Yesterday we talked about the bullish breakout in natural gas, and the emerging fundamental and technical support for higher oil prices.
Today, oil traded lower on a comment from the head of Russia's biggest state-owned energy producing company.
Yesterday, Putin said Russia was on board with OPEC's intentions to cut production (to raise oil prices). Today, the head of his top energy producing company said, "why would we?" The easy answer to that question is, if you don't, oil prices at a sustained $25 a barrel will decimate your economy, crush your currency and send you into default.
Given that backdrop for oil producing countries, higher prices are coming.
And with that, yesterday we discussed the opportunities in energy companies that are, or soon will be, emerging from bankruptcy.
On that note, today, I want to revisit a piece I wrote a piece back in May on the wave of bankruptcies in the energy industry, and the specific case of SandRidge Energy. SandRidge emerged from bankruptcy last week and began trading at $18 a share. Is it a buy?
First, here's a little back story. The SandRidge bankruptcy wasn't out of necessity, it was an act of opportunism.
When oil was $26 back in February, the U.S. shale industry was getting hurt badly. But within months, the price of oil had nearly doubled from the lows. And it was at that point, with oil near $50 again, that one of the big natural gas producers, SandRidge energy, chose to pursue bankruptcy.
Now, every company in the energy business was reeling from the fall in oil prices, but this is a company that just five months earlier, and when oil prices were at the same level (around $48), announced a $190 million acquisition, favorable debt restructuring and reduction had taken place, and the company had $1.3 billion in liquidity, which included $790 million in cash.
So why would an energy company like SandRidge, a company that had been surviving through the decline in oil prices, cutting production/cutting jobs, choose that time to file bankruptcy? This was AFTER oil has bounced 85% and oil supply had just swung from a surplus to a deficit. And some of the best oil traders in the world have been projecting oil prices back around $80 by the end of the year. Why would they throw in the towel in May, after a huge bounce back, instead of February, when things looked for more dire?
Back in February, SandRidge management missed a debt payment, opting to exercise a 30-day grace period. It was at that stage that the ultimate negotiation could have come with debt holders. Option 1): Restructure debt and perhaps dilute current shareholders by offering debt holders common shares. That would have given the company time to ride out the storm of the oil price bust. And it would have given all stakeholders a chance to see much better days. Option 2): Close the doors and liquidate assets, and creditors get cents on the dollar.
Instead, SandRidge management and directors negotiated more runway so that they could get to Option 3): the homerun lottery ticket.
In this option, oil prices recover and the company can begin producing profitably again, and brighter days are ahead. But if they rushed to file Chapter 11 bankruptcy, while the business fundamentals remain depressed, they could win big. By swapping new stock for debt, the company gets freed of the noose of debt, and the debt holders exchange a piece of paper that was once worth pennies on the dollar, for common stock in a super-charged debt-free company.
That sounds like a win-win. The company continues to operate as normal. Management keeps their jobs (and likely their golden parachutes). And former debt holders can make a lot of money.
Who pays the price? Shareholders (the owners). Old shareholders of SandRidge stock had no say in the collusion between SandRidge leadership and creditors. So the owners of the company had their interests taken away by a backroom deal and given to debt holders. And within the bankruptcy laws of Chapter 11, shareholders had no leverage.
Though there was a fight and shareholders tried to get a seat at the negotiating table, but the judge ultimately ruled in favor of the accelerated bankruptcy, and wiped out existing shareholders of SandRidge's common stock.
So now SandRidge, which has continued operating it's business as normal throughout the bankruptcy, has emerged with virtually zero debt (interest free debt that converts to common), a half a billion dollars in liquidity and an ability to take advantage of what may be a bullish run in oil and natural gas prices. It's a very bad deal for old shareholders, and potentially a very lucrative deal for new shareholders. The stock was relisted on the NYSE under the same ticker, SD. Including the dilution from convertible debt holders, the opening price last week gave SandRidge a $370 million market cap. At the end of 2013, the market cap of the debt-heavy company was $3 billion!
With over 100 bankruptcies in the oil and gas industry over the past two years, expect more of these companies to emerge from bankruptcies. If they've continued operating and come out debt free, there will be a lot of money to be made in the new stock. As a note, seasoned post-bankruptcy stock investors like to see the price of these stocks come back some before they get involved, as they expect the distressed debt investors that have become stock holders in the bankruptcy to be sellers, so they can get back to their knitting of distressed debt investing, not equity investing.
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