This week I was fortunate enough to be able to take part in a Seeking Alpha interview with SandRidge Energy's (SD) CEO Tom Ward. Mr. Ward was very generous with his time and allowed us as much time as we needed to pick his brain.
I decided to take the information I obtained from the interview and summarize the points that I think investors or potential investors in SandRidge would be interested in.
1) Why SandRidge's Share Price May Rise Significantly in the Next Few Years
I personally think SandRidge has some very attractive assets, the value of which is not being reflected in the current share price. As part of the interview I asked Ward what could help eliminate this discount and send SandRidge's shares higher.
His answer was simple, and I think pretty sensible. Ward simply said that you can't triple cash flow or EBITDA in three years, and not have your stock price double or triple along with it.
And a tripling EBITDA is the exactly the SandRidge three-year plan. How is the company going to do it? Check out the most recent SandRidge presentation which provides the details. With 7,000 drilling locations in the Mississippian and another 7,000-plus in the Permian Basin, there is no doubt that SandRidge has the acreage to grow production for a long time.
2) A $400 Million Investment Worth Almost $9 Billion
There was no way we could discuss SandRidge with its CEO without spending some time on the home run the company has hit in the Mississippian play.
The Mississippian is found in Oklahoma and Kansas. It is a shallow, carbonate oil play where SandRidge has accumulated 1.5 million acres. SandRidge believes that it has 7,000 drilling locations on this acreage with an IRR per well of 91%.
The key to the value creation is that SandRidge acquired all of these acres when they were not in demand, before the industry was on to the economics of the play.
Here are the three phases that SandRidge has gone through in the Mississippian:
Phase 1 - Accumulation
Acres Acquired - 2 million
Average Cost Per Acre - $200
Total Amount Paid - $400 million
Phase 2 - Monetization
Acres Sold - 550,000
Average Price Received Per Acre - $4,236
Total Amount Received - $2.33 billion
Phase 3 - Retained Value
Acres Retained - 1.5 million
Value per acre based on monetizations - $4,236
Total value Retained - $6.35 billion
I'm not playing with you, those are the actual numbers.
Two million acres were acquired for $400 million. About a quarter of those acres were sold for $2.33 billion. And SandRidge retains acreage worth roughly $6.35 billion.
$400 million invested, with proceeds from sale and current value equaling $8.68 billion. Try to match those two-year returns with your equity portfolio.
If Ward were a hedge fund manager who had turned $400 million into $8.6 billion in a couple of years we would be hearing about it every day on the financial networks.
3) SandRidge Is Run By a Guy With the Guts To Make A Hard Decision
CEO Ward was a founding partner of Chesapeake Energy with Aubrey McClendon. In 2006 Ward split from Chesapeake to form SandRidge.
SandRidge was formed with the intention of being a natural gas producer with Ward believing that $7/mcf natural gas or higher was the likely future for the United States.
By 2008 Ward and his management team believed that they had made a mistake in choosing natural gas as the commodity upon which to base the company. In late 2008 SandRidge hedged all of its natural gas production for the next two years in order to buy the company time to make a transition to oil.
In March 2009 Ward went to SandRidge's Board of Directors with the message that the company should acquire assets in the Permian basin. And that is what SandRidge did, with an $800 million acquisition from Forest Oil and the $1.2 billion acquisition of Arena Resources.
If you look at the prices of oil and natural gas today, it is pretty clear that Ward made the right call in aggressively changing the focus of SandRidge. Back in 2008 and 2009, however, it must have taken some serious courage to first admit that the company had made a big mistake in focusing on natural gas, and then second to make two large oil transactions that at the time were very controversial with SandRidge shareholders.
The easy decision in 2008 would have been to do nothing and to hope for a recovery in natural gas. The easy decision would have been the wrong one.
4) Why SandRidge Acquired Dynamic Offshore
This year SandRidge made a $1.275 acquisition of Dynamic Resources. Ward took quite a bit of heat for this acquisition because like the oil-focused Forest and Arena transactions, this one also took shareholders by surprise.
The Dynamic deal was a surprise because SandRidge had been publicly making an exit from operations in the Gulf of Mexico and this was an acquisition of a Gulf of Mexico producer. Shareholders and analysts don't like surprises or changes of direction.
I wrote for Seeking Alpha shortly after the transaction that I thought the deal made a lot of sense for two reasons. One being that the properties were acquired at an extremely attractive price even though it involved issuing equity. The second being that the acquisition, which was done with equity, was a sensible way to bring increased cash flows to fund SandRidge's aggressive capital spending plans and also further deleverage the company.
Ward spoke in the interview about the Dynamic acquisition and how it helped fulfill SandRidge's 2012 funding needs:
"We have a three-year strategy that no other company in the U.S. has, and that's that we're going to triple EBITDA, we're going to double our oil production, and we'll spend within our cash flow by the end of 2014; and all the while, we'll be improving our credit metrics.
So in order to do those four things, we have to raise some capital.
And one those capital raises was a financial transaction, which was buying Dynamic Resources. That acquisition of Dynamic gave us better credit, increased our production by 25,000 barrels a day and gave us the ability then to move forward and improve our credit metrics. Dynamic was the only place you could go buy oil at a price that allowed us to be accretive [on oil] metrics. And that's just because people don't want to be producing in the Gulf of Mexico in 300 foot of water and we just don't see that as an obstacle that makes it worth a third as much as Permian oil."
5) Tom Ward's View on Oil and Natural Gas Prices
Going into this interview one thing I wanted to tap into was Ward's view on oil and natural gas prices going forward.
When we asked him about the future direction of oil prices we got a pretty good answer:
"…the great thing is that I don't have to be a great prognosticator on oil prices, as long as they're over $100 a barrel, because we make 100% rates of return. If we have that ability, then we should hedge it and lock in those prices. And so you see us having the most hedged oil book of any company in the U.S., as we go forward and look into 2013, 2014, and then as we're moving. So, to answer your question, I still believe that you'll have ups and downs in the oil market, we'll see volatility like we have every year, and you'll be able to have prices range between $90 to $120 a barrel, and what we have to do as a company is just be diligent in locking in anything that gives us 100% rates of return. So any time you see oil at a $100, you'll see us hedging out our oil fairly aggressively. In fact, we have over 80% of our oil hedged for 2012 already."
Ward believes that high oil prices are likely the norm going forward, albeit not without the usual swings up and down. The SandRidge strategy is to not be greedy, but rather to lock in (hedge) as much oil production as possible at current prices so that SandRidge can mint money drilling Mississippian and Permian wells.
I expect, like many people do, that this summer is going to see some incredible stress on natural gas producers as natural gas prices stay painfully low. With that in mind I asked Ward if there was any price at which he might be interested in acquiring some natural gas assets from cash-starved competitors.
His immediate answer was that SandRidge was not likely going to be interested in any natural gas assets because SandRidge's capital would achieve much higher returns being invested in SandRidge's high return Mississippian and Permian drilling programs.
With respect to the price of natural gas, Ward thinks current prices are unsustainable and are likely to double from current levels (roughly $2/mcf) over the next year. He doesn't think buying natural gas assets today is a bad idea, just that it would not be the best use of SandRidge's capital.
What Is My Position On SandRidge?
I think SandRidge is likely going to make for an excellent investment at current prices for investors with a three-year time horizon. As Ward said, if EBITDA triples the stock price pretty much has to follow.
And there doesn't seem to be much short of another 2008 financial panic that can stop SandRidge's EBITDA from doing exactly that. The funding for this EBITDA ramp-up seems secure as it is going to come from SandRidge's cash flow (which is predictable as most of its revenue is locked in through oil hedges), an untapped credit line and already closed asset sales.
Despite all of this I'm going to continue to be an interested observer of SandRidge and not a shareholder. I manage a very concentrated portfolio, and that means I need try to avoid companies that carry a lot of debt. SandRidge, which currently has a debt to EBITDA ratio of over 3 to 1, would have to qualify as a company that carries a lot of debt.
For investors with less concentrated portfolios, I think SandRidge makes a lot of sense.