SandRidge Energy is now one of FFH's largest holdings

[FFHWatcher]

I have spent some time in the past week or so reading about SandRidge Energy.  I like to follow what FFH owns to try to learn how to discover value myself or at least try to shed some light into how FFH discovers value.

Without having a strong background in Nat Gas, it has been challenging.  Here are a couple of points;

1/ Early stages of building a significant Nat Gas exploration and development company

2/ Key guy is Tom Ward.  He is the co-founder of Chesapeake Energy with Aubrey McClendon.  Tom was the operations guy.  Chesapeake was Aubrey's vision.  SandRidge is Tom's.  Tom left in 2006 to start his own Nat Gas play.  He bought into a company (Riata Energy), took over the CEO position and then started acquiring using debt and shares.  Changed the name to SandRidge shortly thereafter.  Main area is the WTO (West Texas Overthrust).  Tom has around $500M invested in Sandridge (25M shares x $20 = $500M but market value is about half. Essentially all his shares are pledged for personal loans).

3/ It looks like FFH got interested in 2008 and gradually build up their position to about 1M shares.  FFH bumped that up to about 25M shares, worth around $10 each or $250M.  This occured in or around Dec. 2009, last month.

4/  In addition to the shares, it looks like FFH purchased 2M 6% Convertible Preferred Perpetual for $200M which automatically convert to common shares in 5 years at just under $11 or around 18.5M shares.  These funds along with other debt is being used to fund an acquisition for SandRidge.

5/ Total investment looks like around $450M, unless I somehow double counted the new common share purchases and the 6% Convertible Preferred Perpetual. Capitalization is about 200M common shares plus likely over $2B in debt now.  Maybe $2.5B.  It goes up fast  when you are making $800M acquisitions.  :-)

6/ I think the docs also show that Prem bought 147k shares for his personal account.  Almost all these loans and purchases happened in Nov/Dec. 2009. 

7/ I find it interesting that FFH is investing so heavily in this.  I have a lot to learn about Nat Gas companies.  Very young company.  Very little revenue compared to debt which is exploding but so are reserves, etc.  Potential looks huge.  Around 2Tcf of Nat Gas in proved reserves?

 

All the above may have errors.  I apologize if it does.  I wanted to start a discussion on this company.  For new readers looking to learn, start with Sandridge Energy's homepage and read their 2008 annual report as well as their investor presentations and a transcript of their most recent quarterly report conference call.  It is on the SeekingAlpha website.

 

Looking fwd. to learning more about Nat Gas and discussing SD/SandRidge Energy.  Interesting investment to say the least, IMHO.  Offline is ok too.

 

[value-is-what-you-get]

Thanks for posting your homework FFHWatcher - the depressed Natural Gas price probably won't last forever.

 

 

[dcollon]

There is an article on Realmoney.com discussing SD that was posted at about 2:50pm.  I can't post the article as it's a paid website, but I'm sure they will move it to thestreet.com soon.  Unfortunately, the author refers to Fairfax as Fairchild.  I would think they will fix that soon.

[SharperDingaan]

A time honored custom in the O/G patch is set up your own company, develop your production via either the drill-bit or acquisition, & then sell out to a major. The head-honcho is almost always very experienced, well connected, & just a ‘busting’ at the freedom & opportunity. It’s typically an invitation only network, & a small pool of partners bringing different things to the table.

 

At times it is cheaper to buy someone else than drill. You got the assets because the other guy was over-extended, & he agreed to sell to you. But you’re relying on your solvency to get you through to the point where the production is worth much more than you capitalized at. At other times it is cheaper to drill, & your contacts/know-how will make/break you.

 

They’ve spent some time under the tutorage of some very swift folks in Calgary, & have obviously decided to move forward.

Good for them.

 

SD

 

[FFHWatcher]

I thought I would add a few more things.

 

1/ I just found this today. http://www.bloomberg.com/apps/news?pid=20601103&sid=a0osJlVgkq8I&refer=us 

Many of you may have heard that back in Oct 2008 when Nat Gas stocks were getting hammered, along with everything else, Chesapeake CEO Aubrey McClendon had to sell virtually all of his CHK stock because he used margin to accumulate over $1B or $2B (either way, lots of $) in stock.  He was buying in the $50's on margin only to be pretty much completely wiped out with margin calls.  As it turns out, a similar fate happened to Tom Ward, CEO of SandRidge.  He ended up selling his interest in a bunch of wells back to SandRidge and it looks like he has also sold shares to pay down line of credit.  $60M here and $50M there, etc.  These Nat Gas guys are certainly a different breed than WEB and PW. 

 

2/ Century Plant - Approx. 18 months ago, OXY (Occidental Petroleum) and SD formed a partnership to build an $800M plant that deals with C02.  As I understand it, SD builds it, OXY pays the bills and in return there is an agreement involving C02, Methane and maybe something else for about 30 years.  I believe this plant will allow SD to extract more Nat Gas from their wells that are close to the Century Plant in W. Texas, as C02 seems to be a limiting factor.  You can't just release or burn off the C02 for environmental reasons if it is mixed in with Nat Gas. Therefore, if you find Nat Gas but there is a lot of C02 in it, you need to deal with it.  For some reason, OXY wants C02 to help them get something out of the ground (can't remember what>>>).  Anyways, the added production that the Century Plant could be/looks to be significant for SD.  Methane is also involved and may add revenue in the future (do you see what I mean by not having a full understanding of Nat Gas!!).  Sorry.  Anyways, this asset is key. 

[value-is-what-you-get]

The problem I have with the analysis of any NG plays is that the supply/demand picture has changed dramatically over the last 2 years with the availability of shale gas in Texas etc.  These require $6 Natural Gas to be economical (based on fairly superficial research by me)  If that is indeed the case, there is an argument for a runup from current levels but it has a theoretical ceiling.  Could be a nice short-term gain though.

[rogermunibond]

http://www.sandridgeenergy.com/InvestorRelations/LettertoShareholders/tabid/116/Default.aspx

 

This should answer your questions on the Century Plant.

[value-is-what-you-get]

 

2/ Century Plant - Approx. 18 months ago, OXY (Occidental Petroleum) and SD formed a partnership to build an $800M plant that deals with C02.  As I understand it, SD builds it, OXY pays the bills and in return there is an agreement involving C02, Methane and maybe something else for about 30 years.  I believe this plant will allow SD to extract more Nat Gas from their wells that are close to the Century Plant in W. Texas, as C02 seems to be a limiting factor.  You can't just release or burn off the C02 for environmental reasons if it is mixed in with Nat Gas. Therefore, if you find Nat Gas but there is a lot of C02 in it, you need to deal with it.  For some reason, OXY wants C02 to help them get something out of the ground (can't remember what>>>).  Anyways, the added production that the Century Plant could be/looks to be significant for SD.  Methane is also involved and may add revenue in the future (do you see what I mean by not having a full understanding of Nat Gas!!).  Sorry.  Anyways, this asset is key.  

 

After reading over the annual letter from their website, this sounds like carbon sequestration and oil well rejuvenation all at once.  Very basically, the methane Gas that SD has underground is mixed with CO2 so it is unsellable as is.  The plant will remove the CO2 making the methane commercially viable.  The CO2 then gets piped to OXY who pumps it under pressure down a hole on one side of an oil field in order to boost the pressure of crude oil coming out of the other side of the oil field.  It's a technology designed to accelerate the extraction of oil from existing wells and/or bring previously "tapped out" wells back on line for a few more barrels.  It's all brand new technology which generally means that results should fail to meet expectations.  That said it is also pretty simple technology - like blowing out water lines when you winterize something.

 

I think we'll see a lot of Natural Gas fired Electricity Generation in the near future.  It generates 50% less carbon emissions.

 

I also see a big equity sucking machine in SD from $2,379 million in 09/2008 to ($191) million in 09/2009 with a 10% share dilution for good measure.  Now most of this is the price of Nat Gas but it still looks ugly on paper and I don't have a crystal ball on Nat Gas price.  The market can stay irrational longer than the company can remain solvent!

 

Borrowing from the Dragons "and for those reasons, I'm out"  (but still in indirectly through FFH :D)

[philassor]

FFHWatcher: I have not done any serious digging yet on SD (although I have been intrigued by the company for quite a while).

It appears that FFH is unloading 28.95% of its shares  ???

 

http://www.gurufocus.com/StockBuy.php?GuruName=Prem+Watsa

 

I have spent some time in the past week or so reading about SandRidge Energy.  I like to follow what FFH owns to try to learn how to discover value myself or at least try to shed some light into how FFH discovers value.

Without having a strong background in Nat Gas, it has been challenging.  Here are a couple of points;

1/ Early stages of building a significant Nat Gas exploration and development company

2/ Key guy is Tom Ward.  He is the co-founder of Chesapeake Energy with Aubrey McClendon.  Tom was the operations guy.  Chesapeake was Aubrey's vision.  SandRidge is Tom's.  Tom left in 2006 to start his own Nat Gas play.  He bought into a company (Riata Energy), took over the CEO position and then started acquiring using debt and shares.  Changed the name to SandRidge shortly thereafter.  Main area is the WTO (West Texas Overthrust).  Tom has around $500M invested in Sandridge (25M shares x $20 = $500M but market value is about half. Essentially all his shares are pledged for personal loans).

3/ It looks like FFH got interested in 2008 and gradually build up their position to about 1M shares.  FFH bumped that up to about 25M shares, worth around $10 each or $250M.  This occured in or around Dec. 2009, last month.

4/  In addition to the shares, it looks like FFH purchased 2M 6% Convertible Preferred Perpetual for $200M which automatically convert to common shares in 5 years at just under $11 or around 18.5M shares.  These funds along with other debt is being used to fund an acquisition for SandRidge.

5/ Total investment looks like around $450M, unless I somehow double counted the new common share purchases and the 6% Convertible Preferred Perpetual. Capitalization is about 200M common shares plus likely over $2B in debt now.  Maybe $2.5B.  It goes up fast  when you are making $800M acquisitions.  :-)

6/ I think the docs also show that Prem bought 147k shares for his personal account.  Almost all these loans and purchases happened in Nov/Dec. 2009. 

7/ I find it interesting that FFH is investing so heavily in this.  I have a lot to learn about Nat Gas companies.  Very young company.  Very little revenue compared to debt which is exploding but so are reserves, etc.  Potential looks huge.  Around 2Tcf of Nat Gas in proved reserves?

 

All the above may have errors.  I apologize if it does.  I wanted to start a discussion on this company.  For new readers looking to learn, start with Sandridge Energy's homepage and read their 2008 annual report as well as their investor presentations and a transcript of their most recent quarterly report conference call.  It is on the SeekingAlpha website.

 

Looking fwd. to learning more about Nat Gas and discussing SD/SandRidge Energy.  Interesting investment to say the least, IMHO.   Offline is ok too.

 

[SharperDingaan]

 

Assume that between 'now' & the 'end state' there's a 1/2 to 2/3 dilution of the existing common share equity (prem's convertible being part of it), the average sale price of the production is roughly 2-3 higher than it is today, & that the existing pre-extraction 'proven' reserve is 25% higher than stated (higher prices make more of an existing field 'economic', which raises the pre-extraction 'proven' reserve). End state is about 10-15 years (until the principal eventually retires).

 

The governing principal is that your smaller stake of the bigger (& hopefully more valuable) unknown company is worth a lot more than your bigger stake of the smaller (& known) existing company. Different kind of risk, but the longer you play the greater the likelihood of it occurring.

 

SD

   

 

[FFHWatcher]

FFHWatcher: I have not done any serious digging yet on SD (although I have been intrigued by the company for quite a while).

It appears that FFH is unloading 28.95% of its shares  ???

 

http://www.gurufocus.com/StockBuy.php?GuruName=Prem+Watsa

 

I have spent some time in the past week or so reading about SandRidge Energy.  I like to follow what FFH owns to try to learn how to discover value myself or at least try to shed some light into how FFH discovers value.

Without having a strong background in Nat Gas, it has been challenging.  Here are a couple of points;

1/ Early stages of building a significant Nat Gas exploration and development company

2/ Key guy is Tom Ward.  He is the co-founder of Chesapeake Energy with Aubrey McClendon.  Tom was the operations guy.  Chesapeake was Aubrey's vision.  SandRidge is Tom's.  Tom left in 2006 to start his own Nat Gas play.  He bought into a company (Riata Energy), took over the CEO position and then started acquiring using debt and shares.  Changed the name to SandRidge shortly thereafter.  Main area is the WTO (West Texas Overthrust).  Tom has around $500M invested in Sandridge (25M shares x $20 = $500M but market value is about half. Essentially all his shares are pledged for personal loans).

3/ It looks like FFH got interested in 2008 and gradually build up their position to about 1M shares.  FFH bumped that up to about 25M shares, worth around $10 each or $250M.  This occured in or around Dec. 2009, last month.

4/  In addition to the shares, it looks like FFH purchased 2M 6% Convertible Preferred Perpetual for $200M which automatically convert to common shares in 5 years at just under $11 or around 18.5M shares.  These funds along with other debt is being used to fund an acquisition for SandRidge.

5/ Total investment looks like around $450M, unless I somehow double counted the new common share purchases and the 6% Convertible Preferred Perpetual. Capitalization is about 200M common shares plus likely over $2B in debt now.  Maybe $2.5B.  It goes up fast  when you are making $800M acquisitions.  :-)

6/ I think the docs also show that Prem bought 147k shares for his personal account.  Almost all these loans and purchases happened in Nov/Dec. 2009. 

7/ I find it interesting that FFH is investing so heavily in this.  I have a lot to learn about Nat Gas companies.  Very young company.  Very little revenue compared to debt which is exploding but so are reserves, etc.  Potential looks huge.  Around 2Tcf of Nat Gas in proved reserves?

 

All the above may have errors.  I apologize if it does.  I wanted to start a discussion on this company.  For new readers looking to learn, start with Sandridge Energy's homepage and read their 2008 annual report as well as their investor presentations and a transcript of their most recent quarterly report conference call.  It is on the SeekingAlpha website.

 

Looking fwd. to learning more about Nat Gas and discussing SD/SandRidge Energy.  Interesting investment to say the least, IMHO.   Offline is ok too.

 

 

Not sure what that was but it was an anomaly. That was last year when they only owned 800K shares.  They now own 25M plus another 18.5M assuming the 6% converts in 5 years.  It might have been FFH moving the shares around?  Either way, 28% of 800K shares is nothing compared to what they own today.

[T-bone1]

I spoke to the company and found out the following (my numbers are probably a little off as I'm doing this from memory):

 

1) The 25 Million shares of SD that Fairfax now owns includes the 18 Milllion and change that the convert will mandatorily convert to in 5 years. There is some provision to adjustments to this 18.x number, but I don't know what that is and I think they are using the same number SD assumed in their press release for now.

 

2) The company did buy more shares in December, roughly 5 Million assuming they owned 2 Million before the convert. Not sure if they bought as part of the equity offering, but I assume thats where the shares come from

 

3) Prem did indeed but 147k shares for his personal account. This is the first time they have ever disclosed a personal purchase by Prem, although they would only do so if FFH owned 5-10% of the company and they are required to do so (so assume Prem doesn't own any ICO, SFK, Brick, etc.)

 

A few other thoughts:

 

Tom Ward sold 2 Million shares as part of the december offering, but he is still leveraged (has his shares pledged for bank loans) so I don't think this is a negative. FFH isn't stupid and was buying at the same time.

 

If FFH thinks that we will see deflation in the short term and inflation in the long term - at least this is my interpretation of their public statements - then the convertible they bought is an amazing investment. For the next 5 years they get a safe bond, and then they have a huge equity kicker in a commodity business, potentially worth multiples of their initial investment in an inflationary environment.

 

The $10 Calls for January 2012 on SD are offered at $4.00! I think its safe to assume that a $10.67 (roughly the conversion price) in 2015 (5 years from now) is worth at least $5.00 (more likely around $7-8 if I had to guess). That means if they got 18 Million calls worth $5 apiece right now on a $200 Million convertible, they basically got an instant rebate of $90 Milllion dollars. This calculation is much more meaningful for an instrument like Buffett's GE and GS convertible preferreds, but should give some idea of the huge value of this conversion feature.

[FFHWatcher]

I spoke to the company and found out the following (my numbers are probably a little off as I'm doing this from memory):

 

1) The 25 Million shares of SD that Fairfax now owns includes the 18 Milllion and change that the convert will mandatorily convert to in 5 years. There is some provision to adjustments to this 18.x number, but I don't know what that is and I think they are using the same number SD assumed in their press release for now.

 

2) The company did buy more shares in December, roughly 5 Million assuming they owned 2 Million before the convert. Not sure if they bought as part of the equity offering, but I assume thats where the shares come from

 

3) Prem did indeed but 147k shares for his personal account. This is the first time they have ever disclosed a personal purchase by Prem, although they would only do so if FFH owned 5-10% of the company and they are required to do so (so assume Prem doesn't own any ICO, SFK, Brick, etc.)

 

A few other thoughts:

 

Tom Ward sold 2 Million shares as part of the december offering, but he is still leveraged (has his shares pledged for bank loans) so I don't think this is a negative. FFH isn't stupid and was buying at the same time.

 

If FFH thinks that we will see deflation in the short term and inflation in the long term - at least this is my interpretation of their public statements - then the convertible they bought is an amazing investment. For the next 5 years they get a safe bond, and then they have a huge equity kicker in a commodity business, potentially worth multiples of their initial investment in an inflationary environment.

 

The $10 Calls for January 2012 on SD are offered at $4.00! I think its safe to assume that a $10.67 (roughly the conversion price) in 2015 (5 years from now) is worth at least $5.00 (more likely around $7-8 if I had to guess). That means if they got 18 Million calls worth $5 apiece right now on a $200 Million convertible, they basically got an instant rebate of $90 Milllion dollars. This calculation is much more meaningful for an instrument like Buffett's GE and GS convertible preferreds, but should give some idea of the huge value of this conversion feature.

 

Great job.  Thanks for the digging.  I guess I can't understand how to read the SEC docs?  It seemed pretty clear that they purchased the 25M shares as common shares, not as converts. There was nothing in that filing that mentioned the detail that you just outlined.  Weird, but I really appreciate taking the time to call the company.  It is good to know that someone still digs deeper than their keyboard.  We (me) should take a lesson from this, IMO.  Maybe a lesson on reading the SEC statements too (speaking for myself, of course)  :)

 

Edit. 

20 page SEC document.  Item number 4 on page 10/11

 

Item 4. Ownership.

Based on the most recent information available, the aggregate number and percentage of the shares of common stock (the “Shares”) of SandRidge Energy, Inc. that are beneficially owned by each of the Reporting Persons is set forth in boxes 9 and 11 of the second part of the cover page to this Schedule 13G, and such information is incorporated herein by reference.

The number of Shares as to which each of the Reporting Persons has sole voting power, shared voting power, sole dispositive power and shared dispositive power is set forth in boxes 5, 6, 7 and 8, respectively, on the second part of the cover page to this Schedule 13G, and such information is incorporated herein by reference.

Shares reported as beneficially owned include Shares issuable upon conversion of certain convertible securities of SandRidge Energy, Inc.

Neither the filing of this Schedule 13G nor the information contained herein shall be deemed to constitute an affirmation by V. Prem Watsa, 1109519, Sixty Two, 810679, Fairfax, Fairfax Inc. or Odyssey America Reinsurance Corporation. that such person is the beneficial owner of the Shares referred to herein for purposes of Section 13(d) or 13(g) of the Securities Exchange Act of 1934, as amended, or for any other purpose, and such beneficial ownership is expressly disclaimed.