Chesapeake Energy Corp. (NYSE: CHK) Could Be the Sector's Best Takeover Target

When you hear the term "takeover target," you typically think of a small biotech or technology company - but that's not the case here.

I've found a company that logged $1.4 billion of adjusted EBIDTA and $1.2 billion of operating cash flow. And it just happens to be the second-largest natural gas producer in the United States.

I'm talking about Chesapeake Energy Corp. (NYSE: CHK) - a company that has increased production for 21 consecutive years.

In addition to being the second largest U.S. gas company, Chesapeake is the No. 1 horizontal-well driller in the world, and the most active new-well driller in the United States. The company holds a large portfolio of shale properties, and it plans to triple profitable liquids production.

Even aside from the fact that the company is an attractive takeover target, Chesapeake has enough going for it that it deserves a place in our portfolio.

So it's time to buy Chesapeake Energy Corp. (**).

Why Chesapeake Energy Corp. is a "Buy"

There really couldn't be a better time to start building a position in this energy juggernaut, since natural gas prices are set to climb as the market finishes fill season and looks toward winter withdrawal season starting in October or November.

Chesapeake currently produces a little more than 3 billion cubic feet of natural gas equivalent per day (bcfe/d), about 4% of total consumption in North America. It operates 166 onshore drilling rigs across the United States and has another 105 non-operated but active rigs.

Chesapeake has a strong presence in shale gas, with access to some of the most abundant U.S. natural gas shale plays. It has leading positions in four of the top five shale gas fields: No. 1 in the Marcellus, Haynesville and Bossier shale plays, and No. 2 in the Barnett shale field. It holds leading positions in 12 of the top 15 unconventional liquids-rich plays, including the Anadarko Basin and the Eagle Ford shale field.

As I said earlier, the company has increased production for 21 consecutive years. And while gas production in the second quarter was up 9% year-over-year, the bigger news is that liquid production jumped 62%. Liquids are typically sold at prices similar to crude oil, so an increase there can bring in even more revenue than dry natural gas production.

Chesapeake wants to grow liquids production from 10% of total production in 2010 to 30% to 35% by 2015. It plans to spend 50% of its 2011 capital and 75% of 2012 capital on liquid-rich targets.

Chesapeake is also the world's largest driller of horizontal wells, one of the most valuable technologies in the industry.

Horizontal well drilling offers more production capability than vertical wells. It also gives Chesapeake access to more than 15% of daily U.S. drilling information. That's an important competitive edge as it pertains to uncovering unconventional resources. In the past four years, Chesapeake has discovered five of the top U.S. natural gas and liquids resources.

Chesapeake's assets give the company significant expansion capacity as it grows production. The company also has the option of selling these land holdings for additional liquidity.

All of these factors make Chesapeake Energy a strong investment candidate. But more than that, they make it the best takeover target in the oil and gas sector, in my opinion.

A word of warning, though: Chesapeake has a history of taking big chances for high rewards. It's for people who can handle volatility in their holdings - this is not your grandpa's low-risk investment strategy.

The company has a market cap of $19 billion, with an enterprise value of $30 billion once you take net debt and cash levels into consideration.

Chesapeake Energy stock is up 18% so far this year. It closed Friday at $30.38.

Action to Take: Buy Chesapeake Energy Corp. (NYSE: CHK)(**).

Chesapeake has tremendous resources and it's well positioned for both the long- and short-term future. However, you do need to be careful with this company. Its aggressive growth strategy has led to more volatility than we see with most other stocks.

Let's pick up our position slowly here. If you normally buy a 3% position, let's only pick up one-third of that, or 1% now, with expectations of dollar-cost averaging into the stock as we get closer to winter.

(**) Special Note of Disclosure: Jack Barnes has no interest in Chesapeake Energy Corp. (NYSE: CHK).

About the Writer: Columnist Jack Barnes started his career at Franklin Templeton in 1997. He started out in the company's fund-information department - just as the Asian contagion infected the Asian tiger countries.

Barnes launched his own shop, RIA, in 2003, just as the second Gulf War was breaking out. In early 2006, after logging a one-year return of nearly 83%, Forbes named Barnes the top stock picker in its "Armchair Investors Who Beat the Pros" competition. His two audited hedge funds generated double-digit returns in 2008.

Barnes retired to the beach in the summer of 2009, and continues to write from there. He's now the author of the popular blog, "Confessions of a Macro Contrarian," and his "Buy, Sell or Hold" column appears in Money Morning on twice a week. In his previous BSH column, Barnes analyzed SeaDrill Ltd. (NYSE: SDRL).

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