Prem Watsa Keeps Buying Up SandRidge

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It’s been a tough year for natural gas businesses. Chesapeake Energy Corporation (NYSE:CHK), for example, is down 29% since the beginning of 2012; natural gas prices have dropped, concerns over poor corporate governance arose last spring, and the company has had to plan to sell off some of its assets to raise cash. A similar controversy is currently playing out at SandRidge Energy Inc. (NYSE:SD), as TPG-Axon Capital Management has launched an activist campaign against the company’s CEO and has nominated a shadow Board of Directors. Mount Kellett Capital Management also owns a large stake in the company (find more stocks Mount Kellett owns) and has been dissatisfied with operations at SandRidge. This stock is down 23% since the start of the year.

Prem Watsa

Prem Watsa, a value investor known as “the Warren Buffett of Canada” for his management of holding company Fairfax Financial, however, thinks that everything’s fine at SandRidge. In November he called controversial CEO Tom Ward “one of the best operators in the business” in an interview with Bloomberg News. Now Fairfax- which is another major holder of SandRidge- has increased its stake further, buying about 5 million shares of the stock in late December for a total of about 30 million shares. According to our database of 13F filings, the holding company had only owned 4.4 million shares at the beginning of October (see Watsa’s other stock picks). The battle for control of SandRidge could get nasty.

In the third quarter of 2012, revenue was up 46% from the same period in 2011. However, a large loss on derivative contracts singlehandedly gave SandRidge Energy Inc. negative operating income. It looks to us that without that loss- and, logically, without the large gain on derivative contracts in Q3 2011- that operating income was up nicely from a year earlier despite disadvantageous changes in natural gas prices. Cash flow from operations was about $580 million in the first nine months of 2012; the company used $2 billion of cash in investing activities, primarily capital expenditures, but the cash hoard increased by nearly half a billion dollars as SandRidge managed to make large borrowings and issue royalty trust units.

Wall Street analysts expect SandRidge Energy Inc. to be unprofitable in 2013. We’ve noted the activities of Mount Kellett and TPG-Axon, who are bullish primarily because they believe management can be replaced, and a number of other traders seem to have gone to straight-up bearishness on the company as 18% of the outstanding shares are held short.

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