What’s Buffett Disciple Pabrai Doing in Messy Chesapeake Stock?
Hedge fund manager Mohnish Pabrai is a huge Warren Buffett fan who humbly credits his rise to riches largely to his study of Berkshire Hathaway's (BRK.B) value investing strategies. So what’s he doing buying big into a scandal-ridden, money-losing, cash-flow-negative company like Chesapeake Energy (CHK)?
Pabrai tripled his investment in Chesapeake during the third quarter, a move that made the oil and gas production company about 20% of his fund’s portfolio, according to records gathered by datarama. It’s now the third largest holding in Pabrai Investments, behind Bank of America (BAC) and Citigroup (C) and just ahead of General Motors (GM) and Goldman Sachs Group (GS).
Chesapeake sticks out in that list. The banks and the car company are the sorts of relatively stable, dividend-paying companies all value investors peruse for potential. Chesapeake has become a complicated asset play after a crippling commodity price crash and questionable management ethics led to major restructuring. The share price is down some 34% since the beginning of last year, as seen in a stock chart.
To recap Chesapeake’s unfortunate situation: falling natural gas prices in the past few years made the company’s big bet on the commodity backfire, as it did for its competitors. Things got worse when news reports revealed that the CEO had: a) taken more than $1 billion in loans against his stakes in Chesapeake wells, and b) ran a sizable private hedge fund that traded on the commodities Chesapeake produces. T. Boone Pickens, a well-respected natural gas guru, sold his Chesapeake shares. Carl Icahn, exploiter of messed up companies, bought in. A mini shareholder revolt ensued. There are ongoing Justice Department and SEC probes for various reasons.
Chesapeake has promised to sell stuff in order to raise billions needed to pay down debt. Some delays on the sales front, as well as some unexpected spending, spooked investors as late as November.
This is not a mess one would expect Warren Buffett to join. He’s very fond of solid, rational leaders with long track records of success, and this one has a history of questionable decisions. (The board once bought a collection of antique maps for $12 from the CEO, just to give you a taste.) Granted, there have been some board changes, but there’s not much record of success yet.
Chesapeake’s returns on equity, figured directly or including debt (return on invested capital) are hardly Buffett-level impressive either, even though there are plenty of worse numbers from others in this business now.
It’s possible that Pabrai, like many others, is using Chesapeake as a play on recovering natural gas prices. Although forecasts on gas prices remains is mixed, the spot price has risen 40% in the past six months alone.
Pabrai is an incredibly successful investor who runs every purchase he makes through a checklist of some 80 or more criteria of his own devising. So he probably has really great reasons for buying Chesapeake. But we bet that this time, he didn’t get them from Buffett.
Dee Gill is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.