Tuesday, June 16, 2015 7:26:04 AM
Hey lets get some more high interest debt, since that is what is sinking to company - more 8.75% debt should be the final blow imo 100dollar oil would have allowed SD to continue their 3 shell game but alas oil is down(and for the rest of the year) and most likely 2016 will get no relief.
best to get off while you can there is no play left here at this time-imo
the Edmund Fitzgerard has left the port fully loaded -it 's been good to know ya
https://www.youtube.com/watch?v=K6DUFPNILvM
Raw Energy
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Sandridge's B.S. Verse 2: 'Lien On Me'
Must Read | Jun. 15, 2015 6:15 AM ET | About: SandRidge Energy, Inc. (SD) Subscribers to SA PRO had an early look at this article. Learn more about PRO »
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
In a previous article the author examined an accounting treatment that made Sandridge Energy's Balance Sheet more precarious than thought.
Since that time SD raised $1.25 billion from a Note offering of 8.75% Senior Secured Notes due 2020.
The author summarizes major terms of the Note Indenture and the Revised Credit Agreement entered into by SD with its bank group.
Potential strategies and options for SD going forward are explored.
The author concludes that although the Note offering satisfied immediate liquidity issues, SD's financial position remains precarious and is likely to require significant restructuring to survive.
Introduction
In my previous article on Sandridge Energy (NYSE:SD), I examined an obscure accounting treatment that made its financial condition more precarious than might have seemed obvious at first blush. In comments to that article, there was a great deal of interest in exploring what Sandridge's corporate strategy and next steps might be in addressing its balance sheet (B.S.) issues.
I will attempt to address some conceptual ideas here, starting with an analysis of the recent Note offering SD conducted. Obviously, it is not possible to have thoroughly examined every provision of the documents included in that filing, or to possibly understand the full legal implications of those provisions or terms, so what I will do is try to provide an overview of important terms I identified.
Readers should do their own analysis and make their own decisions about investments or positions in any of SD's securities. I have no current position, and provide this analysis for information purposes only, with an expectation that what is playing out at SD is or will be played out by many other companies in the coming weeks and months.
My overall conclusion, after reviewing the documents and other SD filings, is that while SD was able to raise substantial additional capital via its Note offering, it remains challenged by its existing (and now higher) debt levels and the pricing environment. SD needs substantial improvement in its CAPEX program and in achieving cost reductions, plus cash proceeds from sales and equity offerings, in order to survive as a company. Even if SD does survive, the dilution to various stakeholders in the company is likely to be extreme, at least without dramatic improvement in prices above what is predicted by the futures market.
The Note Offering
On May 28, SD announced its intent to offer via private placement $1.0 billion in Senior Secured Notes due 2020; that amount was subsequently upsized to $1.25 billion, and the offering was closed on June 10. The terms of the Notes include:
A principal amount of $1.25 billion with an interest rate of 8.75%.
A stated maturity date of June 1, 2020.
A "springing" maturity date of October 15, 2019, in the event that the then-outstanding balance of SD's previously existing 2020 notes is greater than $100 million.
A secured position in properties comprising 80% of SD's current reserve value, subject only to the prior lien in favor of SD's bank credit group (i.e. a "second lien").
Restrictions on redeeming the Notes prior to June 1, 2017, without payment of a "make-whole" provision or, with the proceeds of an equity offering, up to 35% of the principal amount of the Notes @ 108.75%.
Optional redemptions after June 1, 2017, at declining premiums to the face amount of the Notes.
Numerous covenants and conditions that will be discussed in further detail later in this article.
Amended And Restated Credit Agreement
Concurrently, with the closing of the Note offering, SD also entered into a revised credit agreement with its bank group. This was necessitated by the need for coordination between the first lien in favor of the banks and the new, second lien granted to the trustee under the Indenture securing the Notes.
The primary terms of the new Credit Agreement include:
A nominal commitment of $1 billion.
An initial borrowing base of $500 million.
A stated maturity date of March 2, 2020.
Financial covenants, including maintenance of agreed upon levels for the (i) ratio of the Company's total secured debt under the Credit Facility to EBITDA, which may not exceed 2.00:1.00 at the end of any fiscal quarter and (ii) ratio of current assets to current liabilities, which must be at least 1.0:1.0 at each quarter end.
Interest rate elections by SD between LIBOR, Eurodollar or fed funds options.
The Net Result Of The Transactions
Prior to the offering, SD had outstanding borrowings under its Credit Agreement of $175 million. With the proceeds of the Note offering, SD repaid its bank debt in full, leaving approximately $1.05 billion in cash after netting out the costs of the offering.
SD has other substantial remaining debt and preferred issues outstanding, as follows, with current market values in parentheses:
8.750% Senior Notes due 2020… $445 million ($267 mm)
7.500% Senior Notes due 2021… $1,178 million ($624 mm)
8.125% Senior Notes due 2022… $750 million ($379 mm)
7.500% Senior Notes due 2023… $822 million ($413 mm)
8.500% Preferred Stock… $265 million ($86 mm)
7.000% Preferred Stock… $300 million ($65 mm)
The total face value of other debt issues is $2.8 billion, having a current market value of $1.1 billion. Preferred equity issues have a face amount of $565 million and a current market value of $151 million. In one sense, then, the Note offering raised enough cash to buy out all of these other debt issues at their current market value, generating a potential "gain" of $1.7 billion to shareholders' equity as a gain on the extinguishment of debt. However, due to apparent restrictions in the terms of the Notes, as discussed below, this is extremely unlikely, even if those holders were receptive to offers at the current market price.
The bottom line is that in exchange for the infusion of cash, Note investors effectively "jumped to the head of the line" in terms of their priority in the capital structure of SD's balance sheet, with a priority lien and a liquidation preference over all of the other securities that SD has previously issued. In the process, these other issues have been relegated to quasi-equity status in this environment, because the current value of SD's reserves is likely insufficient to satisfy all stakeholders, at least not without significant discounts to the face amount of the securities.
How can SD do this? That's a question many investors must be asking themselves. In short, the provisions in the prior senior note deals had very weak financial covenants, allowing liens senior to their interests to be created in substantial amounts. E&P companies like SD have been the primary issuers of high yield debt over the past 5 years, and with lower interest rates, investors chasing that yield were more complacent about future borrowings and priorities than they should have been.
SD is not the first, nor will it be the last, company to explore this giant loophole while attempting to repair its balance sheet, or at least defer a day of reckoning until oil and gas prices have more time to recover. However, one consequence of doing the deal is that SD is now unlikely to be able to access the debt markets for any further issuances, as the unsecured debt markets do not soon forget when a company effectively writes down the value of its previous offerings and puts repayment in doubt. In survival mode, that result is less important to SD than getting the cash, but that is also likely one reason why it chose to do such a large Note offering.
Almost Free Money With No Restrictions??!!
Not by a long shot. As usual, the devil is in the details, all as encompassed in the documentation in the 8-K.
Restrictions on debt and disqualified stock. The Note Indenture provides that no further debt may be incurred unless the Fixed Charge Coverage Ratio exceeds 2.25:1 on a consolidated basis, for any of the types of debt set out below:
Priority lien debt under the Credit Facility may be incurred up to the greater of (A) $950 million, (B) the Borrowing Base or (C) 30% of Adjusted Consolidated Net Tangible Assets (ACNTA). ACNTA is defined as the SEC value of SD's reserves, plus/minus the fair market value of all other assets and liabilities of the company,
parity lien debt (the Notes) is limited to the greater of $1,500 million or 30% of ACNTA.
other indebtedness is only allowed for debt outstanding at the closing date or if the ACNTA coverage ratio is at least 1.1:1.
indebtedness for sale/leaseback transactions is allowed, up to $250 million.
ordinary course of business obligations are allowed, and
a "basket" allowance of $50 million is granted.
In essence, 1. and 2. above are designed primarily to permit the revised bank credit facility and the Notes. Because the limit on the Notes outstanding is $1.5 billion and the initial offering was for $1.25 billion, that means that an additional $250 million in Notes can be issued without violating the terms of the Indenture. The sale/leaseback provision allows SD to sell its HQ building and lease it back, generating cash but subject to a long-term lease, as described below.
Limitations on Restricted Payments. The Indenture first sets out a series of actions that are not permitted, including payment of dividends, purchases of stock, debt, notes, etc., unless certain criteria are met, including among other items:
There is no default under the various agreements.
SD would be allowed to make the payment within existing debt limits.
The total amount of Restricted Payments does not exceed the sum of 50% of Consolidated Net Income earned since April 1, 2015, 100% of the net cash proceeds from capital contributions and/or sales of equity securities since April 1, 2015, and the cash proceeds from conversion or exchange of debt securities for equity securities.
Permitted Payments. The Indenture then goes on to provide that certain actions are allowed, despite the limitations above, including among others:
Payments on existing issues of stock,
exchanges of preferred stock into common stock or acquisitions of such stock funded by the concurrent offering of stock in SD,
exchanges of existing debt securities into stock of SD,
acquisitions of existing debt securities in connection with the concurrent offering of junior debt securities otherwise allowed, and
repurchases of existing unsecured notes not to exceed $250 million, but only if after the repurchase there remains at least $175 million in cash and bank credit availability.
The net impact of all of the above is to significantly restrict the ability of SD to incur additional debt, pay out cash or otherwise use cash to buy back existing securities, at least not without first having attracted some equity capital into the company or, alternatively, deriving net income from operations that could be used to fund such transactions. The Noteholders are clearly trying to establish their position as the lead in any subsequent restructuring efforts and/or in any potential bankruptcy; those provisions have not been summarized here.
The difficulty in reading such a long and complicated series of documents as a casual observer is that it is easy to overlook or not be aware of the interplay of several provisions or the full legal significance of any particular phraseology. A phalanx of senior and junior attorneys, skilled in oil and gas, securities, banking, bankruptcy laws, etc., have created documents that are extremely complex, and care should be exercised by anyone reading them not to rely too heavily on what may seem to be obvious statements or conclusions.
What Other Actions Has SD Taken?
A Debt/Equity Swap. In the earlier article, I touched on the debt for equity swap that SD did in May, when it exchanged unsecured notes for common stock. No other similar transactions have been proposed, and with the stock down from nearly $1.50 then to around $1.10 now, the attractiveness of straight common for debt appears to have been diminished substantially.
Saltwater Disposal MLP. SD announced that it had received a positive ruling from the IRS that would permit it to undertake an IPO of its saltwater disposal unit. No indication of timing has yet been given or estimate of proceeds provided.
An Increase in Authorized Shares. At the shareholders' meeting last week, shareholders approval a proposal to increase the number of authorized shares of common stock from 800 million to 1.8 billion. That would seem to be an indication that SD expects to issue common stock at some point in its restructuring process, an obvious step with the level of its debt even before the most recent transactions.
At the same time, if the price of SD stock falls below $1 and thereafter fails to meet listing standards, it would be faced with the option of doing a reverse split or of somehow regaining compliance with those standards. Stocks that trade in the $1 range often trade as much on their option value as any intrinsic or Net Asset Value, and a reverse split is often accompanied by a subsequent deterioration in the stock price once again, as shareholders in Emerald Oil (NYSEMKT:EOX) discovered just this month.
What Are Some Options For SD's Strategy?
Management has already outlined some steps it expects to undertake and/or hopes to accomplish during 2015. Among the steps that were identified and should be taken:
1. G&A, CAPEX. First, SD should follow through with its efforts to reduce G&A and CAPEX to levels commensurate with a reduced level of activity. SD has been so focused on meeting its (HUGE) drilling obligations that economics suffered. This is purely a stopgap measure, as a company cannot cut its way to profitability on expenses, and it cannot replace cash flow out of production after such dramatic price reductions,
2. real estate. SD should sell all real estate, rigs, artwork, and any "extraneous" assets that can bring in cash without affecting credit/lien repayments,
3. sale/leaseback. With respect to the HQ, SD should sell it and lease it back if it is feasible to do so, (how valuable a tenant will SD be given its financials?)
4. property sales. SD should identify producing properties that can be sold without triggering a repayment to the creditors, and solicit sales. However, this is the situation SD has routinely found itself in over the past few years, and it is not a solution to the need for equity unless such sales generate proceeds far in excess of their borrowing base/reserve value. Sales lower cash flow and debt limits going forward, which then necessitate further sales, etc.,
5. royalty trusts. SD should sell the units in the trusts and/or the associated working interests (an alternative would be to try to exchange SD equity for those but I can't imagine anyone would even consider that), and
6. saltwater disposal. SD should do the IPO of the SWD/services unit if worthwhile.
None of these steps are in violation of the provisions of the revised Credit Facility or of the Note Indentures. In fact, because the actions were thought to be likely, they are referenced specifically, especially the sale/leaseback of the HQ building, which has a $ figure of up to $250 million attached to it. It is not out of the realm of possibility that SD could raise $500 million or more if all of the above steps were taken. That cash, along with the proceeds from the Note offering and bank credit availability, would be enough to fund SD's CAPEX program for 1-2 years if loan covenants on the existing notes due 2020-2023 are not breached in the meantime.
This does not really address the primary problem faced by SD, which is extreme over leverage. While the idea of a huge cash pile undoubtedly lit up the face of many an investor in the debt securities of SD (and the 8.5% preferred, which is up 30% since the date of the swap), the realization that the cash would likely be heavily restricted as to its use has kept bond prices at still substantial discounts.
In fact, there is a good possibility that the Noteholders provided the cash knowing that it could prove to be an incentive for unsecured noteholders and/or preferred stockholders to convert at least a portion of their position to equity in SD in a swap of some sort in the future. At least those who took equity in a swap might have the chance to see their value improve if the use of the proceeds added value beyond what already existed absent the funds, and it also extends the period during which SD has cash available to it to wait out a recovery in prices. Of course, the risk is that the drilling results from SD's ongoing efforts prove as unsuccessful as they have in the past, even with the improvements in technology and the reduction in costs going forward.
This presents somewhat of a dilemma for management and for the common shareholders. If they elect to proceed with their capital plans and they are successful, the value of the existing notes will rise, in theory more so than the value of the common stock. That might make it more difficult to do swaps, putting more pressure on SD to do equity offerings. If, on the other hand, SD proceeds with swap proposals before the results of their 2015 drilling program are known, it risks whatever equity it has left.
So, other than what management has already said they might do, what are some options that SD could consider?
1. Merge with another company. This is almost always #1 on the list of things that any management would like to do… if they could find someone who would let them continue to manage the company after the deal, provide all of the equity and pay an exorbitant premium to do so. Not likely. With better past results and a better price environment, folding the Repsol joint venture properties into SD might have been a more viable option. SD's existing debt level is going to be a serious deterrent to any potential acquirer/merger partner.
2. Merge the Royalty Trusts into SD. SD owns 30-40% of the 3 trusts already, so does not need approval from very many of the outside holders to accomplish such a transaction, in theory. Because of the debt impact within SD, it is unlikely that holders could be convinced to take any SD equity security in exchange for their units, but at a large enough premium maybe even that kind of deal could be of interest. It is often hard for management to see a potential $1 billion in equity so close but yet so hard to obtain. Selling the units themselves gets SD cash but reduces their potential property value.
3. Open Market Purchases of notes. There is room within the debt agreements to do cash purchases of existing notes on the open market as they come available. I would think that this would be an initial step to undertake, just to see how quickly they can accumulate any repurchases in size. Until it is clear what the overall plan and/or the endgame is, however, it is questionable they can acquire enough to be meaningful. Any purchases at $0.50-0.60 on the dollar for cash, the current price range for the notes, would be attractive to common stockholders, at least more attractive than CAPEX projects have been. To be effective, SD must exhibit restraint in how much and how quickly it pursues such deals, because noteholder expectations increase when they sense there is a strong motivation to do them by management.
4. Swaps of Debt for new Debt/Equity. Within this category are an almost unlimited number of options to try to get noteholders to swap their securities for new SD securities. Exchanging debt securities for other debt securities does not provide as much equity help as SD needs, so an equity feature is likely to be a component of any proposed swap.
A "coercive" type of deal might be for SD to offer to exchange notes for a combination of Senior Secured Notes or new Third Lien Secured Notes, plus stock and/or warrants, with a discount and equity component sufficient to bring in enough equity to provide a measurable benefit. This would have the effect of allowing unsecured creditors to perfect their position with a lien senior to other unsecured creditors. The difficulty in doing any sort of swap for equity is that, obviously, with the stock at $1.10/share, the common stockholders will likely be diluted substantially by the offer. That may still be better than the alternatives.
Warrants can be a great way to bridge the gap in transactions that depend on price recovery, but only if they are a sweetener rather than a main component of the consideration. Investment bankers get paid the big bucks to float all these possibilities, particularly in light of other deals they are involved with or see being presented in the market. I think that sort of swap proposal is almost a given at some point.
5. Rights offering. Rights offerings are common in Europe, but less so in the US. In such an offering, shareholders are given the right to purchase new shares in the company, often at a discount and often with a "backstop commitment" from an investor or investor group to buy any shares that are not subscribed for. For illustration purposes only, an example might be to allow shareholders to purchase SD stock for $0.50/share to raise $500 million (1 billion shares). Existing shareholders could purchase up to 2 shares for every share they currently hold to maintain their % ownership in SD, or be diluted by the shares that were exercised.
With a strong group of existing shareholders such an approach might be workable, although the SD group has not yet shown any willingness to contribute additional capital. Such offerings are typically followed by a reverse split to take the price back up to a level that evokes more stability (i.e. 1:20 to take the price up to $10/share). I don't see this as likely, and as EOX discovered the reverse stock split alone has its own drawbacks.
6. Equity offerings. Obviously, if the market were strong and/or SD's results were much better, conducting offerings of common and preferred stock would be the standard way to reduce debt. The extreme debt position means that the size of any equity offering (or other means of increasing equity) needs to be on the order of $1-2 billion. Smaller deals may buy time but do not help with $4 billion in debt outstanding. For reference, E&P companies usually have debt/Enterprise Value (market cap + debt) of 30-50%; SD's ratio is more like 70-80%.
7. Writeoffs. Not exactly a growth strategy, but at this point, there is little benefit to maintaining asset values that are not required for compliance with any debt covenants. Already likely to have impairments due to the value of its reserves in both 2Q and 3Q, SD should also write off any other items of "questionable value," if for no other reason than to set the stage for whatever transaction, swap or otherwise, may be proposed.
Conclusion
SD has been in what is commonly referred to in the E&P industry as a "debt spiral" for years. Faced with debt that was considered too high, they have sold off assets, created royalty trusts and joint ventures, issued many different kinds of debt and preferred equity securities, all with the express intent of focusing on their core Mississippian Lime properties.
Results from the bulk of the capital raised for these drilling efforts have been pretty dismal, so the debt has remained high in relation to the value of SD's reserves. While SD claims to have made significant progress in achieving better economics in the play currently, these results (if true) have been largely overshadowed by the dramatic fall in oil and natural gas prices, to the point where the current value of SD's assets is likely less than the debt outstanding.
SD bought itself some time with the recent Note offering, which provided needed funds for CAPEX. However, significant future steps, including equity capital raises, are necessary if SD is to survive with any value attributable to the common shares. Even then, the dilution likely required to get to such a point is likely to be great, at least absent a dramatic price recovery far beyond what is currently priced into the futures market.
Activity in the short term will likely focus on the steps outlined by management to raise proceeds, with a lesser emphasis on restructuring of the balance sheet unless purchases of debt can be undertaken at discounts significant enough to be of particular interest. Purchases at much of a premium to existing market prices might not provide much real relief or benefit.
Although the timing is pure speculation, I would say that later this year, possibly early next year, SD will likely pursue some sort of swap transaction to convert some or all of the unsecured debt into equity, on terms that make it attractive enough to entice noteholders (by including secured lien + equity + warrant components). Absent material improvement in the results of its CAPEX program, in product pricing or in the equity structure on the balance sheet, SD's prognosis is still very poor, even though the immediate liquidity constraints have been removed. In that regard, it is part of a growing club.
http://seekingalpha.com/article/3258035-sandridges-b-s-verse-2-lien-on-me?auth_param=46e5d:1anvtr6:4c6f9fc693844ca3ca92f4c7afe345a8&uprof=45
SD is bankrupt and won't be able to tread water much longer in the cold waters of Lake Superior
best to get off while you can there is no play left here at this time-imo
the Edmund Fitzgerard has left the port fully loaded -it 's been good to know ya
https://www.youtube.com/watch?v=K6DUFPNILvM
Raw Energy
Oil & gas, master limited partnerships, energy, natural resources
Profile| Send Message| Follow (114 followers)
Sandridge's B.S. Verse 2: 'Lien On Me'
Must Read | Jun. 15, 2015 6:15 AM ET | About: SandRidge Energy, Inc. (SD) Subscribers to SA PRO had an early look at this article. Learn more about PRO »
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
In a previous article the author examined an accounting treatment that made Sandridge Energy's Balance Sheet more precarious than thought.
Since that time SD raised $1.25 billion from a Note offering of 8.75% Senior Secured Notes due 2020.
The author summarizes major terms of the Note Indenture and the Revised Credit Agreement entered into by SD with its bank group.
Potential strategies and options for SD going forward are explored.
The author concludes that although the Note offering satisfied immediate liquidity issues, SD's financial position remains precarious and is likely to require significant restructuring to survive.
Introduction
In my previous article on Sandridge Energy (NYSE:SD), I examined an obscure accounting treatment that made its financial condition more precarious than might have seemed obvious at first blush. In comments to that article, there was a great deal of interest in exploring what Sandridge's corporate strategy and next steps might be in addressing its balance sheet (B.S.) issues.
I will attempt to address some conceptual ideas here, starting with an analysis of the recent Note offering SD conducted. Obviously, it is not possible to have thoroughly examined every provision of the documents included in that filing, or to possibly understand the full legal implications of those provisions or terms, so what I will do is try to provide an overview of important terms I identified.
Readers should do their own analysis and make their own decisions about investments or positions in any of SD's securities. I have no current position, and provide this analysis for information purposes only, with an expectation that what is playing out at SD is or will be played out by many other companies in the coming weeks and months.
My overall conclusion, after reviewing the documents and other SD filings, is that while SD was able to raise substantial additional capital via its Note offering, it remains challenged by its existing (and now higher) debt levels and the pricing environment. SD needs substantial improvement in its CAPEX program and in achieving cost reductions, plus cash proceeds from sales and equity offerings, in order to survive as a company. Even if SD does survive, the dilution to various stakeholders in the company is likely to be extreme, at least without dramatic improvement in prices above what is predicted by the futures market.
The Note Offering
On May 28, SD announced its intent to offer via private placement $1.0 billion in Senior Secured Notes due 2020; that amount was subsequently upsized to $1.25 billion, and the offering was closed on June 10. The terms of the Notes include:
A principal amount of $1.25 billion with an interest rate of 8.75%.
A stated maturity date of June 1, 2020.
A "springing" maturity date of October 15, 2019, in the event that the then-outstanding balance of SD's previously existing 2020 notes is greater than $100 million.
A secured position in properties comprising 80% of SD's current reserve value, subject only to the prior lien in favor of SD's bank credit group (i.e. a "second lien").
Restrictions on redeeming the Notes prior to June 1, 2017, without payment of a "make-whole" provision or, with the proceeds of an equity offering, up to 35% of the principal amount of the Notes @ 108.75%.
Optional redemptions after June 1, 2017, at declining premiums to the face amount of the Notes.
Numerous covenants and conditions that will be discussed in further detail later in this article.
Amended And Restated Credit Agreement
Concurrently, with the closing of the Note offering, SD also entered into a revised credit agreement with its bank group. This was necessitated by the need for coordination between the first lien in favor of the banks and the new, second lien granted to the trustee under the Indenture securing the Notes.
The primary terms of the new Credit Agreement include:
A nominal commitment of $1 billion.
An initial borrowing base of $500 million.
A stated maturity date of March 2, 2020.
Financial covenants, including maintenance of agreed upon levels for the (i) ratio of the Company's total secured debt under the Credit Facility to EBITDA, which may not exceed 2.00:1.00 at the end of any fiscal quarter and (ii) ratio of current assets to current liabilities, which must be at least 1.0:1.0 at each quarter end.
Interest rate elections by SD between LIBOR, Eurodollar or fed funds options.
The Net Result Of The Transactions
Prior to the offering, SD had outstanding borrowings under its Credit Agreement of $175 million. With the proceeds of the Note offering, SD repaid its bank debt in full, leaving approximately $1.05 billion in cash after netting out the costs of the offering.
SD has other substantial remaining debt and preferred issues outstanding, as follows, with current market values in parentheses:
8.750% Senior Notes due 2020… $445 million ($267 mm)
7.500% Senior Notes due 2021… $1,178 million ($624 mm)
8.125% Senior Notes due 2022… $750 million ($379 mm)
7.500% Senior Notes due 2023… $822 million ($413 mm)
8.500% Preferred Stock… $265 million ($86 mm)
7.000% Preferred Stock… $300 million ($65 mm)
The total face value of other debt issues is $2.8 billion, having a current market value of $1.1 billion. Preferred equity issues have a face amount of $565 million and a current market value of $151 million. In one sense, then, the Note offering raised enough cash to buy out all of these other debt issues at their current market value, generating a potential "gain" of $1.7 billion to shareholders' equity as a gain on the extinguishment of debt. However, due to apparent restrictions in the terms of the Notes, as discussed below, this is extremely unlikely, even if those holders were receptive to offers at the current market price.
The bottom line is that in exchange for the infusion of cash, Note investors effectively "jumped to the head of the line" in terms of their priority in the capital structure of SD's balance sheet, with a priority lien and a liquidation preference over all of the other securities that SD has previously issued. In the process, these other issues have been relegated to quasi-equity status in this environment, because the current value of SD's reserves is likely insufficient to satisfy all stakeholders, at least not without significant discounts to the face amount of the securities.
How can SD do this? That's a question many investors must be asking themselves. In short, the provisions in the prior senior note deals had very weak financial covenants, allowing liens senior to their interests to be created in substantial amounts. E&P companies like SD have been the primary issuers of high yield debt over the past 5 years, and with lower interest rates, investors chasing that yield were more complacent about future borrowings and priorities than they should have been.
SD is not the first, nor will it be the last, company to explore this giant loophole while attempting to repair its balance sheet, or at least defer a day of reckoning until oil and gas prices have more time to recover. However, one consequence of doing the deal is that SD is now unlikely to be able to access the debt markets for any further issuances, as the unsecured debt markets do not soon forget when a company effectively writes down the value of its previous offerings and puts repayment in doubt. In survival mode, that result is less important to SD than getting the cash, but that is also likely one reason why it chose to do such a large Note offering.
Almost Free Money With No Restrictions??!!
Not by a long shot. As usual, the devil is in the details, all as encompassed in the documentation in the 8-K.
Restrictions on debt and disqualified stock. The Note Indenture provides that no further debt may be incurred unless the Fixed Charge Coverage Ratio exceeds 2.25:1 on a consolidated basis, for any of the types of debt set out below:
Priority lien debt under the Credit Facility may be incurred up to the greater of (A) $950 million, (B) the Borrowing Base or (C) 30% of Adjusted Consolidated Net Tangible Assets (ACNTA). ACNTA is defined as the SEC value of SD's reserves, plus/minus the fair market value of all other assets and liabilities of the company,
parity lien debt (the Notes) is limited to the greater of $1,500 million or 30% of ACNTA.
other indebtedness is only allowed for debt outstanding at the closing date or if the ACNTA coverage ratio is at least 1.1:1.
indebtedness for sale/leaseback transactions is allowed, up to $250 million.
ordinary course of business obligations are allowed, and
a "basket" allowance of $50 million is granted.
In essence, 1. and 2. above are designed primarily to permit the revised bank credit facility and the Notes. Because the limit on the Notes outstanding is $1.5 billion and the initial offering was for $1.25 billion, that means that an additional $250 million in Notes can be issued without violating the terms of the Indenture. The sale/leaseback provision allows SD to sell its HQ building and lease it back, generating cash but subject to a long-term lease, as described below.
Limitations on Restricted Payments. The Indenture first sets out a series of actions that are not permitted, including payment of dividends, purchases of stock, debt, notes, etc., unless certain criteria are met, including among other items:
There is no default under the various agreements.
SD would be allowed to make the payment within existing debt limits.
The total amount of Restricted Payments does not exceed the sum of 50% of Consolidated Net Income earned since April 1, 2015, 100% of the net cash proceeds from capital contributions and/or sales of equity securities since April 1, 2015, and the cash proceeds from conversion or exchange of debt securities for equity securities.
Permitted Payments. The Indenture then goes on to provide that certain actions are allowed, despite the limitations above, including among others:
Payments on existing issues of stock,
exchanges of preferred stock into common stock or acquisitions of such stock funded by the concurrent offering of stock in SD,
exchanges of existing debt securities into stock of SD,
acquisitions of existing debt securities in connection with the concurrent offering of junior debt securities otherwise allowed, and
repurchases of existing unsecured notes not to exceed $250 million, but only if after the repurchase there remains at least $175 million in cash and bank credit availability.
The net impact of all of the above is to significantly restrict the ability of SD to incur additional debt, pay out cash or otherwise use cash to buy back existing securities, at least not without first having attracted some equity capital into the company or, alternatively, deriving net income from operations that could be used to fund such transactions. The Noteholders are clearly trying to establish their position as the lead in any subsequent restructuring efforts and/or in any potential bankruptcy; those provisions have not been summarized here.
The difficulty in reading such a long and complicated series of documents as a casual observer is that it is easy to overlook or not be aware of the interplay of several provisions or the full legal significance of any particular phraseology. A phalanx of senior and junior attorneys, skilled in oil and gas, securities, banking, bankruptcy laws, etc., have created documents that are extremely complex, and care should be exercised by anyone reading them not to rely too heavily on what may seem to be obvious statements or conclusions.
What Other Actions Has SD Taken?
A Debt/Equity Swap. In the earlier article, I touched on the debt for equity swap that SD did in May, when it exchanged unsecured notes for common stock. No other similar transactions have been proposed, and with the stock down from nearly $1.50 then to around $1.10 now, the attractiveness of straight common for debt appears to have been diminished substantially.
Saltwater Disposal MLP. SD announced that it had received a positive ruling from the IRS that would permit it to undertake an IPO of its saltwater disposal unit. No indication of timing has yet been given or estimate of proceeds provided.
An Increase in Authorized Shares. At the shareholders' meeting last week, shareholders approval a proposal to increase the number of authorized shares of common stock from 800 million to 1.8 billion. That would seem to be an indication that SD expects to issue common stock at some point in its restructuring process, an obvious step with the level of its debt even before the most recent transactions.
At the same time, if the price of SD stock falls below $1 and thereafter fails to meet listing standards, it would be faced with the option of doing a reverse split or of somehow regaining compliance with those standards. Stocks that trade in the $1 range often trade as much on their option value as any intrinsic or Net Asset Value, and a reverse split is often accompanied by a subsequent deterioration in the stock price once again, as shareholders in Emerald Oil (NYSEMKT:EOX) discovered just this month.
What Are Some Options For SD's Strategy?
Management has already outlined some steps it expects to undertake and/or hopes to accomplish during 2015. Among the steps that were identified and should be taken:
1. G&A, CAPEX. First, SD should follow through with its efforts to reduce G&A and CAPEX to levels commensurate with a reduced level of activity. SD has been so focused on meeting its (HUGE) drilling obligations that economics suffered. This is purely a stopgap measure, as a company cannot cut its way to profitability on expenses, and it cannot replace cash flow out of production after such dramatic price reductions,
2. real estate. SD should sell all real estate, rigs, artwork, and any "extraneous" assets that can bring in cash without affecting credit/lien repayments,
3. sale/leaseback. With respect to the HQ, SD should sell it and lease it back if it is feasible to do so, (how valuable a tenant will SD be given its financials?)
4. property sales. SD should identify producing properties that can be sold without triggering a repayment to the creditors, and solicit sales. However, this is the situation SD has routinely found itself in over the past few years, and it is not a solution to the need for equity unless such sales generate proceeds far in excess of their borrowing base/reserve value. Sales lower cash flow and debt limits going forward, which then necessitate further sales, etc.,
5. royalty trusts. SD should sell the units in the trusts and/or the associated working interests (an alternative would be to try to exchange SD equity for those but I can't imagine anyone would even consider that), and
6. saltwater disposal. SD should do the IPO of the SWD/services unit if worthwhile.
None of these steps are in violation of the provisions of the revised Credit Facility or of the Note Indentures. In fact, because the actions were thought to be likely, they are referenced specifically, especially the sale/leaseback of the HQ building, which has a $ figure of up to $250 million attached to it. It is not out of the realm of possibility that SD could raise $500 million or more if all of the above steps were taken. That cash, along with the proceeds from the Note offering and bank credit availability, would be enough to fund SD's CAPEX program for 1-2 years if loan covenants on the existing notes due 2020-2023 are not breached in the meantime.
This does not really address the primary problem faced by SD, which is extreme over leverage. While the idea of a huge cash pile undoubtedly lit up the face of many an investor in the debt securities of SD (and the 8.5% preferred, which is up 30% since the date of the swap), the realization that the cash would likely be heavily restricted as to its use has kept bond prices at still substantial discounts.
In fact, there is a good possibility that the Noteholders provided the cash knowing that it could prove to be an incentive for unsecured noteholders and/or preferred stockholders to convert at least a portion of their position to equity in SD in a swap of some sort in the future. At least those who took equity in a swap might have the chance to see their value improve if the use of the proceeds added value beyond what already existed absent the funds, and it also extends the period during which SD has cash available to it to wait out a recovery in prices. Of course, the risk is that the drilling results from SD's ongoing efforts prove as unsuccessful as they have in the past, even with the improvements in technology and the reduction in costs going forward.
This presents somewhat of a dilemma for management and for the common shareholders. If they elect to proceed with their capital plans and they are successful, the value of the existing notes will rise, in theory more so than the value of the common stock. That might make it more difficult to do swaps, putting more pressure on SD to do equity offerings. If, on the other hand, SD proceeds with swap proposals before the results of their 2015 drilling program are known, it risks whatever equity it has left.
So, other than what management has already said they might do, what are some options that SD could consider?
1. Merge with another company. This is almost always #1 on the list of things that any management would like to do… if they could find someone who would let them continue to manage the company after the deal, provide all of the equity and pay an exorbitant premium to do so. Not likely. With better past results and a better price environment, folding the Repsol joint venture properties into SD might have been a more viable option. SD's existing debt level is going to be a serious deterrent to any potential acquirer/merger partner.
2. Merge the Royalty Trusts into SD. SD owns 30-40% of the 3 trusts already, so does not need approval from very many of the outside holders to accomplish such a transaction, in theory. Because of the debt impact within SD, it is unlikely that holders could be convinced to take any SD equity security in exchange for their units, but at a large enough premium maybe even that kind of deal could be of interest. It is often hard for management to see a potential $1 billion in equity so close but yet so hard to obtain. Selling the units themselves gets SD cash but reduces their potential property value.
3. Open Market Purchases of notes. There is room within the debt agreements to do cash purchases of existing notes on the open market as they come available. I would think that this would be an initial step to undertake, just to see how quickly they can accumulate any repurchases in size. Until it is clear what the overall plan and/or the endgame is, however, it is questionable they can acquire enough to be meaningful. Any purchases at $0.50-0.60 on the dollar for cash, the current price range for the notes, would be attractive to common stockholders, at least more attractive than CAPEX projects have been. To be effective, SD must exhibit restraint in how much and how quickly it pursues such deals, because noteholder expectations increase when they sense there is a strong motivation to do them by management.
4. Swaps of Debt for new Debt/Equity. Within this category are an almost unlimited number of options to try to get noteholders to swap their securities for new SD securities. Exchanging debt securities for other debt securities does not provide as much equity help as SD needs, so an equity feature is likely to be a component of any proposed swap.
A "coercive" type of deal might be for SD to offer to exchange notes for a combination of Senior Secured Notes or new Third Lien Secured Notes, plus stock and/or warrants, with a discount and equity component sufficient to bring in enough equity to provide a measurable benefit. This would have the effect of allowing unsecured creditors to perfect their position with a lien senior to other unsecured creditors. The difficulty in doing any sort of swap for equity is that, obviously, with the stock at $1.10/share, the common stockholders will likely be diluted substantially by the offer. That may still be better than the alternatives.
Warrants can be a great way to bridge the gap in transactions that depend on price recovery, but only if they are a sweetener rather than a main component of the consideration. Investment bankers get paid the big bucks to float all these possibilities, particularly in light of other deals they are involved with or see being presented in the market. I think that sort of swap proposal is almost a given at some point.
5. Rights offering. Rights offerings are common in Europe, but less so in the US. In such an offering, shareholders are given the right to purchase new shares in the company, often at a discount and often with a "backstop commitment" from an investor or investor group to buy any shares that are not subscribed for. For illustration purposes only, an example might be to allow shareholders to purchase SD stock for $0.50/share to raise $500 million (1 billion shares). Existing shareholders could purchase up to 2 shares for every share they currently hold to maintain their % ownership in SD, or be diluted by the shares that were exercised.
With a strong group of existing shareholders such an approach might be workable, although the SD group has not yet shown any willingness to contribute additional capital. Such offerings are typically followed by a reverse split to take the price back up to a level that evokes more stability (i.e. 1:20 to take the price up to $10/share). I don't see this as likely, and as EOX discovered the reverse stock split alone has its own drawbacks.
6. Equity offerings. Obviously, if the market were strong and/or SD's results were much better, conducting offerings of common and preferred stock would be the standard way to reduce debt. The extreme debt position means that the size of any equity offering (or other means of increasing equity) needs to be on the order of $1-2 billion. Smaller deals may buy time but do not help with $4 billion in debt outstanding. For reference, E&P companies usually have debt/Enterprise Value (market cap + debt) of 30-50%; SD's ratio is more like 70-80%.
7. Writeoffs. Not exactly a growth strategy, but at this point, there is little benefit to maintaining asset values that are not required for compliance with any debt covenants. Already likely to have impairments due to the value of its reserves in both 2Q and 3Q, SD should also write off any other items of "questionable value," if for no other reason than to set the stage for whatever transaction, swap or otherwise, may be proposed.
Conclusion
SD has been in what is commonly referred to in the E&P industry as a "debt spiral" for years. Faced with debt that was considered too high, they have sold off assets, created royalty trusts and joint ventures, issued many different kinds of debt and preferred equity securities, all with the express intent of focusing on their core Mississippian Lime properties.
Results from the bulk of the capital raised for these drilling efforts have been pretty dismal, so the debt has remained high in relation to the value of SD's reserves. While SD claims to have made significant progress in achieving better economics in the play currently, these results (if true) have been largely overshadowed by the dramatic fall in oil and natural gas prices, to the point where the current value of SD's assets is likely less than the debt outstanding.
SD bought itself some time with the recent Note offering, which provided needed funds for CAPEX. However, significant future steps, including equity capital raises, are necessary if SD is to survive with any value attributable to the common shares. Even then, the dilution likely required to get to such a point is likely to be great, at least absent a dramatic price recovery far beyond what is currently priced into the futures market.
Activity in the short term will likely focus on the steps outlined by management to raise proceeds, with a lesser emphasis on restructuring of the balance sheet unless purchases of debt can be undertaken at discounts significant enough to be of particular interest. Purchases at much of a premium to existing market prices might not provide much real relief or benefit.
Although the timing is pure speculation, I would say that later this year, possibly early next year, SD will likely pursue some sort of swap transaction to convert some or all of the unsecured debt into equity, on terms that make it attractive enough to entice noteholders (by including secured lien + equity + warrant components). Absent material improvement in the results of its CAPEX program, in product pricing or in the equity structure on the balance sheet, SD's prognosis is still very poor, even though the immediate liquidity constraints have been removed. In that regard, it is part of a growing club.
http://seekingalpha.com/article/3258035-sandridges-b-s-verse-2-lien-on-me?auth_param=46e5d:1anvtr6:4c6f9fc693844ca3ca92f4c7afe345a8&uprof=45
SD is bankrupt and won't be able to tread water much longer in the cold waters of Lake Superior
"It’s hard to fight an enemy who has outposts in your head.”
Sally Kempton
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