When looking at the actions of
Sandridge Energy's (NYSE:
SD
)
CEO Tom Ward, the phrase "heads I win, tails you lose," comes to
mind.
He's overseen an 80% plunge in his company'sstock since
Sandridge's 2007IPO , yet has been rewarded with roughly $150
million in compensation since then. Adding insult, he has been
given a free hand to buy up key parcels ofreal estate that are
adjacent to company-owned acreage, and sell this land to company
rivals, without the need to disclose such transactions to
shareholders. (A practice that should be quite illegal, or at least
quite discouraged.)
Dissident shareholders have had enough. A pair ofhedge funds ,
each owning more than 5% of the company have asked other investors
to support theirproxy efforts to oust the board and management, in
a vote to be held on March 15. These hedge funds contend thatshares
are quiteundervalued in the context of Sandridge'sasset base and
would likely rise in value if a new board and management team
wereput into place.
In light of recently announced quarterly results that show
Sandridge's real estate holdings to have a much greater bias toward
low-priced natural gas and much smaller exposure to pricier crude
oil, it's not clear whether these activist investors are even on
the mark when looking forupside .
In a very cogent analysis, the author of
this article
makes a strong case that shares are indeed fully valued
orovervalued in the context of recent industry real estate
transactions.
Yet there is an even better reason for this management team and
board directors to hand over the keys to new leadership: On its
current course, Sandridge may burn through almost all of itscash ,
so shares may head to just $1.
At least that's the view Canaccord's John Gerdes holds.
A ticking time bomb
Sandridge made the same mistake as many energy drillers: overpaying
for shale-focused real estate a few years ago, only to see plunging
gas prices create much weaker cash flows once the oil and gas
started flowing. Like its peers, Sandridge has been forced to
unload various assets (targeting $2 billion worth of assets in the
process), but the companywill still carry more than $3 billion in
debt on itsbalance sheet when those asset sales are complete.
And as far as Gerdes is concerned, thisdebt load will create
real trouble.
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As he sees it, Sandridge's capital spending plans, which have
not been reduced despite the company's weak balance sheet, are
foolhardy. "The company now outspendscash flow by $1.3 billion per
annum." (Not just this year, but every year until 2017.) He adds
that whilenet debt seems manageable now, at around three times
projectedEBITDA , he expects "this criticalleverage statistic to
rise to over 4x at year end '14, and an untenable 5x by year-end
'15." This math even comes with the assumption that Sandridge will
realize full value for the assets it has recently put on the
block.
How does Gerdes arrive at that $1price target ? That price
equates to amarket value of $600 million, which is what he says the
company's asset base and cash flow generation potential will be
worth after the company's debts are accounted for.
CEO Ward acknowledges the projected cash flow deficits that
willaccrue from his spending plans, but he appears to be counting
on an eventual strong rebound in natural gas prices to sharply
improve theeconomics of Sandridge's major shale plays. To be sure,
gas prices have nearly doubled since hitting bottom a year ago --
recently hitting $3.58 per thousand cubic feet (
MCF
) -- though it seems foolish to simply bank on furthergains to
rescue thisbusiness model .
Other views
To be sure, Gerdes is the mostbearish analyst following the
company. Otheranalysts take a somewhat brighter view and see shares
closer tofair value at a recent $5.80.
- UBS rates the stock as "neutral" with a $6 price target,
noting that "SD offers investors meaningful unbooked resource
potential from the Horizontal Mississippi but is burdened with
continuing high financial leverage and a significantFCF deficit
over the next few years. In addition to the high financial
leverage and organic FCF deficits, investors have a new concern:
Its crown jewel asset in the Horizontal Mississippi is performing
below type curve expectations and appears to be more gassy than
initially expected."
- Goldman Sachs also has a $6 price target but rates it a
"sell," noting that they trade for 6.5 times projected 2014
EBITDA. The company's peers trade at amultiple of 4.6.
- BMO recently downgraded the stock to "underperform ," with a
$4 price target. They suggest that "the stock remains
significantly overvalued as rates of return in the horizontal
Mississippian play aren't strong enough to support the
currentequity value."
Risks to Consider:
As an upside risk, firming natural gas prices, more robust real
estate transaction valuations, or a change in management could help
boost shares.
Action to Take -->
Though the activist hedge funds correctlynote that this is a
company headed for deeper trouble under current management, they
appear to be overestimating any potential upside, even if they can
bring in new leadership. This company has been boxed in by a string
of badinvestments , so a sharp reduction in capital spending
appears inevitable. Yet this would make it harder to generate the
cash flows required by the company's debt covenants.
Short sellers alsospot more downside ahead. They currently hold
13% of thefloat , or 50 million shares, in short accounts. This
stock has been a slow motion train wreck for several years, and the
train isn't slowing down.
-- David Sterman
P.S. -- The abundance of natural gas in the U.S. could lead to a
third industrial revolution. One analyst is predicting a stock
could rise 1,566%. Another stock has already jumped over 1,000% and
is expected to keep going. To learn more about investing in the
natural gas boom, click here.
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.