Last night’s earnings were $0.20 EPS versus a loss of -$0.52 EPS a year ago.  Adjusted earnings were listed as $0.23 EPS.  Revenues were listed as being a 36% gain to $182.4 million.  This was mixed against Thomson Reuters estimates of $0.12 EPS and $242.8 million in revenues.

Average daily production in this last quarter was above levels from a year ago.  The company had the benefit of higher production and higher energy prices, but the rub today is coming because SandRidge cut its production outlook for 2010.  The company also raised its capex to $875 million from $800 million.  This should be no shock at all.  After all, it is integrating the Arena Resources acquisition.  The company said it expects that the full 2010 production will be approximately 120 billion cubic feet equivalent after factoring in oil sales, which looks to be about 10 BCF shy of a target given in May.

The recent rise in oil to over $80 per barrel has killed some of the implied income premium to the market because its hedged oil sales are at $82.46 in 2010, $86.08 in 2011, $87.10 in 2012, and $87.82 in 2013.  The emphasis as a move to oil from gas was obvious as it increased oil production to 1,344 MBbl in second quarter versus 1,211 MBbl in Q1 and 722 MBbl a year ago.

SandRidge also said that the company recently reached an agreement to sell certain deep acreage rights in the Cana Shale play in western Oklahoma for approximately $139.0 million in cash.  It further said that it expects to raise an additional $200 to $400.0 million through the sale of non-core assets by the end of 2011.

This is another instance where short-term price swings are not necessarily aligned in the best manner with long-term prospects for shareholders.  It would also seem that today’s price drop is being exacerbated by a growing frustration in its share base.  A 52-week low after a merger is never viewed as a good thing by shareholders and analysts alike. Using a ‘value investing’ approach is often a hard sell in oil and gas when share prices are not reflecting the full situation.

Shareholders should just go ahead and assume that price targets and production targets (followed by lower revenue) will appear in every research report that comes out between now and next Monday.  In fact, it is probably safe to assume that analyst downgrades are coming.  The current target north of $9.00 per shares from a consensus analyst group is likely to come down significantly now that shares have a $5 handle on them.  If it is being written about today, then it should mostly already be discounted in the stock price with today’s big drop by double-digit percentages.

The $1.6 billion merger with Arena Resources looked like the inverse of the merger with Exxon Mobil Corp. (NYSE: XOM) and XTO Energy.  The deal diversifies its assets and revenues and Arena boosts its position in liquids.  The diversification approach is countered by Apache Corp. (NYSE: APA) in its Mariner Energy Inc. (NYSE: ME) effort and its BP plc (NYSE: BP) $7 billion asset purchase has actually brought on higher share prices with the rise in oil.

SandRidge’s diversification strategy acknowledges the huge price differential between natural gas and crude oil. Arena was a real bargain in retrospect as it used stock and got the company for a low premium.  For each proved barrel of oil equivalent, SandRidge paid $21.80.

Since the Arena acquisition was announced, SandRidge stock has fallen around from $7.50 to around $6.30 around the deal closure and now shares put in a 52-week low of $4.97.  If you ask any Arena holder how they feel now, the answer is obviously “Pissed!”  The dilution was extreme, particularly in the new normal.  We previously looked at the shares proposed in the deal and had a different calculation that the final amount.  SandRidge’s investor site confirms that the current number of shares outstanding is 399,581,000 shares.  In short, just call it 400 million for rounding.  The new market capitalization is roughly $2.1 billion if you account for today’s share price drop.

The diversification approach is countered by Apache Corp. (NYSE: APA), which has offered about $2.7 billion for Mariner Energy Inc. (NYSE: ME) and has paid Devon Energy Corp. (NYSE: DVN) $1.05 billion for Devon’s Gulf of Mexico assets. Apache is also reported to be in discussions with BP plc (NYSE: BP) to buy some of BP’s assets, though none in the Gulf. Apache prefers to stick to what it knows, which is oil.

SandRidge’s diversification strategy acknowledges the huge price differential between natural gas and crude oil. Arena was a real bargain — SandRidge paid just a 17% premium and most of that will be paid in new SandRidge stock. For each proved barrel of oil equivalent, SandRidge paid $21.80. The stickier point is that for each barrel of daily production, SandRidge paid more than $177,000, according to Oil & Gas Journal.

That latter figure could make a SandRidge shareholder what management is thinking. A price of $177,000/flowing barrel is pretty steep. Clearly SandRidge thinks it can increase production dramatically at very low risk.

Shareholders aren’t so sure about that. Since the Arena acquisition was announced the share price has fallen around $7.50 to around $6.30 today. Not only that, average daily trading volume of about 11 million shares has gone as high as 4X that volume and hit nearly 30 million shares traded on the day the deal closed.

At its last quarterly report, Arena had about 39.5 million shares outstanding. SandRidge will issue 4.7771 new shares for each share of Arena stock. That’s another 188 million or so SandRidge shares to add to the 165 million already floated.  That kind of dilution rarely makes shareholders happy. Couple that with the unusually high price SandRidge paid per flowing barrel, and it’s no surprise that trading volumes have been high.

The upside to this deal is that most of SandRidge’s new oil is located in the Permian Basin of west Texas, and the company plans to use secondary and tertiary recovery techniques, including CO2 injection, to further drain known reservoirs. The company owns its on CO2 deposits, most of which it sells to other oil companies.

SandRidge expects the Arena acquisition to be accretive to cash flow in 2011, even after hedging a planned $3 billion of oil revenues. Shareholders don’t think a whole lot of this deal so far, but if everything goes according to plan, they’ll like it a lot better a year from now.

Paul Ausick

Dynavax Technologies Corporation (NASDAQ: DVAX) is up 16.5% on positive drug study news.

Mariner Energy, Inc. (NYSE: ME) is up almost 40% at $25.10 on well over 4 million shares.  Apache is paying some $2.7 billion or $26.22 per share to acquire it in terms of 0.17043 shares of Apache common stock and $7.80 in cash.

Idenix Pharmaceuticals Inc. (NASDAQ: IDIX) is up 16.5% at $4.75 on over 300,000 shares after it reported positive results on its IDX184 in interim analysis of a Phase IIa hepatitis C study.

MGM Mirage (NYSE: MGM) is weighing down casinos on a disappointment. Wynn Resorts Ltd. (NASDAQ: WYNN) and Las Vegas Sands Corp. (NYSE: LVS) are taking breathers too after having seen such large run-ups.

Santarus Inc. (NASDAQ: SNTS) is the worst stock this morning after losing a patent case.

United Parcel Service, Inc. (NYSE: UPS) is hitting new 52-week highs after handily beating earnings expectations last night.  Shares are now up 4.6% at $68.46 versus a prior 52-week high of $65.52.

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JON C. OGG

• Mariner Energy (ME) Started as Buy at Jefferies.
• BP (BP) Cut to Perform at Oppenheimer.
• Chevron (CVX) Cut to Perform at Oppenheimer.
• ConocoPhillips (COP) Cut to Perform at Oppenheimer.
• Exxon Mobil (XOM) Cut to Perform at Oppenheimer.
• Royal Dutch Shell (RDS.A) Cut to Perform at Oppenheimer.

Jon C. Ogg

Today’s crop of thrifty companies includes Devon Energy Corporation (NYSE:DVN), SandRidge Energy Inc. (NYSE:SD), and Mariner Energy, Inc. (NYSE:ME). Actually, Devon only announced that it would announce its 2009 capital budget "in early 2009" when it reports earnings for 2008. This is news because the company historically disclosed its spending plans in December for the following year. This development is not unlike Apple’s announcement that Steve Jobs won’t be attending the Macworld this year.

In October, SandRidge said it was reducing its capex budget from $2billion to $1 billion and upping production to 120 billion cubic feetequivalent. Today the company cut its capex budget by 50%, to $500million and reduced its production guidance for 2009 to 110 billioncubic feet equivalent for the year. That’s a big change in just twomonths.

SandRidge has also been trying to sell properties in East Texas, andtoday’s press release notes that the company had "several bids … thatwould have been accepted had there been certainty with respect tocapital availability." So the company has decided to keep theproperties. Now, the company is reducing its rig count from a high of47 in September to just 12 by December 2009.

Mariner plans to disclose its capex and production guidance for 2009after the market closes today. Hess Corporation (NYSE:HES) previouslyrevealed acapex budget of $3.1 billion for 2009, compared with spending of $3.3billion in the first nine months of 2008 against an original budget of$5 billion. Equitable Resources Inc. (NYSE:EQT) has also revealed a capex budgetcut of nearly 40% for 2009.

So far, capex spending levels look like they are headed back to 2002 or2003 levels, when oil prices were in the $20s/barrel. This is not goodfor the oil companies because when demand picks back up, they won’t bein a position to meet it. Another price spike comes along, and thenasty cycle continues.

With the exception of Devon and Hess, these are either small- ormid-cap companies. That’s important because big companies need bigprojects to invest in. There are no big projects around. Either they’retied up by national oil companies or they cost a fortune, which eventhe biggies aren’t going to spend now.

But smaller companies usually can find projects that provide a decentreturn on a much smaller investment. If SandRidge and Mariner arepulling in, its not because the projects aren’t there. It’s thefinancing. The companies can’t finance new spending strictly from cashflow; they need credit. There’s no credit available at a reasonableprice, so they hold on to as much cash as they can and hope for animprovement soon.

If OPEC’s 4+ million barrel per day cut doesn’t drive oil higher, then capex cuts may become more and more frequent.

Paul Ausick
December 17, 2008