Will SandRidge's Gulf of Mexico Asset Sale Pay Off?

Though SandRidge’s recent sale of Gulf of Mexico assets has its drawbacks, it will allow the company to concentrate fully on its most prized asset -- the Mississippi Lime.

Jan 26, 2014 at 12:00PM

Less than two years after purchasing Dynamic Offshore and its Gulf of Mexico business for $1.275 billion, SandRidge Energy (NYSE:SD) has decided to part with those assets at a substantially lower price.

Though the proceeds from the sale will allow the company to more easily fund its Mississippi Lime drilling program, some aspects of the sale are a little concerning. Let's take a closer look at whether the company's bold move will pay off.

SandRidge exits the Gulf
Earlier this month, SandRidge announced the sale of its Gulf of Mexico and Gulf Coast assets to private equity firm Fieldwood Energy for $750 million in cash and the assumption of $370 million in abandonment liabilities. As part of the deal, SandRidge will also retain a 2% overriding royalty interest in two Gulf exploration prospects -- the Green Canyon 65 (Bullwinkle area) and South Pass 60 blocks -- that appear especially promising.

SandRidge follows other U.S.-based energy producers that have shed Gulf of Mexico assets in recent years to concentrate on onshore drilling. For instance, both Devon Energy (NYSE:DVN) and Apache (NYSE:APA) divested their Gulf of Mexico shelf assets back in 2010 and 2013, respectively, to focus on their North American onshore drilling programs.

The good and the bad
The main negative aspects of SandRidge's transaction are the price paid and its impact on the company's leverage. The company will receive a price substantially lower than the $1.275 billion it initially paid for the Gulf assets, which were generating roughly $100 million in annual free cash flow. The deal will also worsen the company's pro forma leverage ratio from 2.4 to 2.7 times, though that's still under the 3-times threshold considered excessive.

On the plus side, however, the proceeds from the sale should boost pro forma liquidity to more than $2 billion and allow the company to redeploy the capital that was previously allocated to the Gulf to accelerate development in the Mississippi Lime, where it commands a whopping 1.9 million net acres.

Will it pay off?
Though several other companies have recently retrenched from the Mississippi Lime, including Royal Dutch Shell (NYSE:RDS-A), which sold its entire 600,000 net leasehold acreage position and 45 producing wells in September, and Chesapeake Energy (NYSE:CHK), which sold a 50% interest in roughly 850,000 net Mississippian acres China's Sinopec for $1 billion in February of last year, SandRidge remains unfazed.

That's because it's armed with numerous advantages that Shell and others didn't have, including a deep knowledge base of the play developed over the course of four years of drilling, a vast existing infrastructure network, and the lowest cost structure in the play. It also has another advantage in the form of "stacked pay potential" across its acreage, which could meaningfully boost the resource potential of its acreage, as well as improve recovery rates.

In the second quarter of this year, SandRidge plans to add three additional rigs in the Mississippian and expects to exit the year with 29 rigs operating in the region. As per the company's updated guidance, it expects Mississippian production to grow 37% this year.

One risk to consider
With Gulf drilling out of the picture, SandRidge has effectively placed all its eggs in its Mississippian basket. Though it's arguably the best-positioned company to exploit the play's potential, there is one risk investors should carefully consider -- the drastic variability of its well results over recent quarters.

For instance, despite connecting more new wells to sales in the third quarter, the company's production grew only 1% sequentially, compared with 20% in the previous quarter. The reason for this could be an abnormally large number of poor performing wells, which resulted in a sharp decline in the company's average oil production rates during the quarter.

This is especially concerning, because it suggests that SandRidge's drilling performance in the years ahead could be volatile and hard to predict. If the company is unable to remedy this issue, all the well cost reductions and infrastructure advantages in the world won't mean much.

Get ready for the next energy boom
SandRidge isn't the only company benefiting from the record oil and natural gas production that's revolutionizing the United States' energy position. That's why The Motley Fool is offering a comprehensive look at three energy companies set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

Fool contributor Arjun Sreekumar owns shares of Chesapeake Energy, Devon Energy, and SandRidge Energy. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information