Can Carl Icahn Push Chesapeake 40% Higher?

For someone pushing 80, Carl Icahn sure is not slowing down. In addition to admiring his energy level, one has to marvel at his continued investment success. After making 400% in Netflix (NFLX), 140% in Herbalife (HLF) and more than a double in Federal Mogul (FDML) and other smaller plays in 2013; the mogul is off to a good start in 2014.

Mr. Icahn made a huge gain on his over 11% stake in Forest Labs (FRX) as that company announced it will be acquired for some $25B by Actavis (ACT) last week. It seems the next target the noted investor and activist will focus on is Chesapeake Energy (CHK).

He has a ~10% position in the company and it has been speculated he is seeking a $40 a share cash bid for Chesapeake. This would be more than a 40% rise over the stock's current price levels. It appears his agitation behind the scenes could already be bearing fruit.

Chesapeake announced this morning that it is pursuing strategic alternatives for its oilfield services division, including selling the unit or spinning it off to the company's shareholders. The division had annual sales of $2.2B in 2013. If spun off, this company could easily have a higher value as a separate entity.

Oil services firms generally are valued in the market at 1.2x to 2x annual revenues giving Chesapeake's energy service business a ~$2.5B to ~$4.5B market value using a back of an envelope calculation. Chesapeake currently has an overall market capitalization of just under $18B.

The company has also recently announced that it is lowering its capital expenditure budget by 20% in FY2014 and will continue to sell off non-core assets. Chesapeake projects 8% to 10% production growth off continuing operations despite the cap ex decline in 2014.

In addition, the company should benefit nicely from the recent spike in natural gas prices. Approximately one third of its natural gas production is unhedged and the rise in NG prices should also allow the company to reset its hedges at higher prices.

Chesapeake is the second-largest domestic producer of natural gas and the 11th largest producer of oil and natural gas liquids.

(click to enlarge)

Chart Source: Investor Presentation

The company is also growing oil and natural gas liquid production nicely. Its biggest focus area right now to accomplish this goal is the booming Eagle Ford shale formation. The company has been very successful in driving down well costs and lowering well completion times in the region in recent years (See Chart).

(click to enlarge)

Chart Source: Investor Presentation

The company earned just 61 cents a share in FY2012 but is marching towards ~$1.65 a share in profits in FY2014 and analysts have just under $2 a share in earnings for FY2015 penciled in right now. Given some of the actions already taken by the company, continued agitation by Mr. Icahn and growing production growth; the noted investor's price target of $40 a share does not seem out of line.

This is especially true if these changes attract the attention of a domestic energy major like Chevron (CVX) or Exxon Mobil (XOM) which are both struggling mightily with replacing current production levels. I will be taking a small speculative position in Chesapeake today either by buying the equity itself or via purchasing some out of the money bull call spreads. This seems prudent given Mr. Icahn's recent successes and Chesapeake's underlying and improving business fundamentals.

Chesapeake reports quarterly earnings later in the week and the conference call afterward should provide greater clarity to the company's direction and details on recent announcements. Stay Tuned.

Source: Can Carl Icahn Push Chesapeake 40% Higher?

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CHK over 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. (More...)

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