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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers