TEXT - S&P may cut SandRidge Energy rating
Overview -- U.S. oil and gas exploration and production company SandRidge Energy Inc. announced plans to sell its primarily oil producing properties in the Permian Basin in Texas. -- The $2.6 billion sale proceeds will be used to repay SandRidge's debt and to fund development of the company's Mississippian play formations in Kansas and Oklahoma. -- We are affirming our 'B' corporate credit rating on SandRidge. We are placing our 'B' issue rating on the company's $4.3 billion of senior unsecured notes on CreditWatch with negative implications. -- The stable outlook reflects our expectation that SandRidge will continue to aggressively grow its asset base while not materially increasing leverage beyond current levels. Rating Action On Dec. 21, 2012, Standard & Poor's Ratings Services affirmed its 'B' long-term corporate credit rating on Oklahoma City-based SandRidge Energy Inc. At the same time, we placed our 'B' issue rating on the company's $4.3 billion of senior unsecured notes on CreditWatch with negative implications. Upon completion of the transaction (which we expect in February 2013), we expect to lower the recovery rating on the notes to '5', resulting in the lowering of the issue rating to 'B-'. A '5' recovery rating indicates our expectation of modest (10% to 30%) recovery for lenders in the event of a default. Rationale The rating action follows the announcement that SandRidge plans to sell Permian Basin properties for approximately $2.6 billion. The transaction materially reduces the company's reserves and production but increases its geographic concentration in the Mid-Continent Mississippian play and Gulf of Mexico shelf. Sale proceeds, which we view as reflecting a relatively high valuation, also provide substantial cash that we expect the company to use to reduce outstanding debt and fund development of its very sizable Mississippian acreage position. The company's interest in the Permian Basin Royalty Trust is unchanged following the sale. The ratings on SandRidge reflect Standard & Poor's assessment of the company's "weak" business risk profile and "highly leveraged" financial risk profile. We base this assessment on what we deem to be an aggressive growth strategy and financial policies--with capital spending well in excess of internally generated cash flow. Somewhat offsetting this, the ratings also reflect the company's focus on increasing production of oil versus natural gas, reflecting the weak near-term natural gas prices. Pro forma the transaction, SandRidge will have approximately 388 million barrels of oil equivalent (mmboe) of proved reserves in 2011 and production of approximately 78,500 barrels of oil equivalent a day (boe/d) in the third quarter of 2012, of which we estimate 43% were oil and natural gas liquids (NGLs). We view the reserve size as large for the rating, and the meaningful component of oil and NGLs is a favorable factor. Through sizable acquisitions and internal investments, the company has established reserve positions more balanced between natural gas and liquids, with reserves in the Mississippian formation in the Mid-Continent and in the West Texas Overthrust (WTO), Earlier this year, the company acquired Dynamic Offshore Resources for $1.2 billion, adding primarily offshore Gulf of Mexico reserves and production that is approximately 50% oil. The company's direct costs of developing and producing natural gas and oil are competitive. Its per-unit cash costs are relatively low for an oil producer, with lifting costs (including production taxes) of about $16 per boe and cash general and administrative expenses of about $6 per boe. We expect operating cost to change little following the Permian sale. Three-year average finding and development costs were about $18 per boe, excluding price-related revisions. As a result, SandRidge requires wellhead prices of about $40 per boe to achieve break-even EBIT profitability (before consideration of any hedges, interest expense, or income taxes). SandRidge has a substantial amount of oil production hedged at favorable prices through 2015 supporting cash flow stability. We view SandRidge's high leverage and aggressive financial policies as constraining the rating. Incorporating the Permian sale and subsequent debt repayment, we expect the company's ratio of debt to EBITDA in 2013, to be an aggressive 5.2x (including our standard adjustments)-approaching the upper limit for the rating. Our forecast assumes that SandRidge generates EBITDA of more than $800 million over the next 12 months under our current 2013 pricing assumptions ($85 per boe for oil and $3 per million cubic feet for natural gas). In 2013, we assume production of approximately 93,000 boe/d, capital expenditures of $1.75 billion, and that the company will outspend cash flow by $1.1 billion--primarily to develop its Mississippian acreage--using proceeds from the sale and cash on hand to fund the shortfall. SandRidge's employs means to finance operations including a combination of royalty trusts, joint ventures, and asset sales as sources of funding, some of which we adjust as debt like obligations. TPG-Axon, a shareholder in SandRidge, is currently pursuing a consent solicitation in order to remove the company's board of directors and replace management. Our ratings on SandRidge do not currently incorporate a view on the likely outcome the vote, which we expect to occur by the end of the first quarter. Liquidity In our view, SandRidge's liquidity is "adequate". Our assessment incorporates the following expectations and assumptions: -- Pro forma for the Permian sale, we estimate that the company will have $2.9 billion of cash and cash equivalents. -- SandRidge had no borrowings on its revolving credit facility as of Sept. 30, 2012. The borrowing base is $775 million. We anticipate no change to borrowing base following the Permian sale. -- The company does not have any significant debt maturities until 2016. -- At our current price deck, we project that the company's capital spending will exceed internally generated cash flows by approximately $1 billion in 2013 after capital spending of $1.75 billion. -- We expect SandRidge to fund the deficit with cash on hand. Recovery analysis The CreditWatch listing with negative implications on SandRidge's senior unsecured debt reflects the reduction in asset value available to noteholders in a default scenario following the Permian sale. For the complete recovery analysis, please see our recovery report on SandRidge to be published on RatingsDirect following the release of this report. Outlook The stable outlook reflects our expectation that SandRidge will continue to aggressively grow its asset base while not materially increasing leverage beyond current levels. We would consider lowering the rating if the company becomes more aggressive in financing its growth with debt, such that debt to EBITDA increases to more than 5.5x, without a clear view to deleveraging. We would consider raising the rating if the company is able to reduce and maintain adjusted total debt to EBITDA to the low-4x area. Related Criteria And Research -- Standard & Poor's Raises Its U.S. Natural Gas Price Assumptions; Oil Price Assumptions Are Unchanged, July 24, 2012 -- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Our Rating Process, April 15, 2008 Ratings List Ratings Affirmed SandRidge Energy Inc. Corporate Credit Rating B/Stable/-- Preferred Stock CCC Ratings On CreditWatch To From SandRidge Energy Inc. Senior Unsecured B/Watch Neg B Recovery Rating 4 4
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