Is SandRidge’s Permian Sale a Game Changer?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Oil and gas driller SandRidge Energy (NYSE: SD) announced that it was selling its Permian Basin properties to privately held Sheridan Production Partners II for $2.6 billion in cash. The sale is another important part of SandRidge’s strategic transition from a natural gas producer into an oil rich E&P company. It also provides the debt heavy company with some financial breathing room.

SandRidge is following the road map of its industry peers by reducing exposure to lower return conventional plays and dry gas in favor of higher return liquid plays. For SandRidge it meant selling these conventional Permian assets in favor of reinvesting the proceeds to fund its drilling in the Mississippi Lime. While the Permian assets were more liquid focused, the assets didn’t have the upside that the company sees in the Mississippian.

According to SandRidge CEO Tom Ward, the Mississippian is “an area we believe generates some of the highest return rates for horizontal drilling in the U.S. today.” The company is putting most of its efforts behind that belief, as it has amassed 1.85 million net acres, which hold 11,000 possible future drilling locations. The sale of the Permian assets ensures that the company has the liquidity to fund its capital expenditures through 2014.

Access to capital is critical and companies like SandRidge have had to be creative in order to access this capital. The company has already publicly launched three income trusts to raise capital, including SandRidge Permian Trust (NYSE: PER), whose assets and operations were unaffected by the deal. Because of the company's heavy debt burden, its only option is to sell assets to fund growth.

SandRidge has closely followed the playbook of Chesapeake Energy (NYSE: CHK) in this regard. Chesapeake, which was co-founded by Tom Ward, has used asset sales, joint ventures and income trusts like Chesapeake Granite Wash Trust (NYSE: CHKR) to raise the necessary capital to fuel the company’s aggressive capital plans.

Both companies have taken advantage of using income trusts to satisfy those investors that are craving yield.  Chesapeake’s Granite Wash Trust is now yielding almost 15% while Sandridge’s Permian Trust just slightly lower.  These trusts provide small, incremental vehicles to raise capital without diluting current investors.

SandRidge likely wouldn’t have had tighter access to capital to begin with if it hadn’t made the same mistakes as Chesapeake. Both companies engaged in debt fueled buying binges as the market neared its top and now both are still digging out of that hole.  The key is that now both are more focused on returns instead of growth at all costs, and that’s a good thing for shareholders.

Now that SandRidge has offloaded its lower return Permian assets, it can solely concentrate on getting the most out of the Mississippian. The company has a competitive advantage in the play thanks to its extensive investments in infrastructure and first mover status. These investments afford the company enviably low operating costs which are among the lowest in the industry. As the play develops it will enable the company to deliver a significant amount of value to its shareholders.

SandRidge was able to quickly follow through on its promise to sell these assets and ended up getting a great value for these mature conventional oil assets. The company is now able to reduce its leverage and fully fund its high return capital program for the next two years. The sale and subsequent liquidity improvement make the company a bit less speculative. If its investments in the Mississippian do pay off the company will produce a lot of value for shareholders. I think the company is in a much better position to outperform from here, and I’m giving them the green thumb in my CAPS profile.

 


latimerburned has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, long JAN 2014 $30.00 calls on Chesapeake Energy, and short JAN 2014 $15.00 puts on Chesapeake Energy. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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