U.S. landlubber SandRidge Energy Inc. has taken the wind out of the sails of investors eager to take part in an initial public offering (IPO) of Dynamic Offshore Resources LLC after agreeing to buy the Gulf of Mexico (GOM) producer outright for nearly $1.28 billion.

Privately held Dynamic, which primarily operates in shallow water, was set to launch an IPO and had been touted in recent days as a “hot” stock. Dynamic was formed three years ago with an initial investment of $450 million by investors that included The Carlyle Group and Riverstone Holdings LLC (see Daily GPI, Feb. 6, 2008). Today it has close to 500,000 watery acres that have net proved reserves totaling about 60 billion boe, half weighted to natural gas and 80% proved developed.

“The value of this acquisition will be evident immediately in our results,” said SandRidge CEO Tom Ward. “We are acquiring these assets for less than [10% of present value] of the proved developed reserves and at just over $50,000 per flowing barrel. Additionally we expect these operations to contribute significant free cash flow in excess of the anticipated annual drilling and recompletion capital budget of $200 million.”

SandRidge shareholders were less than enthusiastic about the turnabout in the company’s strategy, which until now had been dedicated to the less-costly U.S. onshore, in particular the Midcontinent. The stock fell late Wednesday and continued to decline in heavy trading on Thursday. It ended the day down more than 8% at $7.16/share.

Howard Weil, as well as Tudor, Pickering, Holt & Co. Inc. (TPH), downgraded the company. Morningstar’s Mark Hanson wondered what the GOM purchase said about SandRidge’s onshore prospects, including its touted Mississippi Lime and Permian Basin assets.

“Are they conceding that they can’t achieve their plan?” Hanson asked. “Or are they finding the free cash flow to invest in the Permian and Midcontinent, a cash flow bridge to their longer-term strategic goals? This takes them pretty far afield. This has been a company focused on land drilling and now it’s headed into the higher risk offshore well world?”

Some noted that SandRidge is one of the highest levered companies of its peers when it comes to balance sheet and the bottom line. By diluting its existing shares and issuing 74 million shares to Dynamic, which is about 18% of the share base, SandRidge would be able to spread the debt across a bigger base and add free cash flow through the offshore producing assets. The “short-term financial engineering” would make the balance sheet appear to be more solid, said The Street’s Eric Rosenbaum.

TPH’s David Heikkinen and Brad Pattarozzi wrote in a note that SandRidge (SD) “is as tenacious as a honey badger with their defensive driven acquisition that secures future cash flow and shores up their balance sheet. Honey badgers are tough skinned and SD will need to be as multiple compression from buying into the GOM will be painful, but it bridges to 2014-plus.

“2014, however, is a long time away for shareholders that just absorbed 15% more stock issued…” Concerns include “multiple compression, strategy shift, net asset value dilution,” which “outweigh the positives…”

Last August Dynamic acquired some gassy shallow water leases from ExxonMobil Corp, which included 13.5 billion boe of proved reserves with 7 billion boe of probable reserves (see Daily GPI, Sept. 2, 2011). At the end of the third quarter Dynamic had stakes in about 270 productive wells and more than 250 offshore leases.

While most of its leases are in shallow waters, Dynamic also owns a minority stake (49%) in the deepwater Bullwinkle field and platform, which operates at a depth of 1,350 feet.

Oklahoma City-based SandRidge, which until now has been an onshore producer, apparently heeded Dynamic CEO Matt McCarroll’s suggestions. In comments McCarroll made ahead of the planned IPO, he said, “Our thesis was very simple…We felt like it was a buyer’s market in the Gulf of Mexico. Major oil companies were exiting the Gulf to go chase shale plays, to go chase deepwater plays, to go international. There was a lot of additional value to be had and very few buyers chasing it.”

SandRidge was ready to join the case. Under the terms of the transaction Dynamic would receive $680 million in cash and about 74 million shares of SandRidge common stock, which at the time of the deal Wednesday was valued at $8.02/share. Plans are to retain Dynamic’s 130 employees and manage the GOM operations from Dynamic’s Houston offices.

SandRidge secured $725 million in committed financing from Bank of America Merrill Lynch, SunTrust Robinson Humphrey and The Royal Bank of Scotland plc, which it may use to fund the cash portion of the transaction. The company’s $790 million borrowing base facility remains undrawn, it said. The transaction is expected to close before the end of June.

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