Description

Investing in Sandridge gives you the ability to purchase a Class B office building in Oklahoma City for roughly the current enterprise value. You also get access to 7.7-8.6 MMBOE of 2020 production (45% liquids) almost for free. (fair disclosure, my commodity write-ups on VIC have mostly be disasters so caveat emptor)

Now, I get that oil, natural gas, Miss Lime and Sandridge are all dirty words you don’t say around investment committees, but there’s a price for everything (even this turd) and $1.60 seems too low. 

At every secular bottom, you should be able to sum up an investment thesis as; I don’t think it gets too much worse, there’s a reasonable chance it gets better in the next 3-18 months and if I totally bomb my thesis, I probably don’t lose much money at today’s prices. Hell, even if I’m wrong, from this price I may actually make some money depending on how bad the worst-case scenario is. 

Let’s get to basics and protect the downside. Sandridge owns their headquarters in Oklahoma City, 65 miles from Tiger King’s Park (all distances in Oklahoma are conveniently measured in relation to Wynnewood Exotic Animal Park). This headquarters is 489,000 square feet and comes with a 862-space parking facility (remember when SD had employees?) and a 2 acre zen-garden, that had $24 million spent on it. What is it worth? Who knows, but they spent $100 million renovating the building from 2010-2012 (weren’t the Tom Ward years great?) https://oklahoman.com/article/3645688/lobby-open-plaza-nearing-completion-as-sandridge-commons-development-continues  I think a value somewhere between $100 and $200 a foot for the office building seems about as accurate as you’ll get and the rest of the office complex gets tossed in gratis. That puts this office complex at $49 to $98 million, which means Tom Ward likely destroyed shareholder value in both E&P and commercial real estate inside of the same public company (which is impressive when you think about it). They did sell one smaller building for $125/sf in 2018, which shows my valuation is somewhat in the correct range for what’s left. https://newsok.com/article/5594701/sandridge-sells-parkside-building-for-10.75-million

(1971 architecture at its finest)

With 35.8 million shares outstanding and a $1.60 share price, the market cap is $57.3 million and there is $46 million of net debt (Feb 21, 2020 number and unusually low for an E&P) leading to an EV of $103.3 million. Therefore, you’re paying $5.3 to $54.3million for everything left over after the HQ. So, what do you get?

Sandridge has 3 key remaining assets, North Park Colorado, NW STACK in Oklahoma and Miss Lime in Kansas and Oklahoma (both 100-200 miles from Tiger King). 

Let’s look at the 3 assets. 

North Park (93k net acres) is an oil rich drill play early in its lifecycle. The company spent most of 2019 setting money on fire by drilling wells here. There are differing views on capital returns, but let’s be the most pessimistic and assume they put a dollar in the ground and expect to get 50 cents out at some date into the future. North Park produced 4.8 MBoepd during the fourth quarter and 4.2 MBoepd during 2019. I think all of this is moot as at current oil prices, they will likely shut these wells in if they haven’t already. This asset was acquired near the bottom of the last oil crash in 2015 for $190 million and has had substantial spending on it every year since then. $129.3 million was spent on it in 2019. I have no idea what North Park is worth and it’s likely worth a whole lot less than has been spent, but how much less? What about in a higher oil price environment? Let’s call North Park our upside optionality here. For now, I’m going to assume it’s a zero to the asset value but it almost certainly covers the remainder of the enterprise value, letting you have a free look at NW STACK and MISS Lime. 

NW STACK (56k net acres) is a gas rich area that’s underwhelmed repeatedly over its lifespan. During the fourth quarter, NW STACK produced 2.2 MBoepd (38% oil) and 2.8 MBoepd (44% oil) for all of 2019. During 2019 SD used a drill-co to bring fourteen wells to sales. This asset is mediocre at best, but could be on the inflection to better if natural gas prices recover (more below).

MISS Lime (326k net acres) is a gas rich area that’s considered crappier than the NW STACK with higher OPEX and more headaches. That said, the company produced 22.5 MBoepd (16% oil) during the fourth quarter and 25.8 MBoepd (16% oil) for the full year. This is the crown jewel of this trash heap. 

Theoretically, these assets have a PV-10 of $364 million using SEC pricing of $55.69 oil and $2.58 natural gas. While oil is nowhere near $55.69, the gas strip is roughly at this level. More importantly, the PDP PV-10 is $290 million of which $220 million is made up of Mid-Con assets that are primarily gas. Net of the HQ, you’re buying this Mid-con gas PDP at somewhere between 2% and 25% of PDP and they’re tossing in North Park for free. Seem like a bargain so far?

Key Points

The main takeaways you should have thus far are; Sandridge is very leveraged to natural gas, there are a bunch of assets that may have no bid today, but likely more than cover the EV under many scenarios, giving you a free look at a natural gas recovery and with existing cash flow and minimal debt, you don’t have much risk to wait out what is likely happening in natural gas this fall. 

Quick Gas Primer

For the past decade and change, anyone who’s called a bottom in natural gas has regretted it (myself included). That said, with WTI having recently traded at negative prices and the rig count collapsing, many gas rich shale wells have been or will be shut in and hence there’s a pretty good chance that within a few months, we will see a natural gas deficit of 5-20 BCF. I think this leads to natural gas prices with a $3 handle this winter and winter gas is effectively pricing that in already. There’s a not small chance that gas prices surprise to the upside if the weather cooperates. With that in mind, I think that Sandridge is the best way to “play” this as you have minimal downside (HQ building/low net debt/North Park assets) and a whole lot of upside if things go well. 

Economics

Let’s assume that North Park gets shut in during Q2 as the oil hedges run out. Therefore, we’re going to look at only Mid-con starting July 2020 and assume everything else sort of washes (though North Park is likely producing some FCF). 

Based on company guidance, let’s assume 1.0 MMBbl oil, 1.7 MMbl NGL and 25.5 Bcf of gas during the 12 months from Q3/2020 – Q2/2021 for Mid-con.

Let’s assume $25/oil and $15/NGL. That gets you $25m of oil revenue and $25.5m of NGL or $50.5m of liquids revenue. So, we’ve now normalized things to only look at natural gas revenue. 

Sandridge has been plagued by 2 clear problems over the past few years, low Henry Hub gas prices and horrid differentials to Henry Hub (guidance is $1.30 for 2020). Offsetting this, Cheniere’s Midship pipeline got FERC permission to start commercial service on April 16, 2020. Midship provides 1.1 Bcf/d ramping to 1.4 Bcf/d of incremental capacity out of the SCOOP/STACK. There’s 850 MMcf/d of commitments from anchor shippers like Devon, Gulfport and Marathon at $0.26/MMBtu for the first 275 days with rates settling at $0.35/MMBtu afterwards. Non-anchor shippers can pay $0.48/MMBtu immediately. Needless to say, this is a lot less than $1.30. I suspect that there’s going to be a lot of cheap take-away capacity before too long as multiple SCOOP/STACK players lay down rigs and reduce production—all of which is upside to Sandridge. One only needs to look at how close Mid-con is to Henry Hub to see that it makes no sense to pay $1.30.

Let’s look at a world where the differential narrows to $0.50 and natural gas prices are $3.00. That gives Sandridge a $2.50 netback or $63.75 million and total revenue of $114.25. Against that, you have LOE guidance at the midpoint of $75 million including North Park and hypothetically $60 million after you eliminate North Park. Then let’s add in $15 million of pro-forma SG&A (they just eliminated another 26 positions). That gets you to somewhere around $75m in expenses, $10 million in production taxes and $30 million in cash flow before Cap-Ex and maybe $20 million after $10 million in mandatory sustaining capital. I know, it’s haphazard and I’m missing some things and double counting other things. In any case, I think you have a company with a healthy chunk of cash flow here, especially compared to the enterprise value. 

But wait, there’s more!!! I feel pretty confident that the new CEO appointed on April 7, 2020 will focus on cost cutting. Hearsay evidence is that quite a lot of wells are not currently profitable or marginally economic. I suspect that these will be shut in and there are other savings initiatives available here that can shave a few million of LOE and potentially a lot more. 

Now, here’s the important part, if natural gas prices recover beyond current strip, let’s say they go to $4, you get an additional $25.5 million in cash flow. If oil prices recover at all, you have even more cash flow. There’s a lot of upside here. At $4 gas, they may even start to drill a few Miss Lime gas wells as they’ll be rather cheap given the existing infrastructure already in place and drill rigs can be had for a song today. At $3+ gas, these should be 50% or better IRR and there are thousands of drilling locations remaining. Sure, other guys have plenty of drill inventory too, but Marcellus or Haynesville will be swamped with gas leading differentials to blow out and Marcellus players have massive EVs compared to SD, where there’s almost no EV net of the HQ building.

Putting this into perspective, with a much higher SG&A level and $53 realized oil and $1.48 realized gas, Sandridge had $121 million in cash flow from operations in 2019. Of course, they lit that on fire in North Park and then some, but I’m saying this business can produce a lot more cash flow if oil prices recover in 2021 and North Park gets turned back on and they keep Cap-Ex to some reduced number. 

Finally, Carl Icahn has a cost basis of $17. 18 months ago, he turned down a take-out at $13 and has now lost 90% of his money. I assume he just wants the tax loss at this point. The new CEO has a history of cutting costs and selling assets. I assume that’s the plan here and you get an exit before year-end in that case. How many companies have more in credit facility capacity than the EV? It’s actually credit facility accretive to whoever buys this. 

There are a lot of $1 midgets in the energy patch that have a lot of upside or can go to zero. I prefer Sandridge as it isn’t going to zero anytime soon and could potentially have similar upside. 

Look, this isn’t a hard hitting writeup. There are too many moving pieces and too many variables. Corporate disclosure is anemic, I have no idea what the new strategy is and management isn’t in a hurry to get on the phone. I am bullish natural gas and think oil eventually recovers. I want to play that recovery but most options out there involve a lot of financial leverage with a severe risk of permanent impairment if I get it wrong on timing. If my timing is wrong and gas kicks along at $2.25 and oil at $15, Sandridge muddles forward as a perpetual call option for a few years (due to the balance sheet strength), meanwhile everyone else melts away and eventually energy prices recover as there are no producers left. You cannot say that many other companies can survive a long downturn in energy prices, except the large integrated majors, but those guys don’t have the same sort of upside that Sandridge does, especially if someone comes along willing to value a few thousand drill sites in the Miss Lime using $4 gas or all the acreage at North Park that actually has decent IRRs if oil ever recovers in price. This thing had a $13 bid just 18 months ago in a $50 oil and $2.50 natural gas environment. I could see us back there in the future and if not, I don’t think you lose badly from today’s price. 

That’s all I got, please gimme a 2 on this write-up and we can all talk tankers some more.  

Catalyst

Acquisition

Natural Gas Prices Improve

Tiger King Season II