Seeking Alpha
Long/short equity, growth at reasonable price, research analyst, deep value
Profile| Send Message| ()  

On first thought, the announcement by TPG-Axon that SandRidge Energy (SD) should fire the CEO that founded the company and brought it to this position seemed ridiculous. After more research, the investor might just have a point.

The activist investor submitted a letter last Thursday arguing that the Board of Directors should be realigned and the CEO should resign.

SandRidge is an oil and natural gas exploration and production company that primarily focuses on the Mid-Continent, Permian Basin, and Gulf of Mexico.

CEO Tom Ward has become a prominent leader in the oil exploration field making it further unlikely that he will be ousted. He was an original founder of Chesapeake Energy (CHK) that left to start SandRidge. The combined experience suggests that he has the knowledge to make this company successful.

Q3 Highlights

Below are the highlights from the Q3 earnings report:

  • Adjusted EBITDA of $297 million for third quarter 2012 compared to $171 million in third quarter 2011.
  • Operating cash flow of $281 million for third quarter 2012 compared to $147 million in third quarter 2011.
  • Net loss applicable to common stockholders of $184 million, or $0.39 per diluted share, for third quarter 2012 compared to net income available to common stockholders of $561 million, or $1.16 per diluted share, in third quarter 2011.
  • Adjusted net income of $29.6 million, or $0.05 per diluted share, for third quarter 2012 compared to adjusted net income of $5.1 million, or $0.01 per diluted share, in third quarter 2011.
  • Record oil and total production of 4.9 MMBbls and 9.5 MMBoe in the third quarter.
  • SandRidge has now drilled 91 Mississippian wells in eight counties in Kansas covering over 170 miles; 65 wells had an average 30-day IP of 291 Boe per day.

The company reported adjusted earnings of $0.05 compared to analyst estimates of only $0.00. The company has easily beat analyst estimates the last four quarters.

The disappointing part is that analysts now only expect earnings of $0.01 for both Q4 2012 and Q1 2013. The company appears unable to grow earnings much beyond the breakeven level.

Drilling Activities

The company remains active drilling in the Mississippian Lime and Permian Basin. Analysts expect revenue to soar another 30% in 2013, yet earnings are expected to be virtually flat with 2012 levels.

Guidance is for production of 39.2 MMBoe and capital expenditures of $1.75B in 2013. The company will drill 580 horizontal wells in the Mississippian program, while reducing capital directed towards the Permian Basin.

The forecast is for a 20% increase in production over 2012.

Permian Basin Sale

The most bizarre item in the Q3 earnings report was the announcement of exploring a sale of the previously important Permian Basin assets. These assets produce 24,500 Boe per day (67% oil, 15% NGLs and 18% natural gas).

While the company thinks the deal could unlock value in a mature, conventional oil asset, investors don't appear impressed. The stock, which had jumped on the news of the potential for a CEO resignation and sale of the company, plunged to new lows after the earnings report. The stock plunged to $4.81 while ending Friday at $5.51; lows only matched by the October 2011 market plunge.

Analysts have already suggested the company could realize nearly $2.4B for these assets. Though this move further highlights the unpredictable actions of the management team as claimed by the activists.

The company bought the 2011 Gulf of Mexico assets in a surprise move just last year. Most investors likely wonder why that purchase was made if the intent was to turnaround and flip existing assets.

Worst Performing Energy Stock

TPG-Axon argues that the stock has been the worst performing energy stock since its IPO in 2007. The stock is down 76% since the IPO. Based on these facts, the opinion of this shareholder appears very compelling.

The chart comparing other energy stocks over the last 5 years suggests the theory has some validity. SandRidge has plunged while other energy stocks have actually seen solid gains. While Chesapeake Energy Corporation has also accumulated huge negative returns, other comparative stocks such Range Resources (RRC), Continental Resources (CLR), Southwestern Energy (SWN) and Kodiak Oil & Gas (KOG) have reported large gains.

SD Total Return Price Chart

SD Total Return Price data by YCharts

The shareholder further suggests that the company trades at the greatest discount to Net Asset Value due to the inconsistent strategy of management. The estimate is that the stock should be worth $12 - $14 currently if the market had confidence in the management team.

SandRidge Response

The response by the company leaves a lot left for investors to question. Not only was it lacking in any specific details, but the company turned around and announced the potential sale of the Permian assets. The surprise announcement further highlights the incoherent strategy put forward by TPG-Axon.

Conclusion

The facts presented by the activist shareholder have very compelling points. Not only does the company continue to flip assets in unpredictable ways, but the deals never ultimately lead to stock gains. The company isn't able to increase earnings either.

CEO Tom Ward has made some brilliant moves such as moving to oily assets much quicker than most in the industry and consistently hedging oil at attractive prices. Unfortunately these moves aren't rewarding shareholders with high stock prices.

The fact that both Range Resources and Southwestern Energy produced better stock returns while remaining focused on natural gas suggests that investors clearly prefer a simple, focused plan. The stocks originally focused on oil performed best in the 5-year period, while the worst performing ones switched paths such as Chesapeake and SandRidge.

The data speaks volumes that selling the Permian Basin and flipping more drilling into the Mississippian play won't attract investors into SandRidge. Removing Tom Ward from power remains a low probability, but TPG-Axon has clearly presented a picture where the stock price will remain low as long as management can't focus on a simple plan.

Source: SandRidge Energy: Should Tom Ward Go?

Additional disclosure: Please consult your financial advisor before making any investment decisions.