Chesapeake Energy (NYSE: CHK) is rewarding the investors with a phenomenal rally which shows no signs of stopping anytime soon. As the screen goes green, investors often tend to lose sight of important fundamental events which could be roadblocks ahead. One such event for CHK investors is the 2017 Annual meeting of shareholders to vote on increasing the authorized common stock to 2 billion shares. The meeting will be held on May 19, 2017.
In my previous article titled Chesapeake Energy – If Even This Doesn’t Wake Up The Shorts, I Don’t Know What Will, I had urged the shorts to exit their positions. Those who would have heard the advice would have avoided huge losses since the stock has rallied roughly 10 percent and the fact that it closed yesterday near the day's high is telling of the strong momentum. The following daily CHK price chart shows that the stock has also negated the near-term downtrend and broken past several resistances including the 200-day SMA near $6.05. The volume was considerably higher than the average, lending strength to the upmove.
Yesterday’s powerful breakout in CHK could be attributed to the equally formidable displays in oil and gas markets. I have no doubt that the stock can easily touch $6.80-$7.00 in the near term. Investors who entered near $5 would be itching to book profits now which could cause a minor pullback as well.
Given that most of the investors are now focused on the price action in the stock, I think it is worth reminding them of the shareholder vote on May 19 as well as the company’s earnings on May 3. Both of these events have the potential to extend or break this rally. I believe it is time to ask some tough questions.
This article is not intended to provide a bearish thesis but it is definitely aimed at making the investors aware of the fundamental events. Specifically, it will focus on the May 19 meet in which the company hopes to receive a favorable voting on making an amendment to the Certificate of Incorporation. Increasing the number of authorized common stock will dilute the stake of existing stakeholders and reduce the earnings per share. The management lists several reasons for this proposal, namely:
- Raising capital, if we have an appropriate opportunity, through offerings of common stock or securities that are convertible into common stock.
- Exchanges of common stock or securities that are convertible into common stock for other outstanding securities.
- Providing equity incentives to employees, officers, directors, consultants or advisors.
- Expanding our business through the acquisition of other businesses or assets.
- Stock splits, dividends, and similar transactions.
- Other purposes.
I do not agree with points 3 and 5 here. It cannot be morally justified to reward the officers, the management or the advisors at the expense of the shareholders while the company is still in the woods. The argument that such incentives are necessary to retain the talent sounds hollow to me. Instead, it clearly implies that the officials are more concerned about their own welfare rather than thinking clearly about the shareholders’ benefits.
Again, we know that the company will not be cash-flow positive by FY 2018, and therefore, there is no point in even discussing the dividends right now. Only after the energy markets have stabilized at higher levels and the company has maintained free cash flow for some quarters should one reasonably begin to expect any dividend returns.
Source: Chesapeake Energy PRE 14A
The final point “Other purposes” is really interesting to know about. Although the company did not state it explicitly, it dedicated an entire paragraph to discuss the potential of a hostile takeover (Other purposes?). It said,
Although this proposal to increase the authorized capital and common stock has been prompted by business and financial considerations and not by the threat of any hostile takeover attempt (nor is the Board currently aware of any such attempts directed at us), shareholders should be aware that approval of this Proposal 2 could facilitate future efforts by us to deter or prevent changes in control, including transactions in which the shareholders might otherwise receive a premium for their shares over then current market prices.
Using hostile takeover as an excuse, the company may convince the shareholders to sacrifice their stake. But, should the shareholders agree to the proposal for something that might never even come?
As for the other points such as expanding the business by acquiring new companies or assets, does the company see potential investment opportunities right now? If not, then why insist on diluting the stake of existing shareholders? If yes, will it disclose the opportunity to the investors before asking them to compromise with their holdings?
These are just some of the tough questions which every investor must consider before voting on the proposal. I think that the proposal is not shareholder-friendly given the objectives it is aimed at fulfilling. If the proposal to increase the authorized common stock to 2 billion shares gets approved, there might be a good dip in the stock price. My advice now would be to book partial profits in the long positions around $7-$8 and wait for a dip. The stock is in a good trading range and investors should milk the opportunity.
If you have a different opinion, please use the comments section to share it. I would really appreciate a contradictory opinion.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.