Thursday, January 31, 2013

This Energy Company is a Decent Asset Play

There is one independent oil and natural gas exploration and production company that several investment gurus, including T. Boone Pickens, Wallace Weitz, and Canadian Warren Buffett Prem Watsa are investing in. Right after Christmas, Prem Watsa actually added more shares into his existing holdings of this company, bringing his total to more than 59.5 million shares. This company is SandRidge Energy (NYSE: SD). Oil guru T. Boone Pickens owns more than 700,000 shares, and Wallace Weitz owns more than 9.2 million shares of the company. Should investors follow these investment gurus into SandRidge? Let’s find out.
Business with High Leverage
SandRidge, headquartered in Oklahoma, is an independent oil and natural gas located in several areas, including Oklahoma, Kansas, and west Texas. As of the end of 2011, SandRidge was estimated to have around 533 million BOE, with 91% of the total reserved in oil. For the last 3 years, the company has increased the production volume gradually, from 47.9 MBOE per day to 64.1 MBOE per day. As of September 2012, SandRidge had nearly $2.66 billion in total stockholders’ equity, $674 million in cash, and as much as $4.3 billion in long-term debt. The low equity was due to nearly $2.55 billion in treasury stocks and nearly $2.6 billion in accumulated comprehensive losses. Thus, it seemed that SandRidge was highly leveraged.
Permian Sale to Strengthen the Balance Sheet
In December, SandRidge made a move by selling its Permian basin properties for $2.6 billion in cash to Sheridan Production Partners II. The company had three motives for the sale. First, the company has seen that “oily, conventional, mature assets” had a high valuation. Second, it could have cash to reduce debt to be more flexible financially. Third, it could focus on Horizontal Mississippian assets with high rates of return with the potential of long-term growth. The intention of the Permian sale has received different opinions from shareholders. Many thought that the $2.6 billion price tag was low. However, Grew Dewey, the company’s VP, Communications and Community Relations explained that the company had two big assets but didn’t have enough cash, so it had to choose which to focus on. The company thought that the future growth of Permian’s production would be difficult. Tom Ward, SandRidge’s Chairman and CEO commented on the sale, “This is a great outcome for our shareholders. The sale of the Permian assets at this time has allowed us to capitalize on current strong valuations for mature, conventional Permian assets and generate a very strong return on our investment there." Indeed, the cash position has increased to more than $3 billion, and the company intended to use it for debt reduction and focus on “highly scalable, high return Mississippian Play.”
Proxy Battle on an Undervalued Energy Company
The company is currently facing a proxy battle between its management team and several big shareholders. TPG-Axon, a 6.7% owner, has sent the company a letter saying that the fund was filing a lawsuit, as SandRidge didn’t give shareholders enough time to vote. Mount Kellett Capital Management, a 4.5% owner, also mentioned that Tom Ward should be replaced. It thought that the company’s asset was worth around $20 per share. At the current price of $6.23 per share, SandRidge is valued at 1.1x P/B, and as high as 666x P/E, whereas its peers, including Apache Corporation (NYSE: APA) and Occidental Petroleum (NYSE:OXY) are trading at quite reasonable valuations. Apache is valued at 1x P/B and 12.4x P/E, and it is also paying a dividend yield of 0.9%. Occidental Petroleum, one of the biggest global oil/gas giants, is valued at 10.3x P/E and 1.5x P/B. Occidental Petroleum is paying the highest yield among the three, of 2.9%. 
Foolish Bottom Line
As other big shareholders have mentioned, the key to unlocking the value of SandRidge might be via strategic partners and strategic sales. The high P/E ratio is misleading, as the main value stays in the assets it owns. SandRidge owned good oil/gas assets, which could be valued at $20 per share, more than three times higher the current share price. It could be a good opportunistic stock to hold after it strengthened its balance sheet with the cash received from the Permian sale.

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