This month Diamondback Energy Inc. will close on its latest acquisition, this one transformational, a $2.4-billion deal. It doubles the company’s inventory of Tier 1 acreage and adds a new core in the Del­aware Basin for the longtime Midland Basin producer. The seller is privately held Brigham Resources Operating LLC and Brigham Resources Midstream.

This is Diamondback’s eighth, but by far largest, deal since the Midland independent went public in October 2012, raising $218.8 million. Pro forma for the Brigham deal, Dia­mondback cements its status as a Permian Basin powerhouse with 182,106 net acres, 3,350 net locations and an enterprise value of more than $11.4 billion.

Its first horizontal test occurred in June 2012 when it drilled a Wolfcamp B well in Upton County. In October 2012 it went public, remaining focused on the Wolfberry play in the Midland Basin. The Brigham acreage, mostly in Pecos and Reeves counties, Texas, will be Diamondback’s sixth core area, and in fact, its largest. Adding to the allure, these new core Delaware zones have exhibited higher pressures, better porosity and better permeability than the company’s Midland Basin acreage upon which its already considerable success has been built to date. The company should see higher well recoveries and faster payback per fewer wells drilled.

But getting to this point may not have been as easy as it looks. At a meeting last year of the Houston Producers Forum (before the Brigham deal was announced), CEO Travis Stice shared some of the back story about how the Midland company came together.

The groundwork for his decision making was formed by his experiences under the tute­lage of CEO Bobby Shackouls and other key executives at the former Burlington Resources, before the latter was acquired by ConocoPhil­lips in 2006. (For more on the Burlington alumni who are now CEOs, see Oil and Gas Investor, October 2014.)

“We came together as an executive team in 2011,” but it was a little bit different from the standard private equity-backed company in that the assets were largely already in place and had been assembled on the heels of the vertical Wolfberry revolution … by the private equity providers, it was sort of fringe acreage on the edge of the Wolfberry play.”

Each member of the team had an average 24 years of industry experience, mostly within the Permian, so the rocks and the key players were well-known. The company’s ultimate challenge was to make a public company out of these assets in order to fund future growth and acquire additional resources.

“In late 2011, the executives met at the Midland Petroleum Club one night for supper, and I felt like it was important to galvanize the executive team around a common cause,” Stice said. ”We were going to add focus to the organization, so I wanted them to have some ammunition to talk about with the folks they were going to hire, about what we were try­ing to accomplish. So I put the challenge out there and I called it the Three S’s: moving from Survival to Success to Significance,” he recalled.

“The first S was Survival. I’ll be honest, if we had known how bad that survival period would be in the early days, it’s unlikely we would have assembled ourselves, but fortunately we did come together.” Indeed, at one time or another the team faced it all: a fully drawn borrowing base, no additional private equity available, a closed IPO window, lower oil prices and rig contracts with expiring acreage.

Originally, the company was based in Okla­homa City, but Stice moved it right away. “Being a native Midland boy I wasn’t too excited about running a Permian Basin oil and gas company from there, not that it can’t be done, so we moved corporate headquarters to Midland. At the time, the only place I could find for an office was our field office south of the airport. It was a metal building, and I shared it with four pumpers and a foreman. Basically I had my cell phone and laptop in the kitchen of that building.”

Stice began hiring executives he knew from his days at Burlington Resources. Now he had an experienced team to manage the assets, but the next piece of the puzzle was to turn around key operational and cost metrics; both were trending in the wrong direction. Additionally, capital was required to execute a strategy around those assets. Up to this point, the main funding sources of funding were private equity firm Wexford Capital and bank lines.

IPO plans

“Early on, our private equity sponsors had said we’d need to learn how to live out of cash flow and the revolver we had. That was OK until our borrowing base was fully drawn. We had drilling contracts and expiring acreage, and we were trying to ramp production in advance of an IPO. We took drastic measures like slid­ing our payments to vendors out 90 days to try to keep us alive a bit longer, but we knew all along we’d have to go public in order to get the kind of money we needed to really grow. So with no more private equity and the borrowing base fully drawn, we pushed forward toward taking the company public by completing our S-1 documents.”

By June 2012 the company was ready. The management team traveled to Houston for meetings at Credit Suisse’s office to prepare for the IPO launch. Some 40 analysts were scheduled to come in one morning to hear them lay out the full Diamondback story—but all was not rosy.

“Our launch was happening right on the heels of the huge Facebook IPO—which if you saw it a few weeks later, it was not a very favorable story.” [Editor’s note: Facebook’s May 2012 IPO had been a financial disaster. NASDAQ eventually paid $26.5 million to shareholders who sued because of technical glitches during the offering.]

“So at 11:30 that night, we had to go ‘pen­cils down.’ The bankers told us we would not be going public—and when bankers tell you that, you can probably believe it’s true because they always want to do a deal,” Stice said with a laugh. “Since the IPO avenue stalled, we tried to sell the company by mar­keting for two weeks to eight E&P companies. When bids were due, we were astounded that not one of the companies elected to even sub­mit a bid.”

The investment bankers advised him Labor Day might be the next opening when he could try going public. Thus stalled temporarily, he went back to the private equity sponsors and asked for—and got—another $30 million. “This is what survival felt like.” Luckily market sentiment improved by October, so the com­pany priced its IPO at $17.50 under the symbol FANG on the NASDAQ—near the low end of the expected price range. Today FANG trades around $104 per share.

Diamondback’s growth trajectory has attracted plenty of analyst attention since its IPO.

A fork in the road

The next test after survival was, according to Stice’s Three S’s, Success. “We limped across the IPO finish line, paid off the revolver, got all the vendors paid and converted our private equity owners to equity shareholders.”

At the time Diamondback was gearing up to run eight rigs, all vertical. However, imme­diately before and after the IPO, some well results were disappointing, and the company feared it might not be able to deliver on the promises made during the IPO. Was it some­thing about the execution, or was it the rock? This was a critical fork in the road.

“So about six weeks after going public, we made the strategic decision to start drilling the inventory horizontally,” Stice said. “Now today that seems like a foregone conclusion, but in 2012 nobody was going horizontal in the portion of the Permian Basin where we were, and so we were met with quite a bit of resistance. ‘Why would you spend that much money drilling a horizontal well? You get great rates of return from vertical wells.’ But we put all the chips on the table and started drilling horizontals.”

Every quarter thereafter when he talked to Wall Street about FANG’s earnings, “we were shouting from the rooftops that we were on to something. But honestly, we weren’t on anybody’s radar yet … Then in the fall of 2013, Pioneer Natural Resources came along and said it had drilled roughly 18 wells across the Midland Basin, all horizontal and all with spectacular results.”

That timing couldn’t have been better. The market took off, oil prices were rising, and more operators were announcing great horizontal well results. Diamondback rode that wave of market enthusiasm, and with good margins from best-in-class execution, finally began to attract more investor atten­tion, Stice said.

However, Diamondback’s team knew that although the horizontals worked, it didn’t have enough of them and needed to reload the inventory. It decided to use equity as opposed to debt to make a series of acquisitions, about $3 billion total, and each time it made a deal, the stock traded up.

It also jumped on an opportunity to buy 15,000 acres of minerals under the best area of its inventory, which led to its public MLP, Viper Energy Partners (NASDAQ: VNOM). In a year Diamondback’s enterprise value doubled.

Saddling up

“The third S, Significance, kind of snuck up on us,” Stice said, as the team recognized the extent of growth it had achieved. By October 2016, its four-year anniversary, Diamondback had grown a $500-million enterprise company by 16x to $8 billion. Its pre-IPO production of 1,800 barrels a day had risen as well—and now, the Brigham deal will take it up to a pro forma 54,400 barrels of oil equivalent per day, 74% oil.

“We maintained focus on low-cost opera­tions and best-in-class execution throughout the downturn. I am proud that we’ve kept that survival mentality even though we’ve contin­ued to have some success.

“Now we’ve got to figure out what the fourth S is going to be,” Stice said. “Someone in the company said it will be Sustainability and another said it will be Sayonara. I don’t think so [about the latter].”

Stice said he is optimistic about the Perm­ian Basin’s growth profile and its role in the supply equation. “If you believe in production declines and increased demand, we’re going to be in an undersupplied world and it means higher commodity prices. But with that comes higher service costs.”

Efficiencies have been able to deliver lower well costs and that will continue, he predicted. A 20,000-foot measured depth well in the Permian that once could be drilled at the rate of 1,000 feet a day now takes only nine or 10 days, and makes up to 2,000 feet a day, he said.

“Saddle up, because the rodeo is coming back to town.”

The most important thing Stice said he does is allocate capital, and he thinks the company can do that within cash flow and deliver double-digit growth. He vowed to only acquire something when it is accretive. “Our motto is simple: Take good rock and turn it into cash flow.”

This map compares recent Permian Basin deal metrics with Diamondback’s pending acquisition of Brigham Resources.

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