7 Things SandRidge Energy Doesn't Want You to Know

NEW YORK ( TheStreet) -- SandRidge Energy ( SD) just loves to surprise investors.

In fact, you could say the independent, highly levered exploration and production company is always one step ahead. Or, you could counter with the argument that it always seems to be two steps backward for every step forward with this company.

Case in point: The announcement on Thursday from SandRidge Energy that it was dipping its exploration and production toes into the water, literally, spending just under $1.3 billion to acquire mature, shallow water production assets in the Gulf of Mexico.

For an E&P company that has strategically targeted its opportunity in the land-based shale plays, including the Mississippian basin and the Permian, the move into offshore drilling and production caught investors by surprise. SandRidge shares dropped by 9% on Thursday as more than 50 million shares changed hands -- it averages trading of 12 million and hit the 43 million share volume mark by midday.
SandRidge goes offshore: one more surprise from a company full of surprises.

SandRidge made the case on a conference call with analysts on Thursday morning -- as its shares were being punished -- that it had to act while a valuable asset was being offered for cheap. Investors won't get the full picture from SandRidge, though, so here it is, laid out in 7 facts about this deal that aren't included in the company spin.

1. The price of this deal is fair, not cheap.
The privately held offshore company it acquired -- Dynamic Offshore Resources --- had filed to go public in 2011, backed by the Carlyle Group. Capital contributions to Dynamic from Carlyle and its partner Riverstone Holdings equaled roughly $200 million in the three years between 2008 and 2010, according published reports at the time of the S-1 filing.

Seems like the real cheap deal went, as usual, to the private equity players, turning a few hundred million into close to $1.3 billion payday.

Why didn't the company end up waiting to go public after it filed in late 2011? Because SandRidge ended up paying just under the targeted IPO value. So why take the risk -- during the period of time it takes to dot all the "i's" and cross all the "t's" required of an IPO filing -- of a potential fall in crude oil prices caused by a global economic slowdown, which could dampen enthusiasm for the offering?

As far as SandRidge's take that it was an offer the company couldn't refuse, analysts say SandRidge paid a value that is equal to recent deals in the Gulf of Mexico. That means it wasn't cheap, but simply in line with peer comps.

Stifel estimates the deal at 3.3 times EV/EBITDA; Morningstar comes in at 3.7 times. Either way, that's about normal for the Gulf of Mexico. Stifel's analysis adds that when valued on a dollar per barrel of oil equivalent basis, SandRidge paid $21, while other recent Gulf of Mexico deals have been in the $17 range. SandRidge paid $51,000 on a "flowing barrel" basis, while other recent Gulf deals were valued at $40,000 using this metric.

Where the deal does look cheap is compared to SandRidge's market multiple: It's a company trading at 8 times that is buying a company for less than 4 times. But that doesn't change the facts: This deal was average pricing.

Furthermore, there's something wrong with valuation being the primary argument for a deal, rather than strategic fit. Valuation should be secondary to strategic need, more like the icing on the cake when a strategic fit is located in a potential deal.

2. Did SandRidge just take its eye off the ball?
For a company all about the huge opportunity in the shale, what's it doing suddenly saying it can't resist an offshore bolt-on acquisition?

"What does it imply about the opportunities in the horizontal Mississippian and Permian?" asked Morningstar analyst Mark Hanson. "Are they conceding that they can't achieve their plan? Or are they finding the free cash flow to invest in the Permian and mid-Continent, a cash flow bridge to their longer-term strategic goals?"

"This takes them pretty far afield. This has been a company focused on land drilling and now it's headed into the higher risk offshore well world?" Hanson wondered.

3. We'll know part of the answer to this question when SandRidge provides 2012 guidance.
Notably, Sandridge did not provide updated 2012 guidance on Thursday. The question won't be whether it meets it existing goal for 2012 but whether 1+1=2.

In other words, with this deal SandRidge can no longer simply meet its pre-existing goals; it must exceed them. Otherwise, the guidance will imply that the offshore assets are making up for a disappointment elsewhere that wasn't expected.

SandRidge came up just short of its 2011 production goal, 2% lower than its target, when it last reported its guidance in November. Its existing production guidance for 2012 was unchanged at the time, targeting 27.7 millions of barrels of oil equivalent (MMboe). Oil and natural gas production is expected to be 16 million barrels and 70 billion cubic feet, respectively. The company will report fourth quarter earnings on Feb. 24.

4. The deal ain't cheap, and isn't strategic, but it does de-lever the balance sheet.
SandRidge is the most levered E&P company among peers covered by Wall Street, a mini-Chesapeake Energy when it comes to debt and a complicated balance sheet.

The biggest positive from this deal is an example of somewhat tortured logic: By diluting existing shareholders, issuing 74 million shares -- roughly 18% of share base -- the company spreads its debt across a larger share base, while also adding free cash flow through the mature oil-producing offshore assets, and looks less levered as a result. That's not strategic, but it's short-term financial engineering that makes the balance sheet look better.

5. Existing shareholders just felt the pain of dilution.
It's the glass half full or half empty dilemma.

Issuing more shares makes the financial model look improved, but do the assets that shareholders get in return have an equal or greater value than the dilution?

The only big positive from this deal, which is overall a negative, is the delevering of the balance sheet, Stifel wrote.

6. Just one more surprise from a company full of surprises.
For SandRidge shareholders, it's always a rocky ride. Any 10% gain in shares is likely to be met by a 10% decline shortly thereafter when the company announces something unexpected. Most recently, it was a major increase in its spending plan and a buying spree in the Mississippian. Before that, it was the acquisition of Arena Resources.

"Is this just the first of additional acquisitions in the Gulf of Mexico?" asked Stifel analyst Amir Arif. "There is a steep treadmill in the Gulf. Most land-focused E&Ps have been stepping away from the Gulf," he added, referring to the maturity and short-lived nature of the production assets.

Hanson said after the huge increase in capex and previous "radical departures" from strategy, as well as a financial model complicated by joint ventures and royalty trusts that already dilute existing shareholders, the offshore play is one more level of uncertainty introduced to the SandRidge story.

"It's probably a mix of displeasure and uncertainty in the market reaction," Hanson said.

It's displeasure at one more surprise that dilutes shareholders for an uncertain return on acquisition value, and uncertainty about how it impacts SandRidge's strategic focus.

"Their plate was already overflowing before this deal," the analyst added.

7. SandRidge has always been tone-deaf; expect the hard hearing to continue.

Hanson put it best when discussing SandRidge's approach to investor relations and its long history of surprises: "The company has always been a little tone deaf. It's never been apologetic and wasn't today. 'We saw cheap assets and we acquired them and we make no apologies,'" was the tone of the commentary from SandRidge on the call with analysts explaining the deal.

"They almost seem indifferent to the fact that the stock price is up 10% one day and down 10% the next. There must be lots of Rolaids in that office. It's among the most volatile stocks I cover," Hanson said.

In the end, with the 9% slide in SandRidge shares on the deal announcement, it could actually be a reason for potential investors to take a look at the stock. Hanson concluded, even with all the reservations, "It doesn't seem like a bad deal."

The company is increasing production 40% and its 25,000 barrels per day of a fairly low risk, proven asset base.

Stifel's Arif added says that the company may be diluting the upside from its primary Mississippian play in the equity issuance while adding a mature Gulf asset base that has little upside. "The Gulf of Mexico is a steep treadmill," he said.

However, the Stifel analyst still concluded the balance sheet improvement offered by the equity issuance and the slide in the share price could make a case for this being an opportune time to think about getting into the stock.

"One way you always have to think about SandRidge is that Tom CEO Tom Ward is always looking to build value for 3 to 5 years out and the actions taken today should show value 3 to 5 years out even if they hurt the stock in the short term."

It's an argument often made about Chesapeake Energy CEO Aubrey McClendon, too (Ward's former boss): One day, he will be proven right in taking on as much debt as Chesapeake has and keeping Wall Street waiting for an end to all the uncertainty and complicated balance sheet management.

Expect a continued rocky ride, though, until that day of vindication arrives, if it ever does.

-- Written by Eric Rosenbaum from New York.