Chesapeake’s CEO Doesn’t See Why He Should Have Told A Bunch Of Pesky Shareholders About Borrowing A Billion Dollars Against Company AssetsBy Matt Levine
There’s this thing where:
(1) You run a Public Company.
(2) You make the moneys For The Shareholders.
(3) They thank you by giving you some of the moneys, more of them if you make them lots of the moneys, less if you don’t.
This is I suppose a venerable model though probably not the venerablest. The venerablest goes more like:
(1) You are a guy (or girl, but not so much in the venerablest model).
(2) You do a thing that makes the moneys. For you.
(3) You want to do more of that thing so you go to a bank and ask them to lend you money.
(4) You want to do even more of that thing and/or the bank said no because the thing is too risky, so you ask people to buy equity in your thing.
(5) They do.
(6) Now you keep doing your thing and any money that is left over after paying the expenses and the banks and stuff goes to you and your shareholders in proportion to how much equity you and they own.
(7) You feel a vague sense of fondness for those shareholders, if they don’t harass you too much, and sometimes you write them letters being like “hey, thanks for the money you sent me, hope you’re enjoying the money I’m sending you.”
The first model is sort of weird! I mean, it’s a totally sensible bureaucratic thing and it’s a good way to have public markets. Like, Brian Moynihan did not wake up one day with a vision of “I will start a bank. In America. I will call it Bank of America.” Nobody woke up with that vision. Bank of America is an agglomeration of visions and blindnesses, thus the name. If anybody owns it I suppose it’s the shareholders, and I suppose they’re entitled to hire a board to manage it for them, and that board is entitled to hire a guy to manage it for them, and that guy is entitled to be paid $8 million in exchange for his undying or undying-ish loyalty to those shareholders. But the guy in Brooklyn starting an artisanal picklery is not going to raise money from equity investors so he can make money For Them. He’s going to raise money wherever he can get it cheapest so he can make pickles, and money, For Him. The people giving him the money get what they negotiate for, which is maybe an interest rate or maybe a residual share of the profits, but it’s certainly not his undying loyalty.
Anyway Aubrey McClendon, what a guy. In case you missed it, Reuters did a big report on Wednesday about how McClendon, the CEO of Chesapeake Energy, has borrowed “up to $1.1 billion” against his stake in Chesapeake’s gas wells, and how he did some of that borrowing from people (viz. EIG Global Energy Partners) who are also providing financing to Chesapeake, and Chesapeake’s disclosure of all that borrowing was kind of poor. Important background to this is of course that McClendon could borrow up to $1.1 billion against his stake in Chesapeake’s gas wells, because he has a stake in Chesapeake’s gas wells worth let’s just hypothesize more than $1.1 billion,* which as Reuters notes is kind of unusual and due to Chesapeake’s Founder Well Participation Program that lets him buy up to a 2.5% working interest in every well they spud. Anyway, Reuters reported it and the stock dropped 5.5% and today some shareholders sued because stocks are not supposed to drop 5.5% though Chesapeake has in recent years been an exception to that rule generally.
So a thing to notice about Aubrey McClendon is that he is not Brian Moynihan. He is you might say quite good at digging gas out of the ground, which, it turns out, is a skill that can be translated into money. It also turns out that you need money as well as skill to dig gas out of the ground, and somewhere in call it 1993 he decided to get some of that money by IPOing Chesapeake Energy, and now here he is, running Chesapeake Energy and inciting controversy, not for the first time.
You could I guess have various reactions to this from the standard model of he is the CEO of a public company, hired by the board to make money for the shareholders, so WTF is he up to? Like, does this thing mis-align his interests with those of the shareholders? There is it must be said a whole lot of caterwauling about that in the Reuters story, including a bunch of experts saying dumb and/or vague things** and this marvelously testy exchange where Reuters asks a bunch of questions of the form “aren’t you jerks? are you sure? are you sure?” and Chesapeake answers in the form “shut up and go away.”***
But there’s at least some abstract support for Chesapeake’s obviously self-serving claim that “the Company believes the FWPP fosters and promotes the development and execution of the Company’s business by aligning the interests of the [CEO] and the Company.” So, yes, McClendon as the equity owner of a stake in a well with a non-recourse**** loan against it might be incentivized to take more risk than an unlevered equity owner might take, or less, or whatever, I don’t know, but actually in like rough rough cut he is pretty close to CHK. We could use imaginary math to say he’s around 50-60% levered on his interests*****; CHK has $16.7bn in long-term debt and $3bn in preferred stock against $42bn of assets but also has been known to do things that don’t show up as balance-sheet leverage, so a 50%ish or more leverage seems plausible – not that far off from the number we worked out for McClendon in our imagination. So his incentives seem at a first cut to be aligned with those of CHK shareholders. Similarly maybe he is nefariously forcing CHK to do deals with the entities who are nice enough to lend him money, but as CHK points out “The number of financial institutions making oil and gas loans is a finite group and virtually all (if not all) have a lending or other economic relationship with Chesapeake. Thus, it is not surprising that financial institutions have relationship with both Mr. McClendon and Chesapeake.”****** And in fact if EIG is good at financing McClendon it might well be good at financing Chesapeake, and vice versa; again at a glance his interests look aligned with Chesapeake’s.
But of course there’s an easier way to get those interests aligned, which is, instead of giving McClendon billions of dollars worth of levered equity interests in Chesapeake’s wells that sort of end up looking parallel to Chesapeake equity, just give him (billions of dollars worth, if you must, of) Chesapeake equity. He somewhat absurdly owns like $22mm worth of the stock, or 2% of his alleged net worth, which has to be at the low end of kajillionaire CEO equity stakes.
So why didn’t they do that then? The cynical answer is “because this was a scammier way to get him a better deal,” and it’s hard to imagine that there’s no truth to that. Certainly the betterness of the deal includes its relative non-disclosability; Chesapeake argues and Reuters’s experts agree that there are minimal disclosure requirements around ownership and disposition of these interests – unlike common stock, where he’d need to file a Form 4 on any sales. Of course the folks suing think that he should have disclosed details about the leveraging of these interests (again, clearly required in the case of common stock), more than the “Mr. McClendon’s interests are his personal assets and the FWPP does not restrict sales, other dispositions or financing transactions involving FWPP interests previously acquired from the Company” that’s in the proxy, but there’s no special reason to believe that they’re right.
But probably the humanly correct answer is “because he grew up buying and selling interests in oil and gas wells and he kept doing that when he bundled some wells together and took them public.” This should probably not be viewed as the behavior of a scammy public company CEO looking to put one over on his shareholders, but rather as the behavior of an oil and gas wildcatter who is sort of annoyed and confused by the act of having public shareholders. Why shouldn’t he hondle in well participations? What’s public company common equity to him? He’s an oil and gas guy. Get that common stock outta his face.
Which at some broad level is fine. Maybe you want your independent E&P companies run by risk-loving wildcatters who are allergic to public company equity. Maybe alignment with and fealty to shareholders is not your #1 desideratum in a CEO. Like: Carlyle is so uninterested in being a bunch of agents managing their firm to benefit public-shareholder principals that they’ve disclaimed fiduciary duties to those shareholders. If you buy a share (LP interest!) in Carlyle Group, you get what the contract says you get, which is basically a share of its profits whenever it feels like paying those out to you. You don’t get a fairy godmother at Carlyle Group looking out for your best interests. Similarly, if you buy a share of Facebook, well, Mark Zuckerberg has some fiduciary duties to you, but it’s safe to say that your best interests have, like the man said, the minimum amount of his attention. Certainly decision-making will remain a one-man show. Public shareholders are providers of cash that happens to be for whatever reason more attractive than other sources of cash, and they will be compensated fairly for the cash, but they should not expect letters beginning “Dear Facebook Family.”
The thing is, though: you know that going in to the Carlyle and Facebook IPOs. Part of what the recent and recent-ish wave of Internet and private equity IPOs have done is reinvigorated a market for public equity structures that don’t assume shareholder primacy, and that make explicit what many people have long thought, that you can manage a successful public company without assuming that your first and only duty is to cater to shareholders. My sense is that that is a model that can work really well – for Facebook, for Google, for private equity (which is sort of structurally bound to it anyway). Maybe for Chesapeake.
It’s just that Chesapeake IPOed in 1993, without Facebook and Carlyle around to make it look like a relative paragon of corporate governance, and also without the chutzpah to just say in its governance documents or prospectus – or even in its replies to Reuters now – “we are run by a guy who likes drilling wells and making money for himself, and you can co-invest with him and hope for the best, but don’t expect him to tell you stuff beyond what is 100% clearly legally required, or generally to worry much about making you happy.” Instead Chesapeake goes around saying “we are a public company, y’know, like those other public companies.” So it’s no wonder that the shareholders who are suing them now feel a bit deceived.
Chesapeake CEO Sued by Shareholder Over Loans [Reuters]
Chesapeake CEO took $1.1 billion in shrouded personal loans [Reuters]
Chesapeake Energy CEO quietly mortgaging his stake in West Virginia leases [Pittsburgh Post-Gazette]
A corporation’s duty to shareholders [Deus Ex Macchiato]
* Do you like math? Are you okay with your math coming with a large side order of making shit up? Then try this on. CHK discloses $41.7bn worth of evaluated oil and gas properties at cost, plus $16.7bn of unevaluated properties and $7bn of other stuff, less $28.3bn of DD&A. Common stockholders’ book equity is also around $13ish bn, while common market cap is around $11.6bn. So assume that everything is worth like 90ish% of book value, and you get evaluated properties worth $37bn-ish. Also note that CHK’s wells are mostly not 100%-owned; they note that as of “December 31, 2011, we had interests in approximately 45,700 gross (22,000 net) productive wells, so say that the gross value of their properties is $75ish bn. If McClendon has a 2.5% interest in all of them, which is rooooughly correct (he can choose to participate each year and almost always has except once in the ’90s), then his interests are worth $1.9ish billion. All of that is made up! Still.
Note that Reuters says “he has borrowed as much as $1.1 billion – an amount that coincidentally matches Forbes magazine’s estimate of McClendon’s net worth.” I don’t know what to make of that: is it like “Forbes thinks his net worth is $1.1bn but if you subtract these secret loans it’s really zero?” Meh. Or is it “gross interests is $1.9bn, subtract $1.1bn in loans and you’ve got $800mm, then add his CHK stock and other stuff and you’re around where Forbes is”? Exercise for the reader.
** Champion: “‘If [wells in the very early stages of production] are showing that kind of negative cash flow, the wells don’t have value,’ said Phil Weiss, oil analyst at Argus Research who has a sell rating on the company’s shares. But given that McClendon has borrowed more than $1 billion based on the value of his well stakes, ‘I really don’t think (the company’s disclosures) tell me much,’ Weiss said.” No, Phil, they don’t!
*** Ryan Chittum says of this exchange “The snippy reaction of Chesapeake’s lawyers and flacks is another tell that Reuters is on to something.” I dunno, I think both sides score some points here; the questions are pretty grandstandy. A question like
A veteran oil and gas industry analyst whose firm owns shares of Chesapeake and who reviewed the loans documents, said, “While recognizing (McClendon’s) right to privacy, the more information the company releases to shareholders the better – particularly when it’s such a large amount of money and related to the oil and gas business.” What is Chesapeake’s response to this comment?
Really deserves an answer like “[shut up and also t]he statement that the more information the Company releases to the shareholders the better is not a standard for disclosure since it does not require that the information be relevant or material.”
**** Reuters doesn’t use that word but it seems to be true from the Pittsburgh Post-Gazette story first describing McClendon’s loans, as well as from the fact that the loans seem to be through McClendon-controlled limited liability entities and the fact that you would have to be fucking nuts to take out $1bn of recourse debt on stuff owned by your employer.
***** See *, supra. $1.1bn of debt on $1.9bn of asset value. The $1.9bn is made up but importantly so is the $1.1bn; while nothing is totally clear it appears that these are lines that he can draw to pay drilling costs and it’s unlikely that he’s drawn them down fully.
****** This is a good first thing to think about conflicts of interest in finance generally.
Free-floating disclosure: Like every other converts banker, I probably worked on a rotation-based deal for CHK and otherwise had some minimal exposure to them, in my case particularly in the form of seeing them print deals away from me. But no inside info / never met Aubrey. But every other E&P executive I ever talked to had something to say about him. Now I guess they have more. Also: this could have been footnote *******!