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Re: catdaddyrt post# 2686

Tuesday, 07/21/2015 3:09:27 PM

Tuesday, July 21, 2015 3:09:27 PM

Post# of 13692
http://seekingalpha.com/article/3339645-sandridge-energy-what-to-expect?auth_param=46e5d:1aqt5cf:6981c56cf3aa2c7a2190e862fc70c2b1&uprof=45


SandRidge Energy: What To Expect
Must Read | Jul. 20, 2015 2:54 PM ET | 1 comment | About: SandRidge Energy, Inc. (SD) Subscribers to SA PRO had an early look at this article. Learn more about PRO »

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary

Why did the stock price collapse?
What should investors focus on in the Q2 report?
How significant is the earthquake risk for the stock?
What is the credit market telling us?

Important Note: This article is not an investment recommendation or research report. It is not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.

SandRidge Energy (NYSE:SD) common stock has lost more than two thirds of its trading value since my March post "SandRidge Energy: What Happens Once The Cash Pile Runs Out?" (Seeking Alpha Top Idea, March 3, 2015). At the time of this writing (~1pm on July 20, 2015), SD stock is trading at ~$0.60 per share, which implies a market value of the company's common stock of ~$285 million.

While the renewed weakness in oil prices is a major contributing factor, it is difficult to blame the share price decline solely on commodity prices, as both oil and natural gas spot prices are currently very similar to the early March levels.

Unfortunately, I see the stock price decline as a confirmation of the company's acute operational and balance sheet challenges that were visible earlier this year.
Second-Lien Offering Is A Measure Of Last Resort

In June, SandRidge raised $1.25 billion via a second lien bond offering. The bonds bear an 8.75% interest and are senior to the company's existing unsecured bonds (~$3.2 billion aggregate principal amount outstanding).

SandRidge used a portion of the proceeds to repay its revolver balances. Concurrent with the financing, SandRidge's first-lien revolving bank credit facility was amended with an initial $500 million borrowing base and is currently undrawn.

As a result of this financing, the company now has a substantial liquidity cushion that can potentially keep it afloat for quite some time. However, the second-lien offering was hardly good news for stock holders and the current share price reflects that.

Based on my estimate, SandRidge will have ~$0.9 billion of cash on its balance sheet as of June 30, 2015.

The $1.25 billion second-lien financing and the repayment of revolver balances increased the company's total debt outstanding to ~$4.5 billion (aggregate principal amount). Annualized interest payments also stepped up substantially. The company's annual interest burden now is ~$360 million. Assuming an annualized run-rate EBITDA of $500 million, this leaves ~$150 million of discretionary cash flow per year. For comparison, the company's investment budget in 2014 exceeded $1.6 billion, including the carries.

For reference, the following table shows SandRidge's debt as of March 31, 2015:

(click to enlarge)

Being a measure of last resort, the second-lien offering, was effectively an admission by the company's management and Board that SandRidge does not have many viable alternatives left in its toolbox.

Seemingly, the second-lien offering of this size created tremendous short-term liquidity for SandRidge. However, given that the common stock represents a residual claim on the company's assets, common stockholders now find themselves in a deeply subordinated position in the event of a restructuring. In addition to the ~$4.5 billion in total debt, SandRidge has $565 million face value of perpetual convertible preferreds that are also senior to common stock.
Cash Burn To Continue

As reminder, SandRidge outspent its internal cash flow in Q1 by a wide margin. The company generated $146 million in adjusted cash flow for the quarter (before the change in working capital of $56 million - cash flow from operations was $90 million). This result was achieved on very strong price realizations driven by hedges: $88.23 per barrel for oil and $3.36 per Mcf for natural gas. Taking into account regional differentials, these were excellent price realizations that approximately corresponded to a $90 oil / $4.00 natural gas price environment. The unhedged NGL price realization was weak, $14.17 per barrel. SandRidge's net debt increased during the quarter by ~$344 million.

Even though SandRidge has substantially reduced its capital spending run rate, I estimate the company's outspending during the second half of this year to remain high, $150-$200 million. In other words, assuming SandRidge stays within its $700 million spending guidance, the company is likely to exit 2015 with a cash balance in the ~$750 million range. If capital spending exceeds $700 million, the exit cash balance may end up even lower.

Going into 2016, SandRidge will face a difficult dilemma:

One option is to preserve cash and minimize outspending. In that case, production and EBITDA will continue to decline at a significant rate. There is a risk that SandRidge will lose availability under its bank facility based on credit metrics.
The other option is to attempt to maintain production flat. By doing so, SandRidge will be burning through its cash balance at a potentially high rate.

What To Watch For In The Earnings Report

SandRidge is scheduled to release its Q2 2015 results on August 5 after the market's close (conference call on August 6).

The most important metric to watch for in the Q2 report is daily oil production. As reminder, SandRidge's Q1 oil production averaged 29.5 thousand barrels per day, an 8.1% decline from the prior quarter. SandRidge's Q2 volumes will still reflect the high cadence of well completions in the previous two quarters (for example, wells completed in March made their highest monthly contribution in Q2). However, the deep reduction in the pace of capital spending should begin to filter through to production results, with declines accelerating in Q3.

The production decline should be viewed in the context of the company's completion activity. For readers' reference, SandRidge maintained an active completion program in Q1, turning to sales 101 laterals in the Mid-Continent during the quarter. In Q4 2014, 122 laterals were turned to sales.

Investors should also focus on the company's guidance with regard to oil production for the third quarter and the remainder of the year in the context of the number of wells that the company plans to turn inline.
Turnaround Plan?

It appears that some sort of a balance sheet restructuring would be a logical course given the company's situation. A restructuring would address the leverage issues which resolution was deferred but not resolved by the second-lien financing.

Investors need to watch for any signs of a restructuring plan that the company may be in the process of working on. An absence of a restructuring strategy would be a bad sign for the stock.
A Reverse Stock Split Is Likely

With SandRidge's stock trading deep in the sub-$1 per share territory, the company will soon face the risk of being delisted from the New York Stock Exchange.

According to NYSE delisting criteria based on price for common stock (section 802.01C), a company is considered to be below compliance standards if the average closing price of a security as reported on the consolidated tape is less than $1.00 over a consecutive 30 trading-day period. Once notified, the company must bring its share price and average share price back above $1.00 by six months following receipt of the notification. The company must notify the Exchange, within 10 business days of receipt of the notification, of its intent to cure this deficiency or be subject to suspension and delisting procedures. In addition, a domestic company must disclose receipt of the notification by issuing a press release disclosing the fact that it has fallen below the continued listing standards of the Exchange. The company can regain compliance at any time during the six-month cure period if on the last trading day of any calendar month during the cure period the company has a closing share price of at least $1.00 and an average closing share price of at least $1.00 over the 30 trading-day period ending on the last trading day of that month.

In the event the cure action by the company requires approval of its shareholders, it must so inform the Exchange and must obtain the shareholder approval by no later than its next annual meeting, and must implement the action promptly thereafter. The price condition will be deemed cured if the price promptly exceeds $1.00 per share, and the price remains above the level for at least the following 30 trading days.
Are Earthquakes A Threat To The Stock?

The spike in seismicity in north-central Oklahoma is a major problem for the oil and gas industry in the area (which I discussed in detail here). I argued in another note that the industry's potential liability related to damages from earthquakes that have already occurred is likely immaterial and surmountable. The real issue is the risk of a future damaging earthquake. (This risk is of a "black swan" type: the event is improbable but potentially devastating.)

Specifically for SandRidge, I view this risk as a Tier 2 risk: shareholders have much larger and more probable risks to worry about at the moment, in my opinion.
Preferred Stock Prices and Bond Prices Do Not Convey Optimism

[color=red]The credit market appears to have little optimism with regard to the company's future. Preferred shares and bonds have experienced massive declines in the past three months. Below are some of the trading levels for readers' reference:

[color=red]SandRidge Energy 8.50% Convertible Perpetual Preferred Stock (SDXP): ~$22.55 per share (as of ~1:00 pm, July 20, 2015).

Please note that this preferred stock has liquidation preference of $100 per share, is not redeemable and has no stated maturity. Cumulative distributions of 8.50% ($8.50) per annum can be paid in cash or common stock. The preferred shares are convertible any time at the holder's option into 12.4805 common shares of SandRidge, an initial conversion price of $8.0125 per common share. Upon liquidation, the preferred shares are senior to the common shares of the company. The company has 2,650,000 shares of 8.5% Convertible Perpetual Preferred Stock outstanding ($265 million face value).

SandRridge Energy 7.00% Convertible Perpetual Preferred Stock: $[15] per share (highly illiquid, no recent quotes available).

The preferred has liquidation preference $100 per share, is not redeemable and has no stated maturity. Cumulative distributions of 7.00% per annum ($7.00 per annum or $3.50 per quarter) are paid semiannually are non-cumulative and if the board of directors does not declare a dividend or the company fails to pay a dividend declared by the board for any quarterly dividend period, the holder will not be entitled to receive any dividend for that quarterly period and the undeclared or unpaid dividend will not accumulate. The preferred shares are convertible any time at the holder's option into 12.879 (calculated) common shares of SandRidge at an initial conversion price of $7.7645 per common share. Upon liquidation, the preferred shares are senior to the common shares of the company. SandRidge has 3,000,000 shares of 7.0% Convertible Perpetual Preferred Stock outstanding ($300 million face value).

SandRidge Energy 8.125% Senior Unsecured Notes due 2022: $31.75 yielding ~34% (as of July 20, 2015).
In Conclusion…

The outlook for SandRidge remains very challenging.[color=red]

On the operating side, investors should focus on the rate on oil production decline in Q2 and oil production guidance for the remainder of the year (initial production declines are notoriously high in the Miss Lime play and may be exacerbated by the company's active use of electric submersible pumps to accelerate production).

Going into Q3, the company is facing the quadruple challenge of accelerating production declines; weaker hedges; low commodity prices; and higher interest burden.

Even though the company's position is vulnerable, SandRidge has bought itself time by accessing liquidity. The critical question is whether the company has the will to use this time to implement a restructuring strategy and attempt to salvage some value for its shareholders.

In the absence of such a strategy, SandRidge's stock is effectively an option on a major improvement in oil prices as well as the company's ability to deliver a substantially improved average well performance at a substantially reduced well cost.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. The author explicitly disclaims any liability that may arise from the use of this material.


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