Back on March 26th I pointed out that earnings estimates for Chesapeake Energy (CHK) appeared to be too low. At the time the company had just released a bold exploration and production plan for its leaseholds in the Haynesville Shale, but Wall Street was only expecting the company to earn $3.50 in both 2008 and 2009, which seemed way too conservative.
Since then estimates have increased to over $4 per share, which is closer to reality, and CHK stock soared from $47 in late March to north of $70 on July 2nd. Such a large move in the stock was prompted by two events; a sharp move in natural gas prices to above $13, but more importantly, Chesapeake's announcement on July 1st that it had successfully monetized its Haynesville Shale acreage.
Under a joint venture with Plains Exploration (PXP), Chesapeake will sell a 20% stake in its Haynesville Shale acreage (440,000 acres) for $1.65 billion in cash. Not only that, but PXP has also agreed to pay 50% of the development costs for the remaining 80% of the play (which CHK owns), up to an additional $1.65 billion. As a result, Chesapeake is swapping a 20% economic interest in the Haynesville shale for $3.3 billion, with half of the cash paid upfront, and the other half over the course of several years as the land is developed.
Considering that the Haynesville Shale was not even on investors' radar screens earlier this year, this deal is pretty astonishing. The Haynesville represents only 3% of CHK's net acreage, 0.3% of the company's proved reserves, and 21% of the company's risked reserves (proved reserves plus risked, unproved reserves), but the Plains joint venture values Chesapeake's Haynesville acreage at $16.5 billion.
That is especially impressive because even at the all-time high of $74 per share, Chesapeake's equity market value was only about $40 billion. Not surprisingly, those highs were achieved the day after the PXP joint venture was announced.
Over the last few weeks, however, natural gas prices have fallen from $13 to $10 per mcf. As I have written about many times before, CHK shares track gas prices in the short term despite the fact that the company hedges most of its production, thereby insulating it from the volatility of the near term spot market. As a result, CHK shares have fallen from the July 2nd intraday high of $74 to a closing price of $47 on Wednesday.
Is such a move down warranted, especially given the recent Haynesville announcement? Well, Chesapeake has hedged 81% of their remaining 2008 production and 54% of their 2009 production. I would have to say July 2008 prices really have little impact on CHK's financial performance. Still, traders will use the stock as one of their main natural gas trading vehicles, so investors need to live with this price action.
For those who are bullish on natural gas and are fans of Chesapeake, but missed getting in on the stock as an investment, short term market fluctuations have once again provided you a chance to purchase shares for 36% less than their level three weeks ago. CHK's market value is now only $25 billion, versus an implied valuation of more than $16 billion just for the company's Haynesville Shale acreage. Given that single play represents only a fraction of Chesapeake's natural gas assets, this recent collapse in stock price appears to be another case of stock market short term irrationality.
Full Disclosure: Long shares of CHK at the time of writing