest shareholder, owning 13.9% of the company's outstanding shares.

Here is the text of the letter:

Chesapeake is an exploration and production company with a leading acreage position in three of the top U.S. gas plays and four top U.S. liquids plays. The stock fell 20% in the quarter. As natural gas declined in April to its lowest price since 1998, below $2.00/mcf, the media raised questions about CEO Aubrey McClendon’s potential conflicts, board oversight, and CHK’s ability to meet its 2012 cash flow needs. At its lowest point, the stock fell 42% from the end of March. Almost all of what was reported was previously known, but the rapid onslaught of stories blurred the lines between perception and reality. To best represent our clients’ interests, we became more active to push the board and McClendon to focus on what mattered – de-risking the balance sheet, managing costs and reducing discretionary spending while gas prices stayed at uneconomic levels, and focusing on operating the company rather than convincing the world of the long-term case for natural gas. The stock’s decline, pressure from Southeastern and Carl Icahn, and a looming proxy vote brought the most significant governance changes that we have ever witnessed at a company.

• They split the chairman and CEO roles;
• They ended the controversial Founders Well Participation Program (FWPP) early;
• They reduced board compensation and benefits;
• They replaced four board members, with three nominees from Southeastern and one from Icahn, and replaced a fifth member with a new chair;
• They vetted the new, independent chair with Southeastern and Icahn;
• They will replace an additional director at the conclusion of a current audit committee investigation.

In total, the nine board members will consist of seven nominees pre-approved and/or submitted by Southeastern, including Lou Simpson who joined in 2011. The board fully embraces its duty to represent shareholders’ interests. Each member has a record of overseeing corporate assets and holding management accountable for value growth and recognition. Most have indicated their view of CHK’s upside by significant share purchases since their appointment.

Our process and case: Throughout the controversy, nobody has questioned the quality of the company’s assets. McClendon has done an excellent job building a portfolio of some of the best oil and gas acreage in the U.S. at attractive prices. Given the headlines, however, many have asked how CHK meets our “good people” criteria. As a first mover in leasing many shale plays and in pioneering horizontal drilling and fracking, McClendon has long been controversial. From the outset of our investment, we required even more due diligence than normal. Through our multiple industry, client, professional, and personal contacts, we gained insight about McClendon and arrived at a different conclusion than the image currently portrayed by CHK short sellers and much of the media. Also ignored in the criticism is that in 2011, McClendon was recognized as one of only eight public company CEOs who have been in place for over two decades and have earned a 20%+ yearly return for shareholders over that time.

As with every investment, from the outset we had to weigh CHK’s positives against its negatives. We fought against the FWPP behind the scenes well before it dominated headlines. Other negatives were not nearly as dramatic as recently characterized and had been available for years in the public domain to those who took the time to do their research. All of the leadership controversy is now moot. We go forward at CHK with one of the best and most vested independent boards that we have seen. They will be well informed and will make decisions only in the best interests of owners. Combining the new governance with some of the best physical assets we have owned makes us enthusiastic to have CHK as a core holding in the Partners Fund.

Lessons learned: Our conviction about CHK does not mean we are complacent about our path of ownership. We have learned two important lessons as our investment has unfolded. First, we recognize that in commodity businesses, being a low cost provider is not enough of an advantage for an overweight position since the commodity price is subject to going below the cost of production for an unpredictable period of time. Second, we learned a lesson that reinforces the importance of being a long-term investor who tries to work productively with management when change is warranted. We had much more influence in the tremendous governance transformation than we would have otherwise had if we had initiated our investment with guns blazing. The board and management listened to, trusted, and addressed our views knowing that our only agenda was to benefit long-term shareholders.

Read the article on this matter here.

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