chk

[Jason Strasser (strassa2)]

I'm getting curious about how a piece of news exactly influences the price of a stock. It seems to me that there are planned events like an earnings announcement and that if the investor's concensus is hit then the stock price doesnt change because in theory it has already been priced into the stock.

On Wed Aug 8, after trading, Chesapeake announced:

"OKLAHOMA CITY (AP) -- Oil and natural gas exploration company Chesapeake Energy Corp. said Wednesday it will offer $500 million in convertible senior notes.
The company said it will use proceeds from the offering to pay off debt from its revolving credit facility.

The 2.50 percent senior notes due 2037 are convertible into cash and common stock.

Deutsche Bank Securities will act as sole book-running manager for the offering.

Shares of Chesapeake Energy Corp. fell $1.55, or 4.4 percent, to $33.88 in after hours trading. They closed the regular session down 15 cents at $35.43." --AP

This seems like a very isolated look at hows one piece of news effected the prices.

What was known by the street before the announcement:

1) CHK has had negative cash flow for at least the past year.

2) The credit market is getting murdered. I would guess that due to the nature of CHK and the natural gas market that because of the large amount of income generated by the business that people are probably more willing to buy debt of utility companies moreso than most other companies. That being said, because CHK has a negative cash flow and no cash on hand, in order to continue its quick growth rate (which has been priced into the value of the stock) it will have to issue new debt in unfavorable conditions.

3) Aubrey McClendon has a lot of money and his circle of OK business partners (See new orleans hornets). I personally know him through a college roommate, so I've always monitored the stock (I do not own any). It was noted in the journal that CHK might be able to look for in-house funding. So I'm guess the debt markets were not its only choice.

So the news comes out that they are issuing more long term debt to keep the revolving credit door rotating, and then boom the stock drops 5%.

My question is this: the balance sheet indicated to anyone with a brain that CHK would have to look for ways to borrow money at some point in the near future. They had 2 main options, and chose one. Wasn't this priced into the stock? Was the drop in the stock due to the fact that the timing of the refinancing was a certain probability and that this probability distribution could've included points far enough in the future when credit conditions might've been more favorable then they are now? Was it due to the size of the loan? How about the fact that the notes are convertible into stock--was the street worried about the dilutive effect of this issue? I have no real feel for any of this stuff. I'm just looking for someone to explain to me exactly why the stock dropped 5%. Were markets inefficient?

Jason

[spino1i]

Your way overthinking this Jason. I dont think people knew that much info. I think they saw the converitable note sale and knew CHK was going into further debt after being promised in the past that they wouldnt and so felt betrayed and sold (read some message boards right after this happened to get an idea). Also people saw in the past that this sort of event lowered the price of the stock so they sold for that reason too.

If you look at the price the next day it actually went up to -3 1/2% at day's close, and the market was down like 3% that day. So it only underperformed by 1/2% in the end.

This is actually a very clever way to make money with CHK, waiting to buy its shares right after a dip due to issuing debt, because you know Aubrey has to do it and some point. I bought 100 shares of CHK extra the very next morning right after the dip.

Also, the reason CHK has negative cash flow this last year is because they had 60 million in cash sitting around and wanted to invest it further in the company. They are just trying to grow as fast as possible, while taking on some debt. Its a bit bold and possibly risky, but should allow the company to grow extraordinarly fast unless the natural gas markets get murdered.

[spider]

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It seems to me that there are planned events like an earnings announcement and that if the investor's concensus is hit then the stock price doesnt change because in theory it has already been priced into the stock.

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I think it's either wrong or pointless to try and imagine a theoretical consensus existing for any stock. Any major stock is going to have thousands or even millions of holders (though of course, it can be a relatively small number that hold 80% of the shares).

Those stockholders are going to be an insanely heterogeneous group, both in terms their expectations of future earnings, growth, etc. but also in terms of why they are holding the stock (short terms speculators vs long term holders vs employees etc.).

So... whenever there is some genuine news, it will have some effect but b/c so many people are holding the stock for all kinds of different reasons, but it can have all kinds of indirect/non-linear effects such that it really is impossible to expect some linear up/down effect based on some crappy idea of "consensus" expectations.

In short, when the paper talks about consensus earnings expectations, they are talking about something that doesn't really exist in a meaningful way. And if it did, they wouldn't know what it was.

[cbloom]

Yeah, this is definitely something I've learned, that the market is "stupid" in that events which they should totally know are coming are not correctly built into the stock values. So many times I see some news that makes it obvious a certain stock is going up and down and I think "everyone sees that news it must be built into the stock", but then it just keeps going. Like, just as a random example, when Halliburton got the Iraq contract you just know it's making a fortune, and the stock went up a tiny bit immediately, but it didn't go up anywhere close to the proper amount and as the actual profits were announced it just kept going up and up, even though 2 seconds of analysis would've predicted that was going to happen.

So, anyway, don't pass up on a trade because "it should already be compensated for". In general I find stock prices react very strongly to concrete announcements after the fact but do not react properly to things that obviously are coming.

[Groty]

Convert arb guys are the dominate players in the convertible market. By definition, they buy the convertible bonds and short the stock. When a new convert offering is announced, some guys with fast fingers immediately short the issuer's stock to front run the convert arb guys.

Convert arb guys love the current market environment. They prosper and thrive during periods of extreme equity volatility, as the increase in vol juices the value of the embedded options in the convert. And because the straight debt markets are in turmoil, convert buyers demand improved pricing for new deals brought to market. If the current climate continues, they will outperform nearly all other hund fund strategies.

[CrushinFelt]

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My question is this: the balance sheet indicated to anyone with a brain that CHK would have to look for ways to borrow money at some point in the near future. They had 2 main options, and chose one. Wasn't this priced into the stock?

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The answer to this can still be yes even with the price drop that followed. Future events are priced in with probabilities.

This option was clearly the worse option for the firm thus the stock fell. You will see this with mergers as well. Although someone makes an offer of $120/share for a $90/share company, it may not jump that high right away if, for instance, there is a decent probability that the buyout won't go through for a regulatory reason or something.

So to make money consistently off of something like this you have to have a better understanding that the market of what the probabilities are. If the market has it priced at 60/40,but you know it's 90/10, then clearly you're going to act accordingly.

There probably were a few people who were short this stock because they knew better than the market what those probabilities were. If they did it was probably not public information, which is what the stock reflects.

[Jason Strasser (strassa2)]

so.... they were breaking the law if they knew the probabilities were skewed?

[DesertCat]

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There probably were a few people who were short this stock because they knew better than the market what those probabilities were. If they did it was probably not public information, which is what the stock reflects.

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I don't think there is any evidence of non-public information in this. Groty gave the most likely explanation for the price action. The other is simply that investors were disappointed in the size or terms of the offering.

And no, the market isn't perfectly efficient. There aren't many people left in the world who believe that.

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"Observing correctly that the market was frequently efficient, [they] went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day."

Warren Buffett

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