Sanchez Energy: When An IPO Isn't

| About: Sanchez Energy (SN)
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An IPO generally raises cash for the purpose of growing and expanding a business, but not all IPOs are created equal. Take Sanchez Energy (NYSE:SN) for instance, an oil and gas company that went public in December, raising 200 million dollars. The IPO was underwritten by Johnson Rice & Co. LLC and Macquarie Capital Inc.

Johnson Rice & Co. LLC is a New Orleans-based investment company founded in 1987 specializing in the both the retail and oil and gas industries. Johnson Rice claims to have nine senior analysts and thee associate analysts covering companies in both industries. Interestingly enough Sanchez Energy does not appear to be one of the companies currently covered by their analysts. The fact that the underwriter of an IPO does not follow the security it brought public should be an immediate red flag to investors.

Macquarie Capital Inc. is a subsidiary of Macquarie Group, Ltd., the largest investment bank in Australia that has a long and storied history that includes ties to Royal Dutch Shell Petroleum (NYSE:RDS.A). Macquarie claims to have 10 years of experience in the U.S. energy markets. Macquarie Group has also come under regulatory scrutiny back in Australia over its apparent involvement in a telco scam.

Many investors use Yahoo Finance to view information on stocks as the platform has been well developed since the inception of the public worldwide web. Using Yahoo’s platform, one will find that there are no public corporations holding Sanchez Energy stock since its public debut. And aside from the CEO, Antonio R. Sanchez III, and an obscure holding company known as Sanchez Energy Partners, there appears to be no major shareholders. So what is going on here?

According to Sanchez Energy’s first SEC 8K Filing since going public on December 19th, 2011:

(e) On December 30, 2011, one-time discretionary cash bonuses in the amounts of $350,000 to Antonio R. Sanchez, III, the Company's President, Chief Executive Officer and Chairman and $150,000 to Michael G. Long, the Company's Vice President and Chief Financial Officer were approved. The bonuses are being paid in connection with, and in recognition of, Messrs. Sanchez's and Long's contributions to the successful completion of Sanchez Energy Corporation's initial public offering in December 2011. Mr. Long's bonus was paid on December 30, 2011 and Mr. Sanchez's bonus is expected to be paid in January 2012.

The initial 8K filed on December 23, 2011 stated that Sanchez Energy had entered into a “services” agreement with Sanchez Oil and Gas Corporation of Laredo, Texas:

On December 19, 2011, in connection with the closing of the IPO, the Company entered into a Services Agreement (the "Services Agreement") with Sanchez Oil & Gas Corporation ("SOG"), pursuant to which employees of SOG will be provided to the Company to provide certain services to the Company with respect to the Company's business under the direction, supervision and control of SOG. The Company is to compensate SOG for the provision of services to the Company at a price equal to SOG's cost of providing such services, including all direct costs and indirect administrative and overhead costs (including the allocable portion of salary, bonus, incentive compensation and other amounts paid to persons that provide the services on SOG's behalf) allocated in accordance with SOG's regular and consistent accounting practices, including for any such costs arising from amounts paid directly by Sanchez Energy Partners I, LP ("SEP I") or any of its affiliates (SEP I and its affiliates (excluding the Company), together with SOG, the "Sanchez Group") on SOG's behalf or borrowed by SOG from other members of the Sanchez Group, in each case in connection with the performance by SOG of services on the Company's behalf. The Company will also reimburse SOG for sales, use or other taxes, or other fees or assessments imposed by law in connection with the provision of services to the Company (other than income, franchise or margin taxes measured by SOG's net income or margin and other than any gross receipts or other privilege taxes imposed on SOG) and for any costs and expenses arising from or related to the engagement or retention of third party service providers.

This is where this story gets interesting. Sanchez Oil and Gas was founded by A.R. Sanchez, Sr. and Brian O’Brien back in the 1970s as Sanchez-Obrien Oil and Gas. A.R. Sanchez was an office supply salesman that knew all the ranchers around Laredo, and when geologist Brian E. O’Brien came calling, together, they were able to secure the mineral rights to what turned out to be one of the largest natural gas finds in the history of the United States and Texas on the Hereford Ranch. Both become instant millionaires and they created dozens of other local millionaires in the process. Sanchez went on to found the failed Tesoro Savings and Loan Company that went belly-up in the 1980s. Sanchez brilliantly hired away the key banking examiner that shut down his previous bank, (Dennis Nixon), and started the International Bank of Commerce, which today trades on the NYSE as IBOC. This bank made A.R. Sanchez’s son, A.R. Sanchez, Jr., half-a-billion dollars by the late 1990s. A.R. Sanchez, Jr. ran for governor against Rick Perry back in 2002 and lost.

A.R. Sanchez, III, CEO of Sanchez Energy is the son of A.R. Sanchez, Jr.

In my opinion, Sanchez Energy Corporation for all practical purposes appears to be a complex private financial arrangement by which A.R. Sanchez, Jr. is handing over the reins of Sanchez Oil & Gas to his son, A.R. Sanchez, III. I see no value to public shareholders at this time. Energy investors may wish to steer clear of this company until it becomes more apparent as to the intentions and capacity of Sanchez Energy to return value to would-be shareholders that are not insiders. The structure of this company leaves much to be desired in the way of transparency to be called a public corporation.

The float of this company is stated to be 32 million shares. According to the 8K:

The IPO closed on December 19, 2011 and the Company received net proceeds of approximately $202.7 million from the sale of the shares of Common Stock (net of estimated expenses and underwriting discounts and commissions). As described in the Prospectus, the Company paid $50 million of the net proceeds from the offering as partial consideration (together with its issuance to Sanchez Energy Partners I, LP ("SEP I") of up to approximately 22.1 million shares of its common stock) for the contribution by SEP I of the limited liability company interests in SEP Holdings III, LLC and approximately $89 million of the net proceeds as partial consideration (together with its issuance of 909,091 shares of the Common Stock) for the acquisition of the limited liability company interests in SN Marquis LLC. The Company intends to use the remaining net proceeds of approximately $64 million to fund its capital expenditures, and, in particular, its drilling, exploration and acquisition programs through December 2013, its other operating expenses, and for general corporate purposes.

If you understood that paragraph without having to read it twice, you are probably a forensic accountant. If you are like me, you are left scratching your head and asking more questions. The 22.1 million shares and 50 million bucks that went to Sanchez Energy Partners I, LP deserves closer scrutiny. Sanchez Energy Partners 1, L.P. was set up on July 18, 2008 by Frank A. Guerra, CFO of both Sanchez Oil and Gas and VP of the partnership. The sum of $254,000,000.00 was put up by 33 unnamed investors, each of which contributed a minimum of $1,000,000.00. Guerra is listed as a beneficial owner. Antonio R. Sanchez, III is listed as the President of the General Partner. A.R. Sanchez, Jr. is listed as the CEO of the General Partner, and Sanchez Oil & Gas is listed as the Sole Member of the General Partner.

The facts related to this company present a conundrum for would be investors. On one hand, the folks involved in this company have extensive experience in drilling for natural gas and an uncanny record of success during their days as a private company. They have drilled literally hundreds of successful wells. On the other hand, the formation of this new public enterprise and the fact that there are no known institutional investors or analysts following is disconcerting and should be a red flag for investors. Therefore, investors may wish to sit on the sidelines until it becomes more apparent how the company will reward stockholders other than the insiders.

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