SandRidge Energy's Bankruptcy Is An Early Termination

| About: SandRidge Energy, (SD)


The company is still very liquid, holding over $600 million of cash.

Improving macro environment should improve results going forward.

The equity's time value was lost.

You can forecast how the company will perform, but it's difficult to know what the management will do.

So the rumors were true. On Monday, SandRidge Energy (NYSE:SD) (OTCMKT: OTCPK:SDOC) filed for bankruptcy, and if the plan is approved, existing shares will be canceled. While I had a good idea of what the management should do (The Unnecessary Bankruptcy), unfortunately I did not have the foresight to predict what the management will do. Since the company filed Q1 results as well, let's see how the company was doing.

Still Liquid

Yes, the management did decide to file for bankruptcy, but as of Q1, the company was in very good shape from a liquidity perspective. While the cash burn was significant at $230 million, keep in mind that the commodity market reached its low in Q1. Oil slumped to its 13-year low and natural gas dropped to its lowest point in more than a decade. As I've mentioned in my previous articles, things are looking a lot better now as commodities have continued to climb.

In Q1, the average price achieved per barrel of oil was $27.95, today, WTI is standing at $47.92/bbl, almost a $20/bbl difference. It is also $4.02/bbl higher than the actual realized price (including hedges) of $43.93/bbl. At ~1.5 MMbbl of quarterly production, selling at today's price would mean that the company can at least generate $6 million of incremental cash flow. As for natural gas, today's price of $2.04/mmBtu is $0.43 higher than the actual realized price of $1.61. With ~15 Bcf of quarterly production, the price increase can give rise to more than $6 million of cash flow.

In addition to an improving macro environment, the company also had $694 million of cash at the end of Q1, which was reduced to a bit over $600 million as of the date of the bankruptcy filing. With this pile of cash, the company should have no problem in reducing the balance on the credit facility to the permitted borrowing base. In the 10-Q, the management disclosed that on April 20th (an important which I talked about extensively here) the company chose to submit additional property for consideration. So, in all likelihood, the company did not have to pay the difference back anyways.

Illogical Decision

I agree with the management, who has stated going concern issues, that even at today's prices, the company can't survive in the long-run. But that shouldn't prevent the management from trying to realize as much equity value as possible for shareholders. If we want to get a bit academic, equity essentially acts like a call option on assets (which is current appreciating!), and as options are concerned, value increases with time until expiration. Because current prices are not going to save equity holders, common shares are essentially out of the money options on the company's assets (i.e. oil reserves). While the option (equity) may be intrinsically worthless today, it still has some time value. Unfortunately, if the bankruptcy gets approved, the management would be prematurely giving up this value.

Lesson Learned

While one can attempt to dissect the company's financials, one can never truly be sure of what the management is thinking. To relate this back to the V20 Portfolio, two of its holdings (MagicJack and Dex Media) suffered from "execution risk" as the management made decisions that significantly impaired the stocks' upside. I don't think this is a risk that can truly be hedged away, and this is why Buffett prizes management's ability above all else. However, a risky holding like SandRidge should never have occupied a significant portion of your portfolio anyways. As I mentioned in one of my previous articles, SandRidge was a good option on oil (and it still is, if the management didn't push the company into bankruptcy), but you must be prepared to suffer a total loss.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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