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Fairfax’s big bet on natural gas isn’t for everyone

SandRidge Energy Inc., an oil and gas company based in Oklahoma, has been hitting 52-week highs this week. This is good news for a fair number of Canadians – specifically, investors in Fairfax Financial Holdings Inc.

Fairfax owns the equivalent of 62.6 million shares in the company, worth roughly $450-million (U.S.), from a series of transactions dating back to at least 2009. It's one of Fairfax's largest holdings.

It has also, arguably, been one of Fairfax's larger headaches, as what was intended as a long-term play on natural gas with a sharp owner-operator has turned into something a bit different. Fairfax, of course, is a long-term investor, so it is relatively unconcerned with short-term peaks and valleys. It's just that the valleys have been longer and deeper than Fairfax may have hoped for.

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While SandRidge traces its history back three decades, its modern life began in 2006 when industry veteran Tom Ward bought control of it and became CEO. It went public in 2007 at $26 per share and traded as high as $69 in the summer of 2008.

The decline was rapid and steep. SandRidge was highly leveraged, and a fall in natural gas prices as the economy declined in the latter half of the year threatened to take the company with it. SandRidge cut capital expenditures and put assets up for sale, but by year's end, the shares had fallen by 90 per cent.

Enter the bargain hunter. Fairfax filings with U.S. regulators suggest it first took a position in the third quarter of 2008. In November, 2009, it invested $200-million in a series of preferred stock from SandRidge. At the time, SandRidge's recovery seemed well under way, as the shares traded around $10 apiece.

The only consistency since has been inconsistency, with the stock failing to maintain its climb and often dipping. The shares were in the $5 to $6 range in November, 2012; Fairfax responded with another purchase of preferred stock, as well as buying nearly 30 million shares in the open market.

Fairfax declined to comment for this column. In my reporting for a column on Fairfax in March, however, I learned how SandRidge fit into Fairfax's long-term plan: It has, in Fairfax's view, extremely high quality, yet low-cost, oil and gas resources that will increase in value as natural gas prices eventually revert to the mean.

And, importantly, Fairfax has a high degree of respect for Mr. Ward. Here, however, is where the story turns.

Mr. Ward's résumé includes a co-founding role at Chesapeake Energy, a company perhaps best known for its former CEO and co-founder Aubrey McClendon. Mr. McClendon ultimately left Chesapeake in a controversy over a web of deals in which he invested personally, alongside the company, in its wells.

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As it happened, Mr. Ward had arranged the same structure of deals at SandRidge. Activist investors pressed for, and won, his removal in June, 2013; he departed with a $90-million severance package. During the squabble, Fairfax stood behind Mr. Ward, with CEO Prem Watsa praising him as "one of the best operators in the business" in an interview with Bloomberg.

Well, Mr. Ward is gone, but the assets, strategy and some of his former executives remain. As do Fairfax's holdings. The blow has been mitigated by the comfy dividend on preferred shares – the company is receiving 6 per cent on its initial purchase and 8.5 per cent on the second. But big capital gains remain elusive. SandRidge has also posted a net loss in seven of the past 10 quarters.

Should investors follow Fairfax's lead – particularly since the worst seems to be over? Sell-side analysts are overwhelmingly neutral-to-negative on the shares, given their rise this year. Sameer Uplenchwar of Global Hunter Securities, one of three analysts (out of 27) with a "buy" rating, suggests SandRidge is "back on track," but has an $8 target price, suggesting limited upside over the next 12 months.

Fairfax can afford to, and probably must, wait this one out. Individual investors probably don't, and shouldn't, have the patience.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More


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