SandRidge Energy Inc (NYSE:SD) has a big problem. It is handcuffed by its large debt load. Originally, the company was planning to use $90 oil to grow into its balance sheet, but that's no longer an option at the current $50 oil price. Now, it has no choice but to dramatically cut its spending, which is pretty much halting its growth plans and its ability to grow out of its debt issues.
That said, the company's asset base can still generate pretty decent returns thanks to the dramatic drop in service costs as well as the company's innovative efforts to improve well results. The problem is that the company lacks the access to capital to take advantage of the situation. This has SandRidge considering all of its options, including considering a unique funding structure that LINN Energy LLC (NASDAQ:LINE) is planning to use to supplement its own capital constraints.
A billion too high
On SandRidge Energy's fourth-quarter conference call an analyst asked CEO James Bennett if he thought the company had too much debt given the current commodity price environment. The analyst noted that the company currently was carrying $3.2 billion in debt and wanted to know what it planned to do now given that its original plan was to grow into its balance sheet.
Bennett readily admitted that the company had too much debt if the current price environment was the new normal. He said that if that was the case the company would, "probably want to remove $1 billion of debt from the balance sheet." He didn't elaborate on what the company would do to lop off a billion dollars in debt from its balance sheet so the analyst pressed a little further and asked his thoughts on some unique deals he'd seen in the marketplace. He asked,
How do you guys think about doing more of a strategic type of transaction? I think you probably have seen some of the announcements by some other operators like Jones [Energy Inc (NYSE:JONE)] and LINN [Energy]. Are those things that you guys are considering in terms of reducing overall cash costs or cash CapEx to you guys? Or how do you think about that?
Bennett responded by saying,
Yes, those are ideas in the toolbox. Structures like those, or joint ventures or selling non-core assets, entering into drilling partnerships. There's a lot of different ways to go about increasing your cash generation without taking on debt or reducing the right-hand side of your balance sheet. So sure, those are all options that we have on our list.
Because Bennett said his company is looking at structures like the ones Jones Energy and LINN Energy recently set up its worth it to investors to take a look at these deals to see what unique options SandRidge Energy might have at its disposal.
Taking on a strategic partner
What investors will find is that in both cases the company took on GSO Capital Partners, which is the credit platform of the Blackstone Group (NYSE:BX), as a strategic investor. In the Jones Energy deal GSO capital provided it with $50 million in equity funding and $250 million in debt, which Jones plans to use to repay borrowings under its credit facility. This gave the company the liquidity it needed so that it can take advantage of any opportunities that might arise due to the current commodity price environment while also providing the company with a strategic long-term partner that has very deep pockets.
On the other hand, LINN Energy's deal with GSO Capital involved providing it with off balance sheet funding for the company's drilling program. Once finalized, LINN Energy will have access to a 5-year, $500 million funding commitment whereby GSO Capital will fund 100% of a well's cost and in return it will hold an 85% working interest in the well. However, what's interesting about the arrangement is that once GSO Capital receives 115% of its money back LINN Energy gets to keep 95% of that well's future cash flows. Basically, LINN gets access to drilling capital without having to add that capital to its own balance sheet.
Of the two the LINN structure is one that could really help a company like SandRidge, which has lots of future well locations, but lacks the capital to drill those wells. An arrangement like LINN's would give the company the cash it needs to drill more wells without loading down its balance sheet with additional debt. That could help the company grow into its debt even if it never sees the return of $90 oil.
SandRidge Energy has always been a bit too big for its britches ... err balance sheet. While it had planned to grow into its balance sheet, that's not quite as easy at the current oil price. That's forcing the company to look at either cutting a billion dollars of debt from its balance sheet or finding an outside-the-box way to grow into its balance sheet. The good news is that at least the company looks like it does have some options at its disposal.
Matt DiLallo owns shares of Linn Energy, LLC and SandRidge Energy. The Motley Fool owns shares of The Blackstone Group L.P.. 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.