SandRidge Energy (NYSE: SD) has attracted a lot of negative attention lately. TPG-Axon Capital Management and Mount Kellett Capital Management, hedge funds who own sizable stakes in SandRidge, have alleged serious corporate governance issues at the company.
As a result of these allegations and various other shortfalls, the company's shares are the lowest they've been in more than two years. Could this be the perfect opportunity to invest in SandRidge or would investing now be akin to catching a falling knife?
A quick recap of SandRidge's progress
Despite recent revelations of poor corporate management, Oklahoma City-based SandRidge has made a lot of good decisions over its six-year history as an operating entity. Correctly predicting lower natural gas prices in 2008, it made a smart transition toward focusing on oilier plays. And not just any old oily plays; SandRidge actively sought out low-risk, lower-cost, conventional reservoirs.
Unlike competitor Kodiak Oil & Gas (NYSE: KOG), which put all its eggs into one unconventional play, the Bakken, SandRidge sought out acreage in various locations around the country, most notably in the Mississippi Lime play of Kansas and Oklahoma and the prolific Permian Basin of western Texas.
But despite its extensive use of joint ventures and trust vehicles, such as the SandRidge Mississippian Trust I (SDTTU) and the SandRidge Mississippian Trust II (SDR), to raise cash, the company consistently faced a sizable funding gap. In its three-year plan, it highlighted a clear strategy to combat its financing issues.
By growing production rapidly, the company aimed to become self-funded by year-end 2014. Thus far, progress has been respectable, with SandRidge consistently posting strong production gains quarter after quarter. Unfortunately, despite its progress in fulfilling the goals outlined in its three-year plan, the company's stock has languished.
Frustrating stock performance
As I outlined in a previous article, the company's excessive indebtedness and concerns regarding management were the two biggest factors that kept me from becoming a SandRidge shareholder. Still, I've closely tracked the company's progress over the past year, with an eye for new developments regarding management and the company's funding gap.
As a close follower of the company, I sympathize with its shareholders. I can only imagine how frustrating it must have been to witness the stock's disastrous performance firsthand over the past five years; shares have declined nearly 80% from their IPO price in 2007.
I assume that many SandRidge shareholders invested in the company based on a similar investment thesis to mine – that the company's assets reflected tremendous value, but that potential was not reflected in the share price.
Unfortunately, over the past year and a half, every time the stock started to appreciate, it was inevitably pulled back down, usually due to some shortfall on management's part. After reaching a high of almost $13 in early April 2011, shares plunged to under $7 by early August. They bottomed out around $5 in early October, and then rose sharply to close out the year at around $8 a share.
But the rally was short-lived, as shares once again took a beating in January after SandRidge announced its acquisition of Dynamic Offshore, a move investors viewed as highly unexpected and strategically inconsistent. As the impact of the Dynamic acquisition wore off, the stock appreciated modestly, attaining a high of nearly $9 in late February, but only to begin a strong downward trajectory as the market shifted its focus to CEO Tom Ward's involvement with Chesapeake Energy's (CHKA.Q) embattled CEO Aubrey McClendon.
Next, after its second-quarter-earnings release, which highlighted management's inability to reign in spending, shares plunged yet again. And finally, as the most recent allegations of reckless spending and poor corporate governance began to surface, the stock took another beating, reaching a low of $5.19 on November 14. In short, it's been an unpleasant roller coaster ride for SandRidge shareholders.
But does the company's currently depressed share price offer an enticing investment opportunity?
What is SandRidge worth?
I continue to believe that SandRidge's assets hold remarkable potential and that the company's net asset value (NAV) is multiples of its current share price, though a downward revision is likely in order, due to overly optimistic assumptions regarding its acreage in the Mississippi Lime. Still, most energy analysts tend to agree, with fair value estimates ranging from $8 to $20 a share.
TPG-Axon believes that fair value for SandRidge stock, calculated under a wide array of macroeconomic and company-specific scenarios, is between $12-$14 a share, which it reckons is a quite conservative estimate. The hedge fund thinks higher values are realizable through favorably priced asset sales or an improvement in operational execution over the next few years. With the stock currently trading under $6, TPG-Axon's fair value estimate represents more than 100% upside.
The price to NAV ratio for SandRidge is one of the lowest among energy companies. Indeed, a recent analysis by JP Morgan revealed SandRidge's price to NAV at an incredibly low 56%, the worst among the 37 exploration and production companies under the bank's coverage universe. Moreover, the stock's discount to NAV has increased markedly over the years, which TPG-Axon attributes to management shortcomings.
What's next for SandRidge?
Such a display of shareholder activism by two of SandRidge's largest shareholders might be exactly what the company needs to restore confidence and discipline.
To be completely honest, I don't think Ward, despite his various shortcomings, necessarily needs to be fired, as TPG-Axon's CEO suggests. But his credibility certainly has taken a hit, and some reshuffling of the board and of management will likely be necessary, as will an overhaul of the company's executive compensation scheme. If new, independent board members can help reign in the company's excesses and provide necessary discipline, then I think SandRidge may still have a bright future.
While the newly adopted shareholder rights plan suggests that management will put up a fight before ceding control, increased shareholder activism may be an important step in the right direction. If TPG-Axon and Mount Kellett can serve as voices for change and help reconfigure SandRidge's board and perhaps get some new, experienced, and more credible members on its management team, then the value of SandRidge's assets may finally be realized over the next few years.
