SandRidge Energy (UNKNOWN:SD.DL) has been a dismal performer not just this year, but ever since the company's IPO in 2007. In fact, since it went public, it has been the worst-performing energy stock traded on U.S. markets. Shares are down around 80% from its IPO and more than 90% from its June 2008 peak.
On top of this appallingly poor stock performance, two of the company's biggest shareholders are calling for major changes within the company, including firing the company's CEO. How serious are these allegations?
SandRidge under investor scrutiny
Earlier this month, New York-based hedge fund TPG-Axon Capital Management, which owns more than 6% of SandRidge, wrote an incendiary letter to the company's management. In it, the hedge fund demanded major changes including the ouster of founder and CEO Tom Ward. It also alleged frivolous spending and an incoherent business strategy, among other things.
According to TPG-Axon's CEO, Dinakar Singh, SandRidge should be trading between $12-$14 a share, more than twice its current share price. It's certainly baffling that SandRidge shares have remained depressed for so long and trade at one of the biggest discounts to net asset value of any U.S. energy producer. What's the reason for this massive disconnection?
According to Singh, it's a combination of three factors. He argues that the company's strategy has been incoherent and unpredictable, its capital spending program wrought with serious excesses, and its corporate governance "appalling," robbing shareholders of the massive potential value the company holds.
Two months ago, I wrote an article that addressed many of the very factors that TPG-Axon has called attention to. I highlighted the company's seemingly unpredictable strategy, what appeared to be outrageous executive compensation, and Ward's involvement with Chesapeake Energy (NYSE:CHK) CEO Aubrey McClendon. It looks like these concerns were justified.
In light of Singh's letter, restoring management's credibility will be a necessary step for the company's success. As he points out, SandRidge has consistently exceeded its capital budget, often by a wide margin, lending credence to claims that management has displayed fiscal recklessness. In addition, the company's extensive use of leverage has left it vulnerable to a bevy of macroeconomic and market risks.
To raise funds in recent years, the company has relied on joint ventures and trust vehicles, including the SandRidge Mississippian Trust I (NYSE:SDT) and SandRidge Mississippian Trust II (NYSE:SDR). But it has also resorted to less sanguine measures, such as dilutive equity issuances, as well as issuances of high-cost debt.
Management's various shortcomings have led to a high cost of capital for the company, which has been bad news for shareholders. As Singh notes, an untrustworthy management leads to a depressed stock price and a higher cost of capital, which causes significant shareholder dilution over a period of time.
The board's shortcomings
This raises an important question: How did the company's board of directors let all this go on? The overarching aim of a company's board should be to protect the interests of shareholders by ensuring that they are aligned with those of the management.
In SandRidge's case, it increasingly looks like the board didn't do its job. Worse yet, it appears that the board allowed management to continue with poor practices at the expense of shareholders.
"Rather than ensuring that management interests are sensibly aligned with those of shareholders, the Board has siphoned value from shareholders and toward Mr. Ward," wrote Singh. Regarding SandRidge's compensation policies, he added, "Executive compensation policies have been nothing short of egregious, and the Board has sanctioned self-dealing that has transferred significant value to Mr. Ward, at the expense of shareholders."
These are serious allegations, but they appear to be justified. Since the company went public, a large chunk of its cash flow and earnings has gone toward handsomely compensating executives. Yet at the same time, its stock has seen a precipitous decline, while the company's book value per share and its net asset value have declined markedly. As such, shareholder angst is more than justified.
But it looks like change may be around the corner.
Activists as voices for change
These developments at SandRidge underscore a trend of growing disagreements between management teams and large shareholders. Activist investors are gaining clout as voices for change that can successfully convince management to reassess its strategies. In addition, activists are now making bigger bets on companies they believe are ripe for change.
According to a survey of both activist investors and company managements by Schulte Roth & Zabel, a law firm, 60% of activists said they would have no problem allocating 10%-15% of their available capital to a single position. That's a sharp rise since 2008, when just 6% said they would be comfortable with 10%-15% of their money tied up in one company.
To be sure, SandRidge management's credibility has certainly been damaged, and some reshuffling will likely be necessary. But if new, independent board members can help provide much-needed discipline and keep a close tab on management, then I think SandRidge should be on solid footing.
While the new shareholder rights plan, colloquially known as a "poison pill," indicates that management will do everything in its power to avoid a hostile takeover, greater shareholder activism may be the necessary catalyst for change.
Fool contributor Arjun Sreekumar has no positions in the stocks mentioned above. The Motley Fool owns shares of SandRidge Mississippian Trust II. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.