Permian Basin producer Diamondback Energy Inc. is the darling of Wall Street. The Midland, Texas-based company launched an initial public offering in October 2012 and hasn't looked back. The stock, which trades under the highly marketable symbol FANG, is up 200% since the IPO, in spite of the company issuing more than $500 million of additional equity since. Diamondback was formed in 2007 with backing from Wexford Capital LP.

Diamondback's $2.5-billion market capitalization today equates to a value of $38,000 per acre, roughly twice the valuation of best-in-class assets sold straight up in the basin.

Athlon Energy Inc. tells a similar tale. Also with assets in the Permian, initial shares of the Apollo Global Management LLC portfolio company, based in Fort Worth, Texas, soared 50% from its $20 per share offering in the days following its August 2013 debut, although it has pulled back some since. Still, with a $2.7-billion market cap, this three-year-old company is worth $26,000 per acre, according to the public market.

Other Permian-centric players enjoy similar valuation upside: Laredo Petroleum Inc., which went public in late 2011, trades at $25,000 per acre.

In the asset marketplace, prime acreage with proven production in the Permian's Midland Basin was fetching $15,000 to $20,000 an acre as of mid-October, per a report by asset marketer RBC Richardson Barr—and that's the exception rather than the rule. Asset valuations drop off outside that sweet spot.

Privately held Permian players eyeing an exit in their future recognize this valuation gap.

“We're seeing valuation of reserves, production and acreage much higher for publicly traded companies versus the cash M&A market, in the Permian in particular,” says Mike Kelly, analyst with Global Hunter Securities. “It has incentivized a lot of private companies to take a hard look at going public.”

The advent of unconventional horizontal plays in the Permian has sparked investor interest. These plays—particularly those targeting the Wolfcamp—show potential of 800,000 barrels of oil estimated ultimate recovery per well, at costs of $7.5 million on average, notes Kelly. “Those are going to be economics that tip 100% internal rates of return at current prices. That's extremely compelling.”

Investors are thus willing to look forward, believing the region will be developed on multiple benches, he says. “The public market is willing to extend more credit that this trend is likely to get better than worse. Wall Street is off to a head start, and we think it's the right call.”

Horizontal drilling in the Permian is still in its infancy, with the opportunity set compelling enough to motivate investors to buy in at values twice that of the negotiated marketplace, says Kelly, even for companies with more undeveloped acreage than proven production. While only a handful of deals have exceeded $10,000 an acre in the open market, “we think a number of private companies are reflecting $20,000 an acre and beyond in terms of their valuations on the public side.”

Bakken parallels

Gene Shepherd is chief executive officer with Brigham Resources, an upstart in the Permian's Delaware Basin, with backing from Warburg Pincus, Pine Brook Partners and Yorktown Energy Partners. Shepherd compares public investor euphoria in the Permian to that experienced in the Bakken shale, a parallel he knows all too well. Shepherd was on the management team of Brigham Exploration, a Cinderella-story Bakken pure-play that witnessed an exponential increase in valuation before being bought by Statoil in December 2011.

“We've seen this before, where you have this arbitrage opportunity where investors are willing to pay more for acreage housed in a public company than what the same acreage is valued at in the A&D market,” he says. “Investors that are more enthusiastic than the companies trying to acquire the acreage benefits the publicly traded acquirers.”

He points to Oasis Petroleum and Kodiak Oil & Gas as other Williston Basin beneficiaries of the same phenomenon that is currently playing out in the Permian. “They benefitted from the investor enthusiasm and optimism that they were going to be able to grow their production volumes and net asset values over time.”

Based on the outstanding returns experienced in the Williston Basin, investors are now looking at the parallels with the Permian Basin. “The relative size of the two basins and the consistency of the lithology across a large geographic area are two common traits that have investors excited.”

Unfortunately for the operators trying to buy Permian acreage, institutional investors are indirectly driving up acreage values, says Shepherd. They are looking to build positions in established, oil-denominated public companies such as Concho Resources and Laredo Petroleum, but at present there just aren't enough candidates in which to invest.

“You have just a handful of pure-play, Permian-focused companies, so there's a mismatch. There is more demand from the institutional community than there is Permian market-cap available.”

Funded in April 2012, Brigham Resources currently holds some 44,000 net acres in the southern Delaware Basin in Pecos and Reeves counties, Texas, targeting the upper Wolfcamp shale, and another 40,000 acres in the Illinois Basin targeting the New Albany shale. After 18 months of building its team and its initial acreage positions, Brigham recently began operations by picking up two rigs in the Delaware Basin and expects to be at five rigs by year-end. It is drilling its first two horizontal wells currently, and plans to drill roughly 30 in 2014.

Largely comprised of Brigham Exploration veterans, the Brigham Resources team has experienced the benefits of public company valuations, and it certainly would be a public company candidate should the Permian arbitrage opportunity continue to persist into the future. But Shepherd waves that off as too soon to tell.

“It's early and we're only eight months in” since funding, he says. “We've built two outstanding acreage positions and have a lot of drilling to do before we are a candidate to have any liquidity discussions.”

The southern Delaware Basin, where Brigham is currently anchored, is in an earlier stage of development than the Midland Basin side, but could represent a second wave of IPO activity as its stacked-pay potential is unlocked. Concho Resources, another investor Permian favorite, could be a bellwether for southern Delaware successes, where its Big Chief position has shown promising results.

In the meantime, however, Shepherd says the arbitrage window is likely to close at some point. As other companies go public, he explains, their cost of capital goes down and they will be more aggressive when competing for opportunities to buy undeveloped acreage.

“That will narrow the valuation discrepancy between the IPO market and the A&D market,” he says.

Besides, in a perfect world, he says Brigham would prefer to remain private. “It's always nice to not have to broadcast drilling results and where your acreage is located. But,” he adds, “we're all shareholders in our company, and when the time comes, we'll do what's in the best interest of the shareholders.”

IPO sweet spot

While the entire Permian Basin has attracted investor interest, the bullseye for valuations lies in Midland, Martin and Upton counties in Texas.

Says Kelly, “If you are blessed to have acreage there, you should consider an IPO. Investors won't question you.”

Diamondback has been a wildly successful IPO, as has Athlon. “They're outpacing everyone else in the Permian in terms of growth. They're both strong operators.”

To enjoy the rest of this article, please read the February issue of Oil and Gas Investor.

Comments