It appears that SandRidge (SD) is getting quite a lot of attention, so I decided to take a quick look. The thesis behind the investment, albeit speculative, is the restructuring of its board and breakup of the company. One of the biggest backers supporting this is TPG-Axon, which has called for the replacement of the CEO and sale of the company.
Fairfax Financial has also stepped in on SandRidge management's side. Per a couple of 13D/G filings, TPG owns some 30M shares and Fairfax 54.5M. Both of these hedge fund managers have 13Fs in the $1.5-$2.0B range and appear to be in it for the long haul. It appears that TPG has some of the best support, with the S&P now threatening to cut the energy company's debt rating. SandRidge also sold off $2.6B worth of assets in Texas. Investment bank Simmons & Company is also supporting the breakup, but fear poison pill adoption could interfere, however most poison pills are never triggered.
We see a lot of pent up demand for M&A in the natural gas industry, were the number of transactions is near 5-year lows, but the valuations on transactions is at a five year high. Assuming one of the larger oil-gas companies wants to get more exposure to the fast growing natural gas market an acquisition Notable other transactions in the industry over the past few years include XTO and Exxon ($41B deal), El Paso and Kinder ($21B), and Petrohawk and BHP ($12B). The Petrohawk-BHP deal was valued at 17x EBITDA multiple -- trailing basis -- and 7x EBITDA on a forward basis. Based on SandRidge's trailing $1B EBITDA, a 7x multiple would put the buyout valuation at a close to a 100% premium to its current $6.66 per share stock price.
I see the oil and gas company's focus on development and production of assets in the Mid-Continent area of Oklahoma and Kansas, and in western Texas as solid opportunities. One positive is that the estimated proven reserves are around 50/50 oil and gas, which gives the energy company a solid mix and less exposure to the volatile oil industry. The natural gas market has been beaten down of late due to lower than expected gas prices. The natural gas companies have seen pressure across the board, where the First Trust Natural Gas ETF is down over 15% year to date. SandRidge is down only 23%, but this is in part due to the fact that the stock is up 10% over the last month after getting some hedge fund backers.
What's really driving my investment thesis is the fact that a number of hedge funds are supporting the breakup of the energy company. The value in SandRidge is its asset base and the fundamental issue is that management is mismanaging the assets. The short interest comes in at 16%, which suggests any sort of positive news from the company could promote a short squeeze. TPG sees that the assets will be useless in a couple years if management does not rearrange its utilization. The underlying issues for the energy company is its large overhead costs and high a cost of capital.
With the Permian Basin asset selloff, SandRidge plans to refocus on its Mississippi operations, where its owns a net 1.85M acres. Placing a $1,500 per acre value - the same as in the Petrohawk-BHP deal - the land value for these properties alone come to $2.8B. Due to continued inability to effectively execute monetization, earnings for the most recent year are negative, but the depressed 1.5x P/S ratios could easily trade more in line with the industry average, and other peers Petroquest (2.4x), Energen Corporation (2.4x.). Assuming SandRidge can restructure its management and asset utilization it could easily trade at come more in line with peers, then a 2.4x price to sales ratio on next year's sales estimates shows potential upside of over 100%.
There is a lot that must fall into place, but given the hedge fund support and solid asset base this could be a solid addition to a speculative portfolio.