SandRidge Energy, Inc. (fka SDOCQ)

[catdaddyrt]

Clayton Rulli
Long/short equity, value, momentum, options
Profile| Send Message| Follow (528)
SandRidge Energy: Hidden Value & Growth Are Underestimated
Apr. 21, 2014 8:51 AM ET | About: SD

Disclosure: I am long SD. (More...)

Summary

SandRidge Energy may not be worth the entire farm, but there is plenty reason to be long.
New management has been and will continue to cut well costs, while increasing production at a 20%-25% CAGR through 2016.
SandRidge's proposed midstream spin-off is worth over $1 B to the MLP market, and could be a big catalyst to unlocking value.

Not just a respectful rebuttal: Know the past to respect the present

Most of us are familiar with the utter disaster SandRidge Energy (SD) turned out to be under Tom Ward's leadership. If you aren't, I summarized TPG-Axon's scornful summary some time ago- here. Despite the gruesome history, I've been long SD for quite some time, and I'm proud to say I voted to oust Tom Ward. In fact, I covered SD in my first article for SA some years back. As a shareholder, I follow the company extensively and can see new management is really shaking things up. I'm not providing this background because I care if you click my links, but because it's imperative you understand SD's history, or the "before", if you are to appreciate the "after", I'm about explain. Admittedly, much of this article is intended as a respectful rebuttal to Value Digger's recent article, an SA author I hold in high regard.

Cost cuts continue to impress

The company is, as Leon Cooperman said, a "phoenix rising from the ashes", and new management continues to send the flaming bird higher and higher each quarter. With critical focus on cutting drilling costs, capex has been cut from $2.3 B to 1.5 B, a 34% improvement, and G&A has been reduced from $200 MM to $135 MM annually, a 32% improvement. In addition, well costs and LOEs are at record lows, as well design improvements decreased costs by ~$255 M per well, or 45%. Incase some lost track of time, it's been just 2 years since Ward was ousted. Why are these amazing cost reductions being swept under the rug?

New technologies can drive growth and efficiency

Incase you're still not impressed, SandRidge has new ground breaking technologies which should continue to drive efficiencies as they are further implemented this year. Specifically, SandRidge plans to pursue its dual, stacked, and tri-lateral program at several sites, which are estimated to lower costs by $1 MM:(click to enlarge)

Looking ahead, SandRidge estimates well costs will continue to improve, and are said to decline from $3 M to $2.7 M through 2016, and who knows, additional well innovations could drive IRR improvement longer term as technology and additional knowledge of the acreage develops.

Considering these savings, SD projects production will increase at a 20%-25% CAGR through 2016, which will total an almost doubling of production over 3 years time. As over all Cap-Ex remain "relatively flattish" in this time, well do the math; SD projects EBITDA will improve dramatically by 30%. Of course, this will take time to manifest, but just seeing what has happened in the past two years, well you could say I'm a believer.

What is SD worth?

So far, decreased costs has been SD's bread and butter, however we shouldn't forget asset value. First to mention, SD has proposed spinning off it's midstream assets, specifically its electrical infastructure and/or salt water disposal system. The 900 miles of salt water disposal system is the nation's largest of its kind, which currently processes nearly 1 B barrels of water per day, with assets in Oklahoma, Kansas and Texas. Also, an intricate electrical system has been elemental to reduce costs, as limited use of generators which run on diesel is nice reduction in costs.

At year end 2013, roughly $470 M was invested the midstream business, and rightfully so. Without it, drilling and operating wells in the Mississippian would be far more expensive, as some competitors experience as they transport spent water by truck. Recently, SD announced just 1% of total produced water was transported by wheel, down from 5.5% in 2012- a big savings. Given these assets are said to inherently produce roughly $135 M in EBITDA, CEO Bennett thinks this critical business arm could be worth $1.15 B using a 9x EBITDA multiple, a nice little profit from the $470 M spent YE 2013. SD plans to generate audited financial results to prove these EBITDA levels through this year in preparation for an MLP spinoff, and shareholders are hoping this is successful as the move should unlock hidden value.

EV value

SD has ~$3.2 B in senior notes, ~$765 in preferred stock, and a market cap of ~$3.34 B. Adding these metrics we can calculate the EV equals $7.3 B. Now, if we figure the company received ~$750 M in cash from the GOM asset sale and had ~$814 M in cash at year end 2013, we get a total of $1.56 B in cash. With this we can estimate a total EV of ~ $5.74 B net cash.

Now, lets consider SD's traditional oil and gas assets as well as the midstream MLP possibility. Based on YE13 SEC pricing of $93.42/$3.67, SD assets have a PV-10 of $4.1 B. Add in the ~$1B at a 9X EBITDA multiple for the proposed MLP spin off and we can subtract out $5.1B to get a better vibe for SD's total asset base. SO we came up with a PV-10 of $4.1 B and $1 B in midstream MLP spinoff value, versus a total EV of $5.74 B net cash- not bad. So after a coffee and some calculator punching, we can adventurously conclude SD does have some hidden value, but lets take it a step further.

Valuing SD with the proposed MLP spinoff

If we were to use the EV of $5.74 B net GOM asset sale and net cash from above, as well as assume the MLP will be spun off for $1 B in cash, we could use $4.74 B for EV. If we use 2014's EBITDA guidance of $859 M as per slide 26, then subtract the current $20 M EBITDA from the midstream assets, we get an EV/EBITDA multiple of 5.65x (($4.74 B / ($859 M-$20 M)). To get his number I am assuming the auditing of the current midstream assets will result in much higher EBITDA readings, as per CEO Bennett's estimates. Not too shabby, especially when compared to others in the industry.

Now, I'm not proposing the midstream segment will magically grow EBITDA from $20 m to $135 m by marketing to other companies drilling in the area. I am saying the segment already does inherently generate close to this level of savings for the company and thus when measured as if an outside entity charging SD, the EBITDA number will tally to these levels. Let's crunch more numbers.

SD invested $470 M in these assets as per year end 2013, and plans on investing another $100 M or so as per 2014 guidance in slide 27:

Do you think they'd sell $570 M in invested capital that inherently generates over $100 M in EBITDA for just $400 M? I sincerely doubt it. There is simply far too much capital tied up in this system, and again I believe the potential earnings of this segment are hidden and have only been measured thus far in well costs, in which the segment has greatly contributed to reductions or cost savings in that department. Up until now, SD has had no reason to "pay itself" or record the usage of disposal wells or electric transmission lines in terms of EBITDA. Therefore I believe the $20 M currently generated is raw EBITDA, which is only paid by outside companies using the system. Hopefully SD can provide more color on this as 2014 unfolds and as audits come in with reports. However, I believe Value Digger's numbers were far too low for this segment, and were only based on the unpolished $20 M EBITDA that does little to recognize the real value in midstream assets.

Summary:

Assuming SandRidge successfully navigates a recent government inquiry, and the audit of midstream assets do prove a real value of $1 B in MLP value, SD trades at an EV/EBITDA multiple of 5.65x 2014's guidance. Morever, SD is determined to nearly double production by 2016 and improve EBITDA by 30%, driven by further reducing well costs from $3 m to $2.7 M during this period. Mind you, SD will also have a 2013 PV-10 of $4.1 B as a backdrop. As a bonus, Leon Cooperman is at my side as a fellow shareholder. What's not to like about this story?

Additional disclosure: I have a history of selling covered calls against my position, and I could do so again at any time



http://seekingalpha.com/article/2150893-sandridge-energy-hidden-value-and-growth-are-underestimated?isDirectRoadblock=false&uprof=45