In early June, SandRidge (NYSE:SD) announced the sale of its subsidiary SandRidge Tertiary LLC to CO2 Investments, LLC in a deal that will see $130 million in cash added to SandRidge's balance sheet. According to SandRidge, SandRidge Tertiary "is the sole gatherer of CO2 from the four natural gas treatment plants located in the West Texas Overthrust". West Texas is a major center for tertiary oil recovery. Major CO2 recovery projects in this area include operations from Occidental Permian, a subsidiary of Occidental Petroleum (NYSE:OXY), Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM).
Oxy is the largest injector of CO2 for enhanced recovery in the United States, injecting over 550 bcf of CO2 in the Permian Basin in 2011 alone. Oxy operates a natural gas processing facility in West Texas to fulfill its needs in a joint venture with SandRidge. It is unclear how the sale of SandRidge Tertiary will impact the joint venture, though on its face I think it is likely Oxy is looking at higher costs for methane takeaway as it is not currently using most of the methane separated during processing at the plant.
SandRidge & Chesapeake, Ward & McClendon
Late last month, securities arbitration law firm Klayman & Toskes, P.A. announced it was investigating SandRidge on behalf of its clients for "investment losses due to…over-concentration", though responsibility for over-concentration would not lie with SandRidge. A recently announced investigation by the Shareholders Foundation, Incorporated ups the ante. The Shareholders Foundation is indicating that it believes SandRidge violated securities law by materially misrepresenting SandRidge's "business, prospects, and operations." According to the Shareholders Foundation s website, its proceedings are currently classified as an investigation only, and no suit has been filed.
I think that it was only a matter of time before lawsuits targeting SandRidge came to the fore, given SandRidge CEO Tom Ward's close relationship with Chesapeake (NYSE:CHK) CEO Aubrey McClendon. It's also not surprising that the Shareholders Foundation investigated and filed suit against McClendon and certain members of Chesapeake's board last April, alleging that McClendon's participation in Chesapeake's Founders Well Participation Program and subsequent mortgaging of his interests "represented undisclosed risks to Chesapeake Energy investors". The Shareholders Foundation also charges that McClendon's actions represent a conflict of interest that "could compromise his fiduciary duty to Chesapeake investors." The action against Chesapeake is filed with the U.S. District Court for the Western District of Oklahoma, Deborah G Mallow IRA SEP Investment Plan vs Aubrey McClendon, et al., No: 5:12-00436.
As SandRidge and Chesapeake both struggle against low natural gas prices and an increasingly aggressive shareholder base, I think it's increasingly clear that McClendon is basing many of his decisions on what worked in the past for Ward. The problem is McClendon is not Ward. Take for example Chesapeake's recently shelved IPO for Chesapeake Oilfield Services. The IPO of Chesapeake Oilfield Services was a Hail Mary play for Chesapeake's funding gap. At the time the IPO was announced, Chesapeake was already aware of its impending shortfalls and was marketing several of its assets, including the Mississippi Lime in Kansas and Oklahoma and acreage in the Williston Basin. In addition to these holdings, Chesapeake is now also marketing assets in the Permian Basin and the Denver Basin, and is looking for a joint venture partner for the assets in the Mississippi Lime it plans to hold.
Oil India is showing interest in a potential partnership, but given that hydraulic fracturing company FTS International Services LLC underwent a ratings downgrade by Standard & Poor's last week over its relationship to Chesapeake and Chesapeake's reduced drilling forecasts, Oil India and any other potential partners will be stepping carefully and shopping for the best deal possible out of Chesapeake.
Two things about this string of events remind me of Ward's leadership at SandRidge. First, under Ward's guidance SandRidge engineered a number of successful IPOs with the purpose of divesting SandRidge's royalty interests to trust instruments, which instruments in turn pay SandRidge the net proceeds of the offering. The most recent such IPO was for SandRidge Mississippian Trust II (NYSE:SDR). This sounds suspiciously like Chesapeake's plan for Chesapeake Oilfield Services, as outlined in the original S-1, as Chesapeake planned to retain 80% ownership of the Oilfield Services unit.
Secondly, the strategy of seeking joint venture partners is commonplace in this industry, but Ward is a master at exploiting and promoting these arrangements. Last year, SandRidge announced a major joint venture with a subsidiary of Repsol YPF valued at $1 billion, as well as a smaller but still material joint venture with an affiliate of Korea-based Atinum Partners Company, Ltd., in which SandRidge sold a non-operated working interest in 113,000 net acres in the Mississippian play to Atinum for $500 million.
What distinguishes these financial deals authored by SandRidge and Chesapeake (or Ward and McClendon) from daily deals by other energy independents is the fact that neither SandRidge nor Chesapeake has another reliable source of funds. Compared to net leasehold acreage, I believe both firms are far under-producing and over-leveraged for their respective market caps. Additionally, even as Chesapeake tries to raise cash through asset sales, the company is being criticized for continuing to engage in risky investments - which criticism is also leveled at SandRidge.
SandRidge stock is currently battered, trading around $6 per share, 28% below where it began the year. Despite the low trades, the price to book is still high at 2.0, with a forward price to earnings is 19.1. This reinforces the fact that SandRidge is overleveraged and under-producing, with a debt to equity of 1.9. For these unattractive value ratios, SandRidge offers proved reserves of 533 mboe, which are 53% developed. As SandRidge operates in two of the U.S.'s most promising plays, the Permian and the Mississippian, there is a great deal of room for these numbers to move up. Additionally, SandRidge's net operating cash flow from the first quarter 2012 of $153 million and cash balance of $600 million indicate that while SandRidge will not be making major headway on developing its acreage, it is at least able to drill - which the hamstrung Chesapeake is less and less able to do.
For these reasons, I am cautiously bullish on SandRidge. The major concern here is that further inquiry into McClendon's dealings at Chesapeake will uncover information damaging to Ward. However, SandRidge's price to earnings is certainly on the high side, so until SandRidge finds its footing it may be better to hold than acquire.