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Noster Capital's Letter to Chesapeake Board

Noster Capital's Letter to Chesapeake Board

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Published by DealBook
Letter from Noster Capital, a small hedge fund that is invested in Chesapeake Energy, calling for changes at the natural gas driller.
Letter from Noster Capital, a small hedge fund that is invested in Chesapeake Energy, calling for changes at the natural gas driller.

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Published by: DealBook on May 14, 2012
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07/10/2013

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Noster Capital LLP
 1 Knightsbridge Green, London, SW1X 7NE, United KingdomT: +44 (0)20 7042 0470 F: +44 (0)20 7042 0480 www.nostercapital.com
 
Registered in England no.OC331538Authorised and regulated by the Financial Services Authority
 
London, May 12
th
2012
Open Letter to the Board of Directors of Chesapeake Energy Corporation
 
To: Richard K. Davidson
- Board Member 
 To: Kathleen M. Eisbrenner
- Board Member 
 To: V. Burns Hargis
- Board Member 
To: Frank Keating
- Board Member 
To: Charles T. Maxwell
- Board Member 
 To: Merrill A. "Pete" Miller, Jr.
- Board Member 
 To: Don L. Nickles
- Board Member 
 To: Lou Simpson
- Board Member 
 6100 North Western AvenueOklahoma City, Oklahoma73118United StatesDear Board Members of Chesapeake Energy Corporation ("Chesapeake Energy"),Enough is enough!Noster Capital can sympathize with the fact that some members of the Board may have beenunaware of the amount of personal financing that Mr. McClendon had linked to his Founder WellParticipation Program ("FWPP"), although good corporate governance should have mandated thatthe Chief Executive Officer of a company whom you oversee reports to you any and all materialinformation that could conflict his personal interests with those of Chesapeake Energy'sshareholders.Once the news of Mr. McClendon's $1.1 billion debt was made public
1
, the Board lost significantcredibility with investors by claiming initially that you were fully aware of these financingarrangements
2
, only to moderate your stance eight days later by retracting the Company Counsel’s
1
Reuters – April 18
th
2012
2
Henry J. Hood, Senior Vice President and General Counsel of Chesapeake Energy– April 18
th
2012
 
 
Noster Capital LLP
 1 Knightsbridge Green, London, SW1X 7NE, United KingdomT: +44 (0)20 7042 0470 F: +44 (0)20 7042 0480 www.nostercapital.com
 
Registered in England no.OC331538Authorised and regulated by the Financial Services Authority
 
prior statement, claiming that “
The Board of Directors did not review, approve or have knowledge of the specific transactions engaged in by Mr. McClendon or the terms of those transactions 
3
. Inour opinion, the final insult came when the "punishment" for Mr. McClendon's substantial use ofpersonal leverage (news that has led to a formal SEC inquiry) was simply to strip him of thecompany’s Chairmanship and to terminate the FWPP earlier than originally anticipated
4
. We aresorry to say but a truly independent Board would have terminated its Chief Executive Officer on thespot for a far lesser infraction, especially given Mr. McClendon’s historical use of leverage.The company has stated that it does not believe the personal use of such leverage linked to theFWPP (nor the fact that one of the funds that personally lent money to Mr. McClendon laterparticipated in a company bond offering) created a conflict of interest
5
, but yet the market seems todisagree, as the company’s shares have fallen 23% since that news was made public, even thoughthe price of NYMEX natural gas has actually risen by 29% during that same time frame. Webelieve that CEOs of public companies need to remain focused on their fiduciary duty at all times,and the use of such substantial personal indebtedness can pressure them to act in ways that are inconflict to the goal of creating substantial value for shareholders over the long-term, not to mentionthe emotional distress that having such personal liabilities must cause.When we first analysed Chesapeake Energy with the idea of potentially becoming shareholders, asignificant red flag we discovered was the fact that Mr. McClendon had, in the past, invested inChesapeake Energy shares using margin debt and that in 2008, after the stock market collapsed,was forced to liquidate more than 90% of his shares to meet margin calls. And what was theBoard's response to this remarkable misuse of personal leverage? An approximate $110 millionpay package for the 2008 fiscal year
6
that included:- $75 million to buy interests in Chesapeake Energy wells- $20 million stock grant- $12 million to buy Mr. McClendon's map collection (which he was later forced to repurchaseback from the company after losing a lawsuit from Chesapeake Energy shareholders)- $648,000 for the private use of corporate private jets- $577,000 for accounting services
3
Company release – April 26
th
2012
4
Company release – April 26
th
2012
5
Henry J. Hood, Senior Vice President and General Counsel of Chesapeake Energy – April 18
th
2012
6
Schedule 14A – April 30
th
2009
 
 
Noster Capital LLP
 1 Knightsbridge Green, London, SW1X 7NE, United KingdomT: +44 (0)20 7042 0470 F: +44 (0)20 7042 0480 www.nostercapital.com
 
Registered in England no.OC331538Authorised and regulated by the Financial Services Authority
 
- $131,000 for personal engineering support (we are not quite sure what this relates to)Mr. McClendon was the 2
nd
highest paid CEO in America
7
over the past 5 years, with a totalcompensation package of $303.6 million, a period during which CHK shares lost 23% of their value(excluding dividends).On top of the very generous pay package for 2008, during times when most of us (even those whohave made the right investment decisions, without the use of leverage) were tightening our belts,the Board went one step further and also agreed to pay $4.7 million to sponsor the NBA'sOklahoma City Thunder during its 2008/2009 season
8
, a team that Mr. McClendon owns a 19.2%stake in. We could go further and talk about the company's expenditure of $177,000 for food andbeverage catering services, primarily for 2 large events sponsored by the company, using DeepFork Catering's services, an affiliate of Deep Fork Grill, in which Mr McClendon is a 49.7% owner,but we think you got our point by now.While on the topic of generous perks we do not believe that owning fractional shares in 22 different jets (a high-end Gulfstream G-550, eight other Gulfstream jets and 13 Cessna jets)
9
are necessaryin order to retain good quality managers or in order to conduct day-to-day business. According to aWall Street Journal article, Chesapeake is by far the largest single owner of fractional corporate jets in the US. This is once again proof that despite the hardships of the economy, the weakmarket in natural gas prices and the extreme cash needs that Chesapeake Energy faces in theshort-term to keep operating as a going concern, the Board does not seem to be acting in the bestinterests of its shareholders. Does a company the size of Chesapeake Energy really need a fleet of22 private jets? This article from the Journal continues to stipulate that the company is currentlybeing sued for understating perquisites granted to its executives by as much as $10 million a year(from an already generous $14 million over a 5 year period).The Board of any public company is there to keep the executive team in check and to make surethat shareholders’ and other stakeholders’ interests are being well represented. Having failed toterminate Mr. McClendon after recently learning the full extent of the personal liabilities that heincurred in order to fund his participation in the FWPP, and after last Friday's news that there were
7
Fortune.com - America's Highest Paid Chief Executives
8
Henry J. Hood, Senior Vice President and General Counsel of Chesapeake Energy – April 30
th
2009
9
WSJ Article – May 10
th
2012

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