SandRidge Energy Inc. (NYSE: SD) is moving from a case of being grossly oversold to a case where the situation is becoming almost obscene.  The stock is getting crushed after its earnings report because of several issues.  Frankly, the reaction seems overdone even for a negative report in a market that is having a hard time accurately pricing in earnings reports.  The market should have also known most of the issues causing today’s pain.  The losses today won’t offer any comfort to those in pain, but there is a now an opportunity in the making.

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 upside to the Arena-SandRidge deal was that most of SandRidge’s new oil is located in the Permian Basin of west Texas.  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.  The Arena acquisition’s ‘accretiveness’ to cash flow in 2011 is probably now questionable with the hedges.

A comparison with Chesapeake Energy Co. (NYSE: CHK) needs to be brought up as a side note.  Chesapeake reported earnings earlier this week of $0.37 EPS on revenue of $2.01 billion. EPS totaled $0.75, excluding charges; and Thomson Reuters had estimates at $0.69. The company also said it was going to accelerate its purchase of liquids-producing properties and shift about $400 million in capex spending from nat-gas to oil.  Chesapeake currently gets about 90% of revenue from natural gas, where prices are currently less than $5.00 per thousand cubic feet. By 2015 the company hopes to get 25% of revenues from liquids, which is better but still a far cry from being balanced.  Chesapeake shares were at $21.83 going into the earnings.  The stock went to $22.44 yesterday and is trading at $22.48 in mid-day trading Thursday.  If you wonder why the Chesapeake angle is mentioned, it is because Chairman & CEO Tom Ward of SandRidge was a director, president and COO of Chesapeake from the time he co-founded the company in 1989 until February 2006.  Ward also appears to be the largest shareholder at SandRidge.

SandRidge traded as high as $15.00 in 2009 and this was a $40+ stock (and briefly into the $50’s and $60’s) when it came out after the peak of the energy boom.  The past price does not matter.  What matters is where the company is going.  Arena was given the opportunity to go shop itself before the deal closed.  It still closed on its deal with SandRidge.

As of mid-day, SandRidge is down right at 13% at $5.28 and the shares put in a new 52-week low of $4.97.  We have also already seen 35 million shares trade hands versus an average volume of 10 million shares.  The absolute lowest price from March 2009 (at the height of broad-based investor panic) was $4.49. The old 52-week low from May was $5.20 and where the stock closes today versus that level should be looked at when considering real closing lows versus intra-day lows.  The belief of 24/7 all Street is that stocks hitting new 52-week highs or hitting new 52-week lows tend to repeat the process.  That being said, there is no reason to believe that SandRidge shares won’t drift lower before they stabilize.

There is also an accelerated PUT option volume alert here.  More $5.00 PUTS have been traded with over 6,800 contracts traded versus an open interest of only 1,548 contracts.  This is a short-term bet or additional hedging being seen today.  Going out to September, there have been over 8,500 of the $6.00 CALLS versus an open interest of 6,274 contracts.  In December, there have been some 22,000 of the $6.00 Calls versus an open interest of 31,792 contracts; and the December $5.00 Puts have traded some 19,700 contracts versus an open interest of 31,365 contracts.  In January-2011, there have been almost 23,000 contracts traded between the $6.00 and $7.50 Calls that will have tripled he open interest after today. The short interest since mid-May has been very elevated with the short interest being 49 million to 50+ million shares each two-week reporting interval.

What that combined short interest and stock options data adds up to is nothing short of a battleground stock scenario.

If things get too bad here, a larger oil and gas company could easily absorb the hit that might be there from the oil and gas hedges.  The proven reserves could make SandRidge too attractive for a larger buyer.  At $2.1 billion in market cap, even an implied premium could be explained away as a line-item by any large acquirer.

This price reaction today gives any new interested investors a time for patience and maybe even a time for pause.  Many SandRidge holders may think they own a stock called “SadRidge” for a while.  A situations with large price drops on large volume and at new 52-week lows is generally referred to by technicians as the final puking phase.  The difference here is that SandRidge would seem to be a huge opportunity ahead after all the dust settles.  It seems prudent to be patient and to be opportunistic, but don’t forget about SandRidge.  It is very difficult not to think that there is a huge opportunity in the works here.

SandRidge’s stock could easily trade much higher later in 2010 and beyond.

JON C. OGG

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