Dallas Salazar, CapGainr (268 clicks)
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SandRidge's Immediate-Term Viability Improves, But Has Its Long-Term Viability?
Aug. 19, 2015 5:54 PM ET | 2 comments | About: SandRidge Energy, Inc. (SD)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
SandRidge Energy has done well for itself with its most recent debt and balance sheet improvement execution.
Is SandRidge now in control of its own destiny? Or is oil pricing still the primary factor determining long-term viability at this stressed E&P?
The equity and risk pricing markets don't seem to think SandRidge's recent actions have done anything but improve its immediate-term situation.
I want to give credit to SandRidge for executing, but how much of its core issues has been solved?
SandRidge Energy (NYSE:SD), which I consider to be the second-riskiest E&P to own -- outclassed only by Halcon (NYSE:HK) -- has done well for itself with its most recent debt and balance sheet improvement execution. Of course, this doesn't mean anything for the equity in the immediate term (maybe not ever), but it does improve the company's long-term viability. That is undeniable.
There is also no denying the markets muted reaction to the news, as it sold the stock down another 4.3% on the day. This reaction was largely influenced by the immediate-term trending price of oil, which is far more influential in determining the E&P's ultimate fate at this point than anything within reason that SandRidge can do with its capital structure. SandRidge announced the following:
(click to enlarge)
However, even in light of this development, I still consider SandRidge to be an avoid at best and a short at worst (admittedly, I'm not short the stock, so I can't speak to borrowing inventory or cost of borrows). I think betting on SandRidge from the short side is a bet on its failure. This might be premature when considering SandRidge's distance from failure in the currently extremely desperate and accommodative financing environment (speaking in terms of the lenders). Considering that SandRidge has the opportunity to divest assets, the opportunity to execute other debt/equity swaps, to agree to farmouts, and to agree to other JVs, the company does have some room to continue to push out any default event.
Again, this doesn't mean that the share price would react positively to any of these executions. Peer E&Ps that have executed on some or all of these have seen nothing of long-term equity pricing as a result -- good examples are Rex Energy (NASDAQ:REXX), Magnum Hunter (NYSE:MHR), Eclipse Resources (NYSE:ECR), and EXCO Resources (EXCO). To be sure, this is because the underlying source of the problem causing the E&Ps to be stressed, low commodity pricing, and the ripple effects that creates for the operating models hasn't been resolved. This remains the case with SandRidge as well.
Of course, this observation -- that shorting SandRidge might be premature -- assumes a perpetuation of the energy lending sentiment status quo, that SandRidge continues to have access to equity buyers in the equity markets (to place equity for debt/equity swaps), and that the hypothetical short position being put on would be held for a long duration (or indefinitely into a presumed failure by the person shorting). Contrary to my SandRidge long-term short selling opinion, based on my modeling for oil -- which I have bottoming at between Brent $33 and $39 -- SandRidge is an attractive immediate-term, short-term duration, short selling position. SandRidge should trade lower with oil pricing, which I again don't believe has bottomed -- and even more so than its peer group, based on its higher than peer group risk pricing. I think the evidence of a 1:1 correlation to oil pricing for the entire E&P space has been quite apparent for quite some time.
But looking past SandRidge's equity correlation to oil pricing, the company has worked hard to improve its ability to survive at higher oil pricing. If oil pricing can find a bottom in the near term; if SandRidge is close in accuracy to the IRR figures given to analysts during the Q2 2015 investor call (these are highly questionable and unreliable, in my opinion, considering the E&P's history of being incapable of giving clear, transparent IRR figures; see the Q3 2014 investor call); if SandRidge isn't subject to punitive differentials; if SandRidge isn't subject to regulatory pressure in its region; and if SandRidge can continue to deleverage (likely at the expense of dilution and/or asset divestitures), the company should be able to survive the current crisis. If not, and we are making substantial assumptions to reach a positive outcome, the story ends quite differently for the company. But, again, not even the most adamant SandRidge bear would deny that a debt buyback at a steep discount, as well as a debt/equity swap "in disguise" (see: debt conversion options in the 8-K filing), is anything but positive.
That doesn't mean the risk pricing markets have to acknowledge this though, as they largely have not. SandRidge still has a presumed ~40% risk of 12-month default (via Kamakura KRIS modeling) and an unchanged implied CDS pricing. Further underlining the risk pricing markets' complete disregard for the most recent capital structure evolution at SandRidge is the fact that the E&P's 24-month default risk indication still prices at ~30% -- a mere 10% lower than its 12-month default risk. This goes to show that the markets are considering SandRidge to not only be a commodity pricing risk story, but a total model risk story. The problems at SandRidge have been exponentiated by the low commodity pricing environments, but this is overwhelmingly a story of an unhealthy model that needs absurdly high capital productivity and cash flow recycles for an absurdly long and absurdly steady duration to fix what ills it. Clearly, that isn't what I would deem a long-term bull story.
In saying that, SandRidge has done well to slowly delay what I believe is an inevitable trip to zero. But that doesn't mean I believe investors should risk capital on any of the recent news.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
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