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One that got away...



April 18, 2012 – Comments (4) | RELATED TICKERS: SDR , SD.DL , SDT

Ever since developing my theory that dividend-paying IPOs seem to outperform the market I have been keeping an eye out for new ones.  I have keeping tabs on one, SandRidge Mississippian Trust II (SDR), for several months now.  In fact, I came very close to adding in my real-life portfolio.

I was really excited about SDR when I thought that it might price at $19. I was still interested in it at $20. However, as it seemed to get more publicity and people caught on to how successful SandRidge's other trusts have been when the shares officially debuted today they immediately began trading at $21.50.  That is enough of a premium to book value that I am less enthused about the stock now. I still like it enough to add in CAPS, but not with real money.

In addition to the fact that it is trading at a higher price than I was hoping for, there is a few other issues that give me pause about this stock. First, the parent SandRidge (SD) isn't exactly the strongest company in the world.

Also, while SDR's yield would have been double digits in its first year at $19/share it is much lower than that now with the stock trading at $21 and change.  As a result, the surge in share price that I often look for when the general public becomes aware of the massive dividends that many dividend-paying IPOs distribute (yes I know that trusts technically pay distributions, not dividends) might happen this time.  Heck, assuming that it hits its target distributions the yield for SDR is now only 8.7% for year one.  SandRidge's previous trust IPO, Mississippian Trust I (SDT), is still in its first year and it sports a double-digit yield.  This doesn't leave me optimistic that yield-hounds will flock to SDR.

Last, but certainly not least, while nearly 80% of the trust's revenues will come from oil, slightly more than half of its production will be natural gas.  In case you have been asleep for the past year or so the price of natural gas is pretty weak right now.  The current low price of natural gas is built into the trust's distribution assumptions, but it is also assuming that the price of nat gas will improve in the coming months and years.  Its assumed distributions, logically I might add, used nat gas futures prices as a guide for where the price of the commodity will be in the future.  If the expected recovery in nat gas prices does not materialize soon it is entirely possible that SDR would not be able to hit its distribution targets.  Needless to say, that would likely be a bad thing for the stock.

Having said all of this, if SDR is able to pay out the distributions that it forecast in its prospectus, which again in my opinion were based upon reasonable assessments and it has been able to do so with its two other trusts, I think that the total return to the end of the trust is attractive enough to warrant a CAPS play. Any improvement in natural gas prices beyond what it already priced into forward contracts would be gravy.

Was I right in passing on SDR?  Time will tell.  The share prices of just about every dividend-paying IPO have increased significantly over the first few months of trading lately, regardless of the fundamentals.  I sometimes think that I am a little too conservative, but I suppose that I'd rather be conservative than wrong :). 

Anyhow, here's a good article on the new stock from the always interesting Todd Johnson:

Introducing The 3rd SandRidge High Yield Trust

I'd love to hear others' thoughts on SDR.  Thanks for reading everyone.  Have a great day!



4 Comments – Post Your Own

#1) On April 19, 2012 at 3:45 PM, Jbay76 (< 20) wrote:

Peter Lynch has shown that since the inception of the stock market, investign in IPO's are a great way to lose money unless you are the original owners or bankers.  You're best bet is to give an IPO some time before investing, otherwise you'll buy into the high price right before it drops. I can't remember the name of the book otherwise I'd reference it.  Sorry Peter

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#2) On April 19, 2012 at 6:02 PM, constructive (99.97) wrote:

"A substantial body of literature focuses on the average initial returns to initial public offerings (IPOs). These initial returns are large, averaging 22% over the 1965–2004 period." 

"It is well known that IPO stocks on average substantially underperform (over 3-5 years) non-IPO stocks matched on firm size."

If you know any Saudi investment bankers it may be a good idea to subscribe to some of their IPOs.  The average first day return for Saudi IPOs over the last 9 years is 264.5%.

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#3) On April 19, 2012 at 6:07 PM, constructive (99.97) wrote:

"The authors note that Saudi Arabian IPOs are sold only to domestic investors, and that the largest 32 IPOs in their sample have average underpricing of 170.5% and the other 44 IPOs have average underpricing of 332.8%."

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#4) On April 19, 2012 at 6:26 PM, constructive (99.97) wrote:

Between 1980 to 1998, 28% of companies IPOing had negative trailing income.  Between 1999 and 2011, the number has jumped to 61%.

The market significance of unprofitable companies has clearly increased.  General market valuation, which looks expensive by some measures, improves considerably if corrected for this feature.  (Which seems fair since I generally avoid unprofitable companies and mutual funds that invest in them.)

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