Sandridge Permian Trust (fka PERS)

[Timothy Smith]

Based on our update outlook for commodity prices and production, we expect SandRidge Permian Trust to disburse $28.71 per unit between now and its termination on March 31, 2031.

At the current quote of about $17 per unit, an investment translates into an internal rate of return of about 8.25 percent per year. When you consider the conservative bias of our commodity price assumptions, SandRidge Permian Trust appears to offer a compelling value.

We then apply a 5 percent discount rate used in our model, which yields a fair value of $20.50 per unit. Although some might question whether our 5 percent discount rate is sufficient, investors should remember that if inflation were to pick up in coming years, oil prices would likely climb, making our estimated price realizations much too low.

That being said, this esoteric exercise hasn't taken into account other fundamental and technical factors that will continue to influence SandRidge Permian Trust's unit price in the near term. The financial health and motivations of the trust's sponsor, SandRidge Energy, and its controversial CEO, Tom Ward, remain a point of concern.

SandRidge Energy is an aggressive exploration and production that has divested noncore assets, acquired liquids-rich acreage and amended its drilling strategy to shift its production mix to emphasize natural gas over oil and NGLs.

Although we applaud SandRidge Energy's efforts to grow its liquids output, this transition has proved expensive. To fund acquisitions and accelerate drilling activity, the company has assumed a mountain of debt that totaled about $4.3 billion at the end of the third quarter.

Issuing additional stock also swelled the company's float to almost 500 million shares from 138 million shares in 2007; although the firm has grown its oil output, production per share has actually declined over the past five years. Not surprisingly, the stock has floundered and in early November approached the low hit during the financial crisis.

News related to SandRidge Energy's struggles and the strategies pursued by its controversial CEO occasionally drive price fluctuations in the unit price of its three royalty trusts.

For example, units of SandRidge Permian Trust took a hit in early November 2012, after SandRidge Energy announced that it would explore the sale of its assets in the Permian Basin to reduce its debt and fund an expensive horizontal drilling on its Mississippian acreage in Kansas and Oklahoma.

Although SandRidge Energy issued statements emphasizing that this divestment wouldn't include assets associated with SandRidge Permian Trust and wouldn't alter the sponsor's drilling program, the trust's units still sold off precipitously.

But fears that SandRidge Energy wouldn't achieve a fair price for its assets in the Permian Basin have proved overblown. In December 2012, the company announced an agreement to sell this operation for $2.6 billion, or $106,000 per flowing barrel of oil equivalent production, to private-equity fund Sheridan Production Partners II. The company plans to use the proceeds to reduce debt, freeing up enough capital to fund its drilling program through 2014.

The company has other opportunities to monetize assets, including a potential joint venture to develop its Mississippian assets in Kansas. There's also speculation that a larger firm might acquire SandRidge Energy outright, in which case the former's drilling obligations would pass to the acquirer.

As the sale of SandRidge Energy's assets in the Permian Basin improved the firm's creditworthiness, this development should alleviate concerns about whether the sponsor can fund its drilling program.

However, investors have legitimate concerns that SandRidge Energy could raise capital by divesting part of its equity interest in SandRidge Permian Trust. As of its most recent filing, SandRidge Energy owned 2.875 million of the trust's common units and 13.125 million subordinated units, which will convert to standard units once the sponsor fulfills its drilling obligations. Until the subordination period ends, these units only forego their quarterly distribution if the payout on the common stock would fall more than 20 percent short of the quarterly target.

Although we expect SandRidge Energy to ultimately divest some of its equity stake in the trust, the company wouldn't be able to do so until the subordination period ends.

The case of SandRidge Missippian Trust I (SDT) provides insight into how such a sale would affect the stock: When SandRidge sold part of its stake in this trust, the units sold off sharply but recovered once the market absorbed these additional shares. In other words, the sale would give investors an opportunity to buy SandRidge Permian Trust at a nice discount.

Moreover, such a decision wouldn't vitiate the trust's ability to pay its distribution; at that point, the sponsor would have completed the 888 developmental wells.

http://seekingalpha.com/article/1102671-sandridge-permian-trust-what-every-investor-needs-to-know