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Rating Action:

Moody's rates new SM Energy senior notes B1

25 Jan 2011

Proposed offering of $250 million of senior unsecured notes

New York, January 25, 2011 -- Moody's Investors Service assigned a B1 rating to SM Energy Company's (SM Energy) offering of $250 million senior unsecured notes due 2019. Moody's also assigned a Ba3 Corporate Family Rating (CFR) and a Speculative Grade Liquidity rating of SGL-3. The outlook is stable. The proceeds of the offering will be used to repay revolver borrowings and fund planned capital expenditures.

RATINGS RATIONALE

"SM Energy has a sizable production base and assembled a strong acreage position in several oil and natural gas liquid plays," commented Pete Speer, Moody's Vice President. "The company is significantly ramping up capital expenditures in excess of operating cash flow to develop these plays which will require good capital productivity and the execution of significant asset sales to maintain SM Energy's low financial leverage metrics."

SM Energy is a long established independent exploration and production company (formerly known as St. Mary's Land & Exploration) that has transitioned its asset portfolio from conventional properties assembled by its legacy acquire and exploit strategy to an unconventional resource play orientation with positions including the Haynesville, Bakken, Eagle Ford and Granite Wash. The Ba3 CFR is supported by its sizable production and proved reserve scale, significant and growing exposure to oil and natural gas liquid production, and a historical track record of conservative financial policies. Although the company's production volumes and proved developed reserves are smaller than many Ba3 rated peers, SM Energy's leverage metrics are among the lowest of the peer group.

The company's capital spending budget for 2011 of $1.04 billion is an increase of around 20% from 2010 spending and will exceed forecasted cash flow by approximately $400 to $450 million, depending on commodity prices. This creates both execution and financing risks. SM Energy plans to ultimately fill this funding gap with proceeds from asset sales, with approximately $41 million of sales closed so far this year. The company is marketing its Marcellus properties and pursuing the sale or joint venture of a portion of its Eagle Ford properties. Given the inherent uncertainty regarding the timing and amount of these asset sales, this bond issuance will position the company with a fully undrawn $678 million credit facility and a pro forma cash balance of nearly $250 million as it pursues its aggressive production growth plans.

While SM Energy will initially have strong liquidity following the bond offering, the SGL-3 liquidity rating incorporates the uncertainty regarding the timing and amount of additional asset sales and the significant capital spending exposure on the non-operated portion of its Eagle Ford shale acreage. In addition, the holders of the company's $287.5 million senior convertible notes could require the company to repurchase the notes on April 1, 2012, although SM Energy can settle the notes in common stock or cash or some combination thereof. The company should have adequate liquidity for the remainder of 2011 and entering 2012 to manage these potential requirements.

SM Energy's significant outspending of cash flows in 2011 and our expectation for that to continue in 2012 makes a positive rating action unlikely this year. If the production and proved reserve response from this large capital investment falls short of the company's expectations and/or the proceeds from asset sales are not achieved then leverage on production volumes and proved developed (PD) reserves could increase substantially from current pro forma levels of around $10,000/boepd and $5/boe. Debt/production above $15,000 or debt/PD above $7 could result in a negative outlook or ratings downgrade.

The B1 rating on the proposed $250 million senior notes due 2019 reflects both the overall probability of default of SM Energy, to which Moody's assigns a PDR of Ba3, and a loss given default of LGD 5 (73%). The company has a committed $678 million senior secured revolving credit facility and $287.5 million of senior convertible notes due 2027. Both the new senior notes and existing senior convertible notes are unsecured and have no subsidiary guarantees. Therefore both notes are subordinate to the senior secured credit facility's potential priority claim to the company's assets and any liabilities, including trade claims, at the subsidiaries. The size of the potential senior secured and other structurally superior claims relative to the unsecured notes outstanding results in the new senior notes being notched one rating beneath the Ba3 CFR. However, we note that if the convertible notes were retired with senior secured borrowings in the future or if there are other changes that materially increase the proportion of senior secured to senior unsecured debt, the senior notes rating could be double notched under Moody's Loss Given Default Methodology.

The principal methodologies used in this rating were Independent Exploration and Production (E&P) Industry published in December 2008, and Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009.

SM Energy Company is an independent exploration and production company based in Denver, Colorado.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

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New York
Peter Speer
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Steven Wood
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's rates new SM Energy senior notes B1
No Related Data.
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