By Agnes Grunfeld, Managing Director, and Sonja Ryst, Research Analyst
The pressure on SandRidge Energy, Inc. (SD) continues mounting as critics protest about the Oklahoma oil and natural gas company's corporate governance. But SandRidge has shown warning signs of corporate governance problems for more than a year.
On January 17 the shareholder Mount Kellett Capital Management LP asked for an investigation and renewed its call in November for the suspension of SandRidge's CEO Tom Ward, noting the December allegations of another shareholder, TPG-Axon, such as that Mr. Ward and his son Trent Ward acquired mineral rights from third parties ahead of the company and then flipped them to SandRidge or other oil and gas companies at a profit. Meanwhile TPG-Axon pushed ahead on January 16 with its continuing effort to replace SandRidge's current board directors with its own nominees.
Adding fuel to the fire, Reuters published an investigative piece two days earlier outlining how Mr. Ward melded his own financial interests with those of SandRidge using business practices similar to those of Chesapeake Energy Corp.'s CEO Aubrey McClendon. Reuters had reported last spring that by using a program enabling him to acquire stakes in wells the energy company drilled, Mr. McClendon had borrowed as much as $1.1 billion in unreported loans over the last three years.
GMI Ratings put the company on its risk list in October 2011, noting issues such as the board's having approved a number of related party transactions. For example, SandRidge's audit committee chair Everett R. Dobson and Mr. Ward are both minority owners in the Professional Basketball Club, LLC (PBC), which in turn owns the Oklahoma City Thunder, an NBA team based in the company's hometown. In September 2008 SandRidge entered into a five year agreement to pay an average annual sponsorship fee of around $3.275 million for advertising and promotional activities related to Thunder.
Moreover, SandRidge's financial statements show signs that management presents its finances in the best light possible at the risk of disappointing investors down the line, rather than taking a more conservative stance. For example, SandRidge follows the full cost method of accounting for oil and natural gas activities, rather than the successful efforts method. While both are allowable under Generally Accepted Accounting Principles, under full cost all direct and indirect acquisition, exploration, and development costs are capitalized, while under successful efforts many of these costs are charged to expense as incurred if they do not result in proved reserves. In the short run, using the full cost method favored by SandRidge improves reported earnings. However, under this method capitalized costs eventually become subject to a limit, which the company reached in 2008 and 2009. This triggered large impairment charges on their natural gas and oil properties because although proved reserves were revised upwards in 2008, the deterioration in the price of natural gas and oil that year offset the increase. The situation worsened in 2009, when proved reserves were revised downwards. As of its most recent annual report published in February 2012, SandRidge continued using the full cost method of accounting for costs related to its oil and natural gas properties.
SandRidge's financial statements reflected an AGR ® score of 7 in December 2009, indicating higher accounting and governance risk than 93% of comparable companies. Since then the score has risen no higher than a 22, and it was most recently a 16 as of December.
TPG-Axon sent a letter on Nov. 8 to the board outlining offenses ranging from reckless spending to the stock's decline since its initial public offering in 2007. The activist investor said the board should consider selling SandRidge, ousting CEO Tom Ward, and replacing some directors with more "credible, independent" people chosen after extensive consultation with large shareholders. On January 15 TPG-Axon proposed that shareholders elect instead Stephen C. Beasley, Edward W. Moneypenny, Fredric G. Reynolds, Peter H. Rothschild, Dinakar Singh, Alan J. Weber and Dan A. Westbrook.
SandRidge had said in a filing this month that TPG-Axon's nominees would "encourage and facilitate a sale or dramatic restructuring of the Company for the benefit of the TPG-Axon Group and to the potential detriment of the Company's other stockholders."
SandRidge had also responded on Nov. 8 that it is always open to constructive engagement with its shareholders. "While our perspectives on various points made in the letter from TPG-Axon differ in many instances, we agree that SandRidge has valuable assets and that we need to focus on improving performance for shareholders," SandRidge said. The board added that it was working with management toward that end.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.